UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------------------------------
FORM 10-Q
--------------------------------------------------------
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 30, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 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)
Registrant's telephone number, including area code: 631-435-6000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes _X_ No ____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of November 30, 2005, there were 21,428,000 shares of the registrant's common
stock outstanding.
Standard Microsystems Corporation
Form 10-Q
For the Quarter Ended November 30, 2005
Table of Contents
-----------------
Part I Financial Information
Item 1 Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of November 30, 2005 and
February 28, 2005
Condensed Consolidated Statements of Operations for the Three and
Nine-Month Periods Ended November 30, 2005 and 2004
Condensed Consolidated Statements of Cash Flows for the Nine-Month
Periods Ended November 30, 2005 and 2004
Notes to Condensed Consolidated Financial Statements
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3 Quantitative and Qualitative Disclosures About Market Risk
Item 4 Controls and Procedures
Part II Other Information
Item 1 Legal Proceedings
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 Defaults Upon Senior Securities
Item 4 Submission of Matters to a Vote of Security Holders
Item 5 Other Information
Item 6 Exhibits
Signature
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in thousands)
November 30, February 28,
2005 2005
------------- -------------
Assets
Current assets:
Cash and cash equivalents $ 31,731 $ 116,126
Short-term investments 109,982 56,519
Accounts receivable, net 36,686 23,499
Inventories 40,663 33,310
Deferred income taxes 18,313 17,701
Other current assets 5,660 4,584
- --------------------------------------------------------------------------------
Total current assets 243,035 251,739
- --------------------------------------------------------------------------------
Property, plant and equipment, net 33,828 22,630
Goodwill 76,630 29,435
Intangible assets, net 45,311 3,584
Deferred income taxes 9,765 7,163
Other assets 3,777 4,708
- --------------------------------------------------------------------------------
$ 412,346 $ 319,259
================================================================================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 26,387 $ 15,995
Deferred income on shipments to distributors 11,534 7,689
Accrued expenses, income taxes and other
liabilities 27,985 13,400
- --------------------------------------------------------------------------------
Total current liabilities 65,906 37,084
- --------------------------------------------------------------------------------
Deferred income taxes 15,070 -
Other liabilities 15,051 12,326
Shareholders' equity:
Preferred stock - -
Common stock 2,342 2,053
Additional paid-in capital 238,696 187,854
Retained earnings 109,049 100,612
Treasury stock, at cost (25,961) (23,799)
Deferred stock-based compensation (3,799) (1,925)
Accumulated other comprehensive income (loss) (4,008) 5,054
- --------------------------------------------------------------------------------
Total shareholders' equity 316,319 269,849
- --------------------------------------------------------------------------------
$ 412,346 $ 319,259
================================================================================
See Notes to Condensed Consolidated Financial Statements.
STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except per share amounts)
Three Months Ended Nine Months Ended
November 30, November 30,
-------------------------------- ----------------------------------
2005 2004 2005 2004
------------ ------------ ------------ --------------
Revenues $ 86,623 $ 50,755 $ 234,490 $ 153,965
Costs and expenses:
Cost of goods sold 45,697 27,483 126,561 80,128
Research and development 14,907 10,390 42,558 32,472
Selling, general and administrative 17,742 12,989 49,887 36,693
Amortization of intangible assets 1,547 265 4,257 848
In-process research and development - - 895 -
- ----------------------------------------------------------------------------- ----------------------------------
Income (loss) from operations 6,730 (372) 10,332 3,824
Interest income 900 704 2,272 1,726
Other expense, net (21) (20) (73) (58)
- ----------------------------------------------------------------------------- ----------------------------------
Income before provision for income taxes 7,609 312 12,531 5,492
Provision for (benefit from) income taxes 2,218 (301) 4,094 1,072
- ----------------------------------------------------------------------------- ----------------------------------
Net income $ 5,391 $ 613 $ 8,437 $ 4,420
============================================================================= ==================================
Basic net income per share: $ 0.26 $ 0.03 $ 0.41 $ 0.24
============================================================================= ==================================
Diluted net income per share: $ 0.24 $ 0.03 $ 0.39 $ 0.23
============================================================================= ==================================
Weighted average common shares outstanding:
Basic 20,983 18,395 20,548 18,321
Diluted 22,543 19,035 21,558 19,375
See Notes to Condensed Consolidated Financial Statements.
STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
Nine Months Ended
November 30,
----------------------------------------
2005 2004
----------------- -----------------
Cash flows from operating activities:
Cash received from customers and licensees $ 231,685 $ 158,732
Cash paid to suppliers and employees (188,843) (156,309)
Interest received 1,781 1,486
Interest paid (54) (108)
Income taxes refunded (paid) (2,809) 6,703
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 41,760 10,504
- ------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (15,988) (7,335)
Acquisition of Oasis SiliconSystems Holding AG, net of cash acquired (60,349) -
Sales of property, plant and equipment - 1,677
Sales of long-term investments - 4,000
Purchases of short-term investments (375,601) (320,439)
Sales and maturities of short-term investments 322,170 336,626
Other (296) 24
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities (130,064) 14,553
- -------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock 9,416 3,618
Purchases of treasury stock (2,162) (344)
Repayments of obligations under capital leases and notes payable (1,890) (1,575)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 5,364 1,699
- -------------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash and cash equivalents (1,455) 414
- -------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (84,395) 27,170
Cash and cash equivalents at beginning of period 116,126 14,050
- -------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 31,731 $ 41,220
=========================================================================================================================
Reconciliation of net income to
net cash provided by operating activities:
Net income $ 8,437 $ 4,420
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 12,415 8,586
Tax benefits from employee stock plans 2,852 759
In-process research and development charge 895 -
Non-cash stock-based compensation 10,240 1,545
Other adjustments, net 1 (32)
Changes in operating assets and liabilities,
net of business acquisition impact:
Accounts receivable (9,088) (4,576)
Inventories 4,311 (14,713)
Accounts payable, deferred income, accrued expenses and other liabilities 12,544 8,873
Current and deferred income taxes (1,548) 7,018
Other changes, net 701 (1,376)
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities $ 41,760 $ 10,504
=========================================================================================================================
See Notes to Condensed Consolidated Financial Statements.
STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial information of
Standard Microsystems Corporation and subsidiaries, referred to herein as "SMSC"
or "the Company," has been prepared in accordance with accounting principles
generally accepted in the United States and the rules and regulations of the
Securities and Exchange Commission (SEC), and reflects all normal recurring
adjustments which, in management's opinion, are necessary to state fairly the
Company's financial position, results of operations and cash flows for all
periods presented.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements, as
well as the reported amounts of revenues and expenses during the reporting
period. Actual results may differ from those estimates, and such differences may
be material to the financial statements. These condensed consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements for the fiscal year ended February 28, 2005 included in the Company's
annual report on Form 10-K, as filed on May 16, 2005 with the SEC. The results
of operations for the three and nine-month periods ended November 30, 2005 are
not necessarily indicative of the results to be expected for any future periods.
2. Stock-Based Compensation
The Company has in effect several stock-based compensation plans under which
incentive stock options, non-qualified stock options, restricted stock awards
and stock appreciation rights (SARs) are granted to employees and directors. All
stock options and SARs are granted with exercise prices equal to the fair value
of the underlying shares on the date of grant. The Company accounts for stock
option grants in accordance with Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees" and accordingly recognizes no
compensation expense for the stock option grants. Additional pro forma
disclosures as required under Statement of Financial Accounting Standards (SFAS)
No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure," are
detailed below.
For purposes of the pro forma disclosures required by SFAS No. 123, the
estimated fair market value of the Company's options is amortized as an expense
over the options' vesting periods. The fair value of each option grant, as
defined by SFAS No. 123, is estimated on the date of grant using the
Black-Scholes option-pricing model. The Black-Scholes model, as well as other
currently accepted option valuation models, was developed to estimate the fair
value of freely tradable, fully transferable options without vesting
restrictions, that significantly differ from the Company's stock option awards.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in the opinion
of management, the existing models do not necessarily provide a reliable single
measure of the fair value of employee stock options.
Had compensation expense been recorded under the provisions of SFAS No. 123, the
Company's net income (loss) and net income (loss) per share would have been the
pro forma amounts indicated below (in thousands, except per share data):
Three Months Ended Nine Months Ended
November 30, November 30,
----------------------------------------------------
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------
Net income - as reported $ 5,391 $ 613 $ 8,437 $ 4,420
Stock-based compensation expense included in net
income, net of taxes - as reported 2,904 724 6,893 1,055
Stock-based compensation expense determined using the
fair value method for all awards, net of taxes (2,873) (1,877) (10,604) (6,398)
- ----------------------------------------------------------------------------------------------------------------
Net income (loss) - pro forma $5,422 $ (540) $ 4,726 $ (923)
================================================================================================================
Basic net income per share - as reported $ 0.26 $ 0.03 $ 0.41 $ 0.24
================================================================================================================
Diluted net income per share - as reported $ 0.24 $ 0.03 $ 0.39 $ 0.23
================================================================================================================
Basic net income (loss) per share - pro forma $ 0.26 $ (0.03) $ 0.23 $ (0.05)
================================================================================================================
Diluted net income (loss) per share - pro forma $ 0.25 $ (0.03) $ 0.22 $ (0.05)
================================================================================================================
3. Acquisition of OASIS SiliconSystems Holding AG
On March 30, 2005, SMSC announced the completion that day of its acquisition of
OASIS SiliconSystems Holding AG (OASIS). Based in Karlsruhe, Germany, OASIS is
engaged in the development and marketing of integrated circuits that enable
networking of multimedia devices for automotive infotainment applications.
The transaction was accounted for as a purchase under accounting principles
generally accepted in the United States of America, whereby the purchase price
for OASIS has been allocated to the net tangible and intangible assets acquired,
based upon their fair values as of March 30, 2005, and the results of OASIS'
operations subsequent to March 30, 2005 have been included in the Company's
consolidated results of operations.
SMSC acquired all of OASIS' outstanding capital stock in exchange for aggregate
consideration of $118.7 million, including approximately 2.1 million shares of
SMSC common stock valued for accounting purposes at $35.8 million, $79.5 million
of cash, and approximately $3.4 million of direct acquisition costs, including
legal, banking, accounting and valuation fees. The tangible assets of OASIS at
March 30, 2005 included approximately $22.4 million of cash and cash
equivalents, resulting in a net cash outlay of approximately $60.5 million.
SMSC's existing cash balances were the source of the cash used in the
transaction. For accounting purposes, the value of the SMSC common stock was
determined using the stock's market value for the average of the two days before
and after the date the terms of the acquisition were announced. Under the terms
of the Share Purchase Agreement, approximately 1.2 million of the shares and
$1.8 million of the cash issued to the former shareholders of OASIS is being
held in an escrow account as security for certain indemnity obligations of
OASIS' former shareholders. 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 fiscal 2006
performance goals. Actual additional consideration earned, if any, is currently
indeterminable. Any additional consideration earned and paid will be recorded as
goodwill.
The following table summarizes the components of the purchase price (in
millions):
Cash $ 79.5
SMSC common stock (2.1 million shares) 35.8
Transaction costs 3.4
- ------------------------------------------------------------
$ 118.7
============================================================
The following table summarizes the allocation of the purchase price, including
the impact of an adjustment recorded during the three-month period ended
November 30, 2005, which reduced both Accrued expenses and income taxes, and
Goodwill, by approximately $0.4 million (in millions):
Cash and cash equivalents $ 22.4
Accounts receivable 5.8
Inventory 12.9
Other current assets 0.5
Identifiable intangible assets:
Purchased technology 32.4
Customer relationships 10.5
Trademark 5.4
Other 0.6
Property and equipment 2.7
Goodwill 51.5
Deferred income tax benefits 0.6
Accounts payable (1.7)
Accrued expenses and income taxes (6.5)
Deferred income tax liabilities (19.3)
In-process research and development 0.9
- --------------------------------------------------------------------------------
$ 118.7
================================================================================
The majority of OASIS' net assets, including goodwill and identifiable
intangible assets, are located in Europe, and the functional currency of OASIS'
operations in Europe is the euro. Accordingly, these euro-denominated net assets
are translated into U.S. dollars at period-end exchange rates and gains or
losses arising from translation are included as a component of accumulated other
comprehensive income within shareholders' equity.
In accordance with the provisions of SFAS No. 141, OASIS' finished goods
inventory was valued at estimated selling prices less the costs of disposal and
a reasonable profit allowance for the related selling effort; work-in-process
inventory was valued at estimated selling prices of the finished goods less
costs to complete, costs of disposal, and a reasonable profit allowance for the
completing and selling efforts; and raw materials were valued at current
replacement costs. These values initially exceeded OASIS' historical inventory
cost by approximately $1.7 million. This value was included within the $12.9
million of fair value assigned to OASIS' inventory at March 30, 2005, and was
recorded as a component of cost of goods sold as the underlying inventory was
sold between April 2005 and September 2005, $0.1 million of which was recognized
during the three-month period ended November 30, 2005.
The estimated fair value attributed to purchased technology was determined based
upon a discounted forecast of the estimated net future cash flows to be
generated from the technologies, using a discount rate of 25%. The estimated
fair value of purchased technology is being amortized over a period of 8 years
on a straight-line basis, which approximates the pattern in which the economic
benefits of the technology are expected to be realized.
The estimated fair value attributed to customer relationships was determined
based on a discounted forecast of the estimated net future cash flows to be
generated from the relationships, discounted at a rate of 23%. The estimated
fair value of the customer relationships is being amortized over a period of 8
years on a straight-line basis, which approximates the pattern in which the
economic benefits of the customer relationships are expected to be realized.
OASIS owns certain trademarks related to its multimedia networking technology.
The estimated fair value attributed to these trademarks was determined by
calculating the present value of the royalty savings related to the trademarks
using an assumed royalty rate of 1.5% and a discount rate of 23%. These
trademarks have indefinite lives and are therefore not being amortized. They
will be subject to an impairment test on an annual basis, or when an event or
circumstance occurs indicating a possible impairment in value.
Goodwill represents the excess of the purchase price over the fair values of the
net tangible and intangible assets acquired. This acquisition significantly
expands SMSC's sales of integrated circuits into automotive infotainment
applications, and is also providing opportunities for expanded revenues into
other applications, including consumer networking. It also added an assembled
workforce of approximately 150 employees into SMSC's operations. These factors
contributed to recognition of goodwill as a component of the purchase price. In
accordance with SFAS No. 142, goodwill is not amortized but will be tested for
impairment at least annually.
The $0.9 million allocated to in-process research and development represents the
fair value of purchased in-process technology for research projects that, as of
the March 30, 2005 closing date of the acquisition, had not reached
technological feasibility and had no alternative future uses. This value was
based upon discounted cash flows attributable to the projects using a discount
rate of 28%, the estimated time to complete the projects and the levels of risks
involved. These projects are primarily focused on deployment of certain
technology into consumer applications. The $0.9 million estimated fair value of
in-process research and development was reflected within Costs and expenses for
the three-month period ended May 31, 2005.
The following unaudited pro forma financial information presents the combined
operating results of SMSC and OASIS as if the acquisition had occurred as of the
beginning of each period presented. Pro forma data is subject to various
assumptions and estimates, and is presented for informational purposes only.
This pro forma data does not purport to represent or be indicative of the
consolidated operating results that would have been reported had the transaction
been completed as described herein, and the data should not be taken as
indicative of future consolidated operating results. Pro forma financial
information for the three and nine-month periods ended November 30, 2005 and
November 30, 2004, is presented in the following table (in millions, except per
share data):
Three Months Ended Nine Months Ended
November 30, November 30,
--------------------------------------------
2005 2004 2005 2004
-------------------------------------------------------------------------------
Revenues $ 86.6 $ 63.6 $ 238.6 $ 192.0
Net income (loss) $ 4.8 $ (1.0) $ 7.9 $ 2.1
Basic net income (loss) per share $ 0.23 $ (0.05) $ 0.38 $ 0.10
Diluted net income (loss) per share $ 0.21 $ (0.05) $ 0.36 $ 0.10
4. Short-Term 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 November 30, 2005.
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, which creates a
highly liquid market for these securities. 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
generally provides higher yields than money market and other cash equivalent
investments. For all periods through November 30, 2004, the Company classified
auction rate securities as cash equivalents. Effective at February 28, 2005,
auction rate securities were reclassified as short-term investments on the
Company's consolidated balance sheet for all dates presented, reflecting current
interpretations of the accounting treatment for these securities. In addition,
consistent with this change in classification, all purchases and sales of
auction rate securities are reflected in the investing activities section of the
Company's Consolidated Statements of Cash Flows for all periods presented. The
Company does not consider this change in classification to be material to its
financial condition or cash flows. In addition, this reclassification 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. For purposes of
the Condensed Consolidated Statement of Cash Flows for the nine months ended
November 30, 2004, auction rate and other securities at November 30, 2004 were
changed in classification as follows (in thousands):
Cash and Cash Short-Term
Equivalents Investments
- --------------------------------------------------------------------------------
As previously classified $ 119,767 $ 61,113
Change in classification - auction rate securities (78,270) 78,270
Change in classification - other securities (277) 277
- --------------------------------------------------------------------------------
As currently classified $ 41,220 $ 139,660
================================================================================
For the nine-month period ended November 30, 2004, $42.6 million of net cash
used by investing activities, related to activity in auction rate securities,
was previously included in the net change in cash and cash equivalents in the
Consolidated Statements of Cash Flows.
5. Balance Sheet Data
Inventories are valued at the lower of first-in, first-out cost or market and
consist of the following (in thousands):
November 30, February 28,
2005 2005
- ------------------------------------------------------------------------------
Raw materials $ 1,309 $ 1,143
Work in process 22,440 16,626
Finished goods 16,914 15,541
- ------------------------------------------------------------------------------
$ 40,663 $ 33,310
==============================================================================
Property, plant and equipment consist of the following (in thousands):
November 30, February 28,
2005 2005
- ------------------------------------------------------------------------------
Land $ 803 $ 578
Buildings and improvements 15,100 12,064
Machinery and equipment 74,324 68,190
Construction in progress 11,442 1,601
- ------------------------------------------------------------------------------
101,669 82,433
Less: accumulated depreciation 67,841 59,803
- ------------------------------------------------------------------------------
$ 33,828 $ 22,630
==============================================================================
The increase in construction in progress reflects expenditures incurred to
expand the Company's facility in Hauppauge, New York, which will allow
consolidation of the Company's Hauppauge operations into a single facility,
currently expected to occur during fiscal 2007. Portions of the Company's
Hauppauge operations currently occur in a separate 50,000 square foot facility,
the lease for which will expire during fiscal 2007. This expansion project
includes the construction of an expanded warehouse for inventory storage,
shipping, receiving and other logistics activities, which was completed at a
cost of approximately $3.1 million and placed in service during the quarter
ended November 30, 2005. The Company currently expects the cost of this building
expansion, including the new warehouse and inventory storage facility, to be
between $22 million and $24 million. The majority of the expenditures for this
project are expected to occur during fiscal 2006.
6. Net Income Per Share
Basic net income per share is calculated using the weighted-average number of
common shares outstanding during the period. Diluted net income per share is
calculated using the weighted-average number of common shares outstanding during
the period, plus the dilutive effect of unvested restricted stock awards and
shares issuable through stock options.
The shares used in calculating basic and diluted net income per share for the
Condensed Consolidated Statements of Operations included within this report are
reconciled as follows (in thousands):
Three Months Ended Nine Months Ended
November 30, November 30,
2005 2004 2005 2004
---------------------------------------------------------------------------------
Average shares outstanding
for basic net income per share 20,983 18,395 20,548 18,321
Dilutive effect of stock options
and unvested restricted stock awards 1,560 640 1,010 1,054
---------------------------------------------------------------------------------
Average shares outstanding for diluted
net income per share 22,543 19,035 21,558 19,375
---------------------------------------------------------------------------------
Options covering 0.3 million and 1.8 million shares for the three-month periods
ended November 30, 2005 and 2004, respectively, and 1.5 million and 1.0 million
shares for the nine-month periods ended November 30, 2005 and 2004,
respectively, were excluded from the computation of average shares outstanding
for diluted net income per share because their effect was antidilutive.
7. Comprehensive Income
The Company's other comprehensive income consists of foreign currency
translation adjustments from those subsidiaries not using the U.S. dollar as
their functional currency, and unrealized gains and losses on equity investments
classified as available-for-sale. The components of the Company's comprehensive
income for the three and nine-month periods ended November 30, 2005 and 2004
were as follows (in thousands):
Three Months Ended Nine Months Ended
November 30, November 30,
2005 2004 2005 2004
-------------------------------------------------------------------------------
Net income $ 5,391 $ 613 $ 8,437 $ 4,420
Other comprehensive income (loss):
Change in foreign currency
translation adjustments (4,459) 568 (9,102) 558
Change in unrealized gain (loss)
on marketable equity securities,
net of taxes (12) 8 40 (11)
-------------------------------------------------------------------------------
Total comprehensive income (loss) $ 920 $ 1,189 $ (625) $ 4,967
===============================================================================
8. Business Restructuring
In December 2001, the Company announced a restructuring plan for its exit from
the PC chipset business.
The Company's reserve related to this restructuring declined from $0.5 million
at February 28, 2005 to $0.4 million at November 30, 2005, reflecting payments
against previously reserved non-cancelable lease obligations, which will
continue through their respective lease terms through August 2008.
9. Goodwill and Intangible Assets
The Company's March 2005 acquisition of OASIS included the acquisition of $42.9
million of finite-lived intangible assets, an indefinite-lived trademark of $5.4
million, and goodwill of $51.5 million, as adjusted. Some of these intangible
assets are denominated in currencies other than the U.S. dollar, and these March
2005 values reflect foreign exchange rates in effect on the date of the
transaction. The June 2002 acquisition of Tucson, Arizona-based Gain Technology
Corporation included the acquisition of $7.1 million of finite-lived intangible
assets and $29.4 million of goodwill, after adjustments.
All finite-lived intangible assets are being amortized on a straight-line basis,
which approximates the pattern in which the estimated economic benefits of the
assets are realized, over their estimated useful lives. Existing technologies
have been assigned estimated useful lives of between six and eight years, with a
weighted-average useful life of approximately eight years. Customer
relationships and contracts have been assigned useful lives of between one and
ten years, with a weighted-average useful life of approximately eight years.
Intangible assets that are denominated in a functional currency other than the
U.S. dollar have been translated into U.S. dollars using the exchange rate in
effect on the reporting date. As of November 30, 2005 and February 28, 2005, the
Company's identifiable intangible assets consisted of the following (in
thousands):
November 30, 2005 February 28, 2005
- -------------------------------------------------------------------------------
Accumulated Accumulated
Cost Amortization Cost Amortization
- -------------------------------------------------------------------------------
Purchased technologies $ 37,117 $ 6,183 $ 6,179 $ 2,832
Customer relationships
and contracts 9,941 915 326 89
- -------------------------------------------------------------------------------
Total - finite-lived
intangible assets 47,058 7,098 6,505 2,921
- -------------------------------------------------------------------------------
Trademark and other 5,351 - - -
- -------------------------------------------------------------------------------
$ 52,409 $ 7,098 $ 6,505 $ 2,921
===============================================================================
Total amortization expense recorded for finite-lived intangible assets was $1.5
million and $0.3 million for the three-month periods ended November 30, 2005 and
2004, respectively, and $4.3 million and $0.8 million for the nine-month periods
ended November 30, 2005 and 2004, respectively.
Estimated future finite-lived intangible asset amortization expense for the
remainder of fiscal 2006 and thereafter is as follows (in thousands):
Period Amount
- ---------------------------------------------------
Remainder of fiscal 2006 $ 1,533
Fiscal 2007 6,132
Fiscal 2008 6,131
Fiscal 2009 5,359
Fiscal 2010 5,102
Fiscal 2011 and thereafter 15,703
===================================================
10. Retirement Plans
The Company maintains an unfunded Supplemental Executive Retirement Plan to
provide senior management with retirement, disability and death benefits. The
Company's subsidiary, SMSC Japan, also maintains an unfunded retirement plan,
which provides its employees and directors with separation benefits, consistent
with customary practices in Japan. Benefits under these defined benefit plans,
both of which are non-contributory, are based upon various service and
compensation factors. The following table sets forth the components of the
consolidated net periodic pension expense for these plans for the three and
nine-month periods ended November 30, 2005 and 2004, respectively (in
thousands):
Three Months Ended Nine Months Ended
November 30, November 30,
---------------------------------------------
2005 2004 2005 2004
- --------------------------------------------------------------------------------
Service cost - benefits earned $ 86 $ 71 $ 257 $ 214
Interest cost on projected benefit
obligations 98 107 296 320
Net amortization and deferral 67 72 200 217
- --------------------------------------------------------------------------------
Net periodic pension expense $ 251 $ 250 $ 753 $ 751
================================================================================
Additionally, the Company is the beneficiary of life insurance policies that
have been purchased as a method of partially financing benefits under the
Supplemental Executive Retirement Plan.
11. Common Stock Repurchase Program
The Company maintains a common stock repurchase program, as approved by its
Board of Directors, which authorizes the Company to repurchase up to three
million shares of its common stock on the open market or in private
transactions. Under this program, the Company repurchased approximately 150,000
shares of its common stock at a cost of $2.2 million during the first quarter of
fiscal 2006. No shares were repurchased during the second or third quarters of
fiscal 2006. The Company repurchased approximately 22,000 shares at a cost of
$0.3 million during the second quarter of fiscal 2005. The Company currently
holds repurchased shares as treasury stock. As of November 30, 2005, the Company
has repurchased a total of approximately 2.0 million shares of its common stock,
at a cost of $26.0 million, under this program.
12. Operating Segment Information
Because of the impact marketplace technology convergence has had on the
management of the Company's business and internal reporting, beginning with the
quarter ending November 30, 2005 the Company now operates in and reports one
business segment - the design, development, and marketing of semiconductor
integrated circuits. This change will have no impact on the Company's disclosure
because it previously aggregated the results of operating segments into one
reportable segment under the aggregation criteria set forth in SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information."
13. 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 No. 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 reporting of 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.
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations." Interpretation No. 47 clarifies that
an entity must record a liability for a "conditional" asset retirement
obligation if the fair value of the obligation can be reasonably estimated.
Interpretation No. 47 also clarifies when an entity would have sufficient
information to reasonably estimate the fair value of an asset retirement
obligation. Interpretation No. 47 is effective no later than the end of the
fiscal year ending after December 15, 2005. The Company does not expect the
adoption of Interpretation No. 47 to have a material impact on its consolidated
financial position, results of operations and cash flows.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections", which supersedes APB Opinion No. 20, "Accounting Changes" and
"SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements."
SFAS No. 154 provides guidance on the accounting for and reporting of accounting
changes and error corrections. APB Opinion No. 20 had required that changes in
accounting principles be recognized by including the cumulative effect of the
change in the period in which the new accounting principle was adopted. SFAS No.
154 requires retrospective application of the change to prior periods' financial
statements, unless it is impracticable to determine the period-specific effects
of the change. The Statement is effective for fiscal years beginning after
December 15, 2005. The adoption of this statement is not expected to have a
material effect on the Company's financial statements.
ITEM 2. Management's Discussion and Analysis of Financial Conditions 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. These uncertainties may cause
the Company's actual future results to be materially different from those
discussed in forward-looking statements. The Company's risks and uncertainties
include the timely development and market acceptance of new products; the impact
of competitive products and pricing; the Company's ability to procure capacity
from suppliers and the timely performance of their obligations, the effects of
changing economic conditions domestically and internationally and on its
customers; changes in customer order patterns, relationships with and dependence
on customers and growth rates in the personal computer, consumer electronics and
embedded and automotive markets and with the Company's sales channel; changes in
customer order patterns, including order cancellations or reduced bookings; the
effects of tariff, import and currency regulation; potential or actual
litigation; and excess or obsolete inventory and variations in inventory
valuation, among others. In addition, 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.
The Company's forward looking 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
statements are subject to change, and the Company does not undertake to update
such statements, except to the extent required under applicable law and
regulation. These and other risks and uncertainties, including potential
liability resulting from pending or future litigation, are detailed from time to
time in the Company's reports filed with the SEC. Investors are advised to read
the Company's Annual Report on Form 10-K and quarterly reports on Form 10-Q
filed with the SEC, particularly those sections entitled "Other Factors That May
Affect Future Operating Results" for a more complete discussion of these and
other risks and uncertainties. Other cautionary statements and risks and
uncertainties may also appear elsewhere in this report.
Overview
- --------
Description of Business
Many of the world's global technology companies rely upon SMSC as a resource for
semiconductor system solutions that span analog, digital and mixed-signal
technologies. Leveraging 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,
consumer electronics, automotive infotainment and industrial applications. The
Company has developed leading technology positions, providing
application-specific solutions such as mixed-signal PC system controllers,
non-PCI Ethernet, ARCNET, MOST and Hi-Speed USB. Each of these technologies is
increasingly sold into multiple end markets, and the underlying technology,
intellectual property and processes are increasingly being re-used and
re-combined into new solutions. The Company has made certain internal changes
that address this, and accordingly, for accounting purposes, SMSC now operates
in a single segment.
SMSC is headquartered in Hauppauge, New York with operations in North America,
Taiwan, Japan, Korea, China and Europe. Engineering design centers are located
in Arizona, New York, Texas and Karlsruhe, Germany. Additional information is
available at www.smsc.com.
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, revenues, cost of goods sold and operating expenses
relative to revenues. The Company also carefully monitors the progress of its
product development efforts.
Critical Accounting Policies and Estimates
- ------------------------------------------
This discussion and analysis of the Company's financial condition and results of
operations is based upon the unaudited condensed consolidated financial
statements included in this report, which have been prepared in accordance with
accounting principles for interim financial statements generally accepted in the
United States. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period.
The Company believes that the critical accounting policies and estimates listed
below are important to the portrayal of the Company's financial condition and
operating results, and require critical management judgments and estimates about
matters that are inherently uncertain. Although management believes that its
judgments and estimates are appropriate and reasonable, actual future results
may differ from these estimates, and to the extent that such differences are
material, future reported operating results may be affected.
o Revenue recognition
o Inventory valuation
o Determination of the allowance for doubtful accounts receivable
o Valuation of long-lived assets
o Accounting for deferred income taxes
o Legal contingencies
Further information regarding these policies appears within the "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included in the Company's annual report on Form 10-K for the fiscal year ended
February 28, 2005 filed with the SEC on May 16, 2005. During the three-month
period ended November 30, 2005, there were no significant changes to any
critical accounting policies or to the related estimates and judgments involved
in applying these policies.
Business Acquisition
- --------------------
On March 30, 2005, SMSC announced the completion that day of its acquisition of
OASIS SiliconSystems Holding AG (OASIS). Based in Karlsruhe, Germany, OASIS is
engaged in the development and marketing of integrated circuits that enable
networking of multimedia devices for automotive infotainment applications. OASIS
is 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.
SMSC acquired all of OASIS' outstanding capital stock in exchange for aggregate
consideration of $118.7 million, including approximately 2.1 million shares of
SMSC common stock valued for accounting purposes at $35.8 million, $79.5 million
of cash, and approximately $3.4 million of direct acquisition costs, including
legal, banking, accounting and valuation fees. The tangible assets of OASIS at
March 30, 2005 included approximately $22.4 million of cash and cash
equivalents, resulting in a net cash outlay of approximately $60.5 million.
SMSC's existing cash balances were the source of the cash used in the
transaction.
The results of OASIS' operations subsequent to March 30, 2005 have been included
in the Company's consolidated results of operations.
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 fiscal 2006 performance goals. Actual additional
consideration earned, if any, is currently indeterminable. Any additional
consideration earned and paid will be recorded as goodwill.
Stock Appreciation Rights
- -------------------------
The Company maintains a Stock Appreciation Rights (SAR) Plan, the purpose of
which is to attract, retain, reward and motivate employees, directors and
consultants to promote the Company's best interests and to share in its future
success. Each SAR 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.
As of November 30, 2005, there were approximately 1.6 million SARs outstanding,
of which 0.3 million were vested, and the remainder of which are scheduled to
vest at various dates through October 2010. Recognition of compensation expense
for unexercised SARs is based upon the market price of the Company's common
stock at the end of the reporting period and the vesting period of the SAR.
Based upon the $29.90 closing price of the Company's common stock on November
30, 2005, the Company recorded non-cash compensation expense of $3.5 million for
unexercised SARs during the quarter ended as of that date. In addition, the
Company incurred approximately $0.5 million of cash expense for SARs that were
exercised during the third quarter. Of the $4.0 million of combined cash and
non-cash SAR expense recorded during the three months ended November 30, 2005,
$0.3 million is reflected within cost of goods sold, $0.9 million within
research and development, and $2.8 million within selling, general and
administrative expenses. For the current nine-month period, total SAR expense
was $9.5 million, including $0.6 million within cost of goods sold, $2.3 million
within research and development, and $6.6 million within selling, general and
administrative expenses.
Based upon SARs outstanding at November 30, 2005, if the market price of SMSC
common stock remained at $29.90 on February 28, 2006, an expense provision of
approximately $1.3 million would be required in the fourth quarter due to the
passage of additional SARs vesting time. Each $1.00 change in the Company's
stock price above or below $29.90 at February 28, 2006 would result in an
additional expense provision or credit of approximately $0.8 million in the
fourth quarter, with any credit limited to a maximum of $9.5 million.
Results of Operations
- ---------------------
Revenues
SMSC's revenues are derived from sales of products into three vertical
end-markets, as presented in the following tables for the three and nine-month
periods ended November 30, 2005 and 2004 (dollars in millions):
Three Months Ended November 30,
2005 2004
Amount Percent Amount Percent
-------------------------------------------------------------------------------
Mobile and desktop PC $ 40.4 47% $ 28.1 55%
Consumer electronics and infotainment 31.8 37% 9.7 19%
Industrial and other 14.4 16% 13.0 26%
-------------------------------------------------------------------------------
$ 86.6 100% $ 50.8 100%
===============================================================================
Nine Months Ended November 30,
2005 2004
Amount Percent Amount Percent
-------------------------------------------------------------------------------
Mobile and desktop PC $ 115.8 49% $ 87.2 57%
Consumer electronics and infotainment 77.1 33% 24.7 16%
Industrial and other 41.6 18% 42.1 27%
-------------------------------------------------------------------------------
$ 234.5 100% $ 154.0 100%
===============================================================================
Revenues for the three months ended November 30, 2005 were $86.6 million,
compared to revenues of $50.8 million for the year earlier period, an increase
of approximately 71%. Included in the current quarter's revenues are $15.4
million of revenues from products associated with the acquisition of OASIS.
Revenues for the nine months ended November 30, 2005 were $234.5 million,
compared to revenues of $154.0 million for the year-earlier period, an increase
of approximately 52%. Included in the current nine-month period's revenues are
$39.2 million of revenues associated with products acquired from OASIS. The
OASIS revenues reflect shipments subsequent to March 30, 2005, representing
approximately eight months of activity within the current year nine-month
period.
The increase in mobile and desktop PC revenues, for both the three and
nine-month periods, was driven by an increase in revenues from mobile products,
reflecting strong market demand in mobile computing applications, as well as
increased revenues from environmental monitoring and control (EMC) products,
which benefited from broader product offerings in the current year periods.
Revenues from mobile PC products also include $1.1 million of revenue recognized
in the second quarter of fiscal 2006 associated with a prior accounts receivable
collectibility issue, as more fully described in the subsequent paragraph.
Revenues from desktop PC products are down modestly in the current fiscal year
periods, compared to the corresponding prior year periods, reflecting softening
market demand for desktop PCs and lower average selling prices.
During the second half of fiscal 2005, mobile PC revenues were adversely
impacted by an accounts receivable collectibility issue with one of the
Company's Taiwan-based component distributors, which prevented the Company from
recognizing approximately $5.4 million of revenues during that period.
Approximately $2.7 million of inventory underlying those revenues, which had
already been shipped to and resold by the distributor prior to identification of
the collectibility issue, was charged to cost of goods sold in the fourth
quarter of fiscal 2005. During the second quarter of fiscal 2006, the Company
received a payment of $1.1 million from this customer, which recovered a portion
of the distributor's obligation to the Company. This $1.1 million payment was
recognized within revenues for the second quarter of fiscal 2006, without any
associated cost of goods sold, because, as noted above, the underlying inventory
was charged to cost of goods sold during the fourth quarter of fiscal 2005. No
payments were received from this distributor during the three months ended
November 30, 2005. Any future collections from this distributor would be
recognized as revenue when received, but the likelihood of any such payments
remains uncertain.
The increase in revenues from consumer electronics and infotainment products
includes revenues associated with the March 2005 acquisition of OASIS, totaling
$15.4 million and $39.2 million for the three and nine-month periods ended
November 30, 2005, respectively. These OASIS product revenues are from products
serving automotive infotainment applications. Revenues from connectivity
products for consumer electronics applications, which have benefited from
broader product offerings during fiscal 2006, also increased in the current year
periods, compared to the prior year periods.
Industrial and other revenues primarily represent revenues from products used
within industrial information networking applications in various business,
service, factory, transportation and telecommunications environments. Revenues
from these products increased by $1.4 million in the current year quarter,
compared to the prior year quarter. For the current year nine-month period,
industrial and other revenues were approximately neutral to the prior year
nine-month period, exclusive of intellectual property revenues that are also
included in this category.
Revenues from customers outside of North America accounted for approximately 90%
and 88% of the Company's consolidated revenues for the three and nine-month
periods ended November 30, 2005, respectively. The comparable percentages for
the three and nine-month periods in the prior fiscal year were 79% and 81%,
respectively. While the largest portion of the Company's revenues continues to
be derived from Asia, the acquisition of OASIS has significantly increased the
Company's revenues in Europe, which accounts for the general increase in
revenues outside of North America in fiscal 2006 periods, compared to the fiscal
2005 periods. The Company's revenues in Europe, including the impact of OASIS,
were about $16.1 million in the current year quarter, compared to $2.8 million
in the prior year quarter. For the current year nine-month period, revenues in
Europe were $39.7 million, compared to $8.4 million in the prior year nine-month
period. The Company expects that international shipments, particularly to Asia,
will continue to represent a significant portion of its revenues.
Cost of Goods Sold
Cost of goods sold for the quarter ended November 30, 2005 was $45.7 million, or
52.8% of revenues, compared to $27.5 million, or 54.1% of revenues, for the
three months ended November 30, 2004. The decrease in cost of goods sold as a
percentage of revenues in the current year quarter, compared to the prior year
quarter, results from a product mix shift towards consumer electronics and
infotainment products, which generally carry higher margins than desktop PC
products. New consumer electronics product introductions, carrying improved
margins compared to older products, particularly for connectivity applications,
also contributed to the lower cost of goods sold percentage. Partially
offsetting this was a higher proportion of intellectual property revenues in the
prior year quarter. Intellectual property revenues were $2.6 million in the
current year quarter, compared to $2.7 million in the prior year quarter.
For the nine months ended November 30, 2005, cost of goods sold was $126.6
million, or 54.0% of revenues, compared to $80.1 million, or 52.0% of revenues,
for the nine-month period ended November 30, 2004. The increase in cost of goods
sold as a percentage of revenues in the current year nine-month period, compared
to the prior year nine-month period, results from a combination of (1) declines
in average selling prices on certain desktop I/O products, which outpaced
reductions in unit costs; (2) production yield losses aggregating approximately
$1.5 million incurred during the second quarter of fiscal 2006 resulting from
certain atypical production issues; (3) $0.4 million of higher charges for
inventory obsolescence; (4) $0.5 million of higher provisions for SAR
compensation expense in the current year period; and (5) a higher proportion of
intellectual property revenues in the prior year period. Intellectual property
revenues were $7.9 million in the current year nine-month period, compared to
$8.4 million in the prior year nine-month period. Partially offsetting these
factors was $1.1 million of revenue recognized during the current year period
without any associated cost of goods sold, as discussed earlier within the
"Revenues" analysis. The yield losses noted in item (2) were related to certain
device-specific supplier production issues. These issues have been corrected,
and production yields have now returned to normal levels.
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 were $14.9 million, or approximately 17% of revenues, for the three
months ended November 30, 2005, compared to $10.4 million, or approximately 20%
of revenues, for the three months ended November 30, 2004. The increase in the
current year's three-month period, compared to the prior year's three-month
period, is primarily due to the addition of approximately $2.4 million of R&D
expenses associated with the operations of OASIS, whose staff includes
approximately 90 engineers and technicians. The current year quarter also
includes a charge of $0.9 million for SAR compensation expense, compared to $0.2
million in the year-ago quarter. $1.0 million of higher compensation and benefit
costs, driven by higher staff levels, merit increases and benefit cost
increases, also contributed to the increase.
For the nine months ended November 30, 2005, R&D expenses were $42.6 million, or
approximately 18% of revenues, compared to $32.5 million, or approximately 21%
of revenues, for the nine months ended November 30, 2004. The increase in the
current year's nine-month period, compared to the prior year's nine-month
period, is primarily due to the addition of approximately $6.5 million of R&D
expenses associated with the operations of OASIS, which impacted eight months of
the current nine-month period's operating results. The remainder of the increase
resulted primarily from $2.1 million of higher SAR expense, and $1.3 million of
higher compensation and benefit costs, exclusive of the impact of OASIS.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $17.7 million, or
approximately 20% of revenues, for the quarter ended November 30, 2005, compared
to $13.0 million, or approximately 26% of revenues, for the quarter ended
November 30, 2004. The increase in the current year's three-month period,
compared to the prior year's three-month period, reflects $1.8 million of
expenses associated with the operations of OASIS, $2.2 million of higher SAR
expense, $0.3 million of higher employee recruitment and relocation costs, and
$1.1 million of higher compensation and benefit costs (exclusive of the impact
of OASIS), partially offset by $1.1 million of lower legal, accounting and other
professional fees, due in part to lower costs associated with litigation.
For the nine-month period ended November 30, 2005, selling, general and
administrative expenses were $49.9 million, or approximately 21% of revenues,
compared to $36.7 million, or approximately 24% of revenues, for the nine-month
period ended November 30, 2004. This period-over-period increase reflects $5.5
million of expenses associated with the operations of OASIS, $6.1 million of
higher SAR expense, $0.7 million of higher employee recruitment and relocation
costs, and $1.7 million of higher compensation and benefit costs (exclusive of
the impact of OASIS), partially offset by $1.9 million of lower legal,
accounting and other professional fees, due in part to lower costs associated
with litigation.
Amortization of Intangible Assets
For the three and nine-month periods ended November 30, 2005, the Company
recorded $1.3 million and $3.5 million, respectively, of amortization expense
for finite-lived intangible assets acquired in the OASIS transaction, as well as
$0.2 million and $0.8 million, respectively, of amortization expense for
finite-lived intangible assets associated with the acquisition of Gain
Technology Corporation (Gain) during fiscal 2003. Amortization expense of $0.3
million and $0.8 million for the Gain intangible assets was recorded in the
prior year's three and nine-month periods, respectively.
In-Process Research and Development
The $0.9 million in-process research and development expense recorded in the
fiscal 2006 nine-month period represents the fair value of in-process technology
for OASIS research projects that, as of the March 30, 2005 closing date of the
OASIS acquisition, had not reached technological feasibility and had no
alternative future uses. These projects are primarily focused on deployment of
certain technology into consumer electronics applications. The estimated fair
value of this in-process research and development was recorded as an expense in
the quarter ended May 31, 2005.
Other Income and Expense
The increases in interest income in the current year three and nine-month
periods, compared to the corresponding prior year periods, primarily reflects
the impact of higher average interest rates, partially offset by a lower average
level of investments, during the current year periods.
Provision For Income Taxes
The Company's effective income tax rate reflects statutory federal, state and
foreign tax rates, the impact of 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's $4.1 million provision for income taxes for the nine-month period
ended November 30, 2005, reflects an expected fiscal 2006 effective tax rate of
approximately 29%, and also includes $0.35 million of incremental taxes
resulting from internal corporate restructuring activities completed during the
second quarter of fiscal 2006 and a provision of $0.1 million for adjustments
related to differences between the Company's fiscal 2005 income tax return and
the provision for income taxes recorded at the end of fiscal 2005. The 29%
effective tax rate expected for fiscal 2006 is lower than the 31% effective rate
that was expected as of August 31, 2005, reflecting a higher proportionate
impact of income tax credits and tax-exempt interest income against a reduced
pre-tax income projection. The reduced pre-tax income projection resulted
primarily from provisions for SAR expenses recorded through November 30, 2005,
as a result of increases in the market price of the Company's common stock. The
$2.2 million provision for income taxes recorded for the three months ended
November 30, 2005 reflects the cumulative impact of the lower expected effective
income tax rate, as well as the $0.1 million tax adjustment related to the
fiscal 2005 income tax return.
The Company's $1.1 million provision for income taxes for the nine-month period
ended November 30, 2004 reflected an expected fiscal 2005 effective tax rate of
24.5%, as well as a $0.3 million tax benefit related to prior fiscal years,
primarily due to better than expected settlements of open tax audits. The 24.5%
effective tax rate expected for fiscal 2005 was lower than a 26.5% effective
rate that was expected as of August 31, 2004, reflecting a higher proportionate
impact of income tax credits and tax-exempt interest income against a reduced
pre-tax income projection. The $0.3 million income tax benefit recorded for the
three months ended November 30, 2004 reflected the cumulative impact of the
lower expected effective income tax rate, as well as the $0.3 million tax
benefit related to prior fiscal years.
Liquidity and Capital Resources
- -------------------------------
The Company currently finances its operations through a combination of existing
resources and cash generated by operations.
The Company's cash, cash equivalents and short-term investments were $141.7
million at November 30, 2005, compared to $172.6 million at February 28, 2005, a
decrease of $30.9 million.
Operating activities generated $41.8 million of cash during the first nine
months of fiscal 2006, compared to $10.5 million during the first nine months of
fiscal 2005. Operating cash flows during the current year period reflect a $4.8
million combined increase in accounts receivable and inventories (excluding the
impact of the OASIS acquisition), while the prior year's nine-month operating
cash flows were burdened by a $19.3 million combined increase in accounts
receivable and inventory. Discussions of accounts receivable and inventory
activity appear later within this section. The current year nine-month period's
operating activities include $23.6 million of non-cash charges, including
depreciation, amortization, in-process research and development and stock-based
compensation, compared to $10.1 million in the prior year nine-month period.
Investing activities consumed $130.1 million of cash during the first nine
months of fiscal 2006, due principally to $60.3 million used for the acquisition
of OASIS, a net increase of $53.4 million in short-term investments, and $16.0
million of capital expenditures. The $60.3 million of cash used for the
acquisition of OASIS includes $79.5 million of cash paid to the former OASIS
shareholders as part of the transaction's consideration, $3.4 million of
transaction costs ($0.2 million of which were paid in the previous fiscal year),
partially offset by $22.4 million of cash acquired from OASIS. Investing
activities provided $14.6 million of cash during the first nine months of fiscal
2005, due principally to a net decrease of $20.2 million in short-term and
long-term investments, partially offset by $7.3 million of capital expenditures.
Financing activities provided $5.4 million of cash during the first nine months
of fiscal 2006, reflecting $9.4 million of proceeds from exercises of stock
options, partially offset by $2.2 million of treasury stock purchases and $1.9
million of debt repayments. Financing activities provided $1.7 million of cash
during the first nine months of fiscal 2005, comprised of $3.6 million of
proceeds from exercises of stock options, offset by $1.9 million of treasury
stock purchases and debt repayments.
The Company's inventories were $40.7 million at November 30, 2005, compared to
$33.3 million at February 28, 2005. This increase includes $7.3 million of OASIS
product inventories at November 30, 2005.
Accounts receivable increased from $23.5 million at February 28, 2005 to $36.7
million at November 30, 2005, an increase of $13.2 million. This increase
generally reflects the impact of an increase in revenues from $54.9 million for
the three months ended February 28, 2005, to $86.6 million for the three months
ended November 30, 2005, and includes $6.3 million of accounts receivable from
shipments of OASIS products at November 30, 2005.
Total current liabilities increased from $37.1 million at February 28, 2005 to
$65.9 million at November 30, 2005, including $9.6 million of current
liabilities associated with the operations of OASIS, and a $3.8 million increase
in deferred income on shipments to distributors. The increase in deferred income
reflects an increase in distributor inventories in advance of anticipated
product demand during the Company's fourth quarter ending February 28, 2006. The
increase in current liabilities also reflects a $10.4 million increase in
accounts payable, driven by higher inventory purchases and payables related to
the Company's facility expansion. The facility expansion is discussed in the
following two paragraphs.
Capital expenditures for the nine-month period ended November 30, 2005 were
$16.0 million, and were predominantly for facility expansion, production test
equipment, advanced semiconductor design tools and investments in intellectual
property. Capital expenditures were $7.3 million for the nine-month period ended
November 30, 2004.
The Company anticipates that capital expenditures in fiscal 2006 will exceed
those incurred during fiscal 2005, due in part to the Company's in-progress
construction of an addition to its facility in Hauppauge, New York, which will
expand the facility from its current 80,000 square feet to approximately 200,000
square feet, and which will allow consolidation of the Company's Hauppauge
operations into a single facility, currently expected to occur during fiscal
2007. Portions of the Company's Hauppauge operations currently occur in a
separate 50,000 square foot facility, the lease for which will expire during
fiscal 2007. This expansion project includes the construction of an expanded
warehouse for inventory storage, shipping, receiving and other logistics
activities, which was completed at a cost of approximately $3.1 million and
placed in service during the three-month period ended November 30, 2005. The
Company currently expects the cost of this building expansion, including the new
warehouse and inventory storage facility, to be between $22 million and $24
million, of which $14.5 million has been expended through November 30, 2005. The
majority of the expenditures for this project are expected to occur during
fiscal 2006. There were no other material commitments for capital expenditures
as of November 30, 2005.
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. Under this
program, the Company repurchased approximately 150,000 shares of its common
stock at a cost of $2.2 million during the first quarter of fiscal 2006. No
shares were repurchased during the second or third quarters of fiscal 2006. The
Company repurchased approximately 22,000 shares at a cost of $0.3 million during
the second quarter of fiscal 2005. The Company currently holds repurchased
shares as treasury stock. As of November 30, 2005, the Company has repurchased a
total of approximately 2.0 million shares of its common stock, at a cost of
$26.0 million, under this program.
In connection with the March 2005 acquisition of OASIS, up to $20.0 million of
additional consideration, payable in cash and SMSC common stock, may be issued
to the former shareholders of OASIS during fiscal 2007 upon satisfaction of
certain performance goals.
The Company has from time to time considered and executed, and will continue to
consider, various transactions to secure necessary wafer foundry and assembly
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, short-term investments,
cash flows from operations and its borrowing capacity will be sufficient to
finance the Company's operating and capital requirements for at least the next
twelve months and for the foreseeable future thereafter.
Recent Accounting Pronouncements
- --------------------------------
In November 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (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 No. 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 reporting of 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.
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations." Interpretation No. 47 clarifies that
an entity must record a liability for a "conditional" asset retirement
obligation if the fair value of the obligation can be reasonably estimated.
Interpretation No. 47 also clarifies when an entity would have sufficient
information to reasonably estimate the fair value of an asset retirement
obligation. Interpretation No. 47 is effective no later than the end of the
fiscal year ending after December 15, 2005. The Company does not expect the
adoption of Interpretation No. 47 to have a material impact on its consolidated
financial position, results of operations and cash flows.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections", which supersedes APB Opinion No. 20, "Accounting Changes" and
"SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements."
SFAS No. 154 provides guidance on the accounting for and reporting of accounting
changes and error corrections. APB Opinion No. 20 had required that changes in
accounting principles be recognized by including the cumulative effect of the
change in the period in which the new accounting principle was adopted. SFAS No.
154 requires retrospective application of the change to prior periods' financial
statements, unless it is impracticable to determine the period-specific effects
of the change. The Statement is effective for fiscal years beginning after
December 15, 2005. The adoption of this statement is not expected to have a
material effect on the Company's financial statements.
ITEM 3. 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 November 30, 2005, the Company's $110.0 million of short-term investments
consisted primarily of investments in auction rate securities, and investments
in corporate, government and municipal obligations with maturities of between
three and twelve months at acquisition. 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.
As with all fixed-income instruments, these securities are subject to interest
rate risk and would likely decline in market value if market interest rates
increase. If market interest rates were to increase immediately and uniformly by
10% from levels at November 30, 2005, the Company estimates that the fair values
of these investments would decline by an immaterial amount, due to the
portfolio's relatively short-term overall maturity. Furthermore, the Company has
the option to hold its fixed-income investments until maturity and, therefore,
would not expect to realize any material adverse impact to its results from
operations or cash flows from such a decline. Declines in market interest rates
would, over time, reduce the Company's interest income.
Equity Price Risk
The Company has no material investments in equity securities of other companies
on its Consolidated Balance Sheet as of November 30, 2005.
Foreign Currency Risk
The Company has international sales and expenditures and is, therefore, subject
to certain foreign currency rate exposures. The Company conducts a significant
amount of its business in Asia. In order to reduce the risk from fluctuation in
foreign exchange rates, most of the Company's product sales and all of its
arrangements with its foundry, test and assembly vendors are denominated in U.S.
dollars. 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 the first nine months of fiscal 2006,
and there are no obligations under any such contracts as of November 30, 2005.
The Company has never received a cash dividend (repatriation of cash) from SMSC
Japan.
OASIS' operating activities in Europe include transactions conducted in both
euros and U.S. dollars. The euro has been designated as OASIS' functional
currency for its European operations. From time to time, OASIS has entered into
foreign currency contracts to minimize the exposure of its U.S dollar
denominated transactions, assets and liabilities to currency exchange rate risk.
Gains or losses on these contracts are intended to offset the gains or losses
recorded from the remeasurement of certain assets and liabilities from U.S.
dollars into euros. As of November 30, 2005, OASIS has foreign currency
contracts to convert an aggregate of $0.5 million into euros in December 2005.
Gains and losses on these contracts, as well as gains and losses recorded from
the remeasurement of U.S. dollar denominated assets and liabilities into euros,
were not material during the three or nine-month periods ended November 30,
2005.
Other Factors That May Affect Future Operating Results
- ------------------------------------------------------
As a supplier of semiconductors, the Company competes in a challenging business
environment, which is characterized by intense competition, rapid technological
changes and cyclical business patterns. Except for the historical information
contained herein, the matters discussed in this report are forward-looking
statements. The Company faces a variety of risks and uncertainties in conducting
its business, some of which are out of its control, and any of which, were they
to occur, could impair the Company's operating performance. For a more detailed
discussion of risk factors, please refer to the Company's annual report on Form
10-K for the fiscal year ended February 28, 2005 filed with the SEC on May 16,
2005.
ITEM 4. Controls and Procedures
The Company has carried out an evaluation under the supervision and with the
participation of the Company's management, including the Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
the Company's disclosure controls and procedures. There are inherent limitations
to the effectiveness of any system of disclosure controls and procedures,
including the possibility of human error and the circumvention or overriding of
the controls and procedures. Accordingly, even effective disclosure controls and
procedures can only provide reasonable assurance of achieving their control
objectives. Based upon the Company's evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that, as of November 30, 2005, the
disclosure controls and procedures are effective to provide reasonable assurance
that information required to be disclosed in the reports the Company files under
the Exchange Act is recorded, processed, summarized, and reported as and when
required.
There have been no changes in the Company's internal control over financial
reporting during the Company's fiscal quarter covered by this report that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
The Company completed the acquisition of OASIS on March 30, 2005, as more fully
described in Note 3 to the Condensed Consolidated Financial Statements included
within Part I of this report on Form 10-Q. As part of its ongoing integration
activities, the Company is in the process of incorporating its controls and
procedures into OASIS' operating activities.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
As of November 30, 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 2. Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sales of Equity Securities
None.
Purchases of Equity Securities by the Issuer
In October 1998, the Company's Board of Directors approved a plan authorizing
the repurchase of up to one million shares of the Company's common stock in the
open market or in private transactions. The Board of Directors increased the
authorization from one million shares to two million shares in July 2000, and
from two million shares to three million shares in July 2002. The plan has no
specified expiration date. Shares of common stock purchased pursuant to the
repurchase plan are held as treasury stock.
There was no activity under this plan during the current period covered by this
report.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 5. Other Information
None.
ITEM 6. Exhibits
31.1 - Certification of Chief Executive Officer pursuant to Rule 13a-14(a) (17
CFR 240.13a-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 - Certification of Chief Financial Officer pursuant to Rule 13a-14(a) (17
CFR 240.13a-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1 - Certifications of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
STANDARD MICROSYSTEMS CORPORATION
DATE: January 9, 2006 By: /s/ David S. Smith
----------------------------
(Signature)
David S. Smith
Senior Vice President (duly
authorized officer) and
Chief Financial Officer
(principal financial officer)