UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[x] QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-7422
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STANDARD MICROSYSTEMS CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 11-2234952
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
80 Arkay Drive, Hauppauge, New York 11788
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 631-435-6000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ____
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes _X_ No ____
As of May 31, 2004, there were 18,417,890 shares of the registrant's common
stock outstanding.
Standard Microsystems Corporation
Form 10-Q
For the Quarter Ended May 31, 2004
Table of Contents
Part I Financial Information
Item 1 Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of May 31, 2004 and February
29, 2004
Condensed Consolidated Statements of Operations for the Three Months
Ended May 31, 2004 and 2003
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended May 31, 2004 and 2003
Notes to Condensed Consolidated Financial Statements
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3 Quantitative and Qualitative Disclosures About Market Risk
Item 4 Controls and Procedures
Part II Other Information
Item 1 Legal Proceedings
Item 6 Exhibits and Reports on Form 8-K
Signature
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
STANDARD MICROSYSTEMS CORPORATION
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(In thousands)
May 31, February 29,
2004 2004
---- ----
Assets
Current assets:
Cash and cash equivalents $ 130,855 $ 135,161
Short-term investments 27,260 23,136
Accounts receivable, net 29,821 21,946
Inventories 23,199 23,162
Deferred income taxes 14,748 15,064
Other current assets 8,946 8,549
- -------------------------------------------------------------------------------
Total current assets 234,829 227,018
- -------------------------------------------------------------------------------
Property, plant and equipment, net 23,295 23,430
Long-term investments 11,600 15,600
Goodwill 29,595 29,595
Intangible assets, net 4,380 4,697
Deferred income taxes 6,276 6,493
Other assets 3,169 3,192
- -------------------------------------------------------------------------------
$ 313,144 $ 310,025
===============================================================================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 12,661 $ 14,679
Deferred income on shipments to distributors 11,912 7,972
Accrued expenses, income taxes and other
liabilities 11,654 13,168
- -------------------------------------------------------------------------------
Total current liabilities 36,227 35,819
- -------------------------------------------------------------------------------
Other liabilities 11,488 12,104
Shareholders' equity:
Preferred stock - -
Common stock 2,024 2,019
Additional paid-in capital 182,993 181,830
Retained earnings 101,922 99,010
Treasury stock, at cost (23,454) (23,454)
Deferred stock-based compensation (2,658) (1,962)
Accumulated other comprehensive income 4,602 4,659
- -------------------------------------------------------------------------------
Total shareholders' equity 265,429 262,102
- -------------------------------------------------------------------------------
$ 313,144 $ 310,025
===============================================================================
See Notes to Condensed Consolidated Financial Statements.
STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except per share data)
Three Months Ended
----------------------------------
May 31,
----------------------------------
2004 2003
---- ----
Sales and revenues:
Product sales $ 50,352 $ 42,488
Intellectual property revenues 2,701 233
- --------------------------------------------------------------------------------
53,053 42,721
Cost of goods sold 26,385 22,059
- --------------------------------------------------------------------------------
Gross profit 26,668 20,662
Operating expenses (income):
Research and development 10,862 9,101
Selling, general and administrative 11,852 9,513
Amortization of intangible assets 317 360
Gains on real estate transactions - (1,444)
- --------------------------------------------------------------------------------
Income from operations 3,637 3,132
Interest income 466 443
Other expense, net (32) (736)
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Income before provision for income
taxes and minority interest 4,071 2,839
Provision for income taxes 1,159 895
Minority interest in net income of
subsidiary - 61
- --------------------------------------------------------------------------------
Income from continuing operations 2,912 1,883
Loss from discontinued operations (net
of income tax benefits of $92) - (164)
- --------------------------------------------------------------------------------
Net income 2,912 1,719
================================================================================
Basic net income per share:
Income from continuing operations $ 0.16 $ 0.11
Loss from discontinued operations - (0.01)
- --------------------------------------------------------------------------------
Basic net income per share 0.16 0.10
================================================================================
Diluted net income per share:
Income from continuing operations $ 0.15 $ 0.11
Loss from discontinued operations - (0.01)
- --------------------------------------------------------------------------------
Diluted net income per share 0.15 0.10
================================================================================
Weighted average common shares outstanding:
Basic 18,246 16,793
Diluted 19,790 17,331
The sum of the income (loss) per share amounts may not total due to rounding.
See Notes to Condensed Consolidated Financial Statements.
STANDARD MICROSYSTEMS CORPORATION
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
Three Months Ended May 31,
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2004 2003
--------------- ---------------
Cash flows from operating activities:
Cash received from customers and licensees $ 50,938 $ 44,274
Cash paid to suppliers and employees (52,240) (42,623)
Interest received 421 427
Interest paid (39) (24)
Income taxes paid (44) (125)
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Net cash provided by (used for) operating
activities (964) 1,929
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Cash flows from investing activities:
Capital expenditures (2,902) (1,602)
Sales of property, plant and equipment - 7,071
Sales of long-term investments 4,000 1,199
Purchases of short-term investments (7,130) (9,022)
Sales of short-term investments 3,006 12,794
Other 5 (9)
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Net cash provided by (used for) investing
activities (3,021) 10,431
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Cash flows from financing activities:
Proceeds from issuance of common stock 210 31
Repayments of obligations under capital
leases and notes payable (506) (438)
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Net cash used for financing activities (296) (407)
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Effect of foreign exchange rate changes on
cash and cash equivalents (25) 85
Cash used for discontinued operation - (256)
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Net increase (decrease) in cash and cash equivalents (4,306) 11,782
Cash and cash equivalents at beginning of period 135,161 90,025
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Cash and cash equivalents at end of period $ 130,855 $ 101,807
===================================================================================================
Reconciliation of income from continuing operations
to net cash provided by (used for) operating activities:
Income from continuing operations $ 2,912 $ 1,883
Adjustments to reconcile income from continuing
operations to net cash provided by (used for)
operating activities:
Depreciation and amortization 2,942 2,750
Tax benefits from employee stock plans 49 3
Gains from sales of investments and property, net - (696)
Other adjustments, net (5) (67)
Changes in operating assets and liabilities:
Accounts receivable (7,960) (1,739)
Inventories (48) (2,711)
Accounts payable, deferred income, accrued
expenses and other liabilities 451 2,994
Current and deferred income taxes 1,067 621
Other changes, net (372) (1,109)
- ---------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities $ (964) $ 1,929
===================================================================================================
See Notes to Condensed Consolidated Financial Statements.
STANDARD MICROSYSTEMS CORPORATION
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial information of
Standard Microsystems Corporation and subsidiaries, referred to herein as
"SMSC" or "the Company", has been prepared in accordance with generally
accepted accounting principles and the rules and regulations of the
Securities and Exchange Commission, and reflects all adjustments,
consisting only of normal recurring adjustments, which in management's
opinion are necessary to state fairly the Company's financial position,
results of operations and cash flows for all periods presented.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the
financial statements, as well as the reported amounts of sales and revenues
and expenses during the reporting period. Actual results may differ from
those estimates, and such differences may be material to the financial
statements. These condensed consolidated financial statements should be
read in conjunction with the audited consolidated financial statements for
the year ended February 29, 2004 included in the Company's annual report on
Form 10-K, as filed on May 14, 2004 with the Securities and Exchange
Commission (SEC). The results of operations for the three months ended May
31, 2004 are not necessarily indicative of the results to be expected for
any future periods.
2. Stock-Based Compensation
The Company has in effect several stock-based compensation plans under
which incentive stock options, non-qualified stock options and restricted
stock awards are granted to employees and directors. All stock options are
granted with exercise prices equal to the fair value of the underlying
shares on the date of grant. The Company accounts for stock option grants
in accordance with Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees" and accordingly recognizes no
compensation expense for the stock option grants. Additional pro forma
disclosures as required under Statement of Financial Accounting Standards
(SFAS) No. 123, "Accounting for Stock-Based Compensation," as amended by
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure," are detailed below.
For purposes of pro forma disclosures, the estimated fair market value of
the Company's options is amortized as an expense over the options' vesting
periods. The fair value of each option grant, as defined by SFAS No. 123,
is estimated on the date of grant using the Black-Scholes option-pricing
model. The Black-Scholes model, as well as other currently accepted option
valuation models, was developed to estimate the fair value of freely
tradable, fully transferable options without vesting restrictions, that
significantly differ from the Company's stock option awards. Because the
Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate,
in the opinion of management, the existing models do not necessarily
provide a reliable single measure of the fair value of employee stock
options.
For purposes of pro forma disclosures, the estimated fair market value of
the Company's options is amortized as an expense over the options' vesting
periods. Had compensation expense been recorded under the provisions of
SFAS No. 123, the Company's net income (loss) and net income (loss) per
share would have been the pro forma amounts indicated below (in thousands,
except per share data):
Three Months Ended
May 31,
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2004 2003
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Net income - as reported $ 2,912 $ 1,719
Add: Stock-based compensation expense included in net
income, net of taxes - as reported 141 204
Deduct: Stock-based compensation expense determined
using the fair value method for all awards, net of taxes (2,421) (2,436)
----------------------------------------------------------------------------------------
Net income (loss) - pro forma $ 632 $ (513)
========================================================================================
Basic net income per share - as reported $ 0.16 $ 0.10
========================================================================================
Diluted net income per share - as reported $ 0.15 $ 0.10
========================================================================================
Basic net income (loss) per share - pro forma $ 0.03 $ (0.03)
========================================================================================
Diluted net income (loss) per share - pro forma $ 0.03 $ (0.03)
========================================================================================
3. Balance Sheet Data
Inventories are valued at the lower of first-in, first-out cost or market
and consist of the following (in thousands):
May 31, 2004 Feb. 29, 2004
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Raw materials $ 836 $ 910
Work in process 14,514 13,202
Finished goods 7,849 9,050
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$ 23,199 $ 23,162
=========================================================================
Property, plant and equipment consist of the following (in thousands):
May 31, 2004 Feb. 29, 2004
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Land $ 1,570 $ 1,570
Buildings and improvements 21,042 20,842
Machinery and equipment 92,146 90,195
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114,758 112,607
Less: accumulated depreciation 91,463 89,177
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$ 23,295 $ 23,430
========================================================================
4. Net Income Per Share
Basic net income per share is calculated using the weighted-average number
of common shares outstanding during the period. Diluted net income per
share is calculated using the weighted-average number of common shares
outstanding during the period, plus the dilutive effect of unvested
restricted stock awards and shares issuable through stock options.
The shares used in calculating basic and diluted net income per share for
the Condensed Consolidated Statements of Operations included within this
report are reconciled as follows (in thousands):
Three Months Ended
May 31,
----------------------------
2004 2003
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Average shares outstanding for
basic net income per share 18,246 16,793
Dilutive effect of stock options and
unvested restricted stock awards 1,544 538
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Average shares outstanding for
diluted net income per share 19,790 17,331
=========================================================================
Stock options covering 0.2 million and 2.9 million shares for the
three-month periods ended May 31, 2004 and 2003, respectively, were
excluded from the computation of average shares outstanding for diluted net
income per share because their effects were anti-dilutive.
5. Comprehensive Income
The Company's other comprehensive income consists of foreign currency
translation adjustments from those subsidiaries not using the U.S. dollar
as their functional currency, and unrealized gains and losses on equity
investments classified as available-for-sale. The components of the
Company's comprehensive income for the three months ended May 31, 2004 and
2003 were as follows (in thousands):
Three Months Ended
May 31,
--------------------------
2004 2003
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Net income $ 2,912 $ 1,719
Other comprehensive income:
Change in foreign currency translation
adjustment (53) 38
Change in unrealized gain (loss) on marketable
equity securities, net of taxes (4) 14
Reclassification adjustment for loss on marketable
equity security included in net income, net of
taxes - 665
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Total comprehensive income $ 2,855 $ 2,436
===========================================================================
During the three months ended May 31, 2003, the Company sold its remaining
equity investment in Chartered Semiconductor Manufacturing, Ltd. This
investment was classified as available-for-sale, and temporary changes in
its market value, net of income taxes, were included within the Company's
Other comprehensive income, and were presented cumulatively as an
unrealized gain or loss, net of income taxes, within Accumulated other
comprehensive income on the Company's Consolidated Balance Sheets. The
amount presented as a reclassification adjustment in the preceding table
represents the amount previously reported within Other comprehensive income
as an unrealized loss on this investment, net of income taxes, through the
applicable reporting dates.
6. Agreements with Intel Corporation
In 1987, the Company and Intel Corporation (Intel) entered into an
agreement providing for, among other things, a broad, worldwide,
non-exclusive patent cross-license, covering manufacturing processes and
products, thereby providing each company access to the other's current and
future patent portfolios.
In September 2003, the Company and Intel announced that they had enhanced
their intellectual property and business relationship. The companies agreed
to collaborate on certain future Input/Output (I/O) and sensor products,
and Intel agreed to use the Company's devices on certain current and future
generations of Intel products. In addition, the Company agreed to limit its
rights, under its 1987 patent cross-license with Intel, to manufacture and
sell Northbridge products and Intel Architecture Microprocessors on behalf
of third parties. The companies also terminated an Investor Rights
Agreement between them, which had been entered into in connection with
Intel's 1997 acquisition of 1,543,000 shares of the Company's common stock.
Under this agreement, Intel had certain information, corporate governance
and other rights with respect to the activities of the Company.
In respect of this relationship, Intel will pay to the Company an aggregate
amount of $75 million, of which $20 million and $2.5 million was paid and
recognized as Intellectual property revenue in the third and fourth
quarters of fiscal 2004, respectively, and $2.5 million was paid and
recognized as Intellectual property revenue in the first quarter of fiscal
2005. Of the remaining amount, $5 million will be paid during the balance
of calendar year 2004, $10 million will be paid in calendar year 2005, $11
million will be paid in calendar year 2006, and $12 million will be paid in
each of calendar years 2007 and 2008. Such amounts are payable in equal
quarterly installments within each calendar year, and are subject to
possible reduction, in a manner and to an extent to be agreed by the
parties, based upon the companies' collaboration and sales, facilitated by
Intel, of certain future new products of the Company.
7. Business Restructuring
In December 2001, the Company announced a restructuring plan for its exit
from the PC chipset business.
The Company's reserve related to this restructuring declined from $1.0
million at February 29, 2004 to $0.9 million at May 31, 2004, reflecting
payments against previously reserved non-cancelable lease obligations,
which will continue through their respective lease terms through August
2008.
8. Discontinued Operations
The Company had been involved in an arbitration proceeding with Accton
Technology Corporation (Accton) and SMC Networks, Inc. (Networks), relating
to claims associated with the October 1997 purchase of a majority interest
in Networks by Accton from SMSC. This divestiture was accounted for as a
discontinued operation, and accordingly, costs associated with this action,
net of income taxes, were reported within Loss from discontinued operations
on the Consolidated Statements of Operations. These costs totaled $0.2
million for the three months ended May 31, 2003, after applicable income
tax benefits. This action was settled during the fourth quarter of fiscal
2004.
9. Goodwill and Intangible Assets
The Company's June 2002 acquisition of Tucson, Arizona-based Gain
Technology Corporation included the acquisition of $7.1 million of
finite-lived intangible assets and $29.6 million of goodwill, after
adjustments. In accordance with the provisions of SFAS No. 142, this
goodwill is not amortized, but is tested for impairment in value annually,
as well as when an event or circumstance occurs indicating a possible
impairment in its value.
All finite-lived intangible assets are being amortized on a straight-line
basis over their estimated useful lives. Existing technologies were
assigned an estimated useful life of six years. Customer contracts were
assigned useful lives of between one and ten years (with a weighted average
life of approximately seven years), and non-compete agreements were
assigned useful lives of two years. The weighted average useful life of all
intangible assets is approximately six years.
As of May 31, 2004 and February 29, 2004, the Company's finite-lived
intangible assets consisted of the following (in thousands):
May 31, 2004 February 29, 2004
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Accumulated Accumulated
Cost Amortization Cost Amortization
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Existing technologies $ 6,179 $ 2,060 $ 6,179 $ 1,802
Customer contracts 326 65 326 57
Non-compete agreements 410 410 410 359
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$ 6,915 $ 2,535 $ 6,915 $ 2,218
==========================================================================================
Estimated future intangible asset amortization expense for the remainder of
fiscal 2005 and thereafter, is as follows (in thousands):
Period Amount
-------------------------------------------------
Remainder of fiscal 2005 $ 797
Fiscal 2006 1,062
Fiscal 2007 1,062
Fiscal 2008 1,062
Fiscal 2009 290
Fiscal 2010 and thereafter 107
=================================================
10. Real Estate Transactions
During the quarter ended May 31, 2003, the Company sold certain portions of
its Hauppauge, New York real estate holdings, for aggregate proceeds of
$7.0 million, net of transaction costs. These transactions resulted in an
aggregate gain of $1.7 million, $1.4 million of which related to property
in which the Company has no continued interest and was recognized within
the Company's fiscal 2004 first quarter operating results, and $0.3 million
of which related to property that the Company has leased back from the
purchaser and was therefore deferred. This deferred gain is being
recognized within the Company's operating results as a reduction in rent
expense on a straight-line basis over a 30-month period beginning in June
2003, consistent with the term of the lease. The Company's remaining rent
obligation over the term of this lease is approximately $0.5 million.
11. Retirement Plans
The Company maintains an unfunded Supplemental Executive Retirement Plan to
provide senior management with retirement, disability and death benefits.
The Company's subsidiary, SMSC Japan, also maintains an unfunded retirement
plan, which provides its employees and directors with separation benefits,
consistent with customary practices in Japan. Benefits under these defined
benefit plans are based upon various service and compensation factors. The
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. The following table sets forth the
components of the consolidated net periodic pension expense for the three
months ended May 31, 2004 and 2003, respectively (in thousands):
Three Months Ended
May 31,
--------------------------
2004 2003
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Service cost - benefits earned $ 72 $ 66
Interest cost on projected benefit obligations 106 102
Net amortization and deferral 72 68
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Net periodic pension expense $ 250 $ 236
=========================================================================
12. Litigation
In June 2003, SMSC was named as a defendant in a patent infringement
lawsuit filed by Analog Devices, Inc. (ADI) in the United States District
Court for the District of Massachusetts (Analog Devices, Inc. v. Standard
Microsystems Corporation, Case Number 03 CIV 11216). The Complaint, as
amended, alleges that some of the Company's products infringe one or more
of three of ADI's patents, and seeks injunctive relief and unspecified
damages. In September 2003, the Company filed an Answer in the lawsuit,
denying ADI's allegations and raising affirmative defenses and
counterclaims. The Company is vigorously defending the lawsuit and
collecting evidence to support its defenses to infringement and its
allegations of patent invalidity and unenforceability. Although it is
premature to assess the outcome of the litigation, the Company believes
that the allegations against it are without merit.
13. Recent Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board (FASB) revised
SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits." The revised SFAS No. 132 requires additional
disclosures about plan assets, benefit obligations, cash flows, benefit
costs and other relevant information related to pensions and other
postretirement benefits. It also requires certain disclosures related to
pensions and other postretirement benefits to be included in quarterly
filings, which are included within Note 11 to the Condensed Consolidated
Financial Statements included within this report.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company's
Condensed Consolidated Financial Statements and notes thereto contained in
this report.
Portions of this report may contain forward-looking statements about
expected future events and financial and operating results that involve
risks and uncertainties. These include the timely development and market
acceptance of new products; the impact of competitive products and pricing;
the effect of changing economic conditions in domestic and international
markets; changes in customer order patterns, including loss of key
customers, order cancellations or reduced bookings; and excess or obsolete
inventory and variations in inventory valuation, among others. Words such
as "believe," "expect," "anticipate" and similar expressions identify
forward-looking statements. Such statements are qualified in their entirety
by the inherent risks and uncertainties surrounding future expectations and
may not reflect the potential impact of any future acquisitions, mergers or
divestitures.
SMSC competes in the semiconductor industry, which has historically been
characterized by intense competition, rapid technological change, cyclical
market patterns, price erosion and periods of mismatched supply and demand.
In addition, sales of many of the Company's products depend largely on
sales of personal computers (PCs) and peripheral devices, and reductions in
the rate of growth of the PC and peripheral device markets could adversely
affect its operating results. SMSC conducts business outside the United
States and is subject to tariff and import regulations and currency
fluctuations, which may have an effect on its business. All forward-looking
statements speak only as of the date hereof and are based upon the
information available to SMSC at this time. Such information is subject to
change, and the Company may not inform, or be required to inform, investors
of such changes. These and other risks and uncertainties, including
potential liability resulting from pending or future litigation, are
detailed from time to time in the Company's reports filed with the SEC.
Investors are advised to read the Company's Annual Report on Form 10-K and
quarterly reports on Form 10-Q filed with the SEC, particularly those
sections entitled "Other Factors That May Affect Future Operating Results,"
for a more complete discussion of these and other risks and uncertainties.
Overview
--------
Description of Business
SMSC provides semiconductor systems solutions for high-speed communication
and computing applications. Through the integration of its leading-edge
digital, mixed-signal and analog design capabilities and software
expertise, SMSC delivers complete solutions that monitor and manage
computing systems and connect peripherals to computers and to one another.
The Company addresses computing, communications and consumer electronics
markets through world-leading positions in Input/Output and non-PCI
Ethernet products, innovations in USB2.0 and other high-speed serial
solutions, and integrated networking products employed in a broad range of
applications.
SMSC is a fabless semiconductor supplier, whose products are manufactured
by world-class third-party semiconductor foundries and assemblers. To
ensure the highest product quality, the Company conducts a significant
portion of its final testing requirements in the Company's own
state-of-the-art testing operation.
The Company is based in Hauppauge, New York with operations in North
America, Taiwan, Japan, Korea, China and Europe. SMSC operates engineering
design centers in New York, Arizona and Texas.
New Brand Identity and Corporate Image
On April 26, 2004, SMSC was honored to open the Nasdaq stock market and
concurrently unveiled a new global brand identity, including a new logo,
tagline - "Success by Design," and website design at its www.smsc.com
homepage. Through its communication initiatives, the Company is placing
renewed emphasis on building awareness of its market leadership position
and capabilities to serve its customers. The new "Success by Design"
tagline underscores the Company's mission of being an essential ingredient
that fuels its customers' success. This tagline highlights SMSC's culture,
which is deliberate in the manner in which it seeks to ensure success for
its customers and stakeholders.
Critical Accounting Policies and Estimates
------------------------------------------
This discussion and analysis of the Company's financial condition and
results of operations is based upon the unaudited condensed consolidated
financial statements included in this report, which have been prepared in
accordance with accounting principles for interim financial statements
generally accepted in the United States. The preparation of financial
statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the
reported amount of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amount of sales and revenues and expenses during the reporting
period.
The Company believes that the critical accounting policies and estimates
listed below are important to the portrayal of the Company's financial
condition and operating results, and require critical management judgments
and estimates about matters that are inherently uncertain. Although
management believes that its judgments and estimates are appropriate and
reasonable, actual future results may differ from these estimates, and to
the extent that such differences are material, future reported operating
results may be affected.
o Revenue recognition
o Inventory valuation
o Determination of the allowance for doubtful accounts receivable
o Valuation of long-lived assets
o Accounting for deferred income tax assets
o Legal contingencies
Further information regarding these policies appears within the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in the Company's annual report on Form 10-K for the
fiscal year ended February 29, 2004 filed with the SEC on May 14, 2004.
During the three-month period ended May 31, 2004, there were no significant
changes to any critical accounting policies or to the related estimates and
judgments involved in applying these policies.
Results of Operations
---------------------
Sales and Revenues
Sales and revenues for the three months ended May 31, 2004 were $53.1
million, consisting of $50.4 million of product sales and $2.7 million of
intellectual property revenues, compared to sales and revenues of $42.7
million for the prior-year quarter, consisting of $42.5 million of products
sales and $0.2 million of intellectual property revenues. The increase in
product sales of $7.9 million, or 18.6%, reflects increased demand for both
PC I/O and non-PC I/O products. Sales of PC I/O products increased from
$27.8 million in the prior-year quarter to $30.2 million in the
current-year quarter, reflecting the impact of new design-wins and
increased worldwide demand for PCs. Sales of non-PC I/O products, which
include networking and connectivity products, increased from $14.7 million
in the prior-year quarter to $20.2 million in the current-year quarter,
reflecting the impact of new design-wins, broader product offerings, and
the Company's ongoing focus on aggressively identifying and pursuing market
opportunities in its non-PC I/O product lines. Sales of non-PC I/O products
grew to 40% of total product sales in the current-year quarter, compared to
35% in the prior-year quarter.
Product sales from customers outside of North America accounted for
approximately 88% and 90% of the Company's product sales for the
three-month periods ended May 31, 2004 and 2003, respectively, the largest
potion of which was to the Asia and Pacific Rim region. The Company expects
that international shipments, particularly to the Asia and Pacific Rim
region, will continue to represent a significant portion of its product
sales.
Intellectual property revenues for the three months ended May 31, 2004 were
$2.7 million, compared to $0.2 million for the prior-year period.
Intellectual property revenues for the current-year period include a $2.5
million payment from Intel Corporation, as more fully described within Note
6 to the Condensed Consolidated Financial Statements.
Gross Profit
Gross profit for the three months ended May 31, 2004 was $26.7 million, or
50.3% of sales and revenues, compared to $20.7 million, or 48.4% of sales
and revenues, for the three months ended May 31, 2003. Excluding
intellectual property revenues, gross profit was $24.0 million, or 47.6% of
product sales, for the quarter ended May 31, 2004, compared to $20.4
million, or 48.1% of product sales, for quarter ended May 31, 2003. Gross
profit dollars from product sales, excluding the impact of intellectual
property revenues, increased by $3.5 million, or 17.3%, compared to the
year-earlier quarter. The slight decline in gross profit margin percentage
on product sales in the current-year period results from a product mix in
the prior year quarter that was skewed towards several high-margin
products. The Company's gross profit margin, excluding intellectual
property revenues, increased from 45.1% in the fourth quarter of fiscal
2004 to the current quarter's 47.6%.
Newly introduced products generally command higher average selling prices,
which typically decline over product life cycles, due to competitive
pressures and other factors. In order to offset declines in average selling
prices, the Company continually works to incorporate additional
functionality and value to its products, and to reduce the costs of its
products, through product and manufacturing design changes, yield
improvements, manufacturing efficiencies and lower costs negotiated with
subcontract manufacturers.
Research and Development Expenses
R&D expenses were $10.9 million, or 20.5% of sales and revenues, for the
three months ended May 31, 2004, compared to $9.1 million, or 21.3% of
sales and revenues, for the three months ended May 31, 2003. This dollar
increase reflects the impact of engineering staff additions, investments in
advanced semiconductor design tools, higher costs associated with
development programs in advanced semiconductor technologies, and higher
costs for contract design services.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $11.9 million, or 22.3%
of sales and revenues, for the three months ended May 31, 2004, compared to
$9.5 million, or also 22.3% of sales and revenues, for the three months
ended May 31 2003. The dollar increase reflects the impact of additional
staff added to expand the Company's sales and marketing capabilities,
associated recruitment and relocation costs, as well as incremental selling
costs, primarily sales commissions and incentives, associated with higher
product sales in the current year's first quarter. During the three months
ended May 31, 2004 the Company incurred higher professional fees associated
with litigation than the prior-year period, and also incurred additional
costs associated with its April 2004 launch and promotion of its new global
brand identity and corporate image campaign.
Amortization of Intangible Assets
The Company recorded amortization expenses of $0.3 million and $0.4 million
for the three months ended May 31, 2004 and 2003, respectively, for
intangible assets associated with the June 2002 acquisition of Gain.
Gains on Real Estate Transactions
During the quarter ended May 31, 2003, the Company sold certain portions of
its Hauppauge, New York real estate holdings, for aggregate proceeds of
$7.0 million, net of transaction costs. These transactions resulted in an
aggregate gain of $1.7 million, $1.4 million of which related to property
in which the Company has no continued interest and was recognized within
the Company's fiscal 2004 first quarter operating results, and $0.3 million
of which related to property that the Company has leased back from the
purchaser and was therefore deferred. This deferred gain is being
recognized within the Company's operating results as a reduction in rent
expense on a straight-line basis over a 30-month period beginning in June
2003, consistent with the term of the lease. The Company's remaining rent
obligation over the term of this lease is approximately $0.5 million.
Other Income and Expense
During the quarter ended May 31, 2003, the Company sold its remaining
equity investment in Chartered Semiconductor Manufacturing, Ltd., realizing
losses of $0.7 million, which are included within Other expense, net, for
that period.
Provision For Income Taxes
The Company's effective income tax rate primarily reflects statutory
Federal and state income tax rates, adjusted for the impact of tax-exempt
interest income and anticipated income tax credits.
The Company's $1.2 million provision for income taxes for the three months
ended May 31, 2004 reflects an expected fiscal 2005 effective tax rate of
28.5%. The $0.9 million provision for income taxes for the three months
ended May 31, 2003 resulted in an effective tax rate of 31.5% for that
period.
As of May 31, 2003, the Company's expected its effective tax rate to be
approximately 30.0% for fiscal 2004, excluding the tax effect on unusual
and infrequently occurring transactions, which are recorded in the period
in which the transactions occur. Operating results for the first quarter of
fiscal 2004 included unusual and infrequently occurring real estate and
equity security sale transactions that, net, provided $0.7 million of
pre-tax income. Taxes on those transactions were provided for at the
Company's approximate 36.0% incremental income tax rate, the result of
which was an overall effective income tax rate of 31.5% in the first
quarter of fiscal 2004.
The reduction in the Company's expected effective income tax rate for
fiscal 2005, compared to expectations at May 31, 2003 for fiscal 2004,
reflects higher anticipated income tax credits in fiscal 2005.
Discontinued Operations
The Company had been involved in an arbitration proceeding with Accton
Technology Corporation (Accton) and SMC Networks, Inc. (Networks), relating
to claims associated with the October 1997 purchase of a majority interest
in Networks by Accton from SMSC. The divestiture was accounted for as a
discontinued operation, and accordingly, costs associated with this action,
net of income taxes, were reported within Loss from discontinued operations
on the Consolidated Statements of Operations. These costs totaled $0.2
million for the three months ended May 31, 2003, after applicable income
tax benefits. This action was settled during the fourth quarter of fiscal
2004.
Liquidity and Capital Resources
-------------------------------
The Company currently finances its operations through a combination of
existing resources and cash generated by operations.
The Company's cash, cash equivalents and liquid investments (including
marketable securities with maturities in excess of one year) were $169.7
million as of May 31, 2004, compared to $173.9 million at February 29,
2004, a decrease of $4.2 million. The Company's operating activities
consumed $1.0 million of cash during the first quarter of fiscal 2005, due
in part to a banking holiday on the final day of the first quarter, which
delayed approximately $2.7 million of accounts receivable collections from
being credited to the Company's accounts until June 1. Operating activities
for the first quarter of fiscal 2004 generated $1.9 million of cash.
The Company's inventories were $23.2 million at May 31, 2004, level with
inventories at February 29, 2004. Inventories at the Company's distributors
increased during the quarter, as evidenced by the increase in Deferred
income on shipments to distributors from $8.0 million at February 29, 2004
to $11.9 million at May 31, 2004. This increase in distributor inventories
reflects higher anticipated product demand during the second quarter.
Accounts receivable increased from $21.9 million at February 29, 2004 to
$29.8 million at May 31, 2004, an increase of $7.9 million. This increase
reflects the combination of the one-day delay in cash collections discussed
two paragraphs earlier, higher product sales and a reduction in unclaimed
pricing credits by distributors. SMSC accrues a liability for distributor
pricing credits when the distributor earns such credits, but the issuance
of the actual credit memo to the distributor is dependent upon the
distributor's submission of an appropriate claim to SMSC. Delays in
distributors' claims for these credits typically results in lower than
expected accounts receivable balances, since the delays result in full
collections for certain invoices against which the distributor is actually
entitled to, but has not yet claimed, a pricing credit. Overall, the
Company's accounts receivable portfolio remains almost entirely current.
Capital expenditures for the three months ending May 31, 2004 were $2.9
million, and were predominantly for production test equipment. Capital
expenditures for the three months ended May 31, 2003 were $4.8 million,
including $4.3 million in advanced design tools, $3.2 million of which was
financed on a short-term basis by the supplier with payment terms extending
throughout fiscal 2004. The $3.2 million obligation was reported within
Accounts payable at May 31, 2003.
The Company anticipates that capital expenditures in fiscal 2005 will
exceed those incurred during fiscal 2004, due in part to the Company's plan
to begin construction of an addition to its primary facility in Hauppauge,
New York, during fiscal 2005. The current plan is to expand the facility
from its current 80,000 square feet to approximately 200,000 square feet,
allowing consolidation of the Company's Hauppauge operations into a single
facility during fiscal 2006. There were no material commitments for capital
expenditures as of May 31, 2004.
For income tax purposes, the Company has $12.4 million of federal net
operating loss carryforwards that are available to offset ordinary taxable
income generated in fiscal 2005 and beyond. In addition, several capital
losses realized during fiscal 2004 will be carried back to offset capital
gains realized in previous fiscal years, which is expected to result in
claims for approximately $5.3 million of federal income tax refunds later
in fiscal 2005.
The Company has considered in the past, and will continue to consider,
various possible transactions to secure necessary foundry manufacturing
capacity, including equity investments in, prepayments to, or deposits with
foundries, in exchange for guaranteed capacity or other arrangements which
address the Company's manufacturing requirements. The Company may also
consider utilizing cash to acquire or invest in complementary businesses or
products or to obtain the right to use complementary technologies. From
time to time, in the ordinary course of business, the Company may evaluate
potential acquisitions of or investment in such businesses, products or
technologies owned by third parties.
The Company expects that its cash, cash equivalents, short-term
investments, cash flows from operations and its borrowing capacity will be
sufficient to finance the Company's operating and capital requirements for
at least the next 12 months and thereafter for the foreseeable future.
Recent Accounting Pronouncements
--------------------------------
In December 2003, the FASB revised SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." The revised SFAS No. 132
requires additional disclosures about plan assets, benefit obligations,
cash flows, benefit costs and other relevant information related to
pensions and other postretirement benefits. It also requires certain
disclosures related to pensions and other postretirement benefits to be
included in quarterly filings, which are included within Note 11 to the
Condensed Consolidated Financial Statements included within this report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Financial Market Risks
----------------------
Interest Rate Risk - The Company's exposure to interest rate risk relates
primarily to its investment portfolio. The primary objective of SMSC's
investment portfolio management is to invest available cash while
preserving principal and meeting liquidity needs. In accordance with the
Company's investment policy, investments are placed with high
credit-quality issuers and the amount of credit exposure to any one issuer
is limited.
As of May 31, 2004, the Company's $38.9 million of short-term and long-term
investments consisted primarily of investments in corporate, government and
municipal obligations with maturities of between three months and two years
at acquisition. If market interest rates were to increase immediately and
uniformly by 10 percent from levels at May 31, 2004, the Company estimates
that the fair value of these short-term and long-term investments would
decline by an immaterial amount. The Company generally expects to hold
these investments until maturity and, therefore, would not expect operating
results or cash flows to be affected to any significant degree by a sudden
change in market interest rates.
Equity Price Risk - The Company has no material investments in equity
securities of other companies on its Consolidated Balance Sheet as of May
31, 2004.
Foreign Currency Risk - The Company has international sales and
expenditures and is, therefore, subject to certain foreign currency rate
exposure. The Company conducts a significant amount of its business in Asia
and the Pacific Rim region. In order to reduce the risk from fluctuation in
foreign exchange rates, most of the Company's product sales and all of its
arrangements with its foundry, test and assembly vendors are denominated in
U.S. dollars. Most transactions in the Japanese market made by the
Company's majority-owned subsidiary, SMSC Japan, are denominated in
Japanese yen. SMSC Japan purchases a significant amount of its products for
resale from SMSC in U.S. dollars, and from time to time has entered into
forward exchange contracts to hedge against currency fluctuations
associated with these product purchases. No such contracts were executed
during either fiscal 2004 or the first quarter of fiscal 2005, and there
are no obligations under any such contracts as of May 31, 2004.
The Company has never received a cash dividend (repatriation of cash) from
SMSC Japan.
Other Factors That May Affect Future Operating Results
------------------------------------------------------
As a supplier of semiconductors, the Company competes in a challenging
business environment, which is characterized by intense competition, rapid
technological change and cyclical business patterns. Except for the
historical information contained herein, the matters discussed in this
report are forward-looking statements. The Company faces a variety of risks
and uncertainties in conducting its business, some of which are out of its
control, and any of which, were they to occur, could impair the Company's
operating performance. For a more detailed discussion of risk factors,
please refer to the Company's annual report on Form 10-K for the fiscal
year ended February 29, 2004 filed with the Securities and Exchange
Commission on May 14, 2004.
ITEM 4. CONTROLS AND PROCEDURES
The Company has carried out an evaluation under the supervision and with
the participation of the Company's management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of the Company's disclosure controls and procedures.
There are inherent limitations to the effectiveness of any system of
disclosure controls and procedures, including the possibility of human
error and the circumvention or overriding of the controls and procedures.
Accordingly, even effective disclosure controls and procedures can only
provide reasonable assurance of achieving their control objectives. Based
upon the Company's evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that, as of May 31, 2004, the disclosure
controls and procedures are effective to provide reasonable assurance that
information required to be disclosed in the reports the Company files under
the Exchange Act is recorded, processed, summarized and reported as and
when required.
There has been no change in the Company's internal control over financial
reporting during the Company's fiscal quarter covered by this report that
has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
In June 2003, SMSC was named as a defendant in a patent infringement
lawsuit filed by Analog Devices, Inc. (ADI) in the United States District
Court for the District of Massachusetts (Analog Devices, Inc. v. Standard
Microsystems Corporation, Case Number 03 CIV 11216). The Complaint, as
amended, alleges that some of the Company's products infringe one or more
of three of ADI's patents, and seeks injunctive relief and unspecified
damages. In September 2003, the Company filed an Answer in the lawsuit,
denying ADI's allegations and raising affirmative defenses and
counterclaims. The Company is vigorously defending the lawsuit and
collecting evidence to support its defenses to infringement and its
allegations of patent invalidity and unenforceability. Although it is
premature to assess the outcome of the litigation, the Company believes
that the allegations against it are without merit.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 * - Amendment to the Plan for Deferred Compensation in Common
Stock for Outside Directors, dated April 7, 2004.
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.
* Indicates a management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
On April 12, 2004, SMSC filed a report on Form 8-K pursuant to which it
furnished a press release announcing the Company's fourth quarter
fiscal 2004 operating results.
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: July 2, 2004 By: /s/ Andrew M. Caggia
-----------------------------
(Signature)
Andrew M. Caggia
Senior Vice President - Finance
(duly authorized officer) and
Chief Financial Officer
(principal financial officer)