UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________
FORM 10-K
___________________
[x] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended February 28, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 0-7422
___________________
STANDARD MICROSYSTEMS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 11-2234952
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
80 Arkay Drive, Hauppauge, New York 11788
(Address of principal executive offices) (Zip Code)
(631) 435-6000
(Registrant's telephone number, including area code)
___________________
Securities registered pursuant to Section 12(b) of the Act: None
___________________
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.10 par value
Preferred Stock Purchase Rights
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( x )
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes x No ___
Aggregate market value of voting and non-voting common equity held by
non-affiliates of the registrant as of August 31, 2004, based upon the closing
price of the common stock as reported on the NASDAQ National Market on such date
was approximately $289,615,000. As of March 31, 2005 there were 20,847,386
shares of the registrant's common stock outstanding.
Documents Incorporated By Reference
Portions of the registrant's Proxy Statement for the 2005 Annual Meeting of
Shareholders are incorporated by reference into Part II and Part III of this
report on Form 10-K.
Standard Microsystems Corporation
Form 10-K
For the Fiscal Year Ended February 28, 2005
TABLE OF CONTENTS
PART I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accounting Fees and Services
PART IV
Item 15. Exhibits and Financial Statement Schedules
Portions of this Form 10-K contain forward-looking statements concerning various
aspects of the Company's business, including its strategy, product development
efforts, and litigation. These statements involve numerous risks and
uncertainties including those discussed throughout this document. For a further
explanation and details of some of these risks, please refer to "Other Factors
That May Affect Future Operating Results" within Part II, Item 7.
PART I
------
Item 1. Business.
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General Description of the Business
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Standard Microsystems Corporation (the Company, the Registrant, or SMSC) is a
Delaware corporation, organized in 1971. As used herein, the terms Company,
Registrant and SMSC include the Company's subsidiaries, except where the context
otherwise requires.
Many of the world's most successful global technology companies rely upon SMSC
as a go-to resource for semiconductor system solutions that span analog, digital
and mixed-signal technologies. Leveraging substantial intellectual property,
integration expertise and a comprehensive global infrastructure, SMSC solves
design challenges and delivers performance, space, cost and time-to-market
advantages to its customers. SMSC's application focus targets key vertical
markets including mobile and desktop PCs, servers, consumer electronics,
automotive infotainment and industrial applications. The Company has developed
leadership positions in its select markets by providing application specific
solutions such as mixed-signal PC system controllers, non-PCI Ethernet, ARCNET,
MOST, USB2.0 and other high-speed serial communications.
SMSC is headquartered in Hauppauge, New York with operations in North America,
Taiwan, Japan, Korea, China, Singapore and Europe. Engineering design centers
are located in Arizona, New York, Texas and Karlsruhe, Germany. Additional
information is available at www.smsc.com.
Principal Products of the Company
- ---------------------------------
The Company supplies semiconductor devices in three major product platforms:
Connectivity Solutions, Networking Products and Computing Platform Solutions.
Connectivity Solutions - These products provide system level semiconductor
solutions incorporating USB2.0 and other high-speed serial interfaces, enabling
interoperability and connectivity in consumer electronics, multimedia computing
and mobile storage applications. This product family addresses the marketplace's
increasing requirements for high-speed data transfer of information between
diverse systems platforms, utilizing standardized interface protocols. SMSC's
products participate in several product areas within the USB connectivity
market, including hubs, flash card readers and mass storage devices. USB2.0's
ease-of-use and speed have made it the standard to access, share, store and
manipulate high quality media content. Designers are attracted to USB2.0's
plug-and-play features as well as its strong software support and predictable
software development requirements. The ubiquity of USB2.0 silicon and software
makes it a cost-effective choice for designers to add a high-speed serial data
pipe for transferring media content.
Product offerings within SMSC's connectivity solutions product line include:
o Hub controllers, including solutions for 2-port, 3-port, 4-port and
7-port designs.
o Flash card reader products, including controllers supporting up to 15
different flash memory card formats in a single device.
o Mass storage drive controller products, including USB 1.1-based floppy
disk controller devices and USB-to-ATAPI bridges targeted for small
hard disk drives and optical storage devices.
o Standalone USB2.0 physical layer transceiver (PHY) products addressing
UTMI and ULPI interfaces, ideal for portable handheld electronics
devices such as digital still cameras, PDAs, cell phones and MP3
players.
Networking Products - In business environments, on factory floors and in the
home, there continues to be a rapidly expanding demand for computers, machinery,
appliances and other applications to be networked together. The Company's
networking products provide 10/100 Ethernet and ARCNET based solutions offering
design flexibility and optimized throughput for embedded networking applications
in business, industrial and consumer markets.
Ethernet has emerged as an effective and pervasive protocol in networking
technology. The Company's Ethernet solutions are non-PCI based, allowing
designers to effectively incorporate Ethernet connectivity without the need for
a PCI bus, thereby eliminating the additional cost and overhead associated with
using and supporting the PCI bus. SMSC supplies Ethernet connectivity solutions
for embedded applications in consumer electronics, industrial equipment and
enterprise hardware. The bulk of SMSC's networking growth is currently being
derived from consumer electronics design wins, as digital televisions, set-top
boxes and DVD/HDD recorders have all rapidly adopted Ethernet technology. These
devices are increasingly adding networking capabilities to broaden their
feature-sets and attractiveness to the end consumer. Now, many of these devices
are evolving into home media servers using Ethernet networks to transmit or
stream content around the home.
ARCNET and CircLink(TM), an ARCNET derivative, provide connectivity solutions
that are versatile and easy to use, allowing embedded system designers to easily
interconnect various sub-systems inside embedded applications. By replacing
traditionally slow, wire intensive, hard to use serial communications, ARCNET
and CircLink(TM) solutions allow designers to reduce wiring and micro-controller
costs, and create a more flexible and modular systems architecture. These
products target networking applications requiring a high level of determinism
and predictable behavior, such as telecom equipment, robotics and medical
equipment, as well as those applications seeking high throughput, such as
digital copiers and printers and transportation systems.
Product offerings within the Company's networking product line include:
o 10 Mbps and 100 Mbps Ethernet controllers and transceivers targeting
consumer electronics applications.
o Embedded communications products for wireless base stations, copiers,
building automation, robotics, gaming machines and industrial
applications.
Computing Platform Solutions - SMSC is the world's leading supplier of advanced
Input/Output (I/O) products for PC-related computing applications supplied by
major original equipment manufacturers (OEMs) and motherboard manufacturers. The
Company's broad LPC-based and ISA-based product portfolio provides a variety of
integration levels for designers, with unique configurations of serial ports,
parallel ports, keyboard controllers, hardware monitoring, infrared ports, real
time clocks, general purpose I/O pins, logic integration and power management.
The Company is the market leader in providing I/O solutions and embedded
controllers for the rapidly expanding mobile PC market, and in supplying I/O
solutions for desktop PC applications, featuring I/O and USB hubs, and
environmental monitoring and fan control.
SMSC has leveraged its analog design expertise to develop a line of stand-alone
environmental monitoring and control (EMC) products, providing thermal
management, hardware monitoring and voltage supervision, all of which are
critical to ensuring the stability and reliability of computing systems. The
Company's EMC sensor and fan control products are specifically designed to
safeguard today's high-heat, small form factor system designs.
The Company's computing platform solutions products also extend into the
PC-based server market. Advanced I/O products for server applications build on
SMSC's broad I/O and system management expertise and include timers, flash
memory interfaces, thermal management and other requirements of server
configurations.
Product offerings within the Company's computing platform solutions product line
include:
o Microcontrollers that integrate thermal, power and system management
capabilities with keyboard scan, serial port and consumer infrared
functionality into a single device.
o Super I/O controllers.
o System controller I/O devices that integrate various analog
capabilities such as temperature monitoring.
o EMC devices addressing thermal management, hardware monitoring and
voltage supervisory solutions for small form factor, high-heat systems
such as PCs, servers and other embedded devices.
o PC-based server solutions offering timers, flash memory interfaces and
thermal management capabilities.
Acquisition of OASIS SiliconSystems
- -----------------------------------
On March 30, 2005, SMSC announced the acquisition of Karlsruhe, Germany-based
OASIS SiliconSystems Holding AG (OASIS), a leading provider of Media Oriented
Systems Transport (MOST(R)) technology, which enables the seamless transport of
digital audio, video and packet-based data, along with control information,
within automobiles. Serving a top tier customer base of leading automakers and
automotive suppliers, OASIS' infotainment networking technology has been widely
adopted by many European luxury and mid-market car brands, including Audi, BMW,
Fiat, Jaguar, Land Rover, Mercedes-Benz, Porsche, PSA, Saab and Volvo.
The cost of the acquisition was approximately $118.5 million, including
approximately $79.5 million of cash, 2.1 million shares of SMSC common stock,
valued at $35.8 million, and an estimated $3.2 million of direct acquisition
costs, including legal, banking, accounting and valuation fees. Included with
the net assets acquired from OASIS was approximately $22 million of cash and
cash equivalents, so SMSC's net cash outlay for the transaction, including
transaction costs, was approximately $60 million.
Up to $20.0 million of additional consideration, payable in cash and SMSC common
stock, may be issued to OASIS' former shareholders during fiscal 2007 upon
satisfaction of certain future performance goals.
OASIS' revenues in calendar 2004 were approximately $50 million and the company
was profitable. Double-digit percentage growth in revenues and earnings are
expected in calendar 2005 for OASIS. Following the acquisition, OASIS now
operates as a new business unit within SMSC known as Automotive Infotainment
Systems (AIS) with a charter to grow its product offerings in the automotive
industry worldwide.
Competition
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The Company competes in the semiconductor industry, servicing and providing
solutions for a variety of high-speed communication and computer applications.
Many of the Company's larger customers conduct business in the personal computer
and related peripheral devices industries. Intense competition, rapid
technological change, cyclical market patterns, price erosion and periods of
mismatched supply and demand have historically characterized these industries.
The Company faces competition from several large semiconductor manufacturers,
some of which have greater size and financial resources than the Company. The
Company's principal competitors in the advanced I/O controller market include
National Semiconductor Corporation, Winbond Electronics Corporation and
Integrated Technology Express, Inc. (ITE).
Principal competitors in SMSC's businesses outside of the PC market include
Cypress Semiconductor, NEC Corporation, Davicom Semiconductor Inc. and Genesys
Logic, Inc. As SMSC continues to broaden its product offerings, it will likely
face new competitors in other markets. Many of the Company's potential
competitors have the ability to invest larger dollar amounts into research and
development, and some have their own manufacturing facilities, which may give
them a cost advantage on large volume products.
The principal methods that the Company uses to compete include the introduction
of innovative new products, providing industry-leading product quality and
customer service, adding new features to its products, improving product
performance, striving to ensure availability of product and reducing
manufacturing costs. SMSC also cultivates strategic relationships with certain
key customers who are technology leaders in its target markets, and who provide
insight into market trends and opportunities for the Company to better support
those customers' needs.
The Company believes that it currently competes effectively in the areas
discussed in the previous paragraph to the extent they are within its control.
However, given the pace at which change occurs in the semiconductor, personal
computer, automotive and other high-technology industries, SMSC's current
competitive capabilities are not a guarantee of future success and reductions in
the growth rates of these industries could adversely affect its operating
results.
Research and Development
- ------------------------
The semiconductor industry, and the individual markets in which the Company
currently competes, are highly competitive, and the Company believes that
continued investment in research and development (R&D) is essential to
maintaining and improving its competitive position. SMSC has strategic
relationships with many of its customers and tailors its solutions to these
specific customers' needs. Serving a wide array of world class OEMs, the
Company's continued success will be based, among other things, on its ability to
meet the individual needs of these customers and to help them speed their own
products to market.
SMSC's R&D activities are performed by highly-skilled engineers and technicians,
and are primarily directed towards the design of new integrated circuits in both
mainstream and emerging technologies, the development of new software drivers,
firmware and design tools and blocks of logic, as well as ongoing cost
reductions and performance improvements in existing products.
In recent years, SMSC has migrated from an organization with a traditional
strength in digital design, to become a supplier with broad engineering and
design expertise in digital, analog and mixed-signal solutions. Electronic
signals fall into one of two categories - analog or digital. Digital signals are
used to represent the "ones" and "zeros" of binary arithmetic, and are either on
or off. Analog, or linear, signals represent real-world phenomena, such as
temperature, pressure, sound, speed and motion. These signals can be detected
and measured using analog sensors, which represent real-world phenomena by
generating varying voltages and currents. Mixed-signal products combine digital
and analog circuitry into a single device. Mixed-signal solutions can
significantly reduce package sizes by integrating system interfaces, reducing
external component requirements and lowering power consumption, all of which
reduce system costs. During the fourth quarter of fiscal 2005, mixed-signal
devices contributed nearly 70% of SMSC's unit sales.
SMSC employs engineers with a wide range of experience in digital, mixed-signal
and analog circuit design, from experienced industry veterans to new engineers
recently graduated from top universities. Their activities are supported by
state-of-the-art hardware, software and other product design tools procured from
worldwide suppliers. The Company's engineering design centers are strategically
located in New York, Texas, Arizona, and Germany to take full advantage of the
technological expertise found in each area, and to closely cater to its global
customer base.
Manufacturing
- -------------
SMSC provides semiconductor solutions using a fabless manufacturing model, which
is increasingly common in the semiconductor industry. Third party contract
foundries and package assemblers are engaged to fabricate the Company's products
onto silicon wafers, cut these wafers into die and assemble the die into
finished packages. This strategy allows the Company to focus its resources on
product design and development, marketing and quality assurance. It also reduces
fixed costs and capital requirements, and provides the Company access to the
most advanced manufacturing capabilities.
The Company's primary wafer suppliers are Chartered Semiconductor Manufacturing,
Ltd. in Singapore, Taiwan Semiconductor Manufacturing Company, Ltd. (TSMC) in
Taiwan and DongbuAnam Semiconductor in Korea. Wafers for the Company's recently
acquired AIS product line are currently supplied primarily by STMicroelectronics
N.V. The Company may negotiate additional foundry supply contracts and establish
other sources of wafer supply for its products as such arrangements become
useful or necessary, either economically or technologically.
Processed silicon wafers are shipped to various third party assembly suppliers,
most of which are located in Asia, where they are separated into individual
chips that are then encapsulated into plastic packages. As is the case with the
Company's wafer supply requirements, SMSC employs a number of independent
suppliers for assembly purposes. This enables the Company to take advantage of
the subcontractor's high volume manufacturing, related cost savings, speed and
supply flexibility. It also provides SMSC with timely access to cost-effective
advanced process and package technologies. The Company purchases most of its
assembly services from Advanced Semiconductor Engineering, Inc., ST Assembly
Test Services, Ltd., Orient Semiconductor Electronics, Ltd., and Amkor
Technology, Inc.
Following assembly, each of the packaged units receives final testing, marking
and inspection prior to shipment to customers. Final testing for a significant
portion of the Company's products is performed at SMSC's own state-of-the-art
testing operation in Hauppauge, New York. Final testing services of independent
test suppliers, most of which occurs in Asia, are also utilized.
Customers demand semiconductors of the highest quality and reliability for
incorporation into their products. SMSC focuses on product reliability from the
initial stages of the design cycle through each specific design process,
including production test design. In addition, designs are subject to in-depth
circuit simulation at temperature, voltage and processing extremes before
initiating the manufacturing process. The Company prequalifies each of its
assembly and foundry subcontractors. This prequalification process consists of a
series of industry standard environmental product stress tests, as well as an
audit and analysis of the subcontractor's quality system and manufacturing
capability. Wafer foundry production and assembly services are closely monitored
to ensure consistent overall quality, reliability and yield levels.
Sales, Marketing and Customer Service
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SMSC has historically been a successful supplier of Application-Specific Custom
Products (ASCPs), tailored to the specific needs of its customers. To address
certain customers' aggressive cost and time-to-market objectives, the Company is
also increasingly designing and delivering Application-Specific Standard
Products (ASSPs), while remaining focused on retaining its expertise of
providing innovative, yet diverse, product features for its customers.
The Company's sales and marketing strategy is to achieve design wins with
technology leaders in targeted markets through superior sales, field
applications and engineering support. Sales managers are dedicated to key OEM
customers to ensure the highest level of customer service and to promote close
cooperation and communication. The success of its customers is a cornerstone of
SMSC's corporate strategy.
The Company also serves its customers with a worldwide network of field
application engineers. These engineers assist customers in the selection and
proper use of its products and are available to answer customer questions and
resolve technical issues. The field application engineers are supported by
factory application engineers, who work with both the customer's and the
Company's factory design and product engineers to develop the requisite support
tools and facilitate the smooth introduction of new products.
The Company strives to make the design-in of its products as easy as possible
for its customers. To facilitate this, SMSC offers a wide variety of support
tools, including evaluation boards, sample BIOS, diagnostics programs, sample
schematics and PCB layout files, driver programs, data sheets, industry standard
specifications and other documentation. These tools are readily available from
the Company's sales offices and sales representatives. SMSC's home page on the
World Wide Web (www.smsc.com) provides customers with immediate access to its
latest product information. In addition, the Company maintains an electronic
bulletin board so that registered customers can download software updates as
needed. Customers are also provided with reference platform designs for many of
the Company's products, which enable easier and faster transitions from the
initial prototype designs through final production releases.
SMSC markets and sells its products in the United States through a direct sales
force, electronics distributors and manufacturers' representatives. Two
independent distributors are currently engaged to serve the majority of the
North American market. Internationally, products are marketed and sold through
regional sales offices located in Germany, Taiwan, China, Korea and Singapore as
well as through a network of independent distributors and representatives. The
Company serves the Japanese marketplace primarily through its Tokyo, Japan-based
subsidiary, SMSC Japan.
Consistent with industry practices, most distributors have certain rights of
return and price protection privileges on unsold products until the distributor
sells the product. Distributor contracts may be terminated by written notice by
either party. The contracts specify the terms for the return of inventories.
Shipments made by SMSC Japan to distributors in Japan are made under agreements
that permit limited or no stock return or price protection privileges.
The Company generates a significant portion of its sales and revenues from
international customers. While the 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, and to distributors who serve to
feed the high technology manufacturing pipeline, located in Asia. The majority
of the world's personal computer, personal computer motherboard and other high
technology manufacturing activity occurs in that region. The Company expects
that international shipments, particularly to Asia, will continue to represent a
significant portion of its sales and revenues.
The information below summarizes sales and revenues to unaffiliated customers
for fiscal 2005, 2004 and 2003 by geographic region (in thousands):
For the years ended February 28 or 29, 2005 2004 2003
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North America $ 38,075 $ 37,138 $ 14,712
Taiwan 94,599 106,279 82,399
Japan, China and Other Asia Pacific 64,966 62,101 49,504
Europe and Rest of World 11,175 10,355 8,902
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$ 208,815 $ 215,873 $ 155,517
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Intellectual Property
- ---------------------
The Company believes that intellectual property is a valuable asset that has
been, and will continue to be, important to the Company's success. The Company
has received numerous United States patents relating to its technologies and
additional patent applications are pending. It is the Company's policy to
protect these assets through reasonable means. To protect these assets, the
Company relies upon nondisclosure agreements, contractual provisions, and patent
and copyright laws.
SMSC has patent cross-licensing agreements with more than thirty companies,
including such semiconductor manufacturers as Intel, Micron Technology, Samsung,
National Semiconductor and Toshiba, providing access to approximately 45,000
U.S. patents. Almost all of the Company's cross-licensing agreements give SMSC
the right to use, royalty-free, patented intellectual property of the other
companies. In situations where the Company needs to acquire strategic
intellectual property not covered by cross-licenses, the Company at times will
seek to enter into agreements to purchase or license the required intellectual
property.
Backlog and Customers
- ---------------------
The Company's business, and to a large extent much of the semiconductor
industry, is characterized by short-term order and shipment schedules, rather
than volume purchase contracts. The Company schedules production, the cycle for
which is typically several months long, based generally upon a forecast of
demand for its products, recognizing that subcontract manufacturers require long
lead times to manufacture and deliver the Company's final products. The Company
modifies and rebalances its production schedules to actual demand as required.
Sales are made primarily pursuant to purchase orders generally requiring
delivery within one month, and at times, several months. Typical of industry
practice, the Company's backlog may be canceled or rescheduled by the customer
on short notice without significant penalty. In addition, incoming orders and
resulting backlog can fluctuate during periods of perceived or actual
semiconductor supply shortages or overages. As a result, the Company's backlog
may not be a reliable indicator of future sales.
From time to time, several key customers can account for a significant portion
of the Company's sales and revenues. Sales and revenues from significant
customers for fiscal 2005, 2004 and 2003, stated as percentages of total sales
and revenues, are summarized as follows:
For the years ended February 28 or 29, 2005 2004 2003
- --------------------------------------------------------------------
Customer A 13% 16% 20%
Customer B 11% 16% 14%
Customer C 13% 12% 10%
Customer D * 12% 12%
* Less then 10%
The Company expects that its key customers will continue to account for a
significant portion of its sales and revenues in fiscal 2006 and for the
foreseeable future.
Employees
- ---------
At February 28, 2005, the Company employed 559 individuals, including 126 in
sales, marketing and customer support, 138 in manufacturing and manufacturing
support, 204 in research and product development and 91 in administrative
support and facility maintenance activities.
The Company added approximately 150 employees through its March 2005 acquisition
of OASIS, including approximately 30 in sales, marketing and customer support,
90 in research and product development and 30 in manufacturing and
administrative support activities.
The Company's future success depends in large part on the continued service of
key technical and management personnel and on its ability to continue to attract
and retain qualified employees, particularly highly skilled design, product and
test engineers involved in manufacturing existing products and the development
of new products. The competition for such personnel is intense.
The Company has never had a work stoppage. No employees are represented by a
labor organization and the Company considers its employee relations to be good.
Additional Information
- ----------------------
This annual report on Form 10-K, as well as quarterly reports on Form 10-Q,
current reports on Form 8-K, and amendments to reports filed or furnished
pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as
amended, are available free of charge on the Company's web site at www.smsc.com,
as soon as reasonably practicable after the filing of such reports with the
Securities and Exchange Commission. Information contained on the Company's web
site is not part of this report.
Item 2. Properties.
- ---------------------
SMSC's headquarters are located in Hauppauge, New York, where it owns an 80,000
square foot facility and leases a separate 50,000 square foot facility, and
where it conducts research, development, product testing, warehousing, shipping,
marketing, selling and administrative activities. During the fourth quarter of
fiscal 2005, the Company began construction on an expansion of its owned
facility in Hauppauge, New York, which will expand the facility from its current
80,000 square feet to approximately 200,000 square feet. This will allow for the
consolidation of the Company's Hauppauge operations into a single facility,
currently expected to occur during fiscal 2007 upon expiration of the lease on
the separate facility. The Company currently estimates the cost of this
expansion to be between $20 million and $25 million.
In addition, the Company maintains offices in leased facilities in San Jose,
California; Austin, Texas; Phoenix, Arizona; Tucson, Arizona; Munich, Germany;
Tokyo, Japan; Taipei, Taiwan; Shanghai, Shenzhen and Hong Kong, China;
Singapore; and Seoul, South Korea. These leases expire at various times through
August 2008. Facilities operated by OASIS, acquired in March 2005, include
leased facilities in Karlsruhe, Germany; Austin, Texas; Yokohama, Japan; and
Gothenburg, Sweden.
The Company believes that its facilities are adequate to meet its requirements.
Item 3. Legal Proceedings.
- ----------------------------
From time to time as a normal incidence of doing business, various claims and
litigation may be asserted or commenced against the Company. Due to
uncertainties inherent in litigation and other claims, the Company can give no
assurance that it will prevail in any such matters, which could subject the
Company to significant liability for damages and/or invalidate its proprietary
rights. Any lawsuits, regardless of their success, would likely be
time-consuming and expensive to resolve and would divert management's time and
attention, and an adverse outcome of any significant matter could have a
material adverse effect on the Company's consolidated results of operations or
cash flows in the quarter or annual period in which one or more of these matters
are resolved.
In June 2003, SMSC was named as a defendant in a patent infringement lawsuit
filed by Analog Devices, Inc. (ADI) in the United States District Court for the
District of Massachusetts (Analog Devices, Inc. v. Standard Microsystems
Corporation, Case Number 03 CIV 11216). The Complaint, as amended, alleged that
some of the Company's products infringed one or more of three of ADI's patents,
and sought injunctive relief and unspecified damages. In September 2003, the
Company filed an Answer in the lawsuit, denying ADI's allegations and raising
affirmative defenses and counterclaims. During the fourth quarter of fiscal
2005, the Company and ADI reached a settlement of this dispute, under which both
parties agreed to dismiss all claims against each other. As part of the
agreement, the Company made a one-time payment of $6.0 million to ADI, and ADI
granted the Company a royalty-bearing license to the patents in question. The
Company does not expect royalties incurred under the license to have a material
impact on future results of operations.
As of February 28, 2005, SMSC was not a party to any legal proceedings, claims,
disputes or litigation that are expected to have a material adverse effect on
the Company's results of operations or financial condition.
Item 4. Submission of Matters to a Vote of Security Holders.
- --------------------------------------------------------------
None.
Executive Officers of the Registrant
- ------------------------------------
The Company's executive officers and their ages as of April 30, 2005 are as
follows:
Name Age Position
- ------------------------ ---- ------------------------------------------------
Steven J. Bilodeau 46 Chairman of the Board, President and Chief
Executive Officer
Andrew M. Caggia 56 Senior Vice President and Chief Financial
Officer
George W. Houseweart 63 Senior Vice President, General Counsel and
Secretary
Robert E. Hollingsworth 56 Senior Vice President and General Manager,
Connectivity Solutions Group
William D. Shovers 51 Senior Vice President
Peter S. Byrnes 47 Vice President and General Manager, Computing
Platform Solutions Group
Mitchell A. Statham 46 Vice President, Worldwide Sales
Eric M. Nowling 48 Vice President, Controller and Chief Accounting
Officer
Steven J. Bilodeau has served as the Company's President and Chief Executive
Officer, and as a member of the Company's Board of Directors, since March 1999.
Andrew M. Caggia has served as the Company's Senior Vice President and Chief
Financial Officer since February 2000, and as a member of the Company's Board of
Directors since February 2001. Mr. Caggia has announced his retirement as Chief
Financial Officer of SMSC effective on or about May 31, 2005, after which he
will continue employment with SMSC in a part-time capacity to help ensure a
smooth transition.
George W. Houseweart has served as the Company's Senior Vice President, General
Counsel and Secretary since October 2002. Previously, he served as Senior Vice
President and General Counsel from January 1999 to October 2002. Mr. Houseweart
has been an officer of the Company since 1988.
Robert E. Hollingsworth has served as Senior Vice President and General Manager,
Connectivity Solutions Group since November 2003. Previously, he served as
Senior Vice President - Sales and Marketing, from January 2003 through November
2003. He was elected an officer of the Company in January 2003. He served as
Senior Vice President and General Manager - Advanced I/O Products from June 2002
to January 2003; and as Senior Vice President - Sales and Marketing - PC
Products from September 1999 to June 2002.
William D. Shovers was appointed as Senior Vice President in April 2005. He will
assume responsibilities as the Company's Senior Vice President and Chief
Financial Officer upon retirement of Andrew M. Caggia, on or about May 31, 2005.
He has worked for SMSC in a consulting capacity since January 2005. Prior to
joining SMSC, Mr. Shovers was Vice President - Finance, International Group of
Hayes Lemmerz International, Inc. (Hayes) from April 2002 through June 2003 and
served as a consultant for Hayes' International Group from July 2003 through
July 2004. Prior to that, he was Vice President and Chief Financial Officer of
Hayes from January 1993 through October 2001, and a Vice President of Hayes from
November 2001 through March 2002. Hayes filed a voluntary petition for relief
under Chapter 11 of the U.S. Bankruptcy Code in December 2001, and emerged from
bankruptcy in June 2003.
Peter S. Byrnes has served as Vice President and General Manager, Computing
Platforms Solutions Group since November 2003. Previously, he served as Vice
President - Operations from June 2000 through November 2003. Prior to that, he
served as Vice President - Product Assurance and Manufacturing Engineering from
May 1999 to June 2000. Mr. Byrnes has been an officer of the Company since 1998.
Mitchell A. Statham has served as the Company's Vice President, Worldwide Sales
since November 2003. Previously, he served as Vice President, Sales from January
2003 through November 2003, and as Vice President, Worldwide Sales, Advanced I/O
Products from joining SMSC in June 2002 through January 2003. He was elected an
officer of the Company in April 2004. Prior to joining SMSC, he served in
various sales management positions with NEC Electronics from February 1999 to
March 2002.
Eric M. Nowling has served as the Company's Vice President, Controller and Chief
Accounting Officer since February 2000. Mr. Nowling has been an officer of the
Company since 1995.
PART II
-------
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities.
- --------------------------------------------------------------------------------
Market Information and Holders
- ------------------------------
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 718 holders of record of the Company's common stock at
February 28, 2005.
The following table sets forth the high and low closing prices, for the periods
indicated, for SMSC's common stock as reported by the NASDAQ National Market
System:
Fiscal 2005 Fiscal 2004
High Low High Low
------------------ ------------------
First Quarter $ 30.70 $ 20.76 $ 16.00 $ 11.71
Second Quarter 25.22 14.44 21.50 13.50
Third Quarter 27.00 14.15 31.65 19.46
Fourth Quarter 25.60 14.94 36.56 23.70
Dividend Policy
- ---------------
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.
Securities Authorized for Issuance Under Equity Compensation Plans
- ------------------------------------------------------------------
The information under the caption "Equity Compensation Plan Information,"
appearing in the 2005 Proxy Statement related to the 2005 Annual Meeting of
Stockholders (the 2005 Proxy Statement), is hereby incorporated by reference.
For additional information on the Company's stock-based compensation plans,
please see Note 15 of the Notes to Consolidated Financial Statements, included
in Part IV, Item 15 of this Report
Item 6. Selected Financial Data.
- ----------------------------------
(In thousands, except per share data)
As of February 28 or 29, and
for the years then ended 2005 2004 2003 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Operating Results
Product sales $ 197,803 $ 191,969 $ 154,244 $ 128,528 $ 162,008
Intellectual property revenues 11,012 23,904 1,273 30,770 1,420
- -------------------------------------------------------------------------------------------------------------------------
Total sales and revenues 208,815 215,873 155,517 159,298 163,428
Gross profit 94,749 109,637 69,424 78,034 66,768
Research and development 42,988 38,793 31,166 31,178 32,580
Selling, general and administrative 48,759 42,168 36,268 32,744 35,369
Amortization of intangible assets 1,113 1,311 1,167 - -
Gains on real estate transactions (1,017) (1,444) - - -
Settlement charge 6,000 - - - -
Restructuring costs - - (247) 7,734 -
Operating income (loss) (3,094) 28,809 1,070 6,378 (1,181)
Other income (expense) 2,429 985 (14,446) 4,308 34,293
- -------------------------------------------------------------------------------------------------------------------------
Income (loss)from continuing operations $ 1,602 $ 21,542 $ (6,971) $ 7,475 $ 22,164
Net loss from discontinued operations - (24) (500) (1,564) -
Gain on sale of discontinued operations,
net of taxes - - - - 4,765
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) 1,602 21,518 (7,471) 5,911 26,929
Gain on redemption of preferred stock of
subsidiary - 6,685 - - -
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common $ 1,602 $ 28,203 $ (7,471) $ 5,911 $ 26,929
shareholders
=========================================================================================================================
Diluted net income (loss) per share
Income (loss) from continuing
operations $ 0.08 $ 1.17 $ (0.42) $ 0.44 $ 1.29
Net income (loss) 0.08 1.16 (0.45) 0.35 1.57
Net income (loss) applicable to common
shareholders 0.08 1.53 (0.45) 0.35 1.57
- -------------------------------------------------------------------------------------------------------------------------
Diluted weighted average common shares
outstanding 19,318 18,479 16,538 16,900 17,165
- -------------------------------------------------------------------------------------------------------------------------
Balance Sheet and Other Data
Cash and liquid investments $ 172,645 $ 173,897 $ 112,897 $ 126,660 $ 109,174
Working capital 214,655 191,199 145,639 154,981 146,382
Capital expenditures 8,432 10,380 5,695 4,488 14,600
Depreciation and amortization 11,534 9,984 9,809 10,760 11,430
Total assets 319,259 310,025 252,607 236,063 239,098
Long-term obligations 12,326 12,104 12,037 6,973 5,812
Shareholders' equity 269,849 262,102 204,012 193,453 194,315
Book value per common share 14.44 14.27 12.17 12.14 12.08
This selected financial data should be read in conjunction with the Consolidated
Financial Statements and related notes, and the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
contained in this report.
The operating results presented above reflect:
- The receipts of $10.0 million, $22.5 million and $29.6 million of
special intellectual property payments in fiscal 2005, 2004 and 2002,
respectively, as more fully described in Note 9 to the Consolidated
Financial Statements included in this report.
- Sales of real estate in fiscal 2005 and 2004, as more fully described in
Note 11.
- A litigation settlement charge of $6.0 million in fiscal 2005, as more
fully described in Note 16.
- The write-off related to inventory shipped to one of the Company's
distributors during fiscal 2005, as more fully described in Note 2.
- The Company's acquisition of Gain Technology Corporation in fiscal 2003,
as more fully described in Note 4.
- $16.3 million of investment impairment charges recorded in fiscal 2003,
as more fully described in Note 12.
- $9.0 million of business restructuring charges recorded in fiscal 2002,
including $1.3 million within Cost of goods sold and $7.7 million within
Operating expenses.
Item 7. 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. 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. All forward-looking statements speak only
as of the date hereof and are based upon the information available to SMSC at
this time. Such information is subject to change, and the Company may not
inform, or be required to inform, investors of such changes.
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.
These and other risks and uncertainties, including potential liability resulting
from pending or future litigation, are discussed in further detail within the
section entitled "Other Factors That May Affect Future Operating Results" which
appears at the end of this Item 7. Other cautionary statements and risks and
uncertainties may also appear elsewhere in this report.
================================================================================
OVERVIEW
- --------
Description of Business
SMSC provides semiconductor systems solutions for high-speed communication and
computing applications. Through the integration of its digital, mixed-signal and
analog design capabilities and software expertise, SMSC delivers complete
solutions that monitor and manage computing systems and connect peripherals to
computers, to consumer electronics platforms and to one another.
The Company addresses computing, communications and consumer electronics markets
through leading positions in Input/Output and non-PCI Ethernet products,
innovations in USB2.0 and other high-speed serial solutions, and integrated
networking products employed in a broad range of applications.
SMSC is a fabless semiconductor supplier, whose products are manufactured by
world-class third-party semiconductor foundries and assemblers. The Company
conducts a significant portion of its final testing requirements in the
Company's own state-of-the-art testing operation.
The Company is based in Hauppauge, New York with operations in North America,
Taiwan, Japan, Korea, China, Singapore and Europe. SMSC operates engineering
design centers in New York, Arizona, Texas and Germany.
Key Indicators
Management measures the condition and performance of the Company's business in
numerous ways. Among the key quantitative indicators generally used in this
regard are bookings, sales and revenues, gross profit and operating expenses
relative to sales and revenues. The Company also carefully monitors the progress
of its product development efforts.
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.
SMSC 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, SMSC's shipments to
its distributors may experience short-term fluctuations as distributors manage
their inventories to current levels of end-user demand. Therefore, SMSC
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 SMSC 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's revenue recognition is therefore highly dependent upon receiving
pertinent and accurate data from its distributors, in a timely manner.
Distributors routinely provide the Company with product, price, quantity and end
customer data when products are resold, as well as report the quantities of the
Company's products that are still in their inventories. In determining the
appropriate amount of revenue to recognize, the Company uses this data and
applies judgment in reconciling any differences between the distributors'
reported inventories and shipment activities. Although this information is
reviewed and verified for accuracy, any errors or omissions made by the
Company's distributors and not detected by the Company, if material, could
affect operating results.
Shipments made by the Company's Japanese subsidiary to distributors in Japan are
made under agreements that permit limited or no stock return or price protection
privileges. SMSC recognizes revenue from product sales to distributors in Japan,
and to original equipment manufacturers (OEMs), 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 products
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 reviewed for product obsolescence and
impairment in value, based upon assumptions of future demand and market
conditions. The Company often receives orders from customers and distributors
requesting delivery of product on relatively short notice and with lead times
that are shorter than the manufacturing cycle time. In order to provide
competitive delivery times to its customers, the Company builds and stocks a
certain amount of inventory in anticipation of customer demand that may or may
not materialize. Historically, forecasts of customer demand, particularly at a
part-number level, are challenging and can vary significantly from actual future
demand. In addition, as is common in the semiconductor industry, customers may
be allowed to cancel orders with minimal advance notice. These dynamics create
risks that the Company may forecast incorrectly and produce excess or
insufficient inventories.
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 with a charge to Cost of goods sold. While the Company
endeavors to appropriately 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. The Company performs credit
evaluations of its customers' financial condition on a regular basis, using
information provided by the customers as well as publicly available information,
if any. 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.
Valuation of Long-Lived Assets
Long-lived assets, including property, plant and equipment, and intangible
assets, are monitored and reviewed for impairment in value 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, which is measured as
the amount by which the carrying value exceeds the fair value of the asset.
Goodwill is tested for impairment in value annually, as well as when an event or
circumstance occurs indicating a possible impairment in value. The Company
completed its most recent annual goodwill impairment review during the fourth
quarter of fiscal 2005, during which no impairment in value was identified.
Unless an indicator of impairment is identified earlier, the next goodwill
impairment review will be performed in the fourth quarter of fiscal 2006.
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 are subjective and dependent upon management's
assessment of the performance of the investee and its prospects for future
success. During the third quarter of fiscal 2003, impairment charges totaling
$16.3 million were recorded against two such investments, both of which were
subsequently sold during fiscal 2004. As of February 28, 2005, the Company has
no significant long-term equity investments.
Income Taxes
Accounting for income tax obligations requires the 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.
Deferred tax assets resulting from these differences must 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, 2005, the Company had $24.9 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 profit, loss of
market share, delays in product availability, and technological obsolescence.
Legal Contingencies
From time to time, the Company is subject to legal proceedings and claims,
including claims of alleged infringement of patents and other intellectual
property rights and other claims arising in the ordinary course of business.
These contingencies require management to assess the likelihood and possible
cost of adverse judgments or outcomes. Liabilities for legal contingencies are
accrued when it is probable that a liability has been incurred and the amount of
the liability can be reasonably estimated. 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. In addition, the resolution of any future
intellectual property litigation may subject the Company to royalty obligations,
product redesigns or discontinuance of products, any of which could adversely
impact future gross profits.
RESULTS OF OPERATIONS
- ---------------------
Sales and Revenues
The Company's sales and revenues for fiscal 2005 were $208.8 million, including
$197.8 million of product sales and $11.0 million of intellectual property
revenues, compared to fiscal 2004 sales and revenues of $215.9 million, which
included $192.0 million of product sales and $23.9 million of intellectual
property revenues. Fiscal 2003 sales and revenues of $155.5 million included
$154.2 million of product sales and $1.3 million of intellectual property
revenues.
Non-PC I/O products contributed 41% of total product sales in fiscal 2005,
compared to 33% in fiscal 2004 and 27% in fiscal 2003, as the Company
experienced strong demand in its non-PC I/O product lines, product sales for
which grew by 29% during fiscal 2005. Non-PC I/O products include networking,
connectivity and other products. The Company attributes the growing demand to
the impact of new design-wins, broader product offerings in these product lines,
and the Company's ongoing focus on aggressively identifying and pursuing market
opportunities in its non-PC I/O product lines, which is consistent with the
Company's diversification goals. Despite an increase of more than 10% in unit PC
I/O shipments during fiscal 2005, as the Company maintained its leadership in
the market for these devices, product sales from PC I/O products declined in
fiscal 2005, compared to fiscal 2004, largely reflecting the impact of selling
price attrition. The Company's PC I/O business is concentrated in top-tier,
mainstream PC suppliers who are able to exert significant pressure on selling
prices.
The Company's PC I/O product sales were also adversely impacted in fiscal 2005
by an accounts receivable collectibility issue with one of its Taiwan-based
component distributors. During the closing process for the third quarter of
fiscal 2005, the Company determined that this long-time customer, whose credit
history with the Company had consistently been excellent, was experiencing
financial distress and a lack of liquidity. Generally accepted accounting
principles preclude the recognition of revenue when collectibility is not
reasonably assured, and therefore the Company did not recognize approximately
$5.4 million of product sales, of which the majority were PC I/O products, to
this distributor during the second half of fiscal 2005. The inventory for these
product sales, which had a cost of approximately $2.7 million, had already been
shipped to and resold by the distributor prior to identification of the
collectibility issue. The financial condition of this former customer has
continued to deteriorate and future collectibility of its obligations to SMSC
remains uncertain. Therefore, the $2.7 million of inventory shipped to this
customer, but not yet paid for, is reflected within Cost of goods sold in the
Consolidated Statement of Operations for fiscal 2005. The Company aggressively
arranged alternate channels for delivery of products to its end customers, and
no disruption occurred in the supply of the Company's products.
Product sales increased 24% in fiscal 2004 compared to fiscal 2003. This
increase reflected higher product sales in all of SMSC's major product
categories, in terms of both units and dollars. New design-wins and increased PC
demand, following sluggish fiscal 2003 demand which reflected, in part, that
period's business downturn in the semiconductor market, helped to drive growth
in sales of PC I/O products, which increased 14% in fiscal 2004 compared to
fiscal 2003. The Company's non-PC I/O products achieved higher fiscal 2004
product sales reflecting the impact of new product introductions. Product sales
of non-PC I/O products increased 55% in fiscal 2004 over fiscal 2003.
Intellectual property revenues include $10.0 million and $22.5 million in fiscal
2005 and 2004, respectively, received from Intel Corporation pursuant to the
terms of a September 2003 business agreement. Intellectual property revenues for
fiscal 2005 include payments under this agreement of $2.5 million in each of the
year's four fiscal quarters, and in the prior fiscal year include the
agreement's initial payment of $20 million in the third quarter and a payment of
$2.5 million in the fourth quarter.
Sales and revenues by geographic region for the past three fiscal years were as
follows (in thousands):
For the years ended February 28 or 29, 2005 2004 2003
- --------------------------------------------------------------------------------
North America $ 38,075 $ 37,138 $ 14,712
Taiwan 94,599 106,279 82,399
Japan, China and Other Asia Pacific 64,966 62,101 49,504
Europe and Rest of World 11,175 10,355 8,902
- --------------------------------------------------------------------------------
$ 208,815 $ 215,873 $ 155,517
- --------------------------------------------------------------------------------
Intellectual property revenues received from Intel are included within North
America, accounting for the increase in North American sales and revenues in
fiscal 2004, compared to fiscal 2003. Although intellectual property revenues
from Intel declined in fiscal 2005, pursuant to the terms of the underlying
agreement, overall North American sales and revenues increased in fiscal 2005
reflecting increased shipments to a U.S.-based customer.
For product sales to electronic component distributors, their geographic
locations, as reflected in the preceding table, may be different from the
geographic locations of their end customers.
The Company expects that international shipments, particularly to Asia, will
continue to represent a significant portion of its sales and revenues for the
foreseeable future. A significant portion of the world's high technology
manufacturing and assembly activity occurs in Asia, where many of the Company's
significant customers conduct business.
Cost of Goods Sold and Gross Profit
Cost of goods sold includes the cost of purchasing finished silicon wafers
manufactured by independent foundries, including mask and tooling costs; costs
for assembly, packaging, and mechanical and electrical testing; manufacturing
overhead, quality assurance and other support overhead, including costs of
personnel and equipment associated with manufacturing support; product royalties
paid to suppliers of intellectual property incorporated into the Company's
devices; and provisions for excess, slow-moving or obsolete inventories.
Gross profit for fiscal 2005 was $94.7 million, or 45.4% of sales and revenues,
compared to $109.6 million, or 50.8% of sales and revenues, in fiscal 2004.
Gross profit for fiscal 2003 was $69.4 million, or 44.6% of sales and revenues.
Excluding the impact of intellectual property revenues, gross profit was 42.3%
of product sales in fiscal 2005, compared to 44.7% in fiscal 2004 and 44.2% in
fiscal 2003.
During fiscal 2005, the Company continued to experience a change in its product
mix, with more of its product sales being derived from non-PC I/O products.
While in the past, non-PC I/O products traditionally produced higher gross
profit margins than PC I/O products, the Company introduced certain new products
during fiscal 2005 into a very competitive market that currently generate lower
gross profit margins than other non-PC I/O products. Accordingly, the Company is
not currently realizing the overall increased gross profit percentage at the
level that would otherwise be expected from a higher product sales mix of non-PC
I/O products. The Company is working on increasing its margins through design
changes, enhanced product features and cost saving initiatives, as it continues
expanding its new product offerings in these competitive markets. The Company
also recorded higher charges for slow-moving and obsolete inventory in fiscal
2005, compared to fiscal 2004, reflecting several customer product transitions
occurring more rapidly than anticipated.
The slight improvement in gross profit percentage on product sales in fiscal
2004, to 44.7%, as compared to 44.2% achieved in fiscal 2003 (excluding
intellectual property revenues in both periods), reflected the combination of
lower wafer and assembly costs, an increase in unit production, lower inventory
obsolescence charges, and a product mix shift towards non-PC I/O products.
Research and Development Expenses
Research and development (R&D) expenses consist primarily of salaries and
related costs of employees engaged in research, design and development
activities, costs related to engineering design tools and computer hardware,
subcontractor costs and device prototyping costs. The Company's R&D activities
are performed by highly-skilled and experienced engineers and technicians, and
are primarily directed towards the design of new integrated circuits and the
development of new software drivers, firmware and design tools and blocks of
logic, as well as ongoing cost reductions and performance improvements in
existing products.
The Company intends to continue its efforts to develop innovative new products
and technologies and believes that an ongoing commitment to R&D is essential in
order to maintain product leadership and compete effectively. Therefore, the
Company expects to continue to make significant R&D investments in the future.
R&D expenses for fiscal 2005 were $43.0 million, or approximately 21% of sales
and revenues, compared to $38.8 million, or approximately 18% of sales and
revenues, for fiscal 2004. This increase includes $1.8 million of higher
compensation and benefit costs driven by engineering staff additions, $0.9
million of higher depreciation expense associated with investments in advanced
semiconductor design tools and $0.9 million of higher device prototype costs. A
portion of the increase in R&D expenses as a percentage of sales and revenues in
the current fiscal year, compared to fiscal 2004, results from the higher
intellectual property revenues reported in the prior year.
R&D expenses for fiscal 2004 were $38.8 million, or approximately 18% of sales
and revenues, compared to $31.2 million, or approximately 20% of sales and
revenues, for fiscal 2003. Fiscal 2004 R&D expenses included a full year of
expenses associated with the Company's June 2002 acquisition of Gain Technology
Corporation (Gain), compared to nine months of such expenses in fiscal 2003.
Including the impact of Gain, the increase in fiscal 2004 reflects the impact of
engineering staff additions, which resulted in $4.5 million in additional
compensation and benefit costs, and $2.7 million of additional costs associated
with investments in advanced design tools.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $48.8 million, or
approximately 23% of sales and revenues, for fiscal 2005, compared to $42.2
million, or approximately 20% of sales and revenues, for fiscal 2004, and $36.3
million, or approximately 23% of sales and revenues, for fiscal 2003. The
increase in fiscal 2005, compared to fiscal 2004, includes $2.9 million of
higher legal fees, primarily associated with litigation, $1.9 million of higher
expenses associated with expanded worldwide resources in sales and marketing and
$1.2 million of higher consulting and professional fees, primarily associated
with projects to achieve compliance with provisions of the Sarbanes-Oxley Act of
2002. The increase in fiscal 2004, compared to fiscal 2003, includes $4.0
million of higher expenses associated with expanded worldwide resources in sales
and marketing.
Amortization of Intangible Assets
Amortization expense of $1.1 million, $1.3 million and $1.2 million in fiscal
2005, 2004 and 2003, respectively, represents the amortization of intangible
assets associated with the Company's June 2002 acquisition of Gain.
Gains on Real Estate Transactions
During the third quarter of fiscal 2005, the Company sold its remaining parcel
of idle real estate in Hauppauge, New York, for net proceeds of $1.7 million,
after transaction costs. This property had a carrying value of approximately
$0.4 million. The contract of sale required the Company to complete the
remediation of certain soil contamination of uncertain origin identified at this
property, at its expense. In recognition of both the uncertain cost and
uncertain completion date of the soil remediation obligation at that time, the
Company did not reflect the impact of this transaction within its Statement of
Operations for the third quarter of fiscal 2005. The Company subsequently
completed the project during the fourth quarter of fiscal 2005, and received
final regulatory approval thereafter. Accordingly, the Company recognized a gain
of $1.0 million on this transaction, after related soil remediation project
costs, in the fourth quarter of fiscal 2005.
During the first quarter of fiscal 2004, the Company sold certain portions of
its Hauppauge, New York real estate holdings, for aggregate proceeds of $7.0
million, net of transaction costs. These transactions resulted in an aggregate
gain of $1.7 million, $1.4 million of which related to property in which the
Company had no continued interest and was recognized within the Company's fiscal
2004 first quarter operating results, and $0.3 million of which related to
property that the Company leased back from the purchaser and was therefore
deferred. This deferred gain is being recognized within the Company's operating
results as a reduction in rent expense on a straight-line basis over a 30-month
period beginning in June 2003, consistent with the term of the lease. The
Company's remaining rent obligation over the term of this lease is approximately
$0.2 million.
Settlement Charge
In June 2003, SMSC was named as a defendant in a patent infringement lawsuit
filed by Analog Devices, Inc. (ADI), which alleged that some of the Company's
products infringed one or more of three of ADI's patents, and sought injunctive
relief and unspecified damages. In September 2003, the Company filed an Answer
in the lawsuit, denying ADI's allegations and raising affirmative defenses and
counterclaims. During the fourth quarter of fiscal 2005, the Company and ADI
reached a settlement of this dispute, under which both parties agreed to dismiss
all claims against each other. As part of the agreement, the Company made a
one-time payment of $6.0 million to ADI, which is reported as a Settlement
charge on the Company's Consolidated Statement of Operations for fiscal 2005.
Also as part of the settlement, ADI granted the Company a royalty-bearing
license to the patents in question. The Company does not expect royalties
incurred under the license to have a material impact on future results of
operations.
Other Income and Expense
The increase in interest income, from $1.9 million in fiscal 2004 to $2.5
million in fiscal 2005, primarily reflects the impact of higher average interest
rates during fiscal 2005. The modest decline in interest income, from $2.1
million in fiscal 2003 to $1.9 million in fiscal 2003, reflects a decline in
interest rates on investments during fiscal 2004, partially offset by higher
levels of investments.
During fiscal 2004, the Company sold its remaining equity investment in
Chartered Semiconductor Manufacturing, Ltd. (Chartered), realizing losses of
$0.7 million, which are included within Other income (expense), net. Other
income (expense), net was nominal in both fiscal 2005 and 2003.
Provision for Income Taxes
The Company's effective income tax rate reflects statutory federal, state and
foreign 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 income tax credits. The Company recorded an income tax benefit of $2.3
million for fiscal 2005, which reflects the impact of $1.1 million of income tax
credits, and $0.6 million and $0.7 million of tax benefits associated with
export sales and tax-exempt income, respectively.
The provision for income taxes for fiscal 2004 was $8.1 million, which resulted
in an effective income tax rate of 27% against $29.8 million of income before
income taxes. This provision included $0.5 million of income tax credits, $0.8
million of tax benefits associated with export sales and a benefit of $0.8
million associated with better than anticipated settlements of previously open
tax audits.
The provisions for, or benefits from, income taxes from continuing operations
have not been reduced for approximately $0.9 million, $7.8 million and $1.8
million of tax benefits in fiscal 2005, 2004 and 2003 respectively, derived from
activity in stock-based compensation plans. These tax benefits have been
credited to Additional paid-in capital.
Discontinued Operations
The Company had been involved in an arbitration proceeding with Accton
Technology Corporation (Accton) and SMC Networks, Inc. (Networks), relating to
claims associated with the October 1997 purchase of a majority interest in
Networks by Accton from SMSC. The divestiture was accounted for as a
discontinued operation, and accordingly, costs associated with this action, net
of income taxes, were reported within Loss from discontinued operations on the
Consolidated Statements of Operations. These costs totaled $0.3 million and $0.8
million, before applicable income tax benefits, in fiscal 2004 and 2003,
respectively. In September 2003, the arbitration panel issued its decision in
this action, which directed the release of an escrow account to SMSC and awarded
certain other payments among the parties. In December 2003, the parties reached
a final settlement of the award, resulting in SMSC receiving $2.7 million in
cash, including the escrow account, and realizing a pre-tax gain of $0.3
million, which is included within Loss from discontinued operations for fiscal
2004.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Company currently finances its operations through a combination of existing
resources and cash generated by operations. The Company had no bank debt during
fiscal 2005, 2004 or 2003.
The Company's cash, cash equivalents and liquid investments (including
investments in marketable securities with maturities in excess of one year, if
any) were $172.6 million at February 28, 2005, compared to $173.9 million at
February 29, 2004.
Operating activities generated $3.5 million of cash during fiscal 2005, compared
to $46.4 million of cash generated in fiscal 2004. This decrease in operating
cash flow during fiscal 2005 reflects $12.9 million of higher intellectual
property payments received during fiscal 2004, as well as higher operating
expenses incurred during fiscal 2005, including a $6.0 million litigation
settlement payment. The Company also financed larger increases in accounts
receivable and inventories during fiscal 2005, compared to similar activity
during fiscal 2004. Fiscal 2003 operating activities generated $14.9 million of
cash.
Investing activities provided $96.5 million of cash during fiscal 2005, due
principally to a net decrease of $103.3 million in short-term and long-term
investments, and $1.7 million of proceeds from the sale of real estate,
partially offset by $8.4 million of capital expenditures. Investing activities
consumed $68.1 million of cash during fiscal 2004, due principally to a net
increase of $59.8 million in short-term and long-term investments, $10.4 million
of capital expenditures and $5.2 million used to purchase the minority
investment interest in SMSC Japan, partially offset by $7.1 million of proceeds
from the sale of real estate. Investing activities consumed $21.2 million of
cash during fiscal 2003, including $15.7 million of cash used for the
acquisition of Gain and $5.7 million of capital expenditures.
Net cash provided by financing activities during fiscal 2005 included $4.2
million of proceeds from exercises of stock options, partially offset by $0.3
million of treasury stock purchases and $2.1 million of debt repayments.
Financing activities provided $17.3 million of cash during fiscal 2004,
including $18.9 million of proceeds from exercises of stock options, which were
driven by increases in the market price of the Company's common stock during
certain periods of fiscal 2004, partially offset by $1.6 million of debt
repayments. Financing activities consumed $7.8 million of cash during fiscal
2003, including $10.4 million for purchases of treasury stock and $2.6 million
for debt repayments, partially offset by $5.2 million of proceeds from exercises
of stock options.
The Company's inventories were $33.3 million at February 28, 2005, compared to
$23.2 million at February 29, 2004. This increase resulted from the
replenishment of depleted buffer stock inventories during fiscal 2005, higher
product demand expected in the first quarter of fiscal 2006 compared to the
first quarter of fiscal 2005, and certain accelerated purchases of high-volume
parts in response to apparent shortages in the supply chain during the middle of
fiscal 2005.
Accounts receivable increased from $21.9 million at February 29, 2004 to $23.8
million at February 28, 2005. As noted within the Sales and Revenues section of
this discussion, the Company experienced a collectibility issue with one of its
Taiwan-based distributors during the second half of fiscal 2005. Upon
identification of this issue, the Company discontinued using this distributor,
and redirected all of the business previously conducted with this distributor to
different customers, some of which were new customers. Accounts receivable at
February 28, 2005 includes certain accounts receivable from these new customers,
to the extent that they were granted credit terms. The Company's accounts
receivable portfolio remains almost entirely current as of February 28, 2005,
and, as compared to the February 29, 2004 portfolio, has shifted towards
accounts with shorter credit terms, which has the impact of reducing overall
accounts receivable. Offsetting the effect of this credit term shift is the
impact of a reduction in unclaimed pricing credits by distributors during fiscal
2005. SMSC accrues a liability for distributor pricing credits when a
distributor ships the Company's products and earns such credits, but the
issuance of the actual credit memo to the distributor is dependent upon the
distributor's submission of an appropriate claim to SMSC. Delays in
distributors' claims for these credits typically result in lower than expected
accounts receivable balances, since the delays result in full collections for
certain invoices against which the distributor is actually entitled to, but has
not yet claimed, a pricing credit. It has been the Company's experience that all
such pricing credits are ultimately claimed, although the timing of the claims
varies by distributor. These pricing credits are recorded as a reduction of
product sales when accrued, and the resulting reserves for pricing credits and
other allowances are accounted for as reductions of accounts receivable.
Total current liabilities increased from $35.8 million at February 29, 2004 to
$37.1 million at February 28, 2005, primarily reflecting a $1.3 million increase
in Accounts payable associated with a higher level of inventory.
Capital expenditures for fiscal 2005 were $9.3 million, of which $8.4 million
was paid in cash. The current year's capital investments include expenditures of
$0.9 million for advanced design tools, which are being financed by the
suppliers with payment terms extending through September 2007. The Company
acquired $3.9 million and $1.9 million of advanced design tools during fiscal
2004 and 2003, respectively, under similar agreements, for which the vendors
also provided extended payments. Payments under these agreements are reported
within Cash flows from financing activities on the Consolidated Statements of
Cash Flows. Capital expenditures in fiscal 2005, 2004 and 2003 were
predominantly for production test equipment, advanced semiconductor design tools
and investments in intellectual property. Capital expenditures were $14.3
million and $7.6 million for fiscal 2004 and 2003, respectively, including the
aforementioned vendor-financed design tools.
The Company anticipates that capital expenditures in fiscal 2006 will exceed
those incurred during fiscal 2005, resulting from an expansion of the Company's
primary facility in Hauppauge, New York, construction on which began during the
fourth quarter of fiscal 2005. This project will expand the facility from its
current 80,000 square feet to approximately 200,000 square feet, allowing
consolidation of the Company's Hauppauge operations into a single facility,
currently expected to occur during fiscal 2007. The Company currently expects
the cost of this building expansion to be between $20 million and $25 million,
of which $1.6 million has been expended, and is classified as construction in
progress, at February 28, 2005. Approximately $20 million of the expenditures
for this project are expected to occur during fiscal 2006. There were no other
material commitments for capital expenditures as of February 28, 2005.
During fiscal 2005, the Company filed claims for $7.3 million of Federal income
tax refunds, which resulted from the carry back of several capital losses
realized during fiscal 2004 against capital gains reported in previous fiscal
years. Refunds of $6.9 million were received against these claims during fiscal
2005, and receipt of the remaining $0.4 million refund is dependent upon
completion of the related I.R.S. audit. For income tax purposes, the Company has
approximately $22.2 million of federal net operating loss carryforwards as of
February 28, 2005, which are available to offset ordinary taxable income
generated in fiscal 2006 and beyond.
SMSC maintains a common stock repurchase program, as approved by its Board of
Directors, which authorizes the Company to repurchase up to three million shares
of its common stock on the open market or in private transactions. As of
February 28, 2005, the Company had repurchased approximately 1.8 million shares
of common stock at a cost of $23.8 million under this program, including 21,800
shares repurchased at a cost of $0.3 million in fiscal 2005. No shares were
repurchased under this program during fiscal 2004.
In March 2005, the Company announced the acquisition of 100% of the outstanding
common stock of OASIS SiliconSystems Holding AG (OASIS), a leader in the
development and marketing of integrated circuits that enable the networking and
transport of digital audio, video, data and control information among multimedia
devices within an automobile. OASIS is based in Karlsruhe, Germany and is
supported by an engineering team based in Austin, Texas and several other
offices worldwide.
The cost of the acquisition was approximately $118.5 million, including
approximately $79.5 million of cash, 2.1 million shares of SMSC common stock,
valued at $35.8 million, and an estimated $3.2 million of direct acquisition
costs, including legal, banking, accounting and valuation fees. Included with
the net assets acquired from OASIS was approximately $22 million of cash and
cash equivalents, so SMSC's net cash outlay for the transaction, including
transaction costs, was approximately $60 million.
Up to $20.0 million of additional consideration, payable in cash and SMSC common
stock, may be issued to OASIS' former shareholders during fiscal 2007 upon
satisfaction of certain future performance goals.
The Company's contractual payment obligations and purchase commitments as of
February 28, 2005 were as follows (in thousands):
Payment Obligations by Period
- ------------------------------------------------------------------------------------------------
Within 1 Between Between
Total year 1 and 3 years 3 and 5 years Thereafter
- ------------------------------------------------------------------------------------------------
Operating leases $ 4,505 $ 1,955 $ 2,539 $ 11 $ -
Other obligations 2,458 1,931 527 -
Inventory and other
purchase commitments 19,963 19,963 - - -
- ------------------------------------------------------------------------------------------------
Total $ 26,926 $ 23,849 $ 3,066 $ 11 $ -
================================================================================================
Inventory and other purchase obligations include purchase commitments for
processed silicon wafers and assembly and test services. The Company depends
entirely upon subcontractors to manufacture its silicon wafers and provide
assembly services, as well as for certain of its test services. Due to the
length of subcontractor lead times, the Company orders these materials and
services well in advance, and generally expects to receive and pay for these
materials and services within the next six months.
For purposes of the preceding table, obligations for the purchase of goods or
services are defined as agreements that are enforceable and legally binding and
that specify all significant terms, including: fixed or minimum quantities to be
purchased; fixed, minimum or variable price provisions; and the approximate
timing of the transaction. The Company cannot cancel these obligations without
incurring cost. Non-cancelable purchase orders for manufacturing requirements
are typically fulfilled by vendors within short time horizons, generally three
months or less. The Company has additional purchase orders, not included within
the table, that represent authorizations to purchase rather than binding
agreements.
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
investments in such businesses, products or technologies owned by third parties.
The Company expects that its cash, cash equivalents, liquid 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 2006.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------
In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 151, Inventory Costs, An Amendment of ARB No. 43, Chapter 4. SFAS No. 151
clarifies that abnormal inventory costs such as costs of idle facilities, excess
freight and handling costs, and wasted materials (spoilage) are required to be
recognized as current period charges. The provisions of SFAS No. 151 are
effective for fiscal years beginning after June 15, 2005. The Company is
currently evaluating the provisions of SFAS No. 151 and does not expect that its
adoption will have a material impact on its consolidated financial condition,
results of operations and cash flows.
In December 2004, the FASB issued SFAS No. 123R (Revised 2004), Share-Based
Payment. The scope of SFAS No. 123R includes a wide range of share-based
compensation arrangements including stock options, restricted stock plans,
performance-based awards, stock appreciation rights, and employee stock purchase
plans. SFAS No. 123R replaces SFAS No. 123, Accounting for Stock-Based
Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees. SFAS No. 123, as originally issued in 1995, established as preferable
a fair-value-based method of accounting for share-based payment transactions
with employees. However, that statement permitted the option of continuing to
apply the guidance in APB Opinion 25, provided that the footnotes to the
consolidated financial statements disclosed pro forma net income and net income
per share, as if the preferable fair-value-based method had been applied. SFAS
No. 123R requires that compensation costs relating to share-based payment
transactions be recognized in the consolidated financial statements.
Compensation costs will be measured based on the fair value of the equity or
liability instruments issued. SFAS No. 123R is effective for the first annual
reporting period that begins after June 15, 2005. The Company is currently
evaluating the impact of SFAS No. 123R and believes that the adoption of this
statement could have a material impact on its consolidated financial position,
results of operations and cash flows.
In December 2004, the FASB issued Statement No. 153, Exchanges of Nonmonetary
Assets, an amendment of APB Opinion No. 29. SFAS No. 153 addresses the
measurement of exchanges of nonmonetary assets and redefines the scope of
transactions that should be measured based on the fair value of the assets
exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges in fiscal
periods beginning after June 15, 2005. The Company does not expect the adoption
of SFAS No. 153 will have a material impact on its consolidated financial
position, results of operations and cash flows.
In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-2,
Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004. The American Jobs
Creation Act introduces a special one-time dividends received deduction on the
repatriation of certain foreign earnings to U.S. companies, provided certain
criteria are met. FSP No. 109-2 provides accounting and disclosure guidance on
the impact of the repatriation provision on a company's income tax expense and
deferred tax liability. The Company is currently studying the impact of the
one-time favorable foreign dividend provision and intends to complete the
analysis by the end of fiscal 2006. Accordingly, the Company has not recorded
any adjustments to its income tax expense or deferred income taxes to reflect
the tax impact of any repatriation of non-U.S. earnings it may make.
OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
- ------------------------------------------------------
Before deciding to make, maintain or increase an investment in SMSC, investors
should carefully consider the risks described below, in addition to the other
information contained in this report and in the Company's other reports filed or
furnished with the SEC, including the Company's reports on Forms 10-Q and 8-K.
The risks and uncertainties described below are not the only ones facing the
Company. Additional risks and uncertainties not presently known or those that
are currently deemed immaterial may also affect the Company's operations. Any of
the risks, uncertainties, events or circumstances described below could cause
the Company's financial condition or results of operations to be adversely
affected.
The Semiconductor Industry - The Company 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. The semiconductor industry has experienced
significant economic downturns at various times in the past, characterized by
diminished product demand and accelerated erosion of selling prices. In
addition, many of the Company's competitors in the semiconductor industry are
larger and have significantly greater financial and other resources than the
Company.
The Personal Computer Industry - Demand for many of the Company's products
depend largely on sales of personal computers and peripheral devices. Reductions
in the rate of growth of the PC market could adversely affect the Company's
operating results. In addition, as a component supplier to PC manufacturers, the
Company may experience greater demand fluctuation than its customers themselves
experience. Also, some of the Company's products are used in PCs for the
consumer market, which can be more volatile than other segments of the PC
marketplace.
The PC industry is characterized by ongoing product changes and improvements,
much of which is driven by several large companies whose own business strategies
play significant roles in determining PC architectures. Future shifts in PC
architectures may not always be anticipated or be consistent with the Company's
product roadmaps.
Product Development and Technological Change - The Company's prospects are
highly dependent upon the successful development and timely introduction of new
products at competitive prices and performance levels, with acceptable margins.
The success of new products depends on various factors, including timely
completion of product development programs, market acceptance of the Company's
and its customers' new products, securing sufficient foundry capacity for volume
manufacturing of wafers, achieving acceptable wafer fabrication yields by the
Company's independent foundries and the Company's ability to offer these new
products at competitive prices. The Company's products are generally designed
into its customers' products through a competitive process which evaluates the
Company's product features, price, and many other considerations. In order to
succeed in having the Company's products incorporated into new products being
designed by its customers, the Company must anticipate market trends and meet
performance, quality and functionality requirements of such customers and must
successfully develop and manufacture products that adhere to these requirements.
In addition, the Company must meet the timing and price requirements of its
customers and must make such products available in sufficient quantities. There
can be no assurance that the Company will be able to identify market trends or
new product opportunities, develop and market new products, achieve design wins
or respond effectively to new technological changes or product announcements by
others.
The Company's future growth will depend, among other things, upon its ability to
continue to expand its product lines and products into new markets. To the
extent that the Company attempts to compete in new markets, it may face
competition from suppliers that have well-established market positions and
products that have already been proven to be technologically and economically
competitive. There can be no assurance that the Company will be successful in
displacing these suppliers in the targeted applications.
Price Erosion - The semiconductor industry is characterized by intense
competition. Historically, average selling prices in the semiconductor industry
generally, and for the Company's products in particular, have declined
significantly over the life of each product. While the Company expects to reduce
the average selling prices of its products over time as it achieves
manufacturing cost reductions, competitive and other pressures may require the
reduction of selling prices more quickly than such cost reductions can be
achieved. If not offset by reductions in manufacturing costs or by a shift in
the mix of products sold toward higher-margin products, declines in the average
selling prices could reduce gross margins.
Business Concentration in Asia - A significant number of the Company's foundries
and subcontractors are located in Asia. Many of the Company's customers also
manufacture in Asia or subcontract manufacturing to Asian companies. A
significant portion of the world's personal computer component and circuit board
manufacturing, as well as personal computer assembly, occurs in Taiwan, and many
of the Company's suppliers and customers are based in, or do significant
business in, Taiwan. This concentration of manufacturing and selling activity in
Asia, and in Taiwan in particular, poses risks that could affect the supply and
cost of the Company's products, including currency exchange rate fluctuations,
economic and trade policies and the political environment in Taiwan and other
Asian communities.
Reliance upon Subcontract Manufacturing - The vast majority of the Company's
products are manufactured and assembled by independent foundries and subcontract
manufacturers. This reliance upon foundries and subcontractors involves certain
risks, including potential lack of manufacturing availability, reduced control
over delivery schedules, the availability of advanced process technologies,
changes in manufacturing yields and potential cost fluctuations. During
downturns in the semiconductor economic cycle, reduction in overall demand for
semiconductor products could financially stress certain of the Company's
subcontractors. If the financial resources of such independent subcontractors
are stressed, the Company may experience future product shortages, quality
assurance problems, increased manufacturing costs or other supply chain
disruptions.
Forecasts of Product Demand - The Company generally must order inventory to be
built by its foundries and subcontract manufacturers well in advance of product
shipments. Production is often based upon either internal or customer-supplied
forecasts of demand, which can be highly unpredictable and subject to
substantial fluctuations. Because of the volatility in the Company's markets,
there is risk that the Company may forecast incorrectly and produce excess or
insufficient inventories. This inventory risk is increased by the trend for
customers to place orders with shorter lead times and the customers' ability to
cancel or reschedule existing orders.
Strategic Relationships with Customers - The Company's future success depends in
significant part on strategic relationships with certain of its customers. If
these relationships are not maintained, or if these customers develop their own
solutions, adopt a competitor's solution, or choose to discontinue their
relationships with SMSC, the Company's operating results could be adversely
affected.
In the past, the Company has relied on its strategic relationships with certain
customers who are technology leaders in its target markets. The Company intends
to pursue and continue to form these strategic relationships in the future.
These relationships often require the Company to develop new products that
typically involve significant technological challenges. The customers frequently
place considerable pressure on the Company to meet their tight development
schedules. Accordingly, the Company may have to devote a substantial portion of
its resources to these strategic relationships, which could detract from or
delay completion of other important development projects.
Customer Concentration - A limited number of customers account for a significant
portion of the Company's sales and revenues. The Company's sales and revenues
from any one customer can fluctuate from period to period depending upon market
demand for that customer's products, the customer's inventory management of the
Company's products and the overall financial condition of the customer.
Shipments to Distributors - A significant portion of the Company's product sales
are made through distributors. The Company's distributors generally offer
products of several different suppliers, including products that may be
competitive with the Company's products. Accordingly, there is risk that these
distributors may give higher priority to products of other suppliers, thus
reducing their efforts to sell the Company's products. In addition, the
Company's agreements with its distributors are generally terminable at the
distributor's option. No assurance can be given that future sales by
distributors will continue at current levels or that the Company will be able to
retain its current distributors on acceptable terms. A reduction in sales
efforts by one or more of the Company's current distributors or a termination of
any distributor's relationship with the Company could have an adverse effect on
the Company's operating results.
Strategic Business Acquisitions - The Company has made strategic acquisitions of
complementary businesses, products and technologies in the past and may continue
to pursue such acquisitions in the future as business conditions warrant.
Business acquisitions can involve numerous risks, including: unanticipated costs
and expenses; risks associated with entering new markets in which the Company
has little or no prior experience; diversion of management's attention from its
existing businesses; potential loss of key employees, particularly those of the
purchased organization; potential dilution of future earnings; and future
impairment and write-offs of purchased goodwill, other intangible assets, and
fixed assets due to unforeseen events and circumstances.
Protection of Intellectual Property - The Company has historically devoted
significant resources to research and development activities and believes that
the intellectual property derived from such research and development is a
valuable asset that has been, and will continue to be, important to the
Company's success. The Company relies upon nondisclosure agreements, contractual
provisions and patent and copyright laws to protect its proprietary rights. No
assurance can be given that the steps taken by the Company will adequately
protect its proprietary rights. During its history, the Company has executed
patent cross-licensing agreements with many of the world's largest semiconductor
suppliers, under which the Company receives and conveys various intellectual
property rights. Many of these agreements are still effective. The Company could
be adversely affected should circumstances arise which cause certain of these
agreements to terminate prematurely.
Infringement and Other Claims - Companies in the semiconductor industry often
aggressively protect and pursue their intellectual property rights. From time to
time, the Company has received notices claiming that the Company has infringed
upon or misused other parties' proprietary rights. The Company has also in the
past received, and may again in the future receive, notices of claims related to
business transactions conducted with third parties, including asset sales and
other divestitures.
If it is determined that the Company's products or processes were to infringe on
other parties' intellectual property rights, a court might enjoin the Company
from further manufacture and/or sale of the affected products. The Company would
then need to obtain a license from the holders of the rights and/or reengineer
its products or processes in such a way as to avoid the alleged infringement.
There can be no assurance that the Company would be able to obtain any necessary
license on commercially reasonable terms acceptable to the Company or that the
Company would be able to reengineer its products or processes to avoid
infringement. An adverse result in litigation arising from such a claim could
involve the assessment of a substantial monetary award for damages related to
past product sales which could have a material adverse effect on the Company's
result of operations and financial condition. In addition, even if claims
against the Company are not valid or successfully asserted, defense against the
claims could result in significant costs and a diversion of management and
resources.
Dependence on Key Personnel - The success of the Company is dependent in large
part on the continued service of its key management, engineering, marketing,
sales and support employees. Competition for qualified personnel is intense in
the semiconductor industry, and the loss of current key employees, or the
inability of the Company to attract other qualified personnel, including the
inability to offer competitive stock-based and other compensation, could hinder
the Company's product development and ability to manufacture, market and sell
its products.
Internal Controls Over Financial Reporting - Section 404 of the Sarbanes-Oxley
Act of 2002 requires the Company to evaluate the effectiveness of its system of
internal controls over financial reporting as of the end of each fiscal year,
beginning with fiscal 2005, and to include a report by management assessing the
effectiveness of its system of internal controls over financial reporting within
its annual report. Section 404 also requires the Company's independent
registered public accounting firm to attest to, and report on, management's
assessment of the Company's system of internal controls over financial
reporting.
The Company's management does not expect that its system of internal controls
over financial reporting will prevent all error and all fraud. A control system,
no matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the control system's objectives will be met. Further,
the design of a control system must recognize that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, involving the Company have been, or will be, detected. These
inherent limitations include faulty judgments in decision-making and breakdowns
that may occur because of simple error or mistake. Controls can also be
circumvented by individual acts, by collusion of two or more people, or by
management override of the controls. The design of any system of controls is
based in part on certain assumptions about the likelihood of future events, and
the Company cannot provide assurance that any design will succeed in achieving
its stated goals under all potential future conditions. Over time, controls may
become inadequate because of changes in conditions or deterioration in the
degree of compliance with policies or procedures. Because of the inherent
limitations in a cost-effective control system, misstatements due to error or
fraud may occur and not be detected.
Although the Company's management has concluded that its system of internal
controls over financial reporting was effective as of February 28, 2005, there
can be no assurance that the Company or its independent registered public
accounting firm will not identify a material weakness in the system of internal
controls over financial reporting in the future. A material weakness in the
Company's system of internal controls over financial reporting would require
management and the Company's independent registered public accounting firm to
evaluate the Company's system of internal controls as ineffective. This in turn
could lead to a loss of public confidence, which could adversely affect the
Company's business and the price of its common stock.
Corporate Governance - In recent years, the Nasdaq National Market, on which the
Company's common stock is listed, has adopted comprehensive rules and
regulations relating to corporate governance. These laws, rules and regulations
have increased, and may continue to increase, the scope, complexity and cost of
the Company's corporate governance, reporting and disclosure practices. As a
result, the Company's board members, Chief Executive Officer, Chief Financial
Officer and other corporate officers could face increased risks of personal
liability in connection with the performance of their duties. As a result, the
Company may have difficultly attracting and retaining qualified board members
and officers, which would adversely affect its business. Further, these
developments could affect the Company's ability to secure desired levels of
directors' and officers' liability insurance, requiring the Company to accept
reduced insurance coverage or incur substantially higher costs to obtain
coverage.
Changes in Accounting for Equity Compensation - The Company has historically
used stock options as a key component of employee compensation in order to align
employees' interests with the interests of our stockholders, encourage employee
retention, and provide competitive compensation packages. The Financial
Accounting Standards Board has recently adopted changes to generally accepted
accounting principles that will require a charge to earnings for employee stock
option grants and other equity incentives beginning in fiscal 2007. To the
extent that this or other new regulations make it more difficult or expensive to
grant options to employees, the Company may incur increased compensation costs.
The Company may also consider changes to its equity compensation strategy and
find it more difficult to attract, retain and motivate employees. Any of these
results could materially and adversely affect the Company's business.
Volatility of Stock Price - The market price of the Company's common stock can
fluctuate significantly on the basis of such factors as the Company's or its
competitors' announcements of new products, quarterly fluctuations in the
Company's financial results or in the financial results of other semiconductor
companies, changes in the expectations of market analysts or investors, or
general conditions in the semiconductor industry or in the financial markets. In
addition, stock markets in general have experienced extreme price and volume
volatility in recent years. This volatility has often had a significant impact
on the stock prices of high technology companies, at times for reasons that
appear unrelated to performance.
Environmental Regulation - Environmental regulations and standards are
established worldwide to control discharges, emissions, and solid wastes from
manufacturing processes. Within the United States, federal, state and local
agencies establish these regulations. Outside of the United States, individual
countries and local governments establish their own individual standards. The
Company believes that its activities conform to present environmental
regulations and the effects of this compliance have not had a material effect on
the Company's capital expenditures, operating results, or competitive position.
While to date the Company has not experienced any material adverse impact from
environmental issues, no assurances can be given as to the impact of future
environmental compliance requirements. Should environmental regulations be
amended or an unforeseen circumstance occur, it could subject the Company to
fines, require the Company to acquire expensive remediation equipment or to
incur other expenses to comply with environmental regulations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
- ---------------------------------------------------------------------
Interest Rate Risk - The Company's exposure to interest rate risk relates
primarily to its investment portfolio. The primary objective of SMSC's
investment portfolio management is to invest available cash while preserving
principal and meeting liquidity needs. In accordance with the Company's
investment policy, investments are placed with high credit-quality issuers and
the amount of credit exposure to any one issuer is limited.
As of February 28, 2005, the Company's $56.5 million of short-term investments
consisted primarily of investments in corporate, government and municipal
obligations with maturities of between three and twelve months at acquisition.
If market interest rates were to increase immediately and uniformly by 10% from
levels at February 28, 2005, the Company estimates that the fair values of these
short-term investments would decline by an immaterial amount. The Company
generally expects to hold these investments until maturity and, therefore, would
not expect operating results or cash flows to be affected to any significant
degree by the effect of a sudden change in market interest rates.
Equity Price Risk - The Company is not exposed to any significant equity price
risks at February 28, 2005.
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 fluctuations in foreign exchange rates, most of the Company's product
sales and all of its arrangements with its foundry, test and assembly vendors
are denominated in U.S. dollars. Most transactions in the Japanese market made
by the Company's subsidiary, SMSC Japan, are denominated in Japanese yen. SMSC
Japan purchases a significant amount of its products for resale from SMSC in
U.S. dollars, and from time to time has entered into forward exchange contracts
to hedge against currency fluctuations associated with these product purchases.
No such contracts were executed during either fiscal 2005 or 2004, and there are
no obligations under any such contracts as of February 28, 2005.
The Company has never received a cash dividend (repatriation of cash) from SMSC
Japan.
Item 8. Financial Statements and Supplementary Data.
- ------------------------------------------------------
The financial statements and supplementary data required by this item are
included in Part IV, Item 15 of this Report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
- --------------------------------------------------------------------------------
Not applicable.
Item 9A. Controls and Procedures.
- ----------------------------------
Disclosure Controls and Procedures
Under the supervision and with the participation of the Company's management,
including its Chief Executive Officer and Chief Financial Officer, the Company
conducted an evaluation of the effectiveness of its disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act)
as of February 28, 2005. Disclosure controls and procedures include controls and
procedures designed to reasonably assure that information required to be
disclosed in the Company's reports filed under the Exchange Act, such as this
Form 10-K, are recorded, processed, summarized and reported within the time
periods specified in the U.S. Securities and Exchange Commission's (SEC's) rules
and forms. Disclosure controls and procedures are also designed to reasonably
assure that such information is accumulated and communicated to the Company's
management, including the Chief Executive Officer and the Chief Financial
Officer, as appropriate to allow timely decisions regarding required disclosure.
Based upon this evaluation, the Company's Chief Executive Officer and Chief
Financial Officer have concluded that, as of February 28, 2005, the Company's
disclosure controls and procedures were effective to provide reasonable
assurance that information required to be disclosed in the Company's Exchange
Act reports is recorded, processed, summarized and reported within the time
periods specified by the SEC, and that material information relating to SMSC and
its consolidated subsidiaries is made known to the Company's management,
including the Chief Executive Officer and the Chief Financial Officer, to allow
timely decisions regarding required disclosures.
Management's Report on Internal Control Over Financing Reporting
The Company's management is responsible for establishing and maintaining
adequate internal control over financial reporting. Internal control over
financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act as a process designed by, or under the supervision of, the
Company's principal executive and principal financial officers and effected by
the Company's board of directors, management and other personnel, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles and includes those policies and
procedures that:
(1) Pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of the
assets of the Company;
(2) Provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and
(3) Provide reasonable assurances regarding prevention or timely detection
of unauthorized acquisition, use or disposition of the Company's assets
that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of its internal control over
financial reporting as of February 28, 2005. In making this assessment, the
Company's management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in its report entitled Internal
Control-Integrated Framework. Based upon this assessment, management has
concluded that, as of February 28, 2005, the Company's internal control over
financial reporting is effective based on those criteria.
Management's assessment of the effectiveness of the Company's internal control
over financial reporting as of February 28, 2005 has been audited by
PricewaterhouseCoopers LLP, an independent registered public accounting firm, as
stated in their report which appears herein.
Changes in Internal Control Over Financial Reporting
No change in the Company's internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the
fiscal quarter ended February 28, 2005 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
Item 9B. Other Information
- ---------------------------
Not applicable.
PART III
--------
Item 10. Directors and Executive Officers of the Registrant.
- -------------------------------------------------------------
The information concerning the Company's executive officers required by this
item is incorporated herein by reference to the section within Part I of this
report entitled "Executive Officers of the Registrant."
The information concerning the Company's directors required by this item is
incorporated herein by reference to the section entitled "Election of Directors"
appearing in the 2005 Proxy Statement.
The information concerning the Company's Section 16(a) beneficial ownership
reporting compliance required by this item is incorporated herein by reference
to the section entitled "Section 16(a) Beneficial Ownership Reporting
Compliance" appearing in the 2005 Proxy Statement.
The information concerning the Company's code of ethics as required by this item
is incorporated herein by reference to the section entitled "Code of Business
Conduct and Ethics" appearing in the 2005 Proxy Statement.
Item 11. Executive Compensation.
- ---------------------------------
The information appearing in the 2005 Proxy Statement under the captions
"Executive Compensation" and "Director Compensation" is incorporated herein by
this reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
- --------------------------------------------------------------------------------
The information required by this item is incorporated by reference to
information set forth in the 2005 Proxy Statement under the headings "Voting
Securities of Certain Beneficial Owners and Management" and "Equity Compensation
Plan Information."
Item 13. Certain Relationships and Related Transactions.
- ---------------------------------------------------------
The information appearing in the 2005 Proxy Statement under the caption "Certain
Relationships and Related Transactions" is incorporated herein by this
reference.
Item 14. Principal Accounting Fees and Services.
- -------------------------------------------------
The information appearing in the 2005 Proxy Statement under the caption
"Principal Accounting Fees and Services" is incorporated herein by this
reference.
PART IV
-------
Item 15. Exhibits and Financial Statement Schedules.
- -----------------------------------------------------
1. Consolidated Financial Statements (See Item 8):
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of February 28, 2005 and
February 29, 2004
Consolidated Statements of Operations for the three years ended
February 28, 2005
Consolidated Statements of Shareholders' Equity for the three years
ended February 28, 2005
Consolidated Statements of Cash Flows for the three years ended
February 28, 2005
Notes to Consolidated Financial Statements
2. Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts
Schedules not listed above have been omitted because they are not applicable,
not required or the information required to be set forth therein is included in
the Consolidated Financial Statements or notes thereto.
The consolidated financial statements and financial statement schedule listed in
Section 1 and Section 2 of this Item 15, respectively, appear within this report
immediately following the Index to Exhibits.
3. Exhibits:
Exhibits, which are listed on the Index to Exhibits, are filed as part of this
report and such Index to Exhibits is incorporated by reference.
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
STANDARD MICROSYSTEMS CORPORATION
(Registrant)
By: /s/ ANDREW M. CAGGIA
--------------------
Andrew M. Caggia
Senior Vice President and Chief Financial Officer,
and Director
(Principal Financial Officer)
Date: May 16, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated.
Signature and Title Date
------------------- ----
/s/ STEVEN J. BILODEAU May 16, 2005
----------------------
Steven J. Bilodeau
Chairman of the Board,
President and Chief Executive Officer
(Principal Executive Officer)
/s/ ERIC M. NOWLING May 16, 2005
-------------------
Eric M. Nowling
Vice President, Controller and
Chief Accounting Officer
(Principal Accounting Officer)
/s/ ROBERT M. BRILL May 16, 2005
-------------------
Robert M. Brill
Director
/s/ TIMOTHY P. CRAIG May 16, 2005
--------------------
Timothy P. Craig
Director
/s/ JAMES A. DONAHUE May 16, 2005
--------------------
James A. Donahue
Director
/s/ PETER F. DICKS May 16, 2005
------------------
Peter F. Dicks
Director
/s/ IVAN T. FRISCH May 16, 2005
------------------
Ivan T. Frisch
Director
INDEX TO EXHIBITS:
Exhibit No. Description
- ----------- -----------
3.1 Certificate of Incorporation of Standard Microsystems Corporation,
as amended and restated, incorporated by reference to Exhibit 3 (a)
to the registrant's Form 10-K for the fiscal year ended February
28, 1991.
3.2 By-Laws of Standard Microsystems Corporation, as amended and
restated, incorporated by reference to Exhibit 3.1 to the
registrant's Form 8-K filed on April 10, 2002.
4.1 Rights Agreement with ChaseMellon Shareholder Services L.L.C., as
Rights Agent, dated January 7, 1998, incorporated by reference to
Exhibit 1 to the registrant's Registration Statement on Form 8-A
filed January 15, 1998.
4.2 Amendment No. 1 to Rights Agreement with ChaseMellon Shareholder
Services L.L.C., as Rights Agent, dated January 23, 2001,
incorporated by reference to Exhibit 4.2 to the registrant's Form
10-K for the fiscal year ended February 28, 2001.
4.3 Amendment No. 2 to Rights Agreement with ChaseMellon Shareholder
Services L.L.C., as Rights Agent, dated April 9, 2002, incorporated
by reference to Exhibit 3 to the registrant's Registration
Statement on Form 8-A/A filed April 10, 2002.
10.1* Employment Agreement with Steven J. Bilodeau, dated March 18, 1999,
incorporated by reference to Exhibit 10.5 to the registrant's Form
10-K for the fiscal year ended February 28, 1999.
10.2* Employment Agreement with Andrew M. Caggia, dated January 7, 2000,
incorporated by reference to Exhibit 10.5 to the registrant's Form
10-K for the fiscal year ended February 29, 2000.
10.3* Amendments to Employment Agreements with Steven J. Bilodeau and
Andrew M. Caggia, incorporated by reference to Exhibit 10.3 to the
registrant's Form 10-K for the fiscal year ended February 28, 2002.
10.4* Employment Agreement with William D. Shovers, dated April 18,
2005, incorporated by reference to Exhibit 10.1 to the registrant's
Form 8-K filed on April 21, 2005.
10.5* 1994 Director Stock Option Plan, incorporated by reference to
Exhibit A to the registrant's Proxy Statement dated May 31, 1995.
10.6* 2001 Director Stock Option Plan, incorporated by reference to
Exhibit B to the registrant's Proxy Statement dated July 11, 2001.
10.7* Amendment to the 2001 Director Stock Option Plan, dated April 4,
2002, incorporated by reference to Exhibit 10.7 to the registrant's
Form 10-K for the fiscal year ended February 28, 2002.
10.8* Amendment to the 1994 Director Stock Option Plan, adopted July 14,
1998, incorporated by reference to information appearing on page 11
of the registrant's Proxy Statement dated June 1, 1998.
10.9* Retirement Plan for Directors, incorporated by reference to Exhibit
10.14 to the registrant's Form 10-K for the fiscal year ended
February 28, 1995.
10.10* Amendment to the Retirement Plan for Directors, incorporated by
reference to Exhibit 10.11 to the registrant's Form 10-K for the
fiscal year ended February 28, 2002.
10.11* 1993 Stock Option Plan for Officers and Key Employees, incorporated
by reference to Exhibit A to the registrant's Proxy Statement dated
May 25, 1993.
10.12* Executive Retirement Plan, incorporated by reference to Exhibit
10(x) to the registrant's Form 10-K for the fiscal year ended
February 28, 1994.
10.13* Amendment to the Executive Retirement Plan, incorporated by
reference to Exhibit 10.14 to the registrant's Form 10-K for the
fiscal year ended February 28, 2002.
10.14* Amendment to the Executive Retirement Plan, dated January 28, 2003,
incorporated by reference to Exhibit 10.15 to the registrant's Form
10-K for the fiscal year ended February 28, 2003.
10.15* Amendment to the Executive Retirement Plan, dated January 1, 2005,
incorporated by reference to Exhibit 10.2 to the registrant's Form
10-Q for the quarterly period ended August 31, 2004.
10.16* Resolutions adopted October 31, 1994, amending the Retirement Plan
for Directors and the Executive Retirement Plan, incorporated by
reference to Exhibit 10.18 to the registrant's Form 10-K for the
fiscal year ended February 28, 1995.
10.17* 1994 Stock Option Plan for Officers and Key Employees, incorporated
by reference to Exhibit A to the registrant's Proxy Statement dated
May 26, 1994.
10.18* Resolutions adopted January 3, 1995, amending the 1994, 1993 and
1989 Stock Option Plans and the 1991 Restricted Stock Plan,
incorporated by reference to Exhibit 10.19 to the registrant's Form
10-K for the fiscal year ended February 28, 1995.
10.19* 1996 Restricted Stock Bonus Plan, incorporated by reference to
Exhibit 10.18 to the registrant's Form 10-K for the fiscal year
ended February 28, 2002.
10.20* 1998 Stock Option Plan for Officers and Key Employees, incorporated
by reference to Exhibit A to the registrant's Proxy Statement dated
June 1, 1998.
10.21* 1999 Stock Option Plan for Officers and Key Employees, incorporated
by reference to Exhibit A to the registrant's Proxy Statement dated
June 9, 1999.
10.22* 2000 Stock Option Plan for Officers and Key Employees, incorporated
by reference to Exhibit A to the registrant's Proxy Statement dated
June 6, 2000.
10.23* 2001 Stock Option and Restricted Stock Plan for Officers and Key
Employees, incorporated by reference to Exhibit C to the
registrant's Proxy Statement dated June 11, 2001.
10.24* Resolutions adopted April 7, 2004, amending the 1999 and 2000 Stock
Option Plans and the 2001 and 2003 Stock Option and Restricted
Stock Plans, incorporated by reference to Exhibit 10.1 to the
registrant's Form 10-Q for the quarterly period ended August 31,
2004.
10.25* Plan for Deferred Compensation in Common Stock for Outside
Directors, dated March 7, 1997, as amended, incorporated by
reference to Exhibit 10.23 to the registrant's Form 10-K for the
fiscal year ended February 28, 2002.
10.26* Amendment to the Plan for Deferred Compensation in Common Stock for
Outside Directors, dated July 10, 2002, incorporated by reference
to Exhibit 10.25 to the registrant's Form 10-K for the fiscal year
ended February 28, 2003.
10.27* Amendment to the Plan for Deferred Compensation in Common Stock for
Outside Directors, dated April 7, 2004, incorporated by reference
to Exhibit 10.1 to the registrant's Form 10-Q for the quarterly
period ended May 31, 2004.
10.28* 2002 Inducement Stock Option Plan, incorporated by reference to
Exhibit 10.26 to the registrant's Form 10-K for the fiscal year
ended February 28, 2003.
10.29* 2003 Director Stock Option Plan, incorporated by reference to
Exhibit C to the registrant's Proxy Statement dated July 9, 2003.
10.30* 2003 Stock Option and Restricted Stock Plan, incorporated by
reference to Exhibit B to the registrant's Proxy Statement dated
July 9, 2003.
10.31* 2003 Inducement Stock Option Plan, incorporated by reference to
Exhibit 4.3 to the registrant's Form S-8 filed September 15, 2003.
10.32* 2004 Employee Stock Appreciation Rights Plan, incorporated by
reference to Exhibit 10.1 to the registrant's Form 8-K filed on
October 1, 2004.
10.33* Resolution adopted to modify compensation provided to non-employee
directors, dated December 21, 2004, incorporated by reference to
Item 1.01 in the registrant's Form 8-K filed on December 23, 2004.
10.34 SMSC Management Incentive Plan - Form of Agreement, filed herewith.
10.35 Agreement and Plan of Merger among Standard Microsystems
Corporation, SMSC Sub, Inc., and Gain Technology Corporation, dated
April 29, 2002, incorporated by reference to Exhibit 2.1 to the
registrant's Form 8-K filed on June 19, 2002.
10.36 Share Purchase Agreement by and among Standard Microsystems
Corporation, SMSC GmbH and the Shareholders of OASIS SiliconSystems
Holding AG, dated March 30, 2005, incorporated by reference to
Exhibit 2.1 to the registrant's Form 8-K filed on April 5, 2005.
21 Subsidiaries of the Registrant, filed herewith.
23.1 Consent of PricewaterhouseCoopers LLP, filed herewith.
31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)
of the Securities Exchange Act, filed herewith.
31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)
of the Securities Exchange Act, filed herewith.
32.1 Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
* Indicated a management or compensatory plan or arrangement.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Standard Microsystems Corporation:
We have completed an integrated audit of Standard Microsystems Corporation's
February 28, 2005 consolidated financial statements and of its internal control
over financial reporting as of February 28, 2005 and audits of its February 29,
2004 and February 28, 2003 consolidated financial statements in accordance with
the standards of the Public Company Accounting Oversight Board (United States).
Our opinions, based on our audits, are presented below.
Consolidated financial statements and financial statement schedule
In our opinion, the accompanying consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Standard Microsystems Corporation and its subsidiaries at February
28, 2005 and February 29, 2004, and the results of their operations and their
cash flows for each of the three years in the period ended February 28, 2005 in
conformity with accounting principles generally accepted in the United States of
America. These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (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 of financial statements 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 audits provide a reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management's assessment, included in Management's Report
on Internal Control over Financial Reporting appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
February 28, 2005 based on the criteria established in Internal Control --
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), is fairly stated, in all material respects, based on
those criteria. Furthermore, in our opinion, the Company maintained, in all
material respects, effective internal control over financial reporting as of
February 28, 2005, based on criteria established in Internal Control --
Integrated Framework issued by the COSO. The Company's management is responsible
for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
New York, New York
May 16, 2005
Standard Microsystems Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
As of February 28 or 29, 2005 2004
- ------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 116,126 $ 14,050
Short-term investments 56,519 144,247
Accounts receivable, net of allowance
for doubtful accounts of $438 and
$446, respectively 23,788 21,946
Inventories 33,310 23,162
Deferred income taxes 17,701 15,064
Other current assets 4,295 8,549
- ------------------------------------------------------------------------------
Total current assets 251,739 227,018
Property, plant and equipment, net 22,630 23,430
Long-term investments - 15,600
Goodwill 29,435 29,595
Intangible assets, net 3,584 4,697
Deferred income taxes 7,163 6,493
Other assets 4,708 3,192
- ------------------------------------------------------------------------------
$ 319,259 $ 310,025
==============================================================================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 15,995 $ 14,679
Deferred income on shipments to distributors 7,689 7,972
Accrued expenses, income taxes and other
liabilities 13,400 13,168
- ------------------------------------------------------------------------------
Total current liabilities 37,084 35,819
- ------------------------------------------------------------------------------
Other liabilities 12,326 12,104
Commitments and contingencies
Shareholders' equity:
Preferred stock, $0.10 par value,
authorized 1,000 shares, none issued - -
Common stock, $0.10 par value,
authorized 30,000 shares,
issued 20,533 and 20,191 shares, and
outstanding 18,691 and 18,371 shares,
respectively 2,053 2,019
Additional paid-in capital 187,854 181,830
Retained earnings 100,612 99,010
Treasury stock, 1,842 and 1,820 shares,
respectively, at cost (23,799) (23,454)
Deferred stock-based compensation (1,925) (1,962)
Accumulated other comprehensive income 5,054 4,659
- ------------------------------------------------------------------------------
Total shareholders' equity 269,849 262,102
- ------------------------------------------------------------------------------
$ 319,259 $ 310,025
==============================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
Standard Microsystems Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
For the years ended February 28 or 29, 2005 2004 2003
- --------------------------------------------------------------------------------------------------------------
Product sales $ 197,803 $ 191,969 $ 154,244
Intellectual property revenues 11,012 23,904 1,273
- --------------------------------------------------------------------------------------------------------------
208,815 215,873 155,517
Cost of goods sold 114,066 106,236 86,093
- --------------------------------------------------------------------------------------------------------------
Gross profit 94,749 109,637 69,424
Operating expenses (income):
Research and development 42,988 38,793 31,166
Selling, general and administrative 48,759 42,168 36,268
Amortization of intangible assets 1,113 1,311 1,167
Gains on real estate transactions (1,017) (1,444) -
Settlement charge 6,000 - -
Restructuring cost adjustments - - (247)
- --------------------------------------------------------------------------------------------------------------
Income (loss) from operations (3,094) 28,809 1,070
Other income (expense):
Interest income 2,532 1,918 2,069
Interest expense (134) (112) (166)
Impairments of investments - - (16,306)
Other income (expense), net 31 (821) (43)
- --------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and minority interest (665) 29,794 (13,376)
Provision for (benefit from) income taxes (2,267) 8,051 (6,422)
Minority interest in net income of subsidiary - 201 17
- --------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations 1,602 21,542 (6,971)
Loss from discontinued operations (net of
income tax benefits of $14 and $281) - (24) (500)
- --------------------------------------------------------------------------------------------------------------
Net income (loss) 1,602 21,518 (7,471)
Gain on redemption of preferred stock of subsidiary - 6,685 -
- --------------------------------------------------------------------------------------------------------------
Net income (loss) applicable to common shareholders $ 1,602 $ 28,203 $ (7,471)
==============================================================================================================
Basic net income (loss) per share:
Income (loss) from continuing operations $ 0.09 $ 1.25 $ (0.42)
Loss from discontinued operations - - (0.03)
- --------------------------------------------------------------------------------------------------------------
Basic net income (loss) per share 0.09 1.25 (0.45)
Gain on redemption of preferred stock of subsidiary - 0.39 -
- --------------------------------------------------------------------------------------------------------------
Basic net income (loss) applicable to common shareholders $ 0.09 $ 1.64 $ (0.45)
==============================================================================================================
Diluted net income (loss) per share:
Income (loss) from continuing operations $ 0.08 $ 1.17 $ (0.42)
Loss from discontinued operations - - (0.03)
- --------------------------------------------------------------------------------------------------------------
Diluted net income (loss) per share 0.08 1.16 (0.45)
Gain on redemption of preferred stock of subsidiary - 0.36 -
- --------------------------------------------------------------------------------------------------------------
Diluted net income (loss) applicable to common shareholders $ 0.08 $ 1.53 $ (0.45)
==============================================================================================================
The sum of the income (loss) per share amounts may not total due to rounding.
The accompanying notes are an integral part of these consolidated financial
statements.
Standard Microsystems Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
Deferred Accumulated
Additional Stock- Other
Common Stock Paid-In Retained Treasury Stock based Comprehensive
Shares Amount Capital Earnings Shares Amount Compensation Income Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at February 28, 2002 17,277 $ 1,728 $ 120,913 $ 84,963 (1,338) $(13,861) $ (1,408) $ 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 1,919 - - - (1,617) - 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 1,859 147,655 77,492 (1,820) (23,454) (2,102) 2,562 204,012
Comprehensive income:
Net income - - - 21,518 - - - - 21,518
Other comprehensive income
Change in unrealized gain
on investments - - - - - - - 709 709
Foreign currency translation
adjustment - - - - - - - 1,388 1,388
---------
Total other comprehensive
income 2,097
---------
Total comprehensive income 23,615
Stock options exercised 1,539 154 18,758 - - - - - 18,912
Tax effect of employee stock
plans - - 7,778 - - - - - 7,778
Stock-based compensation 62 6 954 - - - (890) - 70
Amortization of deferred
stock-based compensation - - - - - - 1,030 - 1,030
Gain on redemption of
preferred stock of subsidiary - - 6,685 - - - - - 6,685
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at February 29, 2004 20,191 2,019 181,830 99,010 (1,820) (23,454) (1,962) 4,659 262,102
Comprehensive income:
Net income - - - 1,602 - - - - 1,602
Other comprehensive income
Change in unrealized gain
(loss) on investments - - - - - - - (47) (47)
Foreign currency translation
adjustment - - - - - - - 442 442
---------
Total other comprehensive
income 395
---------
Total comprehensive income 1,997
Stock options exercised 310 31 4,187 - - - - - 4,218
Tax effect of employee
stock plans - - 872 - - - - - 872
Stock-based compensation 32 3 965 - - - (916) - 52
Amortization of deferred
stock-based compensation - - - - - - 953 - 953
Purchases of treasury stock - - - - (22) (345) - - (345)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at February 28, 2005 20,533 $ 2,053 $ 187,854 $100,612 (1,842) $(23,799) $ (1,925) $ 5,054 $ 269,849
- ------------------------------------------------------------------------------------------------------------------------------------
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 or 29, 2005 2004 2003
- ---------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Cash received from customers and licensees $ 207,854 $ 218,127 $ 154,202
Cash paid to suppliers and employees (213,309) (173,559) (143,314)
Interest received 2,489 1,777 2,279
Interest paid (134) (112) (142)
Income tax refunds received 6,636 174 1,888
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 3,536 46,407 14,913
- --------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (8,432) (10,380) (5,695)
Acquisition of Gain Technology Corporation,
net of cash acquired - - (15,669)
Purchase of minority interest in subsidiary - (5,180) -
Sales of property, plant and equipment 1,670 7,121 148
Purchases of short-term and long-term
investments (434,355) (588,272) (245,182)
Sales and maturities of short-term and
long-term investments 537,617 528,441 245,229
Other 22 155 (38)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing
activities 96,522 (68,115) (21,207)
- ---------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock 4,218 18,912 5,188
Purchases of treasury stock (345) - (10,375)
Repayments of obligations under capital leases
and notes payable (2,144) (1,564) (2,617)
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing
activities 1,729 17,348 (7,804)
- --------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash
and cash equivalents 289 829 1,038
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) discontinued
operations - 2,586 (923)
- ---------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 102,076 (945) (13,983)
Cash and cash equivalents at beginning of year 14,050 14,995 28,978
- ---------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 116,126 $ 14,050 $ 14,995
=====================================================================================================================
Reconciliation of income (loss) from continuing
operations to net cash provided by operating activities:
Income (loss) from continuing operations $ 1,602 $ 21,542 $ (6,971)
Adjustments to reconcile income (loss) from continuing
operations to net cash provided by operating activities,
net of the effects of business acquisition:
Depreciation and amortization 11,534 9,984 9,809
Stock-based compensation 1,130 1,100 1,232
Gains on sales of investments and property (1,017) (696) (47)
Non-cash asset impairments and write-offs 2,734 - 16,306
Tax benefits from employee stock plans 872 7,778 1,828
Other adjustments, net (35) 213 (143)
Changes in operating assets and liabilities:
Accounts receivable (7,023) 622 (1,411)
Inventories (10,056) (5,022) (184)
Accounts payable, deferred income, accrued expenses
and other liabilities 2,769 9,048 464
Current and deferred income taxes 3,502 472 (3,622)
Other changes, net (2,476) 1,366 (2,348)
- ---------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities $ 3,536 $ 46,407 $ 14,913
=====================================================================================================================
The Company acquired $943, $3,894 and $1,876 of design tools in fiscal 2005,
2004 and 2003, respectively, through long-term financing provided by suppliers.
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
digital, mixed-signal and analog integrated circuits for a broad range of
high-speed communication and computing applications, serving such markets as
mobile and desktop PCs, servers, consumer electronics, automotive infotainment
and industrial applications. The Company's products provide solutions in
mixed-signal PC system control, USB connectivity, networking and embedded
control systems.
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 2005 presentation, including a change in
classification for auction rate securities, as further discussed under the
caption Investments within this Note 2.
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. Shipping and handling costs are included within
Cost of goods sold.
Certain of the Company's products are sold to electronic component 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. At the time of shipment to distributors, the
Company records a trade receivable for the selling price, relieves inventory for
the carrying value of goods shipped, and records this gross margin as Deferred
income on sales to distributors on the Consolidated Balance Sheet. This deferred
income represents the gross margin on the initial sale to the distributor;
however, the amount of gross margin recognized in future Consolidated Statements
of Operations will typically be less than the originally recorded deferred
income as a result of price allowances. Price allowances offered to distributors
are recognized as reductions in product sales when incurred, which is generally
at the time the distributor resells the product.
Shipments made by the Company's Japanese subsidiary to distributors in Japan are
made under agreements that permit limited or no stock return or price protection
privileges. Revenue for shipments to distributors in Japan is recognized upon
shipment to the distributor.
Revenue recognition for special intellectual property payments received in
fiscal 2005 and 2004 is discussed within Note 9. 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
instruments purchased with original maturities of three months or less.
Investments
Short-term investments consist of investments in obligations with maturities of
between three and twelve months, at acquisition, and investments in auction rate
securities. All of these investments are classified as available-for-sale. The
costs of these short-term investments approximate their market values as of
February 28, 2005 and February 29, 2004.
The Company invests excess cash in a variety of marketable securities, including
auction rate securities. Auction rate securities have long-term underlying
maturities, but have interest rates that are reset every 90 days or less, at
which time the securities can typically be purchased or sold, creating a highly
liquid market. The Company's intent is not to hold these securities to maturity,
but rather to use the interest rate reset feature to provide liquidity as
necessary. The Company's investment in these securities provides higher yields
than money market and other cash equivalent investments. In prior fiscal years,
auction rate securities were classified as cash equivalents, reflecting their
highly liquid nature. They are now being classified as short-term investments
for all periods presented in the accompanying consolidated financial statements,
reflecting recently converging interpretations of the accounting treatment for
these securities. In addition, reflecting this change in classification, all
purchases and sales of auction rate securities are reflected in the investing
section of the Company's Consolidated Statements of Cash Flows. The Company does
not consider this change in classification to be material to its financial
condition or cash flows. In addition, it has no effect on the Company's total
current assets, working capital, total assets, or operating cash flows, and the
change in classification in no way revises or restates the Company's
Consolidated Statements of Operations. Auction rate and other securities were
changed in classification as follows as of February 29, 2004 (in thousands):
Cash and Cash Short-Term
Equivalents Investments
- -----------------------------------------------------------------------------
As previously reported $ 135,161 $ 23,136
Change in classification - auction
rate securities (120,850) 120,850
Change in classification - other securities (261) 261
- -----------------------------------------------------------------------------
As currently reported $ 14,050 $ 144,247
=============================================================================
For the fiscal 2004 and 2003, net cash used for investing activities of $46.1
million and $5.9 million related to activity in auction rate securities,
respectively, was previously included in cash and cash equivalents in the
Consolidated Statements of Cash Flows.
The Company classifies all marketable debt and equity securities with remaining
maturities of greater than one year at acquisition, excluding auction rate
securities, as long-term investments. The Company holds no long-term investments
at February 28, 2005. As of February 29, 2004, long-term investments consisted
primarily of investments in corporate obligations and were classified as
available-for-sale. The cost of these long-term investments approximated their
market value as of February 29, 2004.
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.
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.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to concentrations of
credit risk consist of cash, cash equivalents, short-term and long-term
investments and accounts receivable. The Company invests its cash in bank
accounts and money market accounts with major financial institutions, in U.S.
Treasury and agency obligations, and in debt securities of corporations and
agencies with high credit quality. By policy, the Company seeks to limit credit
exposure on investments through diversification and by restricting its
investments to highly rated securities.
The Company's accounts receivable result from trade credit extended on shipments
to original equipment manufacturers, original design manufacturers and
electronic component distributors. The Company can have individually significant
accounts receivable balances from its larger customers. At February 28, 2005,
three customers individually accounted for more than 10% of accounts receivable,
with balances of $3.8 million, $3.9 million and $2.5 million, respectively. At
February 29, 2004, two customers individually accounted for more than 10% of
accounts receivable, with balances of $7.3 million and $3.8 million,
respectively. The Company manages its concentration of credit risk on accounts
receivable by performing ongoing credit evaluations of its customers' financial
condition and limiting the extension of credit when deemed necessary. In
addition, although the Company generally requests no collateral, prepayments or
letters of credit may be required in certain circumstances. The Company
maintains an allowance for potential credit losses, taking into consideration
the overall quality and aging of the accounts receivable portfolio and
specifically identified customer risks.
The Company's product sales were adversely impacted in fiscal 2005 by an
accounts receivable collectibility issue with one of its Taiwan-based component
distributors. During the closing process for the third quarter of fiscal 2005,
the Company determined that this customer, whose credit history with the Company
had consistently been excellent, was experiencing financial distress and a lack
of liquidity. Generally accepted accounting principles preclude the recognition
of revenue when collectibility is not reasonably assured, and therefore the
Company did not recognize approximately $5.4 million of product sales to this
distributor during the second half of fiscal 2005. The inventory for these
product sales, which had a cost of approximately $2.7 million, had already been
shipped to and resold by the distributor prior to identification of the
collectibility issue. The financial condition of this former customer has
continued to deteriorate and future collectibility of its obligations to SMSC
remains uncertain. Therefore, the $2.7 million of inventory shipped to this
customer, but not yet paid for, is reflected within Cost of goods sold in the
Consolidated Statement of Operations for fiscal 2005. The Company aggressively
arranged alternate channels for delivery of products to its end customers, and
no disruption occurred in the supply of the Company's products.
Inventories
Inventories are valued at the lower of first-in, first-out cost or market. The
Company establishes inventory allowances for estimated obsolescence or
unmarketable inventory for the difference between the cost of inventory and
estimated realizable value based upon assumptions about future demand and market
conditions.
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-Lived Assets
The Company assesses the recoverability of long-lived assets, including
property, plant and equipment 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
Goodwill is recorded as the difference, if any, between the aggregate
consideration paid for an acquisition and the fair value of the net tangible and
intangible assets acquired. In accordance with Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, goodwill and
purchased intangibles with indefinite lives are not amortized but are tested for
impairment on an annual basis or whenever events or changes in circumstances
indicate that the carrying amount of these assets may not be recoverable.
Purchased intangible assets with finite useful lives are amortized over their
estimated useful lives and are reviewed for impairment in value when indicators
of impairment, such as reductions in demand, are present.
Research and Development
Expenditures for research and development are expensed in the period incurred.
Advertising Expense
Advertising costs 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, restricted stock awards
and stock appreciation rights 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.
For purposes of pro forma disclosures, the estimated fair market value of the
Company's options is amortized as an expense over the options' vesting periods.
The fair value of each option grant, as defined by SFAS No. 123, is estimated on
the date of grant using the Black-Scholes option-pricing model. The
Black-Scholes model, as well as other currently accepted option valuation
models, was developed to estimate the fair value of freely tradable, fully
transferable options without vesting restrictions, that significantly differ
from the Company's stock option awards. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in the opinion of management, the existing
models do not necessarily provide a reliable single measure of the fair value of
employee stock options.
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 or 29, 2005 2004 2003
- ------------------------------------------------------------------------------
Dividend yield - - -
Expected volatility 59% 62% 64%
Risk-free interest rates 3.83% 2.98% 2.50%
Expected lives (in years) 4.2 4.7 4.9
- ------------------------------------------------------------------------------
The weighted average Black-Scholes per share values of options granted in fiscal
2005, 2004, and 2003 were $13.09, $9.65 and $11.69, respectively.
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 or 29, 2005 2004 2003
- --------------------------------------------------------------------------------
Net income (loss) - as reported $ 1,602 $ 21,518 $ (7,471)
Add: Stock-based compensation expense
included in net
income (loss), net of taxes - as reported 728 845 627
Deduct: Stock-based compensation expense
determined
using the fair value method for all awards,
net of taxes (7,760) (2,073) (7,419)
- --------------------------------------------------------------------------------
Net income (loss) - pro forma $ (5,430) $ 20,290 $ (14,263)
================================================================================
Basic net income (loss) per share -
as reported $ 0.09 $ 1.25 $ (0.45)
================================================================================
Diluted net income (loss) per share -
as reported $ 0.08 $ 1.16 $ (0.45)
================================================================================
Basic net income (loss) per share -
pro forma $ (0.30) $ 1.18 $ (0.86)
================================================================================
Diluted net income (loss) per share -
pro forma $ (0.30) $ 1.11 $ (0.86)
================================================================================
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 they
are earned.
Translation of Foreign Currencies
The functional currencies of the Company's foreign subsidiaries are their
respective local 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
SMSC in U.S. dollars and, from time to time, has entered into forward exchange
contracts to hedge against currency fluctuations associated with these product
purchases. Gains and losses on such contracts have not been significant. As of
February 28, 2005, there are no outstanding commitments under foreign exchange
contracts.
Other 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 December 2004, the FASB issued SFAS No. 123R (Revised 2004), Share-Based
Payment. The scope of SFAS No. 123R includes a wide range of share-based
compensation arrangements including stock options, restricted stock plans,
performance-based awards, stock appreciation rights, and employee stock purchase
plans. SFAS No. 123R replaces SFAS No. 123, Accounting for Stock-Based
Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees. SFAS No. 123, as originally issued in 1995, established as preferable
a fair-value-based method of accounting for share-based payment transactions
with employees. However, that statement permitted the option of continuing to
apply the guidance in APB Opinion 25, provided that the footnotes to the
consolidated financial statements disclosed pro forma net income and net income
per share, as if the preferable fair-value-based method had been applied. SFAS
No. 123R requires that compensation costs relating to share-based payment
transactions be recognized in the consolidated financial statements.
Compensation costs will be measured based on the fair value of the equity or
liability instruments issued. SFAS No. 123R is effective for the first annual
reporting period that begins after June 15, 2005. The Company is currently
evaluating the impact of SFAS No. 123R and believes that the adoption of this
statement could have a material impact on its consolidated financial position,
results of operations and cash flows.
3. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is calculated by dividing net income (loss) 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 unvested restricted stock awards and 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 or 29, 2005 2004 2003
- ------------------------------------------------------------------------
Average shares outstanding for basic
net income (loss) per share 18,376 17,226 16,538
Dilutive effect of stock options and
unvested restricted stock awards 942 1,253 -
- ------------------------------------------------------------------------
Average shares outstanding for diluted
net income (loss) per share 19,318 18,479 16,538
- ------------------------------------------------------------------------
During fiscal 2005 and 2004, stock options covering 1,239,000 and 1,262,000
common shares, respectively, were excluded from the computation of diluted net
income per share, because their effects were anti-dilutive.
The Company reported a net loss from continuing operations in fiscal 2003, and
accordingly, the effect of stock options covering an average of 4,787,000 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.
4. BUSINESS ACQUISITION - GAIN TECHNOLOGY CORPORATION
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. Through this
acquisition, the Company significantly enhanced its analog and mixed-signal
design capabilities, by adding highly skilled engineers and designers to its
staff, acquiring several new products, and expanding its intellectual property
portfolio.
The Company acquired Gain for 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 acquisition was accounted for as a purchase in accordance with the
provisions of SFAS No. 141, and accordingly, Gain's results of operations have
been included in the accompanying consolidated financial statements from the
date of acquisition. The purchase price was allocated to the estimated fair
values of assets acquired and liabilities assumed, as set forth in the following
table.
(in thousands)
--------------------------------------------------------
Current assets $ 1,708
Property, plant and equipment 1,028
Deferred income taxes 1,086
Other assets 41
Goodwill 29,595
Existing technologies 6,179
Other intangible assets 908
--------------------------------------------------------
Total assets acquired 40,545
Current liabilities 3,355
Long-term obligations 1,177
--------------------------------------------------------
Total liabilities assumed 4,532
Net assets acquired 36,013
In-process research and development 87
--------------------------------------------------------
Total consideration $ 36,100
========================================================
The significant allocation of the purchase price to goodwill reflects the
Company's assessment of substantial value in Gain's analog and mixed-signal
design expertise and highly trained engineering staff. Under the provisions of
SFAS No. 141, the value of intellectual capital underlying an assembled
workforce is included within the value assigned to goodwill.
The amounts allocated to existing 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. The $29.6
million assigned to goodwill is not being amortized. Further information
regarding goodwill and other intangible assets is provided within Note 5.
The amount assigned to in-process research and development was related to
ongoing projects that had not yet proven to be commercially feasible, and for
which no alternative future use existed 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 in the following table
give effect to the acquisition of Gain as if it had occurred at the beginning of
fiscal 2003. 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.
(in thousands, except per share data)
Sales and revenues $ 156,755
Net loss (8,449)
=====================================================
Basic net loss per share $ (0.51)
=====================================================
5. GOODWILL AND INTANGIBLE ASSETS
The Company's June 2002 acquisition of Gain Technology Corporation included the
acquisition of $7.1 million of finite-lived intangible assets and $29.6 million
of goodwill. In accordance with the provisions of SFAS No. 142, Goodwill and
Other Intangible Assets, this goodwill is not being amortized, but is tested for
impairment in value annually, as well as when an event or circumstance occurs
indicating a possible impairment in value. The Company performs an annual
goodwill impairment review during the fourth quarter of each fiscal year, and
completed its most recent annual review during the fourth quarter of fiscal
2005, during which no impairment in value was identified.
The Company's finite-lived intangible assets consisted of the following (in
thousands):
As of February 28 or 29, 2005 2004
-----------------------------------------------------------------------------
Accumulated Accumulated
Cost Amortization Cost Amortization
-----------------------------------------------------------------------------
Existing technologies $ 6,179 $ 2,832 $ 6,179 $ 1,802
Customer contracts 326 89 326 57
Non-compete agreements - - 410 359
-----------------------------------------------------------------------------
$ 6,505 $ 2,921 $ 6,915 $ 2,218
=============================================================================
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 were 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
-------------------------------------
2006 $ 1,062
2007 1,062
2008 1,062
2009 290
2010 33
=====================================
6. OTHER BALANCE SHEET DATA
(In thousands)
As of February 28 or 29, 2005 2004
- --------------------------------------------------------------------------
Inventories:
Raw materials $ 1,143 $ 910
Work-in-process 16,626 13,202
Finished goods 15,541 9,050
- --------------------------------------------------------------------------
$ 33,310 $ 23,162
==========================================================================
Property, plant and equipment:
Land $ 578 $ 1,570
Buildings and improvements 12,064 20,732
Machinery and equipment 68,190 90,195
Construction in progress 1,601 110
- --------------------------------------------------------------------------
82,433 112,607
Less: accumulated depreciation 59,803 89,177
- --------------------------------------------------------------------------
$ 22,630 $ 23,430
==========================================================================
Accrued expenses, income taxes
and other liabilities:
Salaries and fringe benefits $ 3,005 $ 2,662
Accrued legal fees 2,274 369
Supplier financing - current portion 1,931 1,998
Other 6,190 8,139
- --------------------------------------------------------------------------
$ 13,400 $ 13,168
==========================================================================
Other liabilities:
Retirement benefits $ 6,595 $ 6,152
Deferred income taxes 4,305 3,722
Supplier financing - long-term portion 527 1,608
Other 899 622
- --------------------------------------------------------------------------
$ 12,326 $ 12,104
==========================================================================
7. SHAREHOLDERS' EQUITY
Common Stock Repurchase Program
The Company maintains a common stock repurchase program, as approved by its
Board of Directors, which authorizes the Company to repurchase up to three
million shares of its common stock on the open market or in private
transactions. As of February 28, 2005, the Company had repurchased approximately
1.8 million shares of common stock at a cost of $23.8 million under this
program, including 21,800 shares repurchased at a cost of $0.3 million in fiscal
2005 and 482,000 shares repurchased at a cost of $9.6 million in fiscal 2003. No
shares were repurchased during fiscal 2004. 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 $0.01 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,
2004, Citigroup reported beneficial ownership of the Company of less than 15%.
8. INCOME TAXES
The provision for (benefit from) income taxes included in the accompanying
Consolidated Statements of Operations consists of the following (in thousands):
For the years ended February 29 or 28, 2005 2004 2003
- -----------------------------------------------------------------------------
Current
Federal $ (646) $ 5,647 $ (3,119)
Foreign 854 365 327
State 192 175 147
- -----------------------------------------------------------------------------
400 6,187 (2,645)
Deferred (2,667) 1,850 (4,058)
- -----------------------------------------------------------------------------
(2,267) 8,037 (6,703)
Less: tax benefits from discontinued
operations - (14) (281)
- -----------------------------------------------------------------------------
$ (2,267) $ 8,051 $ (6,422)
- -----------------------------------------------------------------------------
The tax benefits from discontinued operations represent the taxes resulting from
net losses related to the Company's previous sale of a former division, which
was accounted for as a discontinued operation. This transaction is further
described in Note 14.
The items accounting for the difference between the provision for (benefit from)
income taxes computed at the U. S. federal statutory rate and the Company's
provision for (benefit from) income taxes are as follows (in thousands):
For the years ended February 28 or 29, 2005 2004 2003
- -------------------------------------------------------------------------------
Provision for (benefit from) income taxes
computed at U.S. federal statutory tax
rate $ (233) $ 10,344 $ (4,955)
State taxes, net of federal benefit 125 215 (108)
Differences between foreign and U.S.
income tax rates 209 (62) 237
Tax-exempt income (744) (224) (238)
Export sales benefit (562) (822) (926)
Adjustments to prior years' taxes 22 (817) -
Tax credits (1,104) (518) (675)
Other 20 (79) (38)
- -------------------------------------------------------------------------------
$ (2,267) $ 8,037 $ (6,703)
- -------------------------------------------------------------------------------
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 income taxes are as follows (in thousands):
As of February 28 or 29, 2005 2004
- -----------------------------------------------------------------------
Deferred tax assets (liabilities):
Reserves and accruals not currently
deductible for income tax purposes $ 11,305 $ 12,843
Inventory valuation 1,515 1,498
Intangible asset amortization (997) (1,358)
Restructuring costs 2,024 2,160
Purchased in-process technology 818 938
Property, plant and equipment
depreciation (1,096) (83)
Net operating losses 7,422 4,349
Other, net 3,873 1,210
- -----------------------------------------------------------------------
Net deferred tax assets $ 24,864 $ 21,557
- -----------------------------------------------------------------------
Income (loss) before income taxes and minority interest includes foreign income
of $2.0 million, $1.2 million and $0.2 million for fiscal 2005, 2004 and 2003,
respectively.
At February 28, 2005, the Company had federal net operating loss carryforwards
totaling $22.2 million. Of this amount, $1.5 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 $20.7
million results from net operating losses recorded by the Company in fiscal 2003
and 2005, the tax effects of which are reflected within the current portion of
Deferred income taxes on the Consolidated Balance Sheet at February 28, 2005.
The Company also has $2.2 million of New York State tax credit carryforwards at
February 28, 2005, of which $0.1 million will expire in fiscal 2006. The
remaining $2.1 million of credit carryforwards expire at various dates from
fiscal 2007 through fiscal 2018.
The American Jobs Creation Act of 2004 was signed into law on October 22, 2004.
This act creates a temporary incentive for United States multinationals to
repatriate accumulated income earned outside of the United States at a federal
effective tax rate of 5.25%. On December 21, 2004, the FASB issued FASB Staff
Position No. FAS 109-2, Accounting and Disclosure Guidance for the Foreign
Earnings Repatriation Provision within the American Jobs Creation Act of 2004,
which allows an enterprise time beyond the financial reporting period of
enactment to evaluate the effect of the Act on its plan for reinvestment or
repatriation of foreign earnings. The Company has started an evaluation of the
effects of the repatriation provision; however, it does not expect to be able to
complete this evaluation until after Congress or the Treasury Department provide
additional clarifying language on key elements of the provision. The Company is
currently in the process of evaluating whether or not, and to what extent, if
any, this provision may provide opportunities for tax benefits. The Company
expects to complete such evaluation before the end of fiscal 2006. The Company
estimates that up to $2.0 million may be considered for repatriation under this
provision, with related income taxes of up to $0.1 million.
9. 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, covering manufacturing processes and products, thereby providing
each company access to the other's current and future patent portfolios.
In September 2003, the Company and Intel announced that they had enhanced their
intellectual property and business relationship. The companies agreed to
collaborate on certain future Input/Output (I/O) and sensor products, and Intel
agreed to use the Company's devices on certain current and future generations of
Intel products. In addition, the Company agreed to limit its rights, under its
1987 patent cross-license with Intel, to manufacture and sell Northbridge
products and Intel Architecture Microprocessors on behalf of third parties. The
companies also terminated an Investor Rights Agreement between them, which had
been entered into in connection with Intel's 1997 acquisition of 1,543,000
shares of the Company's common stock. Under this agreement, Intel had certain
information, corporate governance and other rights with respect to the
activities of the Company.
In respect to this relationship, Intel agreed to pay to the Company an aggregate
amount of $75 million, of which $20.0 million and $2.5 million was recognized as
Intellectual property revenue, and paid, in the third and fourth quarters of
fiscal 2004, respectively, and $2.5 million was recognized as Intellectual
property revenue, and paid, in each quarter of fiscal 2005. Of the remaining
amount, $10.25 million is payable in fiscal 2006, $11.25 million is payable in
fiscal 2007, $12.0 million is payable in fiscal 2008 and $9.0 million is payable
in fiscal 2009. Such amounts are payable in quarterly installments each year,
and are subject to possible reduction, in a manner and to an extent to be agreed
by the parties, based upon the companies' collaboration and sales, facilitated
by Intel, of certain future new products of the Company.
10. MINORITY INTEREST IN SUBSIDIARY
The Company conducts its business in the Japanese market through its subsidiary,
SMSC Japan. SMSC Japan's original capitalization in fiscal 1987 included a
minority investment by Sumitomo Metal Industries, Ltd. of Osaka, Japan
(Sumitomo) totaling 2.1 billion yen, or approximately $12.7 million at
then-current exchange rates, in exchange for 20% of SMSC Japan's issued and
outstanding common stock and all of its non-cumulative, non-voting 6% preferred
stock.
In January 2004, SMSC Japan redeemed Sumitomo's common and preferred stock
investments for combined consideration of 551 million yen, or approximately $5.2
million at then-current exchange rates, of which $3.0 million represented the
redemption of the preferred stock investment and $2.2 million was the estimated
fair value of Sumitomo's 20% common stock investment. The difference between the
carrying value and the redemption price of the preferred stock, totaling $6.7
million, was recorded as a credit to Additional paid-in capital, and is also
presented as a component of Net income applicable to common shareholders in the
Consolidated Statement of Operations for fiscal 2004, in accordance with the
provisions of Emerging Issues Task Force Issue No. D-42, The Effect on the
Calculation of Earnings per Share for the Redemption or Induced Conversion of
Preferred Stock. The $2.2 million assigned to Sumitomo's common stock investment
in SMSC Japan was allocated to the underlying net assets acquired at their
respective fair values, which approximated their carrying values.
11. REAL ESTATE TRANSACTIONS
During the third quarter of fiscal 2005, the Company sold its remaining parcel
of idle real estate in Hauppauge, New York, for net proceeds of $1.7 million,
after transaction costs. This property had a carrying value of approximately
$0.4 million. The contract of sale required the Company to complete the
remediation of certain soil contamination of uncertain origin identified at this
property, at its expense. In recognition of both the uncertain cost and
uncertain completion date of the soil remediation obligation at that time, the
Company did not reflect the impact of this transaction within its Statement of
Operations for the third quarter of fiscal 2005. The Company subsequently
completed the project during the fourth quarter of fiscal 2005, and received
final regulatory approval thereafter. Accordingly, the Company recognized a gain
of $1.0 million on this transaction, after related soil remediation project
costs, in the fourth quarter of fiscal 2005.
During fiscal 2004, the Company sold certain portions of its Hauppauge, New York
real estate holdings for aggregate proceeds of $7.0 million, net of transaction
costs. These transactions resulted in an aggregate gain of $1.7 million, $1.4
million of which related to property in which the Company had no continued
interest and was recognized within the Company's fiscal 2004 first quarter
operating results, and $0.3 million of which related to property that the
Company leased back from the purchaser and was therefore deferred. This deferred
gain is being recognized within the Company's operating results as a reduction
of rent expense on a straight-line basis over a 30-month period beginning in
June 2003, consistent with the term of the lease. As of February 28, 2005, the
Company's remaining rent obligation over the term of this lease is approximately
$0.2 million.
12. SALES AND IMPAIRMENTS OF INVESTMENTS
Investment in Chartered Semiconductor
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 Semiconductor Manufacturing Ltd. (Chartered),
based upon a sustained reduction in Chartered's stock price. During the first
quarter of fiscal 2004, the Company sold its remaining equity investment in
Chartered, realizing a loss of $0.7 million, which is included within Other
income (expense), net on the Consolidated Statements of Operations for fiscal
2004.
Investment in SMC Networks, Inc.
The Company's investment in SMC Networks, Inc. was 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, this
investment, which carried an original cost of $8.5 million, was fully written
off in the third quarter of fiscal 2003. Subsequently, as part of the December
2003 arbitration settlement with Accton, discussed within Note 14, the Company
transferred this investment to Accton for a nominal value.
13. BUSINESS RESTRUCTURING
In November 2001, the Company exited the PC chipset business. This
reorganization was implemented to redirect the Company's resources towards
higher growth, higher margin businesses. All obligations under this
restructuring were satisfied and reconciled in periods prior to fiscal 2005,
with the exception of long-term non-cancelable lease obligations, which are
being paid over their respective terms, through August 2008.
The following table provides a summary of the Company's reserve for this
restructuring for the three years ended February 28, 2005 (in thousands):
Non-cancelable
lease Other
obligations Charges Total
- --------------------------------------------------------------------------------
Business restructuring reserve
at February 28, 2002 $ 1,771 $ 333 $ 2,104
Cash payments (397) (21) (418)
Non-cash adjustments - (267) (267)
- --------------------------------------------------------------------------------
Business restructuring reserve
at February 28, 2003 1,374 45 1,419
Cash payments (414) - (414)
Non-cash adjustments - (45) (45)
- --------------------------------------------------------------------------------
Business restructuring reserve
at February 29, 2004 960 - 960
Cash payments (433) - (433)
- --------------------------------------------------------------------------------
Business restructuring reserve
at February 28, 2005 $ 527 $ - $ 527
================================================================================
14. DISCONTINUED OPERATIONS
The Company had been involved in an arbitration proceeding with Accton
Technology Corporation (Accton) and SMC Networks, Inc. (Networks), relating to
claims associated with the October 1997 purchase of a majority interest in
Networks by Accton from SMSC. This divestiture was accounted for as a
discontinued operation, and accordingly, costs associated with this action, net
of income taxes, were reported within Loss from discontinued operations on the
Consolidated Statements of Operations. These costs totaled $0.3 million and $0.8
million in fiscal 2004 and 2003, respectively, before applicable income tax
benefits. This action was settled during the fourth quarter of fiscal 2004, with
SMSC realizing a pre-tax gain of $0.3 million, which is included within Loss
from discontinued operations on the Consolidated Statements of Operations for
fiscal 2004.
15. 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 a portion 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 $1.2 million, $1.1 million and $1.0
million in fiscal 2005, 2004 and 2003, respectively.
Common stock for the Company's matching contributions to the Plan is purchased
in the open market. Since its inception, 1,486,000 shares of the Company's
common stock have been contributed to the Plan.
As of February 28, 2005, 358 of the 462 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, 2005, 1,052,000 shares of common stock were available
for future grants of stock options, of which 437,000 can also be issued as
restricted stock awards.
Stock option plan activity is summarized below (shares in thousands):
Weighted Weighted Weighted
Fiscal Average Fiscal Average Fiscal Average
2005 Exercise 2004 Exercise 2003 Exercise
Shares Prices Shares Prices Shares Prices
- ----------------------------------------------------------------------------------------------------------------
Options outstanding, beginning of year 4,255 $16.40 4,778 $14.87 4,063 $12.52
Granted 407 23.24 1,146 17.94 1,732 21.71
Exercised (310) 13.61 (1,405) 12.01 (407) 10.79
Canceled or expired (305) 17.48 (264) 18.87 (610) 21.30
- ----------------------------------------------------------------------------------------------------------------
Options outstanding, end of year 4,047 $17.22 4,255 $16.40 4,778 $14.87
- ----------------------------------------------------------------------------------------------------------------
Options exercisable 1,652 $16.01 1,054 $14.16 1,594 $12.27
- ----------------------------------------------------------------------------------------------------------------
The following table summarizes information relating to currently outstanding and
exercisable options as of February 28, 2005 (shares in thousands):
Weighted
Average Weighted Weighted
Range of Remaining Lives Options Average Exercise Options Average Exercise
- -----------------------------------------------------------------------------------------------------------------------
Exercise Prices (in years) Outstanding Prices Exercisable Prices
- -----------------------------------------------------------------------------------------------------------------------
$ 6.75 - $12.69 5.27 855 $ 9.86 337 $10.26
$12.75 - $14.81 6.01 815 14.21 542 14.18
$14.90 - $19.92 7.75 1,259 18.39 485 18.02
$20.00 - $24.58 7.30 824 22.56 260 22.47
$24.94 - $27.90 8.92 294 26.95 28 25.63
- -----------------------------------------------------------------------------------------------------------------------
4,047 1,652
- -----------------------------------------------------------------------------------------------------------------------
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, 2005, the
expiration dates of the outstanding options under this plan range from July 15,
2007 to January 18, 2015, and the exercise prices range from $8.50 to $30.12
(weighted average $17.40) per share.
The following is a summary of activity under the Director Stock Option Plan over
the past three fiscal years (shares in thousands):
Weighted Weighted Weighted
Fiscal Average Fiscal Average Fiscal Average
2005 Exercise 2004 Exercise 2003 Exercise
Shares Prices Shares Prices Shares Prices
- -----------------------------------------------------------------------------------------------------------------------------
Options outstanding, beginning of year 263 $17.52 271 $15.03 261 $12.78
Granted 42 20.10 129 20.52 102 17.29
Exercised - - (134) 15.33 (92) 11.11
Canceled or expired - - (3) 20.25 - -
- -----------------------------------------------------------------------------------------------------------------------------
Options outstanding, end of year 305 $17.86 263 $17.52 271 $15.03
- -----------------------------------------------------------------------------------------------------------------------------
Options exercisable 251 $17.40 181 $16.41 269 $14.98
- -----------------------------------------------------------------------------------------------------------------------------
Shares available for future grants, end of year 24 66 92
- -----------------------------------------------------------------------------------------------------------------------------
Director Deferred Compensation Plan
The Company has a deferred compensation plan for its non-employee directors,
which requires eligible directors to defer either 50% or 100% of their basic
annual compensation. 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 a quarterly basis. 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, pursuant to a plan
amendment implemented in fiscal 2003, is generally required to be paid in the
form of common stock. Compensation expense under this plan was $0.1 million,
$0.3 million and $0.1 million in fiscal 2005, 2004 and 2003, respectively.
The following is a summary of the activity under this plan (units in thousands):
For the years ended February 28 or 29, 2005 2004 2003
- -------------------------------------------------------------------------------
Common stock equivalent units,
beginning of year 29 35 31
Common stock equivalent units
earned 7 5 4
Distributions - (11) -
- -------------------------------------------------------------------------------
Common stock equivalent units,
end of year 36 29 35
- -------------------------------------------------------------------------------
Common stock equivalent units
available, end of year 43 50 65
- -------------------------------------------------------------------------------
Range of common stock prices
used to calculate common stock
equivalent units $16.31-$26.72 $14.82-$26.45 $16.43-$22.60
- -------------------------------------------------------------------------------
Restricted Stock Awards
The Company provides common stock awards to certain officers and key employees.
The Company grants these awards, at its discretion, from the shares available
under its 2001 and 2003 Stock Option and Restricted Stock Plans. The shares
awarded are typically earned in 25%, 25% and 50% increments on the first, second
and third anniversaries of the award, respectively, and 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 unvested awards. Deferred compensation expense of $1.9 million and $2.0
million associated with unearned shares under this plan as of February 28, 2005
and February 29, 2004, respectively, is reported within Shareholders' equity on
the Company's Consolidated Balance Sheets. Compensation expense for these awards
was $0.9 million, $1.0 million and $0.9 million in fiscal 2005, 2004 and 2003,
respectively.
Through February 28, 2005, 173,000 shares, net of cancellations, have been
awarded under this plan, and 127,000 shares are unvested. The Company, at its
discretion, can grant restricted stock awards from the shares available under
its 2001 and 2003 Stock Option and Restricted Stock Plans.
Stock Appreciation Rights Plan
In September 2004, the Company's Board of Directors approved a Stock
Appreciation Rights (SAR) Plan (the Plan), the purpose of which is to attract,
retain, reward and motivate employees and consultants to promote the Company's
best interests and to share in its future success. The Plan authorizes the
Board's Compensation Committee to grant up to two million SAR awards to eligible
officers, employees and consultants. Each award, when granted, provides the
participant with the right to receive payment in cash, upon exercise, for the
appreciation in market value of a share of SMSC common stock over the award's
exercise price. The exercise price of a SAR is equal to the closing market price
of SMSC stock on the date of grant. SAR awards generally vest over four or
five-year periods, and expire no later than ten years from the date of grant.
Activity under the Stock Appreciation Rights Plan is summarized below (shares in
thousands):
Weighted
Fiscal Average
2005 Exercise
SARs Prices
- ---------------------------------------------------------------------
SARs outstanding, beginning of year - -
Granted 1,468 $17.10
Exercised - -
Canceled or expired (9) $17.10
- ---------------------------------------------------------------------
SARs outstanding, end of year 1,459 $17.10
- ---------------------------------------------------------------------
SARs exercisable - -
- ---------------------------------------------------------------------
The Company recognizes compensation expense for the appreciation of a SAR
award's market value over its exercise price over the term of the award. The
Company recorded $0.1 million of compensation expense for these awards during
fiscal 2005.
Retirement Plans
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. Based upon a measurement
performed as of February 28, 2005, the following table sets forth the components
of the Plan's net periodic pension expense, the changes in the Plan's projected
benefit obligation, 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 or 29, 2005 2004 2003
- --------------------------------------------------------------------------------
Service cost - benefits earned during
the year $ 124 $ 115 $ 100
Interest cost on projected benefit
obligations 408 389 358
Net amortization and deferral 268 252 245
- --------------------------------------------------------------------------------
Net periodic pension expense $ 800 $ 756 $ 703
- --------------------------------------------------------------------------------
Projected benefit obligation:
Beginning of year $ 7,116 $ 6,628 $ 6,070
Service cost - benefits earned
during the year 124 115 100
Interest cost 408 389 358
Benefit payments (275) (275) (275)
Other (561) 259 375
- --------------------------------------------------------------------------------
End of year $ 6,812 $ 7,116 $ 6,628
- --------------------------------------------------------------------------------
As of February 28 or 29, 2005 2004 2003
- --------------------------------------------------------------------------------
Actuarial present value of:
Vested benefit obligation $ 5,407 $ 4,763 $ 4,586
Nonvested benefit obligation 458 670 563
- --------------------------------------------------------------------------------
Accumulated benefit obligation 5,865 5,433 5,149
Effect of projected future salary
increases 947 1,683 1,479
- --------------------------------------------------------------------------------
Projected benefit obligation 6,812 7,116 6,628
Unrecognized gain or (loss) (422) (1,006) (754)
Unrecognized net transition asset (981) (1,225) (1,470)
Additional minimum liability 456 548 745
- --------------------------------------------------------------------------------
Accrued pension cost $ 5,865 $ 5,433 $ 5,149
- --------------------------------------------------------------------------------
Assumptions used in determining
actuarial present value of benefit
obligations:
Discount rate 5.59% 5.85% 6.00%
Weighted average rate of compensation
increase 4.00% 7.00% 7.00%
- --------------------------------------------------------------------------------
The discount rate used in the Plan's measurement is based upon a weighted
average of high-quality long-term investment yields during the six-month period
preceding the date of measurement. The weighted average rate of compensation
increase was reduced for the fiscal 2005 measurement to better reflect
management's current expectations of future compensation trends.
Although the Plan is unfunded, the Company is the beneficiary of life insurance
policies that have been purchased as a method of partially financing benefits.
The cash surrender value of these policies is approximately $1.6 million at
February 28, 2005.
Annual benefit payments under this plan are expected to be approximately $0.2
million, $0.3 million, $0.5 million, $0.6 million and $0.5 million in fiscal
2006 through fiscal 2010, respectively, and approximately $2.5 million
cumulatively in fiscal 2011 through fiscal 2015.
The Company's subsidiary, SMSC Japan, also maintains an unfunded retirement
plan, which provides its employees and directors with separation benefits,
consistent with customary practices in Japan. Benefits under this defined
benefit plan are based upon length of service and compensation factors. Based
upon valuations of the Plan performed as of February 28, 2005, and February 29,
2004, the following table sets forth the components of the Plan's net periodic
pension expense, the changes in the Plan's projected benefit obligation, 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 or 29, 2005 2004
- -------------------------------------------------------------------------------
Service cost - benefits earned during the year $ 230 $ 152
Interest cost on projected benefit obligations 21 17
Net amortization and deferral 22 21
- -------------------------------------------------------------------------------
Net periodic pension expense $ 273 $ 190
- -------------------------------------------------------------------------------
Projected benefit obligation:
Beginning of year $ 1,088 $ 810
Service cost - benefits earned during the year 230 152
Interest cost 21 17
Benefit payments (81) -
Other (221) 108
- -------------------------------------------------------------------------------
End of year $ 1,037 $ 1,088
- -------------------------------------------------------------------------------
As of February 28 or 29, 2005 2004
- -------------------------------------------------------------------------------
Accumulated benefit obligation (entirely vested) $ 991 $ 836
Effect of projected future salary increases 46 253
- -------------------------------------------------------------------------------
Projected benefit obligation 1,037 1,088
Unrecognized gain or (loss) 271 -
Unrecognized net transition asset (174) (187)
Other (8) (9)
- -------------------------------------------------------------------------------
Accrued pension cost $ 1,126 $ 892
- -------------------------------------------------------------------------------
Assumptions used in determining actuarial
present value of benefit obligations:
Discount rate 1.75% 2.00%
Weighted average rate of compensation increase 2.00% 3.50%
- -------------------------------------------------------------------------------
The discount rate used in the Plan's measurement is based upon an average of
high-quality long-term investment yields in Japan. The weighted average rate of
compensation increase was reduced for the fiscal 2005 measurement to better
reflect management's current expectations of future compensation trends.
Annual benefit payments under this plan are expected to be no more than $0.1
million for the foreseeable future.
16. COMMITMENTS AND CONTINGENCIES
Compensation
Certain executives and key employees are employed under separate agreements
terminating on various dates through fiscal 2009. These agreements provide,
among other things, for annual base salaries totaling $1.2 million in fiscal
2006, and $0.3 million in each of fiscal 2007 and 2008.
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.
At February 28, 2005, future minimum lease payments for non-cancelable lease
obligations are as follows (in thousands):
Minimum
Lease
Payments
- ------------------------------------------------
2006 $ 1,955
2007 1,336
2008 827
2009 376
2010 and thereafter 11
- ------------------------------------------------
Total minimum lease payments $ 4,505
================================================
Total rent expense for all operating leases was $2.8 million, $2.6 million and
$1.9 million in fiscal 2005, 2004 and 2003, respectively.
Open Purchase Orders
As of February 28, 2005, the Company had approximately $20.0 million in
obligations under open purchase orders. Open purchase orders represent
agreements to purchase goods or services that are enforceable and legally
binding and that specify all significant terms, including quantities to be
purchased, pricing provisions and the approximate timing of the transactions.
These obligations primarily relate to future purchases of wafers from foundries,
assembly and testing services and manufacturing and design equipment.
Supplier Financing
During fiscal 2005 and 2004, the Company acquired $0.9 million and $3.9 million,
respectively, of software and other tools used in product design, for which the
suppliers provided payment terms through fiscal 2008.
At February 28, 2005, future supplier financing obligations are as follows (in
thousands):
- -------------------------------------------------------
2006 $ 1,931
2007 354
2008 173
- -------------------------------------------------------
Total supplier financing obligations $ 2,458
=======================================================
The Company's Consolidated Balance Sheets include the current portion of these
obligations within Accrued expenses, income taxes and other liabilities, and the
long-term portion within Other liabilities.
Litigation
From time to time as a normal incidence of doing business, various claims and
litigation may be asserted or commenced against the Company. Due to
uncertainties inherent in litigation and other claims, the Company can give no
assurance that it will prevail in any such matters, which could subject the
Company to significant liability for damages and/or invalidate its proprietary
rights. Any lawsuits, regardless of their success, would likely be
time-consuming and expensive to resolve and would divert management's time and
attention, and an adverse outcome of any significant matter could have a
material adverse effect on the Company's consolidated results of operations or
cash flows in the quarter or annual period in which one or more of these matters
are resolved.
In June 2003, SMSC was named as a defendant in a patent infringement lawsuit
filed by Analog Devices, Inc. (ADI) in the United States District Court for the
District of Massachusetts (Analog Devices, Inc. v. Standard Microsystems
Corporation, Case Number 03 CIV 11216). The Complaint, as amended, alleged that
some of the Company's products infringed one or more of three of ADI's patents,
and sought injunctive relief and unspecified damages. In September 2003, the
Company filed an Answer in the lawsuit, denying ADI's allegations and raising
affirmative defenses and counterclaims. During the fourth quarter of fiscal
2005, the Company and ADI reached a settlement of this dispute, under which both
parties agreed to dismiss all claims against each other. As part of the
agreement, the Company made a one-time payment of $6.0 million to ADI, and ADI
granted the Company a royalty-bearing license to the patents in question. The
Company does not expect royalties incurred under the license to have a material
impact on future results of operations.
As of February 28, 2005, SMSC was not a party to any legal proceedings, claims,
disputes or litigation that are expected to have a material adverse effect on
the Company's results of operations or financial condition.
17. INDUSTRY SEGMENT, GEOGRAPHIC, CUSTOMER AND SUPPLIER INFORMATION
Industry Segment
Although the Company had three operating segments at February 28, 2005, these
segments conform to aggregation criteria set forth in SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information, and their operating
results are therefore aggregated into one reportable operating segment - the
design, development and marketing of semiconductor integrated circuits.
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.
Sales and Revenues by Geographic Region
The Company's sales by major geographic region are based upon the geographic
location of the customers who purchase the Company's products. For product sales
to electronic component distributors, their geographic locations may be
different from the geographic locations of the end customers. The information
below summarizes sales and revenues to unaffiliated customers by geographic area
(in thousands):
For the years ended February 28 or 29, 2005 2004 2003
- --------------------------------------------------------------------------------
North America $ 38,075 $ 37,138 $ 14,712
Taiwan 94,599 106,279 82,399
Japan, China and Other Asia Pacific 64,966 62,101 49,504
Europe and Rest of World 11,175 10,355 8,902
- --------------------------------------------------------------------------------
$ 208,815 $ 215,873 $ 155,517
- --------------------------------------------------------------------------------
Significant Customers
Revenues from significant customers, as percentages of total sales and revenues,
are summarized as follows:
For the years ended February 28 or 29, 2005 2004 2003
- --------------------------------------------------------------------------------
Customer A 13% 16% 20%
Customer B 11% 16% 14%
Customer C 13% 12% 10%
Customer D * 12% 12%
* Less then 10%
Significant Suppliers
The Company does not operate a wafer fabrication facility. Three 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.
18. RELATED PARTY TRANSACTIONS
During fiscal 2005, 2004 and 2003, the Company purchased $1.2 million, $0.8
million and $1.1 million of test equipment and supplies in the ordinary course
of business from Delta Design, Inc., whose President and Chief Executive Officer
serves on SMSC's Board of Directors.
19. SUBSEQUENT EVENT - ACQUISITION OF OASIS SILICONSYSTEMS HOLDING AG
In March 2005, the Company announced the acquisition of 100% of the outstanding
common stock of OASIS SiliconSystems Holding AG (OASIS), a leader in the
development and marketing of integrated circuits that enable the networking and
transport of digital audio, video, data and control information among multimedia
devices within an automobile. OASIS is based in Karlsruhe, Germany and is
supported by an engineering team based in Austin, Texas and several other
offices worldwide. This acquisition serves to complement the Company's existing
product offerings, augment its engineering workforce, and enhance its
technological capabilities.
The aggregate cost of the acquisition was approximately $118.5 million,
including approximately $79.5 million of cash, 2.1 million shares of SMSC common
stock, valued at $35.8 million, and an estimated $3.2 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. Up to $20.0 million of additional consideration, payable in cash and
SMSC common stock, may be issued to OASIS' former shareholders during fiscal
2007 upon satisfaction of certain future performance goals. Any additional
consideration earned and paid will be recorded as goodwill. Included within the
assets acquired from OASIS were approximately $22 million of cash and cash
equivalents.
The following table summarizes the preliminary allocation of the purchase price
to the fair values of the assets acquired and liabilities assumed, and the value
of in-process research and development, at the date of acquisition. The Company
is in the process of completing its review and assessment of the fair values of
OASIS' tangible assets, and obtaining third-party valuations of certain
intangible assets, and thus the allocation of the purchase price is subject to
further refinement. The final allocation could differ significantly from the
preliminary amounts presented in the following table. The estimated useful lives
of finite-lived intangible assets are also still being evaluated.
(in millions)
-------------------------------------------------------------
Net current assets $ 31.1
Net non-current liabilities,
including deferred income taxes (15.9)
Intangible assets and goodwill 102.4
In-process research and development 0.9
-------------------------------------------------------------
Total consideration $ 118.5
=============================================================
20. QUARTERLY FINANCIAL DATA (UNAUDITED)
(In thousands, except per share data. The sum of the income (loss) per share
amounts may not total due to rounding.)
Quarter ended May 31 Aug. 31 Nov. 30 Feb. 28
- -----------------------------------------------------------------------------
Fiscal 2005
Product sales $ 50,352 $ 47,233 $ 48,026 $ 52,192
Intellectual property
revenues 2,701 2,924 2,729 2,658
- -----------------------------------------------------------------------------
53,053 50,157 50,755 54,850
Gross profit 26,668 23,897 23,272 20,912
Income (loss) from
operations 3,637 559 (372) (6,918)
Net income (loss) 2,912 895 613 (2,818)
=============================================================================
Basic net income (loss)
per share $ 0.16 $ 0.05 $ 0.03 $ (0.15)
- -----------------------------------------------------------------------------
Diluted net income
per share $ 0.15 $ 0.05 $ 0.03 $ (0.15)
=============================================================================
Average shares outstanding:
Basic net income (loss)
per share 18,246 18,308 18,395 18,552
Diluted net income (loss)
per share 19,790 19,169 19,035 18,552
Market price per share:
High $ 30.70 $ 25.22 $ 27.00 $ 25.60
Low 20.76 14.44 14.15 14.94
=============================================================================
Operating results for the fourth quarter of fiscal 2005 include a $6.0 million
settlement charge, a $2.7 write-off related to inventory held by one of the
Company's distributors and a $1.0 million gain on the sale of real estate.
Quarter ended May 31 Aug. 31 Nov. 30 Feb. 29
- -----------------------------------------------------------------------------
Fiscal 2004
Product sales $ 42,488 $ 47,961 $ 52,302 $ 49,218
Intellectual property
revenues 233 328 20,447 2,896
- -----------------------------------------------------------------------------
42,721 48,289 72,749 52,114
Gross profit 20,662 21,506 42,399 25,070
Income from operations 3,132 1,944 20,268 3,465
Income from continuing
operations 1,883 1,506 14,787 3,366
Gain (loss) from
discontinued operations (164) (26) (3) 169
Net income 1,719 1,480 14,784 3,535
Gain on redemption of preferred
stock of subsidiary - - - 6,685
Net income applicable to common
shareholders 1,719 1,480 14,784 10,220
=============================================================================
Basic net income per share:
Income from continuing
operations $ 0.11 $ 0.09 $ 0.84 $ 0.19
Gain (loss) from
discontinued operations (0.01) - - 0.01
- -----------------------------------------------------------------------------
Basic net income per share 0.10 0.09 0.84 0.20
Gain on redemption of
preferred stock of
subsidiary - - - 0.37
- -----------------------------------------------------------------------------
Basic net income per share
applicable to common
shareholders $ 0.10 $ 0.09 $ 0.84 $ 0.57
=============================================================================
Diluted net income per share:
Income from continuing
operations $ 0.11 $ 0.08 $ 0.77 $ 0.17
Gain (loss) from
discontinued operations (0.01) - - 0.01
- -----------------------------------------------------------------------------
Diluted net income
per share 0.10 0.08 0.77 0.18
Gain on redemption
of preferred stock of
subsidiary - - - 0.34
- -----------------------------------------------------------------------------
Diluted net income per
share applicable to
common shareholders $ 0.10 $ 0.08 $ 0.77 $ 0.51
=============================================================================
Average shares outstanding:
Basic net income
per share 16,793 16,863 17,577 18,007
Diluted net income
per share 17,331 17,722 19,242 19,887
Market price per share:
High $ 16.00 $ 21.50 $ 31.65 $ 36.56
Low 11.71 13.50 19.46 23.70
=============================================================================
Operating results for the third and fourth quarters of fiscal 2004 include $20.0
million and $2.5 million, respectively, of special intellectual property
revenues.
Schedule II - Valuation and Qualifying Accounts
For the Three Years Ended February 28, 2005
(In thousands)
Balance at Charged to Charged to Balance
Beginning Costs and Other at End of
of Period Expenses Accounts Deductions Period
- ----------------------------------------------------------------------------------------------------------------
Year Ended February 28, 2005
Allowance for Doubtful Accounts $ 446 $ --- $ (8) (a) $ ---- $ 438
Reserve for Product Returns $ 65 $ 521 $ ---- $ (428) (b) $ 158
Year Ended February 29, 2004
Allowance for Doubtful Accounts $ 460 $ 13 $ ---- $ (27) $ 446
Reserve for Product Returns $ 200 $ 113 $ ---- $ (248) (b) $ 65
Year Ended February 28, 2003
Allowance for Doubtful Accounts $ 450 $ 10 $ ---- $ ---- $ 460
Reserve for Product Returns $ 438 $ 208 $ ---- $ (446) (b) $ 200
(a) Represents adjustment of reserve balance based upon evaluation of accounts
receivable collectibility.
(b) Represents returns of product from customers.