Exhibit 13
PORTIONS OF ANNUAL REPORT TO SHAREHOLDERS
FINANCIAL TABLE OF CONTENTS
Selected Financial Data
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Consolidated Statements of Operations
Consolidated Balance Sheets
Consolidated Statements of Shareholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Reports of Independent Public Accountants
Standard Microsystems Corporation and Subsidiaries
SELECTED FINANCIAL DATA
(In thousands, except per share data)
As of February 28 or 29, and for the years then ended 2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Operating Results
Product sales ....................................... $ 154,244 $ 128,528 $ 162,008 $ 151,371 $ 154,352
Intellectual property revenues ...................... 1,273 30,770 1,420 1,876 1,474
- ------------------------------------------------------------------------------------------------------------------------------------
Total sales and revenues ............................ 155,517 159,298 163,428 153,247 155,826
Gross profit ........................................ 69,424 78,034 66,768 59,363 55,980
Research and development ............................ 31,166 31,178 32,580 24,365 17,437
Selling, general and administrative ................. 36,268 32,744 35,369 32,993 30,550
Amortization of intangible assets ................... 1,167 - - - -
Restructuring costs ................................. (247) 7,734 - - -
Operating income (loss) ............................. 1,070 6,378 (1,181) 2,005 6,439
Other income (expense) .............................. (14,446) 4,308 34,293 3,415 2,221
Income (loss) from continuing operations ............ $ (6,971) $ 7,475 $ 22,164 $ 3,442 $ 6,003
Net loss from discontinued operations ............... (500) (1,564) - - (5,255)
Gain (loss) on sales of discontinued operations,
net of taxes ....................................... - - 4,765 4,151 (13,293)
Cumulative effect of change in accounting
principle, net of taxes ............................ - - - (2,924) -
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) ................................... $ (7,471) $ 5,911 $ 26,929 $ 4,669 $ (12,545)
Diluted net income (loss) per share
Income (loss) from continuing operations ............ $ (0.42) $ 0.44 $ 1.29 $ 0.22 $ 0.38
Net income (loss) ................................... (0.45) 0.35 1.57 0.29 (0.79)
- ------------------------------------------------------------------------------------------------------------------------------------
Diluted weighted average common shares outstanding .... 16,538 16,900 17,165 15,915 15,824
- ------------------------------------------------------------------------------------------------------------------------------------
Balance Sheet and Other Data
Cash and short-term investments ..................... $ 112,897 $ 126,660 $ 109,174 $ 75,405 $ 70,071
Working capital ..................................... 145,639 154,981 146,382 11,016 98,342
Capital expenditures ................................ 5,695 4,488 14,600 10,503 10,847
Depreciation and amortization ....................... 10,752 11,614 11,792 9,988 10,544
Total assets ........................................ 247,949 236,063 239,098 258,508 198,657
Long-term obligations ............................... 7,379 6,973 5,812 22,151 7,816
Shareholders' equity ................................ 204,012 193,453 194,315 201,792 158,434
Book value per common share ......................... 12.17 12.14 12.08 12.80 10.21
This selected financial data should be read in conjunction with the Consolidated
Financial Statements and related notes, and the section entitled "Management's
Discussion andAnalysis of Financial Condition and Results of Operations"
contained in this report.
The operating results presented above reflect:
- The Company's acqusition of Gain Technology Corporation in fiscal 2003,
as more fully described in Note 4 to the Consolidated Financial
Statements included in this report.
- $16.3 million of investment impairment charges recorded in fiscal 2003,
as more fully discussed in Note 9.
- The receipt of a $29.6 million special intellectual property payment in
fiscal 2002, as more fully described in Note 7.
- $9.0 million of business restructuring charges recorded in fiscal 2002,
as more fully descsribed in Note 6.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The following discussion should be read in conjunction with the Company's
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, including 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.
Standard Microsystems Corporation (the Company or 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 and peripheral
devices, and reductions in the rate of growth of the PC 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 will not necessarily inform investors of such changes, except as
required by law. 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 Securities and Exchange Commission
(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.
Overview
Description of Business
SMSC is a designer and worldwide supplier of advanced digital, mixed-signal and
analog semiconductor solutions for a broad range of communications and computing
applications in the areas of Advanced Input/Output (I/O), USB connectivity,
networking and embedded control systems. The Company is a fabless semiconductor
supplier whose products are manufactured by world-class third-party
semiconductor foundries and assemblers. To ensure the highest 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 prominent as the world's leading supplier of Advanced I/O
integrated circuits for desktop and mobile personal computers. Advanced I/O
circuits contain a variety of individual functions ranging from legacy PC I/O to
leading edge system management, including flash memory, infrared communications
support, a real-time clock, and power management.
The Company serves the networking and connectivity markets with its families of
integrated Ethernet and USB 2.0 products, along with other products, which
provide solutions for the needs of network printers, set-top boxes, home gateway
products, automobile navigation systems, cellular base stations, USB peripherals
and a variety of other machine-to-machine communications applications.
The Company's headquarters are located in Hauppauge, New York, and SMSC operates
design and validation centers in New York, Austin, Texas, Tucson, Arizona and
Phoenix, Arizona, and has sales offices in the United States, Europe, Taiwan and
China. The Company conducts most of its business in the Japanese market through
its majority-owned subsidiary, SMSC Japan.
Customers and Product Life Cycles
SMSC sells its products to a worldwide customer base, which includes most of the
world's leading personal computer and personal computer motherboard
manufacturers. The Company's Advanced I/O circuits reside on the motherboards of
personal computer products sold by Dell, Fujitsu, Gateway,
Hewlett-Packard/Compaq, IBM, Intel, NEC, Sony, Toshiba and most other leading
manufacturers. The Company also sells its products through electronics
distributors, who provide value-added access to a broad base of smaller personal
computer suppliers, as well as to many customers who use the Company's products
in diverse networking, connectivity and embedded systems applications.
While demand for the Company's products is primarily driven by the worldwide
demand for personal computers, peripheral devices, and embedded systems
applications sold by U.S.-based suppliers, a significant portion of the
Company's products are sold to manufacturing subcontractors of those U.S.-based
suppliers, located in Asia and the Pacific Rim. The majority of the world's
personal computer, personal computer motherboard and other high technology
manufacturing activity occurs in that region.
The evaluation, testing and design-in of the Company's products by customers
typically takes several months or more, with an additional three to nine months
or more before a customer typically commences volume production of equipment
incorporating the products. In light of the economic slowdown in the technology
sector over the past several years, it may now take significantly longer than
three to nine months before customers commence volume production of equipment
incorporating the Company's products. Due to these dynamics, the Company can
experience significant delays between incurring expenses for research and
development, marketing, selling, administrative efforts, and investments in
inventory, and the corresponding generation of sales and revenue, if any. As is
typical in the semiconductor industry, the Company's rate of new orders can vary
significantly from month to month. If anticipated sales and revenues in any
quarter do not occur as expected, expenses and inventory levels could be
disproportionately high, and the Company's results of operations for that
quarter, and potentially for future quarters, could be adversely impacted.
From time to time, several key customers can account for a significant portion
of the Company's sales and revenues. During fiscal 2003, 2002 and 2001, the
Company had customers whose purchases represented greater than 10% of the
Company's sales and revenues in those fiscal years. In fiscal 2003, three
customers accounted for 19.6%, 14.3% and 12.1%, respectively, of the Company's
sales and revenues. In fiscal 2002, two customers accounted for 29.0% and 15.2%,
respectively, of the Company's sales and revenues. In fiscal 2001, one customer
accounted for 11.2% of the Company's sales and revenues. No other customer
represented more than 10% of the Company's sales and revenues in those fiscal
years. The Company expects that its key customers will continue to account for a
significant portion of its sales and revenues in fiscal 2004 and for the
foreseeable future.
Gross Profit
The Company's gross profit has been impacted in the past, and may continue to be
impacted in the future, by various factors, including:
o Product mix
o Position of products in their respective life cycles
o Competitive pricing strategies
o Manufacturing efficiencies and inefficiencies
o Semiconductor foundry manufacturing capacity
Advanced I/O products typically have short production life cycles, are sold in
high-volume, and generally produce lower gross margins than products for
networking and embedded systems applications, which typically have longer
production life cycles and are shipped in lower unit volumes. In addition, newly
introduced products generally command higher average selling prices and gross
margins, both of which typically decline over product life cycles, due to
competitive pressures and other factors. In order to offset declines in average
selling prices, the Company continually works to add additional functionality
and value to its products, and to reduce the costs of its products, through
product and manufacturing design changes, yield improvements, manufacturing
efficiencies and lower costs negotiated with subcontract manufacturers.
Business Acquisition
In June 2002, the Company acquired all of the outstanding common stock of Gain
Technology Corporation (Gain), a developer and supplier of high-speed,
high-performance analog and mixed-signal communications integrated circuits and
proprietary intellectual property cores, based in Tucson, Arizona. Gain now
operates as SMSC Analog Technology Center, Inc., (ATC). Total initial
consideration paid for the acquisition of ATC was approximately $36.1 million,
consisting of approximately 749,000 shares of SMSC common stock valued at $17.9
million, $16.6 million of cash, and $1.6 million of direct acquisition costs.
Through this acquisition, the Company significantly enhanced its analog and
mixed-signal capabilities, by adding 35 highly skilled engineers and designers,
acquiring several new products, and expanding its intellectual property
portfolio.
The Company's new GT3200 device, acquired through the ATC acquisition, is the
first in a family of high-performance analog physical layer (PHY) and high-speed
serial data communication devices specifically designed for the new USB 2.0
connectivity standard. It is fully certified by the USB Interoperability Forum
and complements the Company's existing family of USB 2.0 products.
Leveraging ATC's assets and expertise, the Company is pursuing additional
product opportunities in high-speed, high-performance USB connectivity and
several new markets.
Business Restructuring
In November 2001, the Company's Board of Directors approved management's plan to
exit the PC chipset business, redirect the Company's resources, and increase its
focus on leveraging its core technologies toward higher growth, higher margin
businesses. As a result, the Company discontinued further investments in PC
chipset development activities. This restructuring was announced on December 3,
2001.
The decision to exit this business was based upon an assessment of the PC
chipset marketplace, and management's conclusions that the opportunities for
profitability in this marketplace had declined, and the costs of entry had
increased, to a point where further investments in PC chipset technology were
not justified. In addition to the changing market prospects for PC chipset
products, the current, unprecedented semiconductor market downturn had prevented
the Company from producing profits while continuing its significant investment
in PC chipset products.
As a result of this restructuring, the Company recorded charges of $9.0 million
in fiscal 2002, of which $7.7 million was classified within operating expenses
and $1.3 million was classified within cost of goods sold on the Consolidated
Statements of Operations. The restructuring-related charges included $5.3
million for impairments in asset values, $1.3 million for excess and obsolete
inventory, $1.9 million for long-term, non-cancelable lease obligations, $0.3
million for a workforce reduction of 55 people, and $0.2 million in other costs.
In fiscal 2003, the Company reduced these charges by $0.2 million, after
reassessing its remaining obligations under this restructuring plan.
The Company completed its restructuring program during the fourth quarter of
fiscal 2002. Substantially all of the $0.3 million in cash payments related to
the workforce reduction were made in that period. Payments related to the
non-cancelable lease obligations will be paid over their respective terms,
through August 2008. Substantially all of the remaining restructuring costs were
non-cash.
By virtue of this restructuring, the Company redeployed certain resources
previously devoted to PC chipset marketing and development programs back to its
core technologies in high-speed communications and computing applications. The
restructuring had minimal impact on product sales, as the Company had yet to
achieve significant product sales of PC chipset products.
Results of Operations
Sales and Revenues
The Company's sales and revenues for fiscal 2003 were $155.5 million, including
$154.2 million of product sales and $1.3 million of intellectual property
revenues, compared to fiscal 2002 sales and revenues of $159.3 million, which
included $128.5 million of product sales and $30.8 million of intellectual
property revenues. Fiscal 2001 sales and revenues were $163.4 million, including
$162.0 million in product sales and $1.4 million in intellectual property
revenues.
Product sales increased 20% in fiscal 2003, compared to fiscal 2002, outpacing
the nominal overall growth in worldwide semiconductor revenues in calendar 2002
(quoted as less than 2% by independent market research sources), primarily on
the strength of new design-wins with several key customers achieved during
fiscal 2002 and fiscal 2003. The Company believes that it increased its Advanced
I/O market share during fiscal 2003 on the strength of these key design-wins. In
addition, following a prolonged slump dating back to the early part of fiscal
2002, sales of the Company's networking and USB connectivity products increased
in fiscal 2003, compared to fiscal 2002, reflecting contributions from several
new products in each of these product lines.
The decline in product sales in fiscal 2002, to $128.5 million, as compared to
$162.0 million in fiscal 2001, resulted primarily from a decrease in unit
volumes, reflecting the unfavorable economic conditions in the semiconductor
industry. Many of the Company's customers faced slowing demand for their
products and needed to work down significant inventory balances throughout
fiscal 2002. Despite this ongoing economic slowdown in the technology sector,
the Company's 21% decline in product sales in fiscal 2002 was lower than the 30%
- - 35% calendar 2001 revenue decline experienced by the overall semiconductor
industry, as estimated by independent market research sources.
Intellectual property revenues in fiscal 2002 included a $29.6 million payment
received from Intel Corporation, further details regarding which appear within
the section of this discussion titled Technology and Patent License Agreements
with Intel Corporation.
Sales and revenues from customers outside of North America accounted for 91% of
the Company's sales and revenues in fiscal 2003, compared to 73% in fiscal 2002
and 77% in fiscal 2001. The fiscal 2002 comparison was impacted by the $29.6
million intellectual property payment received from Intel Corporation in that
period, without which 90% of the Company's fiscal 2002 sales and revenues were
from customers outside of North America. This trend reflects an increasing
portion of the world's high technology manufacturing activity occurring in Asia.
The Company expects that international shipments, particularly to the Asia and
Pacific Rim region, will continue to represent a significant portion of its
sales and revenues for the foreseeable future.
Gross Profit
Gross profit for fiscal 2003 was $69.4 million, or 44.6% of sales and revenues,
compared to $78.0 million, or 49.0% of sales and revenues reported for fiscal
2002. Gross profit in fiscal 2001 was $66.8 million, or 40.9% of sales and
revenues. Excluding the impact of the $29.6 million intellectual property
payment received from Intel Corporation and $1.3 million of inventory charges
associated with the Company's fiscal 2002 restructuring, the gross profit
percentage in fiscal 2002 would have been 38.3% of sales and revenues.
The improvement in gross profit in fiscal 2003, to 44.6% of sales and revenues,
as compared to 38.3% of sales and revenues (as adjusted per the preceding
paragraph) achieved in fiscal 2002, reflects the combination of lower product
costs, new product introductions, an increase in unit production, and lower
inventory obsolescence charges, unrelated to the November 2001 restructuring,
recorded in fiscal 2003 as compared to fiscal 2002.
The decrease in gross profit percentage in fiscal 2002, to 38.3% of sales and
revenues, as adjusted, compared to 40.9% in fiscal 2001, reflects a decrease in
unit shipments, which resulted in lower fixed overhead absorption. The fiscal
2002 gross profit percentage was also adversely impacted by a product mix shift
away from embedded systems, networking, and connectivity products, which
traditionally contribute higher gross margins than Advanced I/O products.
Research and Development Expenses
The Company's research and development (R&D) consists of circuit design,
development and validation, product engineering, software development and
related support activities. The Company's ongoing commitment to R&D is essential
to maintaining product leadership in existing product lines and to providing
innovative new product offerings, which, in turn, drive the Company's
opportunities for future growth.
R&D expenses were $31.2 million in both fiscal 2003 and fiscal 2002, and $32.6
million in fiscal 2001. Fiscal 2003 R&D expenditures include increased expenses
driven by the June 2002 acquisition of ATC, and reduced expenditures for PC
chipset development activities resulting from the Company's November 2001
restructuring.
Fiscal 2002 R&D expenses decreased to $31.2 million, compared to $32.6 million
in fiscal 2001. This decrease reflects the impact of the Company's November 2001
business restructuring, which, at the time, reduced annual R&D expenses by
approximately $5.0 million, including $2.9 million in compensation and benefit
costs. These cost reductions impacted R&D expenses incurred in the fourth
quarter of fiscal 2002.
Selling General and Administrative Expenses
Selling, general and administrative expenses were $36.3 million, or
approximately 23% of sales and revenues, in fiscal 2003, compared to $32.7
million, or approximately 21% of sales and revenues, in fiscal 2002. Fiscal 2001
selling, general and administrative expenses were $35.4 million, or
approximately 22% of sales and revenues. Contributing to the increase in fiscal
2003, as compared to fiscal 2002, were higher variable selling expenses
associated with increased product sales in fiscal 2003, administrative costs
associated with the operation of ATC, and additional staff added to expand the
Company's sales and marketing capabilities. This was partially offset by the
impact of the Company's November 2001 business restructuring, which, at the
time, reduced annual selling, general and administrative expenses by
approximately $0.9 million, beginning in the fourth quarter of fiscal 2002.
The decline in selling, general and administrative expenses in fiscal 2002, to
$32.7 million, compared to $35.4 million in fiscal 2001, resulted from lower
variable selling expenses associated with reduced product sales in fiscal 2002,
as well as the impact of the Company's November 2001 business restructuring.
Cost containment efforts in travel expenses and other administrative costs,
driven by an economic slowdown and other events, also contributed to the decline
in fiscal 2002. Partially offsetting these lower costs in fiscal 2002 were a
$0.3 million litigation settlement and $0.7 million of non-recurring
professional fees incurred during fiscal 2002.
Amortization of Intangible Assets
The $1.2 million of amortization of intangible assets recorded in fiscal 2003
represents amortization of intangible assets associated with the acquisition of
Gain Technology Corporation in June 2002.
Impairment of Investments
During the third quarter of fiscal 2003, the Company recorded non-cash charges
totaling $16.3 million for declines in value, considered to be other than
temporary, of its equity investments in SMC Networks, Inc. and Chartered
Semiconductor Manufacturing Ltd. (Chartered).
The Company's investment in SMC Networks, Inc. is a residual minority equity
interest in a non-public company sold by SMSC in 1997. Based upon a valuation
analysis performed by the Company with the assistance of a third party during
the third quarter of fiscal 2003, this investment, which carried an original
cost of $8.5 million, was fully written off.
During the third quarter of fiscal 2003, the Company recorded a $7.8 million
charge for a decline in value, considered to be other than temporary, of its
equity investment in Chartered, based upon a sustained reduction in Chartered's
stock price performance, reducing the cost basis of the remaining investment to
$2.9 million.
Following these charges, the remaining investment in Chartered stock represents
the only material investment in equity securities of other companies on the
Company's Consolidated Balance Sheet.
As of February 28, 2003, the Company held approximately 444,000 of its original
828,000 Chartered American Depository Shares, which are reported on the
Consolidated Balance Sheet at $1.8 million, based upon their closing price on
the Nasdaq Stock Market on that date. This further decline in value, as compared
to the investment's cost basis as adjusted in the third quarter of fiscal 2003,
is reported as a component of Accumulated Other Comprehensive Income on the
Company's Consolidated Balance Sheet. If Chartered's stock continues to trade
below the Company's adjusted cost basis, further write-downs of this investment
in the future are possible.
During fiscal 2002, the Company recorded charges totaling $0.7 million to
write-down two cost-basis investments in privately held companies. Management
concluded that these investments had experienced impairments in value considered
to be other than temporary. Both investments now carry no net book value.
Other Income and Expenses
The decline in interest income, from $5.5 million in fiscal 2001 to $3.5 million
in fiscal 2002, and then to $2.1 million in fiscal 2003, reflects a decline in
interest rates on short-term investments over these periods.
The Company's Other income (expense), net, was nominal in fiscal 2003. Other
income (expense), net, totaled $1.7 million in fiscal 2002, including gains of
$0.6 million realized from the sale of two underutilized facilities and gains of
$1.1 million realized on sales of a portion of an equity investment.
In fiscal 2001, the Company realized significant gains on the sales of portions
of its investment in Chartered, as well as proceeds from sales of call options
covering a portion of its Chartered stock holdings. During fiscal 2001, the
gains totaled $24.2 million, while proceeds from the sales of call options were
$2.2 million. The Company also realized gains of $2.5 million on other equity
investment sales in fiscal 2001. No sales of Chartered stock, or related call
options, were executed in either fiscal 2003 or fiscal 2002.
Income Taxes
Generally, the Company's income tax rate is a function of the federal, state and
foreign statutory tax rates, the impact of certain permanent differences between
the book and tax treatment of certain expenses, and the impact of tax-exempt
income and various tax credits.
The Company's effective income tax benefit rate for fiscal 2003 was
approximately 48%. By comparison, the effective income tax rate was
approximately 30% in fiscal 2002 and 33% in fiscal 2001. Compared to fiscal
2002, the fiscal 2003 income tax benefit rate includes the impact of higher
income tax credits and the impact of tax benefits associated with qualified
export sales, partially offset by lower tax-exempt income. The 30% effective
income tax rate in fiscal 2002, lower than the 33% rate reported in fiscal 2001,
primarily reflects an increased impact of tax-exempt income in fiscal 2002
compared to fiscal 2001.
Discontinued Operations
The Company has been involved in several legal actions relating to past
divestitures of divisions and business units. These divestitures were accounted
for as discontinued operations, and accordingly, costs associated with these
actions are reported as a Loss from discontinued operations on the Consolidated
Statements of Operations. These costs totaled $0.8 million, before applicable
income tax benefits of $0.3 million, in fiscal 2003, and $2.5 million, before
applicable income tax benefits of $0.9 million, in fiscal 2002.
In March 1999, the Company's Board of Directors approved a plan for the Company
to divest its Foundry Business Unit (FBU). This divestiture was completed on
June 1, 1999, with the Company selling the assets of the FBU to privately held
Inertia Optical Technology Applications, Inc. (IOTA) of Newark, New Jersey, in
exchange for 38% of IOTA's outstanding common stock. The combined businesses
then began operating as Standard MEMS, Inc. (SMI). During fiscal 2001, the
Company sold the majority of its ownership interest in SMI, reducing its
ownership interest in SMI below 5% and realizing an after-tax gain of $4.8
million.
Technology and Patent License 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 between the two companies, covering manufacturing processes and
products, thereby providing each company access to the other's current and
future patent portfolios.
In September 1999, the two companies announced a technology exchange agreement
(the Agreement) that would allow SMSC to accelerate its then ongoing development
of Intel compatible chipset products. Chipset products are integrated circuits
that communicate with the microprocessor (CPU) and assist in controlling the
flow of information within a personal computer or similar application. The
Agreement provided, among other things, for Intel to transfer certain
intellectual property related to Intel chipset architectures to SMSC, and
continues to provide SMSC the opportunity to supply Intel chipset components
along with its own chipset solutions. The Agreement also limited SMSC's rights
regarding Northbridges and Intel Architecture Microprocessors under the 1987
agreement.
The Agreement included provisions for its termination under certain
circumstances. Under one such provision, beginning in the third year of the
Agreement and annually thereafter, SMSC could elect to terminate the Agreement
should SMSC not achieve certain minimum chipset revenue amounts set forth in the
Agreement, unless Intel paid SMSC an amount equal to the shortfall between the
minimum revenue amount and the actual revenue for that period. Upon the
Agreement terminating under this provision, the limitations imposed by the
Agreement on the Northbridge rights under the 1987 agreement would terminate
immediately, and the limitations imposed by the Agreement on the microprocessor
rights under the 1987 agreement would terminate twelve months later. Should
Intel elect to make the revenue amount shortfall payment, the provisions of the
Agreement would remain in force for the subsequent twelve-month period, for
which another minimum revenue amount would be applicable, and at the end of
which a similar termination event would arise. Minimum chipset revenue amounts
were $30 million, $45 million, and $60 million for the twelve months ending
September 21, 2001, 2002, and 2003, respectively, increasing by 10% for each
succeeding twelve-month period following 2003, until expiration of the Agreement
in July 2007.
In September 2001, pursuant to the provisions described in the preceding
paragraph, SMSC notified Intel of a chipset revenue shortfall of approximately
$29.6 million for the twelve months ended September 21, 2001. In November 2001,
the Company received a $29.6 million payment from Intel, which is reported as
intellectual property revenue on the Company's Consolidated Statement of
Operations for fiscal 2002.
In September 2002, SMSC notified Intel of a chipset revenue shortfall of
approximately $44.9 million for the 2002 twelve-month period. Intel did not make
a payment to SMSC of that shortfall within the time frame specified within the
Agreement, and SMSC gave Intel notice of termination of the Agreement in
accordance with the terms thereof. The Company and Intel have commenced
discussions regarding their various corporate and intellectual property
relationships, including under the Agreement. However, there can be no assurance
as to the outcome of those discussions.
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 short-term investments decreased to
$112.9 million as of February 28, 2003, compared to $126.7 million at February
28, 2002. This decrease reflects, among other things, $15.7 million of cash used
for the acquisition of ATC, and $10.4 million used for purchases of treasury
stock. As of February 28, 2003, the Company had $145.6 million of working
capital, and a current ratio of 6.9 to 1, compared to $155.0 million and 7.5 to
1, respectively, at February 28, 2002. The Company had no bank debt at February
28, 2003 or February 28, 2002.
Operating activities generated $14.9 million of cash in fiscal 2003. Investing
activities consumed $15.3 million of cash for the same period, including the
$15.7 million used in the acquisition of ATC and $5.7 million used for capital
expenditures, partially offset by $5.9 million for maturities, net of purchases,
of short-term investments. Financing activities consumed $7.8 million of cash
during fiscal 2003, including the $10.4 million for purchases of treasury stock
and $2.6 million for payments of obligations under capital leases and notes
payable, partially offset by $5.2 million generated from the issuance of common
stock through exercises of stock options.
The company continues to actively manage its inventories. Despite the increase
in product sales in fiscal 2003, compared to fiscal 2002, the Company's
inventories at February 28, 2003 remained at $17.6 million, consistent with
February 28, 2002. The Company's inventories typically increase during the first
half of its fiscal year in anticipation of shipment requirements during the
second half of the year.
Accounts receivable increased from $21.8 million at February 28, 2002 to $22.7
million at February 28, 2003, consistent with the increase in product sales in
fiscal 2003. The Company's accounts receivable portfolio remains almost entirely
current.
Reflecting the adverse economic conditions, capital spending was somewhat
restrained in both fiscal 2003 and 2002, totaling approximately $5.7 million and
$4.5 million, respectively. Capital expenditures in fiscal 2004 are expected to
exceed those incurred in fiscal 2003, but will depend upon, among other factors,
the level of economic recovery, if any, in the high technology sector. Capital
expenditures are typically incurred to support the Company's semiconductor test
operation and to acquire hardware, software and other tools used in the design
of the Company's products. There were no material commitments for capital
expenditures as of February 28, 2003.
During fiscal 2003, the Company purchased approximately 482,000 shares of
treasury stock in open market transactions at a cost of $9.6 million. In
addition, cash flow for fiscal 2003 includes $0.8 million of treasury stock
purchases from late February 2002, which settled in early March 2002. As of
February 28, 2003, the Company held 1,820,000 shares of treasury stock, at a
cost of $23.5 million. Approximately 1.2 million shares remain available for
repurchase under the Company's common stock repurchase program.
The Company's contractual payment obligations and purchase commitments as of
February 28, 2003 were as follows (in thousands):
Payment Obligations by Period
- --------------------------------------------------------------------------------
Within 1 Between
Total year 1 and 3 Thereafter
years
- --------------------------------------------------------------------------------
Capital leases ........... $ 443 $ 365 $ 78 $ ---
Operating leases ......... 7,018 2,306 3,523 1,189
Other obligations ........ 1,741 1,414 327 ---
Purchase commitments ..... 13,460 13,460 --- ---
- --------------------------------------------------------------------------------
Total ........... $ 22,662 $ 17,545 $ 3,928 $ 1,189
================================================================================
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 through the end of
fiscal 2004.
Critical Accounting Policies and Estimates
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 the following critical accounting policies and estimates
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.
Revenue Recognition
Sales and revenues and associated gross profit from shipments to the Company's
distributors, other than to distributors in Japan, are deferred until the
distributors resell the products. Shipments to distributors, other than to
distributors in Japan, are made under agreements allowing price protection and
limited rights to return unsold merchandise. In addition, the Company's
shipments to its distributors may experience short-term fluctuations as
distributors manage their inventories to current levels of end-user demand.
Therefore, the Company considers the policy of deferring revenue on shipments to
distributors to be a more meaningful presentation of the Company's operating
results. It allows investors to better understand end-user demand for the
products that the Company sells through distribution channels and it better
focuses the Company on end-user demand. This policy is a common practice within
the semiconductor industry. The Company relies upon its distributors to supply
the Company with distribution sales and inventory information regarding its
products, and, although the information is diligently reviewed and verified for
accuracy, any errors or omissions made by those distributors and not detected by
the Company, if material, could affect operating results.
The Company recognizes revenue from product sales to original equipment
manufacturers (OEMs) and to distributors in Japan at the time of shipment, net
of appropriate reserves for product returns and allowances. For these revenues,
the Company must make assumptions and estimates of future product returns and
sales allowances, and any differences between those estimates and actual
results, if material, could affect that period's operating results.
Inventories
The Company's inventories are comprised of complex, high technology parts that
may be subject to rapid technological obsolescence and which are sold in a
highly competitive industry. Inventories are valued at the lower of first-in,
first-out cost or market, and are actively reviewed for product obsolescence and
impaired values, based upon assumptions of future demand and market conditions.
When it is determined that inventory is stated at a higher value than that which
can be recovered, the Company writes this inventory down to its estimated
realizable value. While the Company diligently endeavors to forecast customer
demand and stock commensurate levels of inventory, unanticipated inventory
write-downs in the future may be required.
Allowance for Doubtful Accounts
The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. These
estimated losses are based upon historical bad debts, specific customer
creditworthiness and current economic trends. If the financial condition of a
customer deteriorates, resulting in the customer's inability to make payments
within approved credit terms, additional allowances may be required. The Company
performs credit evaluations of its customers' financial condition on a regular
basis, and has not experienced any material bad debt losses during the past
three fiscal years.
Valuation of Long-Lived Assets
Long-lived assets, including property, plant and equipment, goodwill and
intangible assets, are monitored and are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of any such asset
may not be recoverable. The determination of recoverability is based on an
estimate of undiscounted cash flows expected to result from the use of an asset
and its eventual disposition. The estimated cash flows are based upon, among
other things, certain assumptions about expected future operating performance,
growth rates and other factors. Estimates of undiscounted cash flows may differ
from actual cash flows due to factors such as technological changes, economic
conditions, and changes in the Company's business model or operating
performance. If the sum of the undiscounted cash flows (excluding interest) is
below the carrying value, an impairment loss is recognized, measured as the
amount by which the carrying value exceeds the fair value of the asset.
Marketable and non-marketable long-term equity investments are also monitored
for indications of impairment in value. The Company records an impairment charge
against these investments when the investment is judged to have experienced a
decline in value that is other than temporary. Judgments regarding the value of
non-marketable equity investments is subjective and is dependent upon
management's assessment of the performance of the investee and its prospects for
future success. The Company holds minority equity investments in several
publicly and privately owned companies, some of which operate in the
semiconductor industry and are subject to many of the same business risks faced
by SMSC. During the third quarter of fiscal 2003, impairment charges totaling
$16.3 million were recorded against two of these investments.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, which requires
recognition of deferred tax assets and liabilities using enacted tax rates for
the effect of temporary differences between the book and tax bases of recorded
assets and liabilities. SFAS No. 109 also requires that deferred tax assets be
reduced by a valuation allowance if it is more likely than not that some or all
of the deferred tax assets will not be realized.
The Company regularly evaluates the realizability of its deferred tax assets by
assessing its forecasts of future taxable income and reviewing available tax
planning strategies that could be implemented to realize the deferred tax
assets. At February 28, 2003, the Company had $20.3 million of deferred tax
assets in excess of deferred tax liabilities, all of which are considered fully
realizable. Factors that may affect the Company's ability to achieve sufficient
future taxable income for purposes of realizing its deferred tax assets include
increased competition, a decline in sales and revenues or gross margins, loss of
market share, delays in product availability, and technological obsolescence.
Legal Contingencies
From time to time, the Company is involved in legal actions arising in the
ordinary course of business. There can be no assurance that any third-party
assertions against the Company will be resolved without costly litigation, in a
manner that is not adverse to its financial position, results of operations or
cash flows. As of February 28, 2003, no estimate can be made of any possible
loss or possible range of loss associated with the resolution any such
contingencies. If additional information becomes available which indicates that
a loss, or range of losses, is probable, the Company would then record a charge
for the minimum estimated liability, which could materially impact operating
results and financial condition.
Recent Accounting Pronouncements
In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS No.
146, Accounting for Exit or Disposal Activities. SFAS No. 146 requires that the
liabilities for costs associated with an exit or disposal activity be recognized
at their fair values when the liabilities are incurred. Under previous guidance,
liabilities for certain exit costs were recognized at the date that management
committed to an exit plan, which is generally before the actual liabilities are
incurred. SFAS No. 146 is effective only for exit or disposal activities
initiated after December 31, 2002. The adoption of SFAS No. 146 did not have a
material impact on the Company's financial statements.
In November 2002 the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45), effective prospectively for guarantees issued
or modified after December 31, 2002. Under this Interpretation, a guarantor is
required to recognize, at the inception of certain guarantees, a fair value
liability for the obligations it has undertaken in issuing the guarantee. The
Company did not have any outstanding guarantees at February 28, 2003 that were
required to be recorded as obligations pursuant to the provisions of FIN 45.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123 (SFAS No. 123), which is effective for financial statements for fiscal years
ending after December 15, 2002, with early adoption permitted. SFAS No. 148 will
enable companies that choose to adopt the fair value based method to report the
full effect of employee stock options in their financial statements immediately
upon adoption, and to make available to investors better and more frequent
disclosure about the cost of employee stock options. The Company will continue
to apply the disclosure-only provisions of both SFAS No. 123 and SFAS No. 148.
Financial Market Risks
Interest Rate Risk - The Company's exposure to interest rate risk relates
primarily to its investment portfolio. The primary objective of the Company'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 February 28, 2003, the Company's $22.9 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% from levels at
February 28, 2003, the Company estimates that the fair value of these short-term
investments would decline by an immaterial amount. The Company generally expects
to hold its short-term investments until maturity and, therefore, would not
expect operating results or cash flows to be affected to any significant degree
by the effect of a sudden change in market interest rates on short-term
investments.
Equity Price Risk - The Company is exposed to an equity price risk on its
investment in Chartered Semiconductor Manufacturing, Ltd. (Chartered). For every
10% adverse change in the market value of Chartered common stock, the Company
would experience a decrease of approximately $0.2 million in its February 28,
2003 investment value. The Company recorded a non-cash charge of $7.8 million in
the third quarter of fiscal 2003 for a decline in value of this investment,
considered to be other than temporary, based upon a sustained reduction in
Chartered's stock price performance. Following this charge, the remaining
investment in Chartered stock represents the only material investment in equity
securities of other companies on the Company's Consolidated Balance Sheet. The
Company has sold call options covering this investment in the past and may do so
in the future to reduce a portion of this market risk. No call options were sold
covering this investment during fiscal 2003 or fiscal 2002.
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. 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. Transactions in the Japanese market made by the
Company's majority owned subsidiary, SMSC Japan, are denominated in Japanese
yen. SMSC Japan purchases a significant amount of its products for resale from
Standard Microsystems Corporation in U.S. dollars, and from time to time enters
into forward exchange contracts to hedge against currency fluctuations
associated with these product purchases. During fiscal 2003, SMSC Japan entered
into a contract with a Japanese financial institution to purchase U.S. dollars
to meet a portion of its U.S. dollar denominated product purchase requirements.
Gains and losses on this contract were not significant. As of February 28, 2003,
the remaining commitments under this contract, which expired in March 2003, were
not significant.
The Company has never received a cash dividend (repatriation of cash) from SMSC
Japan nor does it expect to receive such a dividend in the near future.
Standard Microsystems Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
For the years ended February 28, 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------
Product sales ............................................. $ 154,244 $ 128,528 $ 162,008
Intellectual property revenues ............................ 1,273 30,770 1,420
- ----------------------------------------------------------------------------------------------------------------
155,517 159,298 163,428
Cost of goods sold ........................................ 86,093 81,264 96,660
- ----------------------------------------------------------------------------------------------------------------
Gross profit .............................................. 69,424 78,034 66,768
Operating expenses:
Research and development ................................ 31,166 31,178 32,580
Selling, general and administrative ..................... 36,268 32,744 35,369
Amortization of intangible assets ....................... 1,167 - -
Restructuring costs ..................................... (247) 7,734 -
- ----------------------------------------------------------------------------------------------------------------
Income (loss) from operations ............................. 1,070 6,378 (1,181)
Other income (expense):
Interest income ......................................... 2,069 3,450 5,534
Interest expense ........................................ (166) (133) (212)
Impairments of investments .............................. (16,306) (669) -
Other income (expense), net ............................. (43) 1,660 28,971
- ----------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and minority interest ... (13,376) 10,686 33,112
Provision for (benefit from) income taxes ................. (6,422) 3,171 10,852
Minority interest in net income of subsidiary ............. 17 40 96
- ----------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations .................. (6,971) 7,475 22,164
Discontinued operations:
Gain (loss) from discontinued operations (net of
income taxes of ($281), ($918), and $2,799) .......... (500) (1,564) 4,765
- ----------------------------------------------------------------------------------------------------------------
Net income (loss) ......................................... $ (7,471) $ 5,911 $ 26,929
================================================================================================================
Basic net income (loss) per share:
Income (loss) from continuing operations ................ $ (0.42) $ 0.47 $ 1.39
Gain (loss) from discontinued operations ................ (0.03) (0.10) 0.30
- ----------------------------------------------------------------------------------------------------------------
Basic net income (loss) per share ......................... $ (0.45) $ 0.37 $ 1.69
================================================================================================================
Diluted net income (loss) per share:
Income (loss) from continuing operations ................ $ (0.42) $ 0.44 $ 1.29
Gain (loss) from discontinued operations ................ (0.03) (0.09) 0.28
- ----------------------------------------------------------------------------------------------------------------
Diluted net income (loss) per share ....................... $ (0.45) $ 0.35 $ 1.57
================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Standard Microsystems Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
As of February 28, 2003 2002
- --------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents .................. $ 90,025 $ 98,065
Short-term investments ..................... 22,872 28,595
Accounts receivable, net of allowance
for doubtful accounts of $460 and
$450, respectively ...................... 22,738 21,828
Inventories ................................ 17,644 17,585
Deferred income taxes ...................... 8,545 8,582
Other current assets ....................... 8,710 4,317
- --------------------------------------------------------------------------------
Total current assets ....................... 170,534 178,972
Property, plant and equipment, net ........... 22,257 24,170
Goodwill ..................................... 29,773 -
Intangible assets, net ....................... 6,008 -
Investment in Chartered Semiconductor ........ 1,840 9,992
Deferred income taxes ........................ 11,779 7,196
Other assets ................................. 5,758 15,733
- --------------------------------------------------------------------------------
$ 247,949 $ 236,063
================================================================================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable .......................... $ 9,114 $ 8,477
Deferred income on shipments to
distributors ............................ 5,943 6,225
Accrued expenses, income taxes and
other liabilities ....................... 9,838 9,289
- --------------------------------------------------------------------------------
Total current liabilities .................. 24,895 23,991
- --------------------------------------------------------------------------------
Other liabilities ........................... 7,379 6,973
Commitments and contingencies
Minority interest in subsidiary .............. 11,663 11,646
Shareholders' equity:
Preferred stock, $.10 par value
authorized 1,000 shares, none issued ..... - -
Common stock, $.10 par value authorized
30,000 shares, issued 18,590 and
17,277 shares, respectively ............. 1,859 1,728
Additional paid-in capital ................. 145,553 119,505
Retained earnings .......................... 77,492 84,963
Treasury stock, 1,820 and 1,338 shares,
respectively, at cost ................... (23,454) (13,861)
Accumulated other comprehensive income ..... 2,562 1,118
- --------------------------------------------------------------------------------
Total shareholders' equity ................. 204,012 193,453
- --------------------------------------------------------------------------------
$ 247,949 $ 236,063
================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Standard Microsystems Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
Accumulated
Additional Other
Common Stock Paid-In Retained Treasury Stock Comprehensive
Shares Amount Capital Earnings Shares Amount Income Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at February 29, 2000 ................... 16,431 $ 1,643 $ 112,297 $ 52,123 (671) $ (4,379) $ 40,108 $ 201,792
Comprehensive loss:
Net income ................................... - - - 26,929 - - - 26,929
Other comprehensive loss
Change in unrealized gain on investments .... - - - - - - (33,778) (33,778)
Foreign currency translation adjustment ..... - - - - - - (960) (960)
-----------
Total other comprehensive loss ............... (34,738)
-----------
Total comprehensive loss ..................... (7,809)
Shares issued under Incentive Savings
and Retirent Plan ......................... 23 2 317 - - - - 319
Stock options exercised ...................... 333 33 3,003 - - - - 3,036
Tax effect of employee stock plans ........... - - 567 - - - - 567
Stock-based compensation ..................... 95 10 - - - - - 10
Amortization of deferred stock-based
compensation .............................. - - 351 - - - - 351
Net exercise of stock warrants ............... 200 20 (20) - - - - -
Purchases of treasury stock .................. - - - - (327) (3,951) - (3,951)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at February 28, 2001 ................... 17,082 1,708 116,515 79,052 (998) (8,330) 5,370 194,315
Comprehensive income:
Net income .................................. - - - 5,911 - - - 5,911
Other comprehensive loss
Change in unrealized gain on investments . - - - - - - (2,683) (2,683)
Foreign currency translation adjustment .. - - - - - - (1,569) (1,569)
-----------
Total other comprehensive loss .............. (4,252)
-----------
Total comprehensive income .................. 1,659
Stock options exercised ..................... 169 17 1,543 - - - - 1,560
Tax effect of employee stock plans .......... - - 595 - - - - 595
Stock-based compensation .................... 26 3 210 - - - - 213
Amortization of deferred stock-based
compensation .............................. - - 642 - - - - 642
Purchases of treasury stock ................. - - - - (340) (5,531) - (5,531)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at February 28, 2002 ................... 17,277 1,728 119,505 84,963 (1,338) (13,861) 1,118 193,453
Comprehensive loss:
Net loss .................................... - - - (7,471) - - - (7,471)
Other comprehensive income
Change in unrealized gain on investments . - - - - - - (283) (283)
Foreign currency translation adjustment .. - - - - - - 1,727 1,727
-----------
Total other comprehensive income ............ 1,444
-----------
Total comprehensive loss .................... (6,027)
Stock options exercised ..................... 489 49 5,139 - - - - 5,188
Tax effect of employee stock plans .......... - - 1,828 - - - - 1,828
Stock-based compensation .................... 75 7 302 - - - - 309
Amortization of deferred stock-based
compensation .............................. - - 923 - - - - 923
Issuance of common stock for business
acquisition ............................... 749 75 17,856 - - - - 17,931
Purchases of treasury stock ................. - - - - (482) (9,593) - (9,593)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at February 28, 2003 ................... 18,590 $ 1,859 $ 145,553 $ 77,492 (1,820) $(23,454) $ 2,562 $ 204,012
- ------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
Standard Microsystems Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the years ended February 28, 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Cash received from customers and licensees ..................... $ 154,202 $ 152,884 $ 163,355
Cash paid to suppliers and employees ........................... (143,314) (122,655) (160,868)
Interest received .............................................. 2,279 4,208 4,795
Interest paid .................................................. (142) (133) (212)
Income taxes received (paid) ................................... 1,888 (5,349) (8,239)
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities ......... 14,913 28,955 (1,169)
- ------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures ........................................... (5,695) (4,488) (14,600)
Acquisition of Gain Technology Corporation, net of
cash acquired ................................................. (15,669) (2,500) -
Sales of property, plant and equipment ......................... 148 2,004 891
Sales of long-term equity investments and options .............. 78 1,064 38,608
Purchases of short-term investments ............................ (32,292) (32,595) (10,632)
Maturities of short-term investments ........................... 38,204 13,629 3,003
Other (38) (83) (140)
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities ........ (15,264) (22,969) 17,130
- ------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock ......................... 5,188 1,560 3,111
Purchases of treasury stock .................................... (10,375) (4,750) (3,951)
Repayments of obligations under capital leases and
notes payable ................................................. (2,617) (1,002) (924)
- ------------------------------------------------------------------------------------------------------------------------
Net cash used for financing activities ....................... (7,804) (4,192) (1,764)
- ------------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash and cash
equivalents ................................................. 1,038 (691) (424)
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) discontinued operations .......... (923) (2,583) 12,367
- ------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents .............. (8,040) (1,480) 26,140
Cash and cash equivalents at beginning of year .................... 98,065 99,545 73,405
- ------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year .......................... $ 90,025 $ 98,065 $ 99,545
========================================================================================================================
Reconciliation of income (loss) from continuing operations
to net cash provided by (used for) operating activities:
Income (loss) from continuing operations .......................... $ (6,971) $ 7,475 $ 22,164
Adjustments to reconcile income (loss) from continuing
operations to net cash provided by (used for) operating
activities, net of the effects of business acquisition:
Depreciation and amortization ................................... 10,752 11,614 11,792
Gains on sales of investments and property ..................... (47) (1,639) (28,935)
Asset impairments ............................................... 16,306 5,602 -
Other adjustments, net .......................................... (143) 80 (221)
Changes in operating assets and liabilities:
Accounts receivable ........................................... (1,411) (5,666) (44)
Inventories ................................................... (184) 14,172 (12,139)
Accounts payable and accrued expenses and other
liabilities .................................................. 753 (1,450) 3,982
Other changes, net ............................................ (4,142) (1,233) 2,232
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities .............. $ 14,913 $ 28,955 $ (1,169)
========================================================================================================================
During fiscal 2003, the Company acquired $1,876 of design tools through
long-term financing provided by the supplier.
The accompanying notes are an integral part of these consolidated financial
statements.
Standard Microsystems Corporation
and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Standard Microsystems Corporation (the Company or SMSC), a Delaware corporation
founded in 1971 and based in Hauppauge, New York, is a worldwide supplier of
leading edge digital, mixed-signal and analog integrated circuits for a broad
range of high-speed communication and computing applications. The Company's
products provide solutions in Advanced Input/Output (I/O) technology,
environmental monitoring and control, USB connectivity, networking and embedded
control systems. SMSC is the world's leading supplier of Advanced I/O integrated
circuits for desktop and mobile personal computers.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The Company's fiscal year ends on the last day in February. The consolidated
financial statements include the accounts of the Company and its subsidiaries
after elimination of all significant intercompany accounts and transactions.
Reclassifications
Certain items in the prior years' consolidated financial statements have been
reclassified to conform to the fiscal 2003 presentation.
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 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 revenues and expenses during the reporting period. The
Company bases the estimates and assumptions on historical experience and on
various other factors that it believes to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results could differ from those estimates.
Revenue Recognition
The Company recognizes revenue from product sales to original equipment
manufacturers (OEMs) and end-users at the time of shipment, net of appropriate
reserves for product returns and allowances. The Company's terms of shipment are
customarily FOB shipping point.
Certain of the Company's products are sold to distributors under agreements
providing for price protection and rights to return unsold merchandise.
Accordingly, recognition of revenue and associated gross profit on shipments to
a majority of the Company's distributors is deferred until the distributors
resell the products. Shipments made by the Company's Japanese subsidiary to
distributors in Japan are made under agreements that permit limited or no stock
return privileges and no price protection or other sales price rebates. Revenue
for shipments to distributors in Japan is recognized upon shipment to the
distributor.
Revenue recognition for a special intellectual property payment received in
fiscal 2002 is discussed within Note 7. The Company recognizes its other
intellectual property revenues upon notification of sales of the licensed
technology by its licensees. The terms of the Company's licensing agreements
generally require licensees to give notification to the Company and to pay
royalties no later than 60 days after the end of the quarter during which the
sales take place.
Cash and Cash Equivalents
Cash and cash equivalents consist principally of cash in banks and highly liquid
debt instruments purchased with original maturities of three months or less.
Short-Term Investments
Marketable debt and equity securities are reported at fair value. As of February
28, 2003, short-term investments consisted primarily of investments in corporate
obligations with maturities of between three and twelve months and are
classified as available-for-sale. Unrealized gains and losses on short-term
investments are included as a separate component of Shareholders' equity. The
cost of these short-term investments approximates their market value as of
February 28, 2003.
Fair Value of Financial Instruments
The carrying amounts reported in the Consolidated Balance Sheets for cash and
cash equivalents, accounts receivable, accounts payable and accrued expenses
approximate fair value due to their short maturities. The amounts presented for
other long-term liabilities also approximate their fair values.
Inventories
Inventories are valued at the lower of first-in, first-out cost or market.
Property, Plant and Equipment
Property, plant and equipment are carried at cost and depreciated on a
straight-line basis over the estimated useful lives of the buildings (20 to 25
years) and machinery and equipment (3 to 7 years). Upon sale or retirement of
property, plant and equipment, the related cost and accumulated depreciation are
removed from the accounts, and any resulting gain or loss is reflected
currently.
Cost-Basis Investments
Equity investments representing an ownership interest of less than 20% in
non-publicly traded companies are carried at cost. Changes in the values of
these investments are not recognized unless they are sold, or an impairment in
value is deemed to be other than temporary.
Long-Term Investments in Equity Securities
Investments in publicly traded equity securities are classified as
available-for-sale and are carried at fair value on the accompanying
Consolidated Balance Sheets. Unrealized gains and temporary losses on such
securities, net of taxes, are reported in Accumulated other comprehensive income
within Shareholders' equity. Impairment charges on these investments are
recorded if declines in value are deemed to be other than temporary.
Long-Lived Assets
The Company assesses the recoverability of long-lived assets, including goodwill
and intangible assets, whenever events or changes in circumstances indicate that
future undiscounted cash flows expected to be generated by an asset's
disposition or use may not be sufficient to support its carrying value. If such
cash flows are not sufficient to support the asset's recorded value, an
impairment charge is recognized to reduce the carrying value of the long-lived
asset to its estimated fair value.
Goodwill and Purchased Intangible Assets
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 requires goodwill and certain other intangible assets to be
tested for impairment at least annually, as well as when an event indicating
possible impairment may have occurred. Intangible assets other than goodwill
that have finite lives are amortized over their estimated useful lives. The
Company adopted the provisions of SFAS No. 142 during fiscal 2003. Further
discussion of the Company's goodwill and intangible assets is provided within
Note 5.
Research and Development
Expenditures for research and development are expensed in the period incurred.
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 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.
In March 2000, the FASB issued Interpretation No. 44, Accounting for Certain
Transactions Involving Stock Compensation - An Interpretation of APB Opinion No.
25 (FIN 44). FIN 44 clarifies certain aspects of APB Opinion No. 25, including
the definition of an employee, the criteria for determining whether a plan
qualifies as a noncompensatory plan, the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and the
accounting for an exchange of stock compensation awards in a business
combination. The Company's accounting for stock-based compensation complies with
the provisions of FIN 44.
Pro forma information regarding net income (loss) and net income (loss) per
share is required by SFAS No. 123, and has been calculated as if the Company has
accounted for its stock option plans under the fair value method of SFAS No.
123. The fair value of stock options issued has been estimated at the dates of
grant using a Black-Scholes option-pricing model with the following weighted
average assumptions:
For the years ended February 28, 2003 2002 2001
- -----------------------------------------------------------------------------
Dividend yield ........................ - - -
Expected volatility ................... 64% 63% 64%
Risk-free interest rates .............. 2.50% 4.17% 4.62%
Expected lives (in years) ............. 4.9 4 4
- -----------------------------------------------------------------------------
The weighted average Black-Scholes values of options granted in fiscal 2003,
2002 and 2001 were $11.69, $7.57 and $8.57, respectively. The values produced by
this model are limited by the inclusion of highly subjective assumptions, which
greatly affect the calculated values.
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.
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):
For the years ended February 28, 2003 2002 2001
- --------------------------------------------------------------------------------
Net income (loss):
As reported ...................... $(7,471) $5,911 $26,929
Pro forma ........................ (14,263) (142) 22,529
- --------------------------------------------------------------------------------
Diluted net income (loss) per share:
As reported ...................... $ (0.45) $ 0.35 $ 1.57
Pro forma ........................ (0.86) (0.01) 1.31
- --------------------------------------------------------------------------------
The effects of applying SFAS No. 123 in this pro forma disclosure are not
indicative of future operating results.
Income Taxes
Deferred income taxes are provided on temporary differences that arise in the
recording of transactions for financial and tax reporting purposes and result in
deferred tax assets and liabilities. Deferred tax assets are reduced by an
appropriate valuation allowance if, in management's judgment, part of the
deferred tax asset will not be realized. Tax credits are accounted for as
reductions of the current provision for income taxes in the year in which the
related expenditures are incurred.
Translation of Foreign Currencies
Assets and liabilities of foreign subsidiaries are translated into U.S. dollars
using the exchange rates in effect at the balance sheet date. Results of their
operations are translated using the average exchange rates during the period.
Resulting translation adjustments are recorded within Accumulated other
comprehensive income within Shareholders' equity.
Foreign Exchange Contracts
The Company purchases most of its materials and transacts most of its
international sales, with the exception of certain sales to customers in Japan,
in U.S. dollars. The Company's Japanese subsidiary, SMSC Japan, serves the
Japanese market and transacts most of its sales to its customers in Japanese
yen. SMSC Japan purchases a significant amount of its products for resale from
Standard Microsystems Corporation in U.S. dollars and, from time to time, enters
into forward exchange contracts to hedge against currency fluctuations
associated with these product purchases. During fiscal 2003, SMSC Japan entered
into a contract with a Japanese financial institution to purchase U.S. dollars
to meet a portion of its U.S. dollar denominated product purchase requirements.
Gains and losses on this contract were not significant. As of February 28, 2003,
the remaining commitments under this contract, which expired in March 2003, were
not significant.
Comprehensive Income
The Company's other comprehensive income (loss) consists of foreign currency
translation adjustments and unrealized gains and losses on investments.
Recent Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146, Accounting for Exit or Disposal
Activities. SFAS No. 146 requires that the liabilities for costs associated with
an exit or disposal activity be recognized at their fair values when the
liabilities are incurred. Under previous guidance, liabilities for certain exit
costs were recognized at the date that management committed to an exit plan,
which is generally before the actual liabilities are incurred. SFAS No. 146 is
effective only for exit or disposal activities initiated after December 31,
2002. The adoption of this statement did not have a material impact on the
Company's financial statements.
In November 2002 the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45), effective prospectively for guarantees issued
or modified after December 31, 2002. Under this Interpretation, a guarantor is
required to recognize, at the inception of certain guarantees, a fair value
liability for the obligations it has undertaken in issuing the guarantee. The
Company did not have any outstanding guarantees at February 28, 2003 required to
be recorded as obligations pursuant to the provisions of FIN 45.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123, which is effective for financial statements for fiscal years ending after
December 15, 2002, with early adoption permitted. SFAS No. 148 allows companies
that choose to adopt the fair value based method to report the full effect of
employee stock options in their financial statements immediately upon adoption,
and to make available to investors better and more frequent disclosure about the
cost of employee stock options. The Company will continue to apply the
disclosure-only provisions of both SFAS No. 123 and SFAS No. 148.
3. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is calculated by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
net income per share is computed by dividing net income by the sum of the
weighted average common shares outstanding during the period plus the dilutive
effect of shares issuable through stock options. Shares used in calculating
basic and diluted net income (loss) per share are reconciled as follows (in
thousands):
For the years ended February 28, 2003 2002 2001
- --------------------------------------------------------------------------------
Average shares outstanding for
basic net income (loss) per share ...... 16,538 16,069 15,925
Dilutive effect of stock options ........ - 831 1,240
- --------------------------------------------------------------------------------
Average shares outstanding for
diluted net income (loss) per share .... 16,538 16,900 17,165
- --------------------------------------------------------------------------------
The Company reported a net loss from continuing operations in fiscal 2003, and
accordingly, the effect of stock options covering 5,054,000 common shares was
antidilutive for that period and was excluded from average shares outstanding
used in the calculation of the fiscal 2003 net loss per share.
Outstanding options covering 273,000 and 511,000 common shares were excluded
from the computation of diluted net income per share for fiscal 2002 and 2001,
respectively, because their effect was antidilutive.
4. BUSINESS ACQUISITION
In June 2002, the Company acquired all of the outstanding common stock of Gain
Technology Corporation (Gain), a developer and supplier of high-speed,
high-performance analog and mixed-signal communications integrated circuits and
proprietary intellectual property cores, based in Tucson, Arizona. Gain now
operates as SMSC Analog Technology Center, Inc. (ATC). Through this acquisition,
the Company significantly enhanced its analog and mixed-signal capabilities, by
adding 35 highly skilled engineers and designers, acquiring several new
products, and expanding its intellectual property portfolio.
The Company acquired ATC for initial consideration of $36.1 million, consisting
of approximately 749,000 shares of SMSC common stock valued at $17.9 million,
$16.6 million of cash (net of cash acquired), and $1.6 million of direct
acquisition costs, including legal, banking, accounting and valuation fees. The
value of the SMSC common stock was determined using the stock's market value for
a reasonable period before and after the date the terms of the acquisition were
announced. The terms of the acquisition provided that up to $17.5 million of
additional consideration, payable in SMSC common stock and cash, may be issued
to ATC's former shareholders during fiscal 2004 upon satisfaction of certain
future performance goals. It has been determined that $15.0 million of the
additional consideration was not earned, and $2.5 million remains contingent
upon future performance. Any additional consideration paid will be recorded as
goodwill.
In accordance with the provisions of SFAS No. 141, Business Combinations, the
purchase price was allocated to the estimated fair values of assets acquired and
liabilities assumed, as set forth in the following table. The fair values
assigned to intangible assets and in-process research and development were
determined with the assistance of a third-party appraisal.
(in thousands)
------------------------------------------------------
Current assets ........................... $ 1,672
Property, plant and equipment ............ 1,114
Deferred income taxes .................... 1,212
Other assets ............................. 41
Goodwill ................................. 29,773
Existing technologies .................... 6,179
Other intangible assets .................. 908
------------------------------------------------------
Total assets acquired .................... 40,899
Current liabilities ...................... 3,709
Long-term obligations .................... 1,177
------------------------------------------------------
Total liabilities assumed ................ 4,886
Net assets acquired ...................... 36,013
In-process research and development ...... 87
------------------------------------------------------
Total initial consideration .............. $ 36,100
======================================================
The amounts allocated to current technologies are being amortized on a
straight-line basis over their estimated useful life of six years. Other
intangible assets are also being amortized on a straight-line basis over their
respective estimated useful lives, ranging from one to ten years. In accordance
with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, the
$29.8 million assigned to goodwill will not be amortized. Further information
regarding goodwill and other intangible assets is provided within Note 5.
The amount assigned to in-process research and development relates to those
ongoing projects that have not yet proven to be commercially feasible, and for
which no alternative future use currently exists for the related technology.
This charge is included within the Company's consolidated operating results for
fiscal 2003.
The unaudited pro forma results of operations set forth below give effect to the
acquisition of ATC as if it had occurred at the beginning of fiscal 2002. Pro
forma data is subject to certain assumptions and estimates, and is presented for
informational purposes only. This data does not purport to be indicative of the
results that would have actually occurred had the acquisition occurred on the
basis described above, nor do they purport to be indicative of future operating
results.
For the years ended February 28, 2003 2002
---------------------------------------------------------------------
(in thousands, except per share data)
Sales and revenues ....................... $ 156,755 $ 165,544
Net income (loss) ........................ (8,449) 3,317
=====================================================================
Basic net income (loss) per share ........ $ (0.51) $ 0.20
Diluted net income (loss) per share ...... (0.51) 0.19
=====================================================================
5. GOODWILL AND INTANGIBLE ASSETS
As discussed within Note 4, the Company's June 2002 acquisition of Gain
Technology Corporation included the acquisition of $7.1 million of finite-lived
intangible assets and $29.8 million of goodwill. 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 value.
As of February 28, 2003, the Company's finite-lived intangible assets consisted
of the following (in thousands):
Accumulated
Cost Amortization Net
------------------------------------------------------------------------------
Existing technologies ...... $ 6,179 $ 772 $ 5,407
Customer contracts ......... 498 154 344
Non-compete agreements ..... 410 153 257
------------------------------------------------------------------------------
$ 7,087 $ 1,079 $ 6,008
==============================================================================
All finite-lived intangible assets are being amortized on a straight-line basis
over their estimated useful lives. Existing technologies have been assigned an
estimated useful life of six years. Customer contracts have been assigned useful
lives of between one and ten years (with a weighted average life of
approximately seven years), and non-compete agreements have been assigned useful
lives of two years. The weighted average useful life of all intangible assets is
approximately six years.
Estimated future intangible asset amortization expense for the next five fiscal
years is as follows (in thousands):
Amortization of
Intangible Assets
---------------------------------------
2004 ........................ $ 1,310
2005 ........................ 1,114
2006 ........................ 1,062
2007 ........................ 1,062
2008 ........................ 1,062
=======================================
6. BUSINESS RESTRUCTURING
In November 2001, the Company's Board of Directors approved management's plan to
exit the PC chipset business, redirect the Company's resources, and increase its
focus on leveraging its core technologies toward higher growth, higher margin
businesses. This restructuring was announced on December 3, 2001. The decision
to exit this business was based upon an assessment of the PC chipset
marketplace, and management's conclusions that the opportunities for
profitability in this marketplace had declined, and the costs of entry had
increased, to a point where further investments in PC chipset technology were
not justified.
As a result of this restructuring, the Company recorded charges of $9.0 million
in fiscal 2002, of which $7.7 million was classified within operating expenses
and $1.3 million was classified within cost of goods sold on the Consolidated
Statement of Operations. In fiscal 2003, the Company reduced these charges by
$0.2 million, after reassessing its remaining obligations under this
restructuring plan.
A summary of the restructuring charge is as follows (in thousands):
Excess and Non-cancelable
Impairments Obsolete Workforce Lease Other
of Assets Inventory Reduction Obligations Charges Total
- -------------------------------------------------------------------------------------------------------------------------------
Charged to expense ................... $ 5,340 $ 1,275 $ 309 $ 1,870 $ 215 $ 9,009
Non-cash charges ..................... (5,190) (1,275) - - (15) (6,480)
Cash payments ........................ - - (307) (99) (19) (425)
- -------------------------------------------------------------------------------------------------------------------------------
Business restructuring reserve at
February 28, 2002 .................. 150 - 2 1,771 181 2,104
Cash payments ........................ - - - (397) (21) (418)
Non-cash charges ..................... - - - - (20) (20)
Adjustment to expense ................ (150) - (2) - (95) (247)
- -------------------------------------------------------------------------------------------------------------------------------
Business restructuring reserve at
February 28, 2003 ................. $ - $ - $ - $ 1,374 $ 45 $ 1,419
===============================================================================================================================
Impairment of Assets
All assets identified as specifically utilized in the Company's PC chipset
development activities were evaluated for possible future use, and those assets
for which there was no alternative future use were written off. Most of these
assets consisted of software and intellectual property used in the design and
development of integrated circuits, many of which were acquired by
non-exclusive, non-transferable licenses. These assets were classified as held
for disposal, which was effected through abandonment of their use. One asset,
which was originally acquired specifically to support the Company's PC chipset
activities, was determined to have alternative future use within the Company's
ongoing operations. An impairment charge of $1.9 million was recorded on this
asset, based upon an assessment of its fair value through comparison to market
values of assets providing functionality similar to the asset's future use.
Excess and Obsolete Inventory
The Company's inventory of PC chipset products, built primarily in anticipation
of future design wins, was determined to have minimal net realizable value and
was written down accordingly.
Workforce Reduction
As a result of this restructuring, and in line with the sustained economic
difficulties of the semiconductor marketplace, the Company eliminated 55
positions, or 11% of its work force, during the third quarter of fiscal 2002.
Most of the positions eliminated were within the Company's engineering and
development staff. This workforce reduction resulted in a $0.3 million charge
for severance benefits.
Non-cancelable Lease Obligations
The workforce reduction created idle floor space at two of the Company's leased
facilities, both of which are subject to long-term, non-cancelable lease
obligations. The restructuring charge included $1.9 million to cover the cost of
this idle space, which was based upon the ratio of idle floor space to total
floor space at each location.
The Company completed its restructuring program during the fourth quarter of
fiscal 2002. Substantially all of the cash payments related to the workforce
reduction were made in that period. Payments related to non-cancelable lease
obligations will be paid over their respective terms, through August 2008.
The restructuring had minimal impact on product sales, as the Company had yet to
achieve significant product sales of PC chipset products.
7. TECHNOLOGY AND PATENT LICENSE 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 between the two companies, covering manufacturing processes and
products, thereby providing each company access to the other's current and
future patent portfolios.
In September 1999, the two companies announced a technology exchange agreement
(the Agreement) that would allow SMSC to accelerate its then ongoing development
of Intel compatible chipset products. Chipset products are integrated circuits
that communicate with the microprocessor (CPU) and assist in controlling the
flow of information within a personal computer or similar application. The
Agreement provided, among other things, for Intel to transfer certain
intellectual property related to Intel chipset architectures to SMSC, and
continues to provide SMSC the opportunity to supply Intel chipset components
along with its own chipset solutions. The Agreement also limited SMSC's rights
regarding Northbridges and Intel Architecture Microprocessors under the 1987
agreement.
The Agreement included provisions for its termination under certain
circumstances. Under one such provision, beginning in the third year of the
Agreement and annually thereafter, SMSC could elect to terminate the Agreement
should SMSC not achieve certain minimum chipset revenue amounts set forth in the
Agreement, unless Intel paid SMSC an amount equal to the shortfall between the
minimum revenue amount and the actual revenue for that period. Upon the
Agreement terminating under this provision, the limitations imposed by the
Agreement on the Northbridge rights under the 1987 agreement would terminate
immediately, and the limitations imposed by the Agreement on the microprocessor
rights under the 1987 agreement would terminate twelve months later. Should
Intel elect to make the revenue amount shortfall payment, the provisions of the
Agreement would remain in force for the subsequent twelve-month period, for
which another minimum revenue amount would be applicable, and at the end of
which a similar termination event would arise. Minimum chipset revenue amounts
were $30 million, $45 million, and $60 million for the twelve months ending
September 21, 2001, 2002, and 2003, respectively, increasing by 10% for each
succeeding twelve-month period following 2003, until expiration of the Agreement
in July 2007.
In September 2001, pursuant to the provisions described in the preceding
paragraph, SMSC notified Intel of a chipset revenue shortfall of approximately
$29.6 million for the twelve months ended September 21, 2001. In November 2001,
the Company received a $29.6 million payment from Intel, which is reported as
intellectual property revenue on the Company's Consolidated Statement of
Operations for fiscal 2002.
In September 2002, SMSC notified Intel of a chipset revenue shortfall of
approximately $44.9 million for the 2002 twelve-month period. Intel did not make
a payment to SMSC of that shortfall within the time frame specified within the
Agreement, and SMSC gave Intel notice of termination of the Agreement in
accordance with the terms thereof. The Company and Intel have commenced
discussions regarding their various corporate and intellectual property
relationships, including under the Agreement. However, there can be no assurance
as to the outcome of those discussions.
8. DISCONTINUED OPERATIONS
In March 1999, the Company's Board of Directors approved a plan for the Company
to divest its Foundry Business Unit (FBU). This divestiture was completed on
June 1, 1999, with the Company selling the assets of the FBU to privately held
Inertia Optical Technology Applications, Inc. (IOTA) of Newark, New Jersey, in
exchange for 38% of IOTA's outstanding common stock. The combined businesses
began operating as Standard MEMS, Inc. (SMI).
The Company reported the operating results, net assets and cash flows of the FBU
as a discontinued operation, and recorded a pre-tax charge of $15.2 million in
fiscal 1999, covering write-downs of certain assets, pre-closing operating
losses, and other costs associated with the transaction. In fiscal 2000, the
Company recorded a $4.2 million adjustment to reduce the loss on the disposition
of this operation, reflecting a previously reserved income tax benefit, as well
as an adjustment of estimated final disposition costs. During fiscal 2001, the
Company sold the majority of its ownership interest in SMI and realized an
after-tax gain of $4.8 million, which appears as a Gain on sale of discontinued
operation on the Consolidated Statement of Operations for the year ended
February 28, 2001. This sale of SMI stock reduced the Company's ownership
interest in SMI below 5%.
The Company has been involved in several legal actions relating to past
divestitures of divisions and business units. These divestitures were accounted
for as discontinued operations and, accordingly, costs associated with these
actions are reported as a Loss from discontinued operations on the Consolidated
Statements of Operations. These costs totaled $0.8 million, before applicable
income tax benefits of $0.3 million, for the year ended February 28, 2003, and
$2.5 million, before applicable income tax benefits of $0.9 million, for the
year ended February 28, 2002. These costs were nominal for the year ended
February 28, 2001.
9. INVESTMENTS AND IMPAIRMENT CHARGES
Investment in Chartered Semiconductor
During fiscal 1996, the Company entered into an agreement with Singapore-based
Chartered Semiconductor Manufacturing Ltd. (Chartered), whereby the Company
acquired a minority equity interest of less than 2% in Chartered for $19.9
million. Under the terms of this agreement, the Company is allocated wafer
production capacity in Chartered's wafer fabrication facilities.
In October 1999, shares of Chartered began trading publicly on the Singapore
stock exchange, and also began trading on the Nasdaq stock market as American
Depository Shares, or ADSs.
Other income (expense), net reported in fiscal 2001 reflects gains realized on
the sales of portions of the Company's investment in Chartered, as well as
proceeds from sales of call options covering a portion of its Chartered stock
holdings. The gains totaled $24.2 million in fiscal 2001, while proceeds from
the sales of call options, none of which were exercised, were $2.2 million
during the same period. No sales of this investment or related call options were
executed in either fiscal 2003 or fiscal 2002.
During the third quarter of fiscal 2003, the Company recorded a $7.8 million
charge for a decline in value, considered to be other than temporary, of its
equity investment in Chartered, based upon a sustained reduction in Chartered's
stock price performance, reducing the cost basis of the remaining investment to
$2.9 million.
As of February 28, 2003, the Company held approximately 444,000 of its original
828,000 Chartered ADSs, which are reported on the Consolidated Balance Sheet at
$1.8 million, based upon their closing price on the Nasdaq Stock Market on that
date. This further decline in value, as compared to the investment's cost basis
as adjusted in the third quarter of fiscal 2003, is reported as a component of
Accumulated other comprehensive income on the Company's Consolidated Balance
Sheet. If Chartered's stock continues to trade below the Company's adjusted cost
basis, further write-downs of this investment in the future are possible.
The investment in Chartered stock represents the only material investment in
equity securities of other companies on the Company's February 28, 2003
Consolidated Balance Sheet.
Investment in SMC Networks, Inc.
As more fully described within Note 15, the Company's investment in SMC
Networks, Inc. is a residual minority equity interest in a non-public company
sold by SMSC in 1997. Based upon a valuation analysis performed by the Company
with the assistance of a third party during the third quarter of fiscal 2003,
this investment, which carried an original cost of $8.5 million, was fully
written off in the third quarter of fiscal 2003.
Other Long-Term Equity Investments
The Company held an equity investment of less than 1% in a publicly traded
company, all of which was sold over the past three fiscal years, resulting in a
nominal pre-tax gain in fiscal 2003, and pre-tax gains of $1.1 million and $2.0
million in fiscal 2002 and 2001, respectively.
During third and fourth quarters of fiscal 2002, the Company recorded charges
totaling $0.7 million to write down two cost-basis investments in privately held
companies. Management concluded that these investments had experienced
impairments in value considered to be other than temporary. Both investments now
carry no net book value.
All gains and losses related to these equity investments are included within
Other income (expense), net, on the Consolidated Statements of Operations.
10. OTHER BALANCE SHEET DATA
(In thousands)
As of February 28, 2003 2002
- -----------------------------------------------------------------------------
Inventories:
Raw materials ......................... $ 761 $ 465
Work-in-process ....................... 7,686 5,820
Finished goods ........................ 9,197 11,300
- -----------------------------------------------------------------------------
$ 17,644 $ 17,585
=============================================================================
Property, plant and equipment:
Land .................................. $ 3,434 $ 3,434
Buildings and improvements ............ 29,927 29,257
Machinery and equipment ............... 81,562 76,121
- -----------------------------------------------------------------------------
114,923 108,812
Less: accumulated depreciation ........ 92,666 84,642
- -----------------------------------------------------------------------------
$ 22,257 $ 24,170
=============================================================================
Other assets:
Common stock of SMC Networks, Inc. .... $ - $ 8,452
Other ................................. 5,758 7,281
- -----------------------------------------------------------------------------
$ 5,758 $ 15,733
=============================================================================
Accrued expenses, income taxes and
other liabilities:
Salaries and fringe benefits .......... $ 2,322 $ 2,358
Current maturities of long-term debt .. 1,756 890
Business restructuring obligations
(current portion) .................... 459 726
Other ................................. 5,301 5,315
- -----------------------------------------------------------------------------
$ 9,838 $ 9,289
=============================================================================
Other liabilities:
Retirement benefits ................... $ 5,811 $ 5,395
Business restructuring obligations .... 960 1,378
Other ................................. 608 200
- -----------------------------------------------------------------------------
$ 7,379 $ 6,973
=============================================================================
11. SALES OF FACILITIES
During the first quarter of fiscal 2002, the Company sold two underutilized
facilities. Combined proceeds from these sales were $2.1 million, before related
expenses, and the sales resulted in a net pre-tax gain of approximately $0.6
million, which is included within Other income (expense), net.
12. SHAREHOLDERS' EQUITY
Common Stock Repurchase Program
In July 2002, the Company's Board of Directors approved an increase in the
number of shares authorized for repurchase under the Company's common stock
repurchase program by one million shares, bringing the total number of shares
authorized for repurchase under the program to three million. This program
allows the Company to repurchase shares of its common stock on the open market
or in private transactions. As of February 28, 2003, the Company had repurchased
approximately 1.8 million shares of common stock at a cost of $23.5 million
under this program, including 482,000 shares repurchased in fiscal 2003 at a
cost of $9.6 million, 340,000 shares repurchased in fiscal 2002 for $5.5
million, and 327,000 shares repurchased in fiscal 2001 for $4.0 million. The
Company currently holds repurchased shares as treasury stock, reported at cost.
Shareholder Rights Plan
The Company maintains a Shareholder Rights Plan as part of its commitment to
ensure fair value to all shareholders in the event of an unsolicited takeover
offer. The Company's current Shareholder Rights Plan was adopted by the Board of
Directors in January 1998, replacing the Company's previous plan that had
expired on January 12, 1998, and was subsequently amended in December 2000 and
in April 2002. Under this plan, the Company's shareholders of record on January
13, 1998 received a dividend distribution of one preferred stock purchase right
for each share of common stock then held, and any new stock issued after the
record date contains the same rights. In the event of certain efforts to acquire
control of the Company, these rights allow shareholders to purchase common stock
of the Company at a discounted price. The rights will expire in January 2008,
unless previously redeemed by the Company at $.01 per right. Citigroup, Inc.'s
(Citigroup) ownership of the Company's common stock is excluded from requiring
distribution of rights under the plan, so long as Citigroup remains a passive
investor and its ownership interest does not exceed 28%. As of December 31,
2002, Citigroup was the beneficial owner of approximately 20% of the Company's
common stock.
Investment by Intel Corporation
In March 1997, the Company and Intel Corporation (Intel) entered into a Common
Stock and Warrant Purchase Agreement (the Agreement) whereby Intel purchased
1,543,000 newly issued shares of the Company's common stock for $9.50 per share,
or $14.7 million. Intel also received a three-year warrant to purchase an
additional 1,543,000 shares. In March 2000, as provided for in the warrant,
Intel executed a "net exercise", whereby Intel was issued 200,000 shares of the
Company's common stock, which was equal in fair value to the excess of the
warrant's market value over its exercise value, as defined in the Agreement. The
Company immediately repurchased these 200,000 shares from Intel for $1.9 million
under its common stock repurchase program. This warrant is now fully exercised.
So long as Intel continues to hold its initial investment, the Agreement
provides Intel a right of first refusal upon certain corporate transactions,
including proposed sales of all or substantially all of the assets of the
Company, certain sales of common stock of the Company and certain other
transactions which would result in or relating to a change in control of the
Company. The Agreement also provides Intel certain other rights, including
demand registration rights with respect to shares acquired under the Agreement,
a right for Intel to designate a representative to serve on the Company's Board
of Directors, and antidilution rights. The Agreement also imposes certain
restrictions upon Intel, including limitations, in certain circumstances, on
Intel's ability to acquire additional shares of the Company's common stock
(referred to as a standstill arrangement), and restrictions on the transfer of
shares acquired pursuant to the Agreement.
13. INCOME TAXES
The provision for income taxes included in the accompanying Consolidated
Statements of Operations consists of the following (in thousands):
For the years ended February 28, 2003 2002 2001
- --------------------------------------------------------------------------------
Current
Federal ............................... $ (3,119) $ 5,308 $ 7,684
Foreign ............................... 327 241 602
State ................................. 147 176 149
- --------------------------------------------------------------------------------
(2,645) 5,725 8,435
Deferred ................................ (4,058) (3,472) 5,216
- --------------------------------------------------------------------------------
(6,703) 2,253 13,651
Less: tax provision for (benefit from)
discontinued operations ............... (281) (918) 2,799
- --------------------------------------------------------------------------------
$ (6,422) $ 3,171 $ 10,852
- --------------------------------------------------------------------------------
The tax provisions for and benefits from discontinued operations represent the
taxes resulting from gains and losses related to the Company's previous sale of
former divisions, which were accounted for as discontinued operations. These
gains and losses are further described in Note 8.
The provision for (benefit from) income taxes related to continuing operations
differs from the amount computed by applying the U.S. federal statutory tax rate
as a result of the following:
For the years ended February 28, 2003 2002 2001
- --------------------------------------------------------------------------------
Provision for (benefit from) income taxes
computed at U.S. federal statutory rate .. (35.0)% 35.0% 35.0%
State taxes, net of federal benefit ........ (0.8) 1.0 0.2
Differences between foreign
and U.S. income tax rates ................ 1.5 (0.7) 0.7
Tax-exempt income .......................... (1.7) (4.5) (2.2)
Export sales benefit ....................... (6.5) - -
Tax credits ................................ (4.6) (1.9) (1.0)
Other ...................................... (0.9) 0.8 0.1
- --------------------------------------------------------------------------------
(48.0)% 29.7% 32.8%
- --------------------------------------------------------------------------------
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The components of the
Company's deferred tax benefits are as follows (in thousands):
As of February 28, 2003 2002
- --------------------------------------------------------------------------------
Deferred tax assets:
Reserves and accruals not currently
deductible for income tax purposes ................. $ 5,307 $ 5,186
Inventory valuation .................................. 2,416 3,372
Intangible asset amortization ........................ 379 2,124
Restructuring costs .................................. 2,321 2,553
Purchased in-process technology ...................... 1,058 1,179
Property, plant and equipment depreciation ........... 347 503
Impairment charges on investments .................... 5,707 -
Net operating losses ................................. 1,449 -
Other, net ........................................... 1,340 861
- --------------------------------------------------------------------------------
Net deferred tax assets .............................. $ 20,324 $ 15,778
- --------------------------------------------------------------------------------
Income (loss) before income taxes and minority interest includes foreign income
of $0.2 million, $0.7 million and $0.9 million for fiscal 2003, 2002 and 2001,
respectively.
At February 28, 2003, the Company had federal net operating losses totaling
$11.7 million. Of this amount, $4.1 million is attributable to the June 2002
acquisition of Gain Technology Corporation and is subject to certain limitations
under Section 382 of the Internal Revenue Code. The remaining $7.6 million
results from the Company's fiscal 2003 operating results, the tax effect of
which is reflected on the Consolidated Balance Sheet at February 28, 2003 as a
receivable within Other current assets. The Company also has $2.5 million of New
York State tax credit carryforwards at the end of fiscal 2003, of which $0.1
million will expire in fiscal 2004. The remaining $2.4 million of credit
carryforwards expire at various dates in fiscal 2005 through fiscal 2016.
14. MINORITY INTEREST IN SUBSIDIARY
Sumitomo Metal Industries, Ltd. of Osaka, Japan (Sumitomo) owns 20% of the
issued and outstanding common stock and all of the non-cumulative, non-voting 6%
preferred stock of the Company's subsidiary, SMSC Japan. This subsidiary,
formerly known as Toyo Microsystems Corporation, was renamed Standard
Microsystems K.K. in March 2002, and is now doing business as SMSC Japan.
The Company and Sumitomo have agreed to declare a preferred dividend if SMSC
Japan should realize net income of at least five times the total amount of
preferred dividends which would be payable on all preferred stock then
outstanding. The annual preferred dividend would be equal to 6% of the
subscription price of 2.16 billion yen, or approximately $1.1 million, at an
exchange rate of 118 yen per dollar. No such dividends have as yet been
declared. In the event that a third party acquires a majority of the outstanding
common stock of the Company, Sumitomo has the option to require the Company to
purchase Sumitomo's interest in SMSC Japan.
15. COMMITMENTS AND CONTINGENCIES
Compensation
Certain executives and key employees are employed under separate agreements
terminating on various dates through fiscal 2006. These agreements provide,
among other things, for annual base salaries totaling $1.5 million, $0.8 million
and $0.2 million in fiscal 2004, 2005 and 2006, respectively.
Leases
The Company and its subsidiaries lease certain facilities and equipment under
operating leases. The facility leases generally provide for the lessee to pay
taxes, maintenance, and certain other operating costs of the leased property.
The Company also leases certain equipment under long-term capital leases, some
of which include options to purchase the equipment for a nominal cost at the
termination of the lease.
At February 28, 2003, future minimum lease payments for non-cancelable lease
obligations are as follows (in thousands):
Capital Operating
Leases Leases
- ---------------------------------------------------------------------
2004 ................................. $ 365 $ 2,306
2005 ................................. 55 1,801
2006 ................................. 23 888
2007 ................................. - 834
2008 ................................. - 692
Thereafter ........................... - 497
- ---------------------------------------------------------------------
Total minimum lease payments ......... 443 $ 7,018
Less: Amount representing interest ... 27 ==========
- -----------------------------------------------------
Present value of minimum
lease payments ...................... 416
Less: Current obligation ............. 343
- -----------------------------------------------------
Long-term obligation ................. $ 73
=====================================================
Included within property and equipment are the following assets held under
capital leases (in thousands):
As of February 28, 2003 2002
- -----------------------------------------------------------------------
Machinery and equipment ................ $ 4,910 $ 4,709
Less: Accumulated depreciation ......... (4,132) (3,265)
- -----------------------------------------------------------------------
$ 778 $ 1,444
=======================================================================
Total rent expense for all operating leases was $1.7 million, $1.8 million and
$1.9 million in fiscal 2003, 2002 and 2001, respectively.
The Company leases one of its buildings and related improvements to an outside
party under a non-cancelable operating lease. At February 28, 2003, the cost and
accumulated depreciation of the leased facility was $7.2 million and $4.9
million, respectively.
Future minimum rental income under this operating lease for the next five fiscal
years and thereafter is as follows (in thousands):
Rental
Income
-----------------------------------------------
2004 .............................. $ 398
2005 .............................. 421
2006 .............................. 445
2007 .............................. 470
2008 .............................. 498
2009 and thereafter ............... 1,225
- ----------------------------------------------------
$ 3,457
====================================================
Litigation
The Company is subject to various lawsuits and claims in the ordinary course of
business. While the outcome of these matters cannot be determined, management
believes that their ultimate resolution will not have a material effect on the
Company's operations or financial position.
In October 1997, the Company sold an 80.1% interest in SMC Networks, Inc., a
then-newly formed subsidiary comprised of its former local area networking
division, to an affiliate of Accton Technology Corporation (Accton). In
consideration for the sale, the Company received $38.2 million in cash, plus an
additional $2.0 million which was placed in an interest-bearing escrow account
as security for the Company's indemnity obligations under the agreement, and
which was scheduled for release to the Company in January 1999. The Company's
19.9% minority interest in SMC Networks, Inc. carried an original cost of $8.5
million. Further discussion regarding this investment appears within Note 9.
In December 1998, Accton notified the Company and the escrow agent of Accton's
intention to seek indemnification and damages from the Company in excess of
$10.0 million by reason of alleged misrepresentations and inadequate disclosures
relating to the transaction and other alleged breaches of covenants and
representations in the related agreements. Based upon those allegations, the
escrow account was not released to the Company as scheduled in January 1999. In
January 1999, SMSC filed an action in the Supreme Court of New York (the Action)
against Accton, SMC Networks, Inc. and other parties, seeking the release of the
escrow account to the Company on the grounds that Accton's allegations are
without merit, and seeking payment of approximately $1.6 million owed to the
Company by SMC Networks, Inc. In November 1999, the Court issued an order
staying the Action and directed the parties to arbitration under the arbitration
provisions of the original transaction agreements. The parties are proceeding
with arbitration and, in July 2000, the Company asserted various claims against
Accton and its affiliates, including claims for fraud, improper transfer of
profits, mismanagement, breach of fiduciary duties and payment default.
The Company remains confident that it negotiated and fully performed its
obligations under the agreements with Accton in good faith and considers the
claims against it to be without merit. The Company is vigorously defending
itself against the allegations made by Accton and, although it is not possible
at this time to assess the likelihood of any liability being established,
expects that the outcome will not be material to the Company. Furthermore, the
Company is vigorously pursuing recovery of damages and other relief from Accton
pursuant to the Company's claims, but the likelihood of any such recovery also
cannot currently be established.
16. BENEFIT AND INCENTIVE PLANS
Incentive Savings and Retirement Plan
The Company maintains a defined contribution Incentive Savings and Retirement
Plan (the Plan) which, pursuant to Section 401(k) of the Internal Revenue Code,
permits employees to defer taxation on their pre-tax contributions to the Plan.
The Plan permits employees to contribute up to 15% of their earnings, through
payroll deductions, based on earnings reduction agreements. The Company makes
matching contributions to the Plan in the form of SMSC common stock. The
Company's matching contribution to the plan is equal to two-thirds of the
employee's contribution, up to 6% of the employee's earnings. The Company's
matching contributions to the Plan totaled $1.0 million, $0.9 million and $0.7
million in fiscal 2003, 2002 and 2001, respectively.
Since July 2000, common stock for the Company's matching contributions to the
Plan has been purchased in the open market. Previously, newly issued common
stock was contributed to the Plan from authorized reserves. Since its inception,
1,334,000 shares of the Company's common stock have been contributed to the
Plan.
As of February 28, 2003, 336 of the 422 employees who had satisfied the Plan's
eligibility requirements to participate were making contributions to the Plan.
Employee Stock Option Plans
Under the Company's stock option plans, the Compensation Committee of the Board
of Directors is authorized to grant options to purchase shares of common stock.
The purpose of these plans is to promote the interests of the Company and its
shareholders by providing officers and key employees with additional incentives
and the opportunity, through stock ownership, to increase their proprietary
interest in the Company and their personal interest in its continued success.
Options are granted at prices not less than the fair market value on the date of
grant. As of February 28, 2003, 459,000 shares of common stock were available
for future grants of stock options or restricted stock awards.
Stock option plan activity is summarized below (shares in thousands):
Fiscal Weighted Fiscal Weighted Fiscal Weighted
2003 Average 2002 Average 2001 Average
Shares Exercise Shares Exercise Shares Exercise
Price Price Price
- ------------------------------------------------------------------------------------------------------------------------
Options outstanding, beginning of year ...... 4,063 $ 12.52 3,500 $ 12.17 2,510 $ 9.10
Granted ..................................... 1,732 21.71 1,138 13.95 1,581 16.11
Exercised ................................... (407) 10.79 (175) 9.49 (287) 8.98
Canceled or expired ......................... (610) 21.30 (400) 14.86 (304) 10.38
- ------------------------------------------------------------------------------------------------------------------------
Options outstanding, end of year ............ 4,778 $ 14.87 4,063 $ 12.52 3,500 $ 12.17
- ------------------------------------------------------------------------------------------------------------------------
Options exercisable ......................... 1,594 $ 12.27 1,110 $ 11.40 565 $ 9.54
- ------------------------------------------------------------------------------------------------------------------------
The following table summarizes information relating to currently outstanding and
exercisable options as of February 28, 2003 (shares in thousands):
Weighted Average
Range of Remaining Lives Options Weighted Average Options Weighted Average
Exercise Prices (in years) Outstanding Exercise Prices Exercisable Exercise Prices
- -----------------------------------------------------------------------------------------------------------------------
$6.250 - $9.500 5.78 1,070 $ 7.96 608 $ 8.32
$9.564 - $14.093 7.44 1,345 13.17 612 13.19
$14.187 - $17.343 8.33 991 15.42 209 15.39
$17.375 - $22.350 8.89 1,179 21.25 137 18.57
$22.380 - $24.950 8.74 193 23.33 28 23.83
- -----------------------------------------------------------------------------------------------------------------------
4,778 1,594
- -----------------------------------------------------------------------------------------------------------------------
Director Stock Option Plan
Under the Company's Director Stock Option Plan, non-qualified options to
purchase common stock may be granted to directors at prices not less than the
market price of the shares at the date of grant. At February 28, 2003, the
expiration dates of the outstanding options under this plan range from July 22,
2006 to January 15, 2013, and the exercise prices range from $8.50 to $20.25
(average $15.03) per share.
The following is a summary of activity under the Director Stock Option Plan over
the past three fiscal years (shares in thousands):
Fiscal Weighted Fiscal Weighted Fiscal Weighted
2003 Average 2002 Average 2001 Average
Shares Exercise Shares Exercise Shares Exercise
Prices Prices Prices
- ------------------------------------------------------------------------------------------------------------------------------------
Options outstanding,
beginning of year ...................... 261 $ 2.78 213 $ 12.27 218 $ 11.03
Granted ................................. 102 17.29 48 15.02 50 18.25
Exercised ............................... (92) 11.11 --- --- (55) 12.71
- ------------------------------------------------------------------------------------------------------------------------------------
Options outstanding, end of year ........ 271 $ 15.03 261 $ 12.78 213 $ 12.27
- ------------------------------------------------------------------------------------------------------------------------------------
Options exercisable ..................... 269 $ 14.98 247 $ 12.61 188 $ 11.88
- ------------------------------------------------------------------------------------------------------------------------------------
Shares available for
future grants, end of year ............. 92 194 ---
- ------------------------------------------------------------------------------------------------------------------------------------
Director Deferred Compensation Plan
The Company has a deferred compensation plan for its non-employee directors,
which permits eligible directors to defer 50% or 100% of their basic annual
compensation, which is otherwise paid in cash. During fiscal 2001, the plan was
modified to require deferral of at least 50% of basic annual compensation by all
plan participants. Under this plan, an unfunded account is established for each
participating director, which is credited with equivalent units of the Company's
common stock on the first day of each quarter. These equivalent units track the
economic performance of the underlying stock, but carry no voting rights. The
deferred compensation earned under this plan is payable when the participant
leaves the Company's Board of Directors, for any reason, and, for current
directors, is paid in either common stock or an equivalent amount of cash, at
the election of the director. During fiscal 2003, the plan was further modified
to eliminate the option of paying the deferred compensation in cash for future
participants in the plan. Compensation expense under this plan was $0.1 million
in each of fiscal 2003, 2002 and 2001, respectively.
The following is a summary of the activity under this plan (units in thousands):
For the years ended February 28, 2003 2002 2001
- --------------------------------------------------------------------------------
Common stock equivalent units,
beginning of year ............... 31 25 23
Common stock equivalent units
earned during the year .......... 4 6 6
Common stock distributed during
the year ........................ - - (4)
- --------------------------------------------------------------------------------
Common stock equivalent units,
end of year ..................... 35 31 25
- --------------------------------------------------------------------------------
Common stock equivalent units
available, end of year .......... 65 69 75
- --------------------------------------------------------------------------------
Range of common stock prices
used to calculate common stock
equivalent units ................ $16.43-$22.60 $9.73-$17.10 $14.38 - $20.25
- --------------------------------------------------------------------------------
Restricted Stock Awards
The Company provides common stock awards to certain officers and key employees.
Awards granted under the plan are typically earned in 25%, 25% and 50%
increments on the first, second and third anniversaries of the award,
respectively. The shares granted are distributed provided the employee has
remained employed by the Company through such anniversary dates; otherwise the
unearned shares are forfeited. The market value of these shares at the date of
award is recorded as compensation expense ratably over the three-year periods
from the respective award dates, as adjusted for forfeitures of awards that did
not vest. Deferred compensation expense of $2.1 million and $1.4 million
associated with unearned shares under this plan as of February 28, 2003 and
2002, respectively, is reported within Additional paid-in capital on the
Company's Consolidated Balance Sheets. Compensation expense for these awards was
$0.9 million, $0.7 million and $0.4 million in fiscal 2003, 2002 and 2001,
respectively.
Through February 28, 2003, 237,000 shares, net of cancellations, have been
awarded under this plan. The Company, at its discretion, can grant restricted
stock awards from the shares available under its 2001 Stock Option and
Restricted Stock Plan. As of February 28, 2003, the Company had 459,000 shares
available for the issuance of stock options and restricted stock awards.
Retirement Plans
In October 2000, the Board of Directors terminated all additional benefits for
active non-employee directors under its Directors Retirement Plan, other than
those benefits already earned, effective in January 2001. Affected directors
were offered the opportunity to retain their vested retirement benefit, or to
exchange that retirement benefit for a restricted stock grant. In January 2001,
a combined 28,000 shares of restricted common stock valued at $0.6 million were
granted to certain directors in exchange for their respective benefits under the
Directors Retirement Plan. Those directors who chose to retain their retirement
benefits, as well as all retired non-employee directors, will continue to
receive benefits under the terms of the original plan, as modified. The annual
retirement benefit is equal to the annual retainer in effect at the date of
retirement or December 31, 2000, whichever is earlier, for a period equal to the
lesser of the director's years of service through December 31, 2000 or ten
years. Following the completion of all payments to current participants, the
Directors Retirement Plan will terminate. Retirement expense recorded under this
plan was $0.1 million in each of fiscal 2003 and 2002, respectively, and was a
nominal amount in fiscal 2001.
The Company maintains an unfunded Supplemental Executive Retirement Plan to
provide senior management with retirement, disability and death benefits. The
Plan's retirement benefits are based upon the participant's average compensation
during the three-year period prior to retirement. The Company is the beneficiary
of life insurance policies that have been purchased as a method of partially
financing these benefits. Based upon the latest available actuarial information,
the following table sets forth the components of the Plan's net periodic pension
expense, the Plan's funded status and the assumptions used in determining the
present value of benefit obligations (dollars in thousands):
For the years ended February 28, 2003 2002 2001
- --------------------------------------------------------------------------------
Service cost - benefits earned
during the year ........................ $ 100 $ 71 $ 80
Interest cost on projected benefit
obligations ............................ 358 346 339
Net amortization and deferral ........... 245 241 244
- --------------------------------------------------------------------------------
Net periodic pension expense ............ $ 703 $ 658 $ 663
- --------------------------------------------------------------------------------
As of February 28, 2003 2002 2001
- --------------------------------------------------------------------------------
Actuarial present value of:
Vested benefit obligation ............ $ 4,586 $ 4,555 $ 3,975
Nonvested benefit obligation ......... 563 287 130
- --------------------------------------------------------------------------------
Accumulated benefit obligation .......... 5,149 4,842 4,105
Effect of projected future salary
increases .............................. 1,479 1,228 809
- --------------------------------------------------------------------------------
Projected benefit obligation ............ 6,628 6,070 4,914
Unrecognized gain or (loss) ............. (754) (379) 565
Unrecognized net transition asset ....... (1,470) (1,715) (1,961)
Additional minimum liability ............ 745 867 587
- --------------------------------------------------------------------------------
Accrued pension cost .................... $ 5,149 $ 4,843 $ 4,105
- --------------------------------------------------------------------------------
Assumptions used in determining actuarial
present value of benefit obligations:
Discount rate ........................... 6.00% 6.00% 7.25%
Weighted average rate of compensation
increase ............................... 7.00% 7.00% 7.00%
- --------------------------------------------------------------------------------
Executive Incentives
The Company's Board of Directors has provided that certain executives receive
incentive compensation based upon certain sales and revenues, earnings and other
performance measures. Incentive compensation of $0.9 million, $0.8 million and
$0.9 million was earned in fiscal 2003, 2002 and 2001, respectively.
17. INDUSTRY SEGMENT, GEOGRAPHIC, CUSTOMER AND SUPPLIER INFORMATION
Industry Segment
The Company operates in a single industry segment in which it designs, develops
and markets semiconductor integrated circuits for the personal computer,
peripheral and embedded systems marketplaces.
Geographic Information
The Company's domestic operations include its worldwide sales and revenues,
exclusive of some of its sales and revenues from customers in Japan, and most of
its operating expenses. The majority of the Company's sales and revenues and
operating profits from customers in Japan are recorded by SMSC Japan. The
Company conducts various sales and marketing operations outside of the United
States through SMSC Japan, and through subsidiaries in Europe and Asia.
The Company's long-lived assets include net property and equipment, and other
long-lived assets. The vast majority of the Company's net property and equipment
is located in the United States. Included within other long-lived assets is an
equity investment in Singapore-based Chartered Semiconductor Manufacturing Ltd.
valued at $1.8 million as of February 28, 2003.
Export Sales
The information below summarizes sales and revenues to unaffiliated customers by
geographic region (in thousands):
For the years ended February 28, 2003 2002 2001
- --------------------------------------------------------------------------------
North America .................. $ 14,712 $ 42,913 $ 37,750
Asia and Pacific Rim ........... 131,903 106,123 101,039
Europe ......................... 8,823 10,157 24,240
Rest of World .................. 79 105 399
- --------------------------------------------------------------------------------
$ 155,517 $ 159,298 $ 163,428
- --------------------------------------------------------------------------------
Significant Customers
Revenues from significant customers, as a percentage of total sales and
revenues, are summarized as follows:
For the years ended February 28, 2003 2002 2001
- --------------------------------------------------------------------------------
Customer A 19.6% 15.2% *
Customer B 12.1% * *
Customer C * 29.0% 11.2%
Customer D 14.3% * *
* Less than 10% of sales and revenues.
Significant Suppliers
The Company does not operate a wafer fabrication facility. Two independent
semiconductor wafer foundries in Asia currently supply substantially all of the
Company's devices in current production. In addition, substantially all of the
Company's products are assembled by one of four independent subcontractors in
Asia.
Concentrations of Credit Risk
The Company sells its products to personal computer and electronic equipment
manufacturers and their subcontractors, and to electronic component
distributors, and maintains individually significant accounts receivable
balances from several of its larger customers. One customer accounts for $7.1
million and $7.5 million of the Company's accounts receivable as of February 28,
2003 and February 28, 2002, respectively. The Company performs credit
evaluations of its customers' financial condition on a regular basis and,
although the Company generally requires no collateral, prepayments or letters of
credit may be required from its customers in certain circumstances. Reserves for
estimated credit losses are maintained and actual losses were not significant
for all years presented.
The Company invests its cash, cash equivalents and short-term investments in a
variety of financial instruments and, by policy, seeks to limit the credit
exposure on these investments through diversification and by restricting the
investments to highly rated securities.
18. QUARTERLY FINANCIAL DATA (UNAUDITED)
(In thousands, except per share data)
Quarter ended May 31 Aug. 31 Nov. 30 Feb. 28
- --------------------------------------------------------------------------------------------------------------------
Fiscal 2003
Product sales $ 33,828 $ 37,948 $ 40,293 $ 42,175
Intellectual property revenues 179 352 305 437
- --------------------------------------------------------------------------------------------------------------------
34,007 38,300 40,598 42,612
Gross profit 15,072 17,111 17,945 19,296
Operating income 27 231 14 798
Income (loss) from continuing operations 433 568 (9,032) 1,060
Loss from discontinued operations (81) (258) (125) (36)
Net income (loss) 352 310 (9,157) 1,024
====================================================================================================================
Basic net income (loss) per share
Income (loss) from continuing operations $ 0.03 $ 0.03 $ (0.54) $ 0.06
Loss from discontinued operations (0.01) (0.01) (0.01) -
- --------------------------------------------------------------------------------------------------------------------
$ 0.02 $ 0.02 $ (0.55) $ 0.06
====================================================================================================================
Diluted net income (loss) per share
Income (loss) from continuing operations $ 0.02 $ 0.03 $ (0.54) $ 0.06
Loss from discontinued operations - (0.01) (0.01) -
- --------------------------------------------------------------------------------------------------------------------
$ 0.02 $ 0.02 $ (0.55) $ 0.06
====================================================================================================================
Average shares outstanding
Basic net income per share 16,060 16,631 16,718 16,748
Diluted net income per share 17,811 18,214 16,718 17,905
Market price per share
High $ 27.65 $ 24.90 $ 22.85 $ 22.43
Low 16.30 16.32 11.80 12.99
====================================================================================================================
Quarter ended May 31 Aug. 31 Nov. 30 Feb. 28
- --------------------------------------------------------------------------------------------------------------------
Fiscal 2002
Product sales $ 30,510 $ 30,120 $ 34,644 $ 33,254
Intellectual property revenues 326 269 29,970 205
- --------------------------------------------------------------------------------------------------------------------
30,836 30,389 64,614 33,459
Gross profit 11,776 12,183 40,299 13,776
Operating income (loss) (4,512) (3,039) 13,591 338
Income (loss) from continuing operations (1,624) (869) 9,195 773
Loss from discontinued operations (245) (307) (116) (896)
Net income (loss) (1,869) (1,176) 9,079 (123)
====================================================================================================================
Basic net income (loss) per share
Income (loss) from continuing operations $ (0.10) $ (0.05) $ 0.57 $ 0.05
Loss from discontinued operations (0.02) (0.02) (0.01) (0.06)
- --------------------------------------------------------------------------------------------------------------------
$ (0.12) $ (0.07) $ 0.56 $ (0.01)
====================================================================================================================
Diluted net income (loss) per share
Income (loss) from continuing operations $ (0.10) $ (0.05) $ 0.56 $ 0.04
Loss from discontinued operations (0.02) (0.02) (0.01) (0.05)
- --------------------------------------------------------------------------------------------------------------------
$ (0.12) $ (0.07) $ 0.55 $ (0.01)
====================================================================================================================
Average shares outstanding
Basic net income (loss) per share 16,102 16,107 16,071 16,018
Diluted net income (loss) per share 16,102 16,107 16,525 17,070
Market price per share
High $ 17.00 $ 17.90 $ 13.82 $ 19.75
Low 12.06 11.79 8.50 12.94
====================================================================================================================
The Company's common stock is traded in the over-the-counter market under the
Nasdaq symbol: SMSC. Trading is reported in the Nasdaq National Market. There
were approximately 898 holders of record of the Company's common stock at April
2, 2003.
The present policy of the Company is to retain earnings to provide funds for the
operation and expansion of its business. The Company has never paid a cash
dividend, and does not expect to pay cash dividends in the foreseeable future.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Standard Microsystems Corporation:
In our opinion, the accompanying consolidated balance sheet as of February 28,
2003 and the related consolidated statements of operations, shareholders' equity
and cash flows present fairly, in all material respects, the financial position
of Standard Microsystems Corporation and its subsidiaries at February 28, 2003,
and the results of their operations and their cash flows for the year then ended
in conformity with accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audit. We conducted our audit of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion. The financial statements of
Standard Microsystems Corporation and its subsidiaries as of February 28, 2002,
and for each of the two years in the period ended February 28, 2002, were
audited by other independent accountants who have ceased operations. Those
independent accountants expressed an unqualified opinion on those financial
statements in their report dated April 4, 2002.
PricewaterhouseCoopers LLP
New York, NY
April 2, 2003
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
THE FOLLOWING REPORT IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN
LLP AND HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP.
To Standard Microsystems Corporation:
We have audited the accompanying consolidated balance sheets of Standard
Microsystems Corporation (a Delaware corporation) and subsidiaries as of
February 28, 2002 and 2001, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended February 28, 2002. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Standard Microsystems
Corporation and subsidiaries as of February 28, 2002 and 2001, and the results
of their operations and their cash flows for each of the three years in the
period ended February 28, 2002, in conformity with accounting principles
generally accepted in the United States.
Arthur Andersen LLP
New York, NY
April 4, 2002