-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WuMaCI1/MJedhKxJkEawITKShtgV/7zbQT7kNvV4eHSos0lNrEx2CUgHlRtyRfa9 ka2U3aIzEhOiG7s6Lc3rbg== 0000093384-04-000009.txt : 20040514 0000093384-04-000009.hdr.sgml : 20040514 20040514161705 ACCESSION NUMBER: 0000093384-04-000009 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20040229 FILED AS OF DATE: 20040514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: STANDARD MICROSYSTEMS CORP CENTRAL INDEX KEY: 0000093384 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 112234952 STATE OF INCORPORATION: DE FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-07422 FILM NUMBER: 04807999 BUSINESS ADDRESS: STREET 1: 80 ARKAY DRIVE CITY: HAUPPAUGE STATE: NY ZIP: 11934 BUSINESS PHONE: 5164342904 MAIL ADDRESS: STREET 1: 80 ARKAY DR CITY: HAUPPAUGE STATE: NY ZIP: 11934 10-K 1 form_10k-fy04.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------- FORM 10-K ------------------- [x] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended February 29, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 0-7422 ------------------- STANDARD MICROSYSTEMS CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 11-2234952 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 80 Arkay Drive, Hauppauge, New York 11788 (Address of principal executive offices) (Zip Code) (631) 435-6000 (Registrant's telephone number, including area code) ------------------- Securities registered pursuant to Section 12(b) of the Act: None ------------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.10 par value Preferred Stock Purchase Rights ================================================================================ (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ( ) Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ___ The aggregate market value of the shares of voting stock of the registrant held by non-affiliates, based upon the last sale price of the registrant's common stock on August 29, 2003, as reported by the Nasdaq Stock Market's National Market, was approximately $351.7 million. As of March 31, 2004, there were 18,397,864 shares of the registrant's common stock outstanding. Documents Incorporated By Reference Portions of the registrant's 2004 Annual Report to Shareholders are incorporated by reference into Part II of this report on Form 10-K, and portions of the registrant's Proxy Statement for the 2004 Annual Meeting of Shareholders are incorporated by reference into Part III of this report on Form 10-K. ================================================================================ Standard Microsystems Corporation Form 10-K For the Fiscal Year Ended February 29, 2004 TABLE OF CONTENTS PART I Item 1. Business Item 2. Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures About Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures PART III Item 10. Directors and Executive Officers of the Registrant Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13. Certain Relationships and Related Transactions Item 14. Principal Accounting Fees and Services PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K Portions of this Form 10-K contain forward-looking statements concerning various aspects of the Company's business, including its strategy, product development efforts, and litigation. These statements involve numerous risks and uncertainties including those discussed throughout this document. For a further explanation and details of some of these risks, please refer to "Other Factors That May Affect Future Operating Results" within Part I, Item 1. PART I Item 1. Business. - ------------------- General Description of the Business Standard Microsystems Corporation (the Company, the Registrant, or SMSC) is a Delaware corporation, organized in 1971. As used herein, the terms Company, Registrant and SMSC include the Company's subsidiaries, except where the context otherwise requires. 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 USB 2.0 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. Principal Products of the Company The Company supplies semiconductor devices in three major product platforms: Connectivity Solutions, Networking Products, and Computing Platform Solutions. Connectivity Solutions - These products provide system level semiconductor solutions incorporating USB 2.0 and other high-speed serial interfaces, enabling interoperability and connectivity in consumer electronics, multimedia computing and mobile storage applications. This product family addresses the marketplace's increasing requirements for high-speed data transfer of information between diverse systems platforms, utilizing standardized interface protocols. SMSC's products participate in several product areas within the USB connectivity market, including flash card readers, pen drives, read/write and optical storage devices and hubs. USB connectivity technology has been very successful in replacing legacy serial and parallel interfaces in computing, consumer electronics and industrial applications. Designers are attracted to its plug-and-play features as well as its strong software support and predictable software development requirements. Product offerings within SMSC's connectivity solutions product line include: o Flash card reader products, including the USB97C2223/2224, which is a bus-powered USB 2.0 flash media controller supporting 10 different flash memory card formats in a single device. o Pen drive controller products, including the USB97C242, which is a USB 2.0 flash drive controller providing a single chip solution for SmartMedia and NAND flash memory devices. o Disk and optical storage drive controller products, including the USB97CFDC, a USB floppy disk controller, and the USB97C202, a USB ATA/ATAPI device contoller. o Hub products, including the USB20H04, a high-performance 4-port USB 2.0 hub controller. o Transceiver products, including the GT3200, a USB 2.0 physical layer (PHY) circuit, providing an interface between a USB cable and a peripheral-side USB controller. Networking Products - In business environments, on factory floors and in the home, there continues to be a rapidly expanding demand for computers, machinery, appliances and other applications to be networked together. The Company's networking products provide Ethernet and ARCNET based solutions offering design flexibility and optimized throughput for embedded networking applications in business, industrial and consumer markets. Ethernet has emerged as an effective and pervasive protocol in networking technology. The Company's Ethernet solutions are non-PCI based, allowing designers to effectively incorporate Ethernet connectivity without the need for a PCI bus, thereby eliminating the additional cost and overhead associated with using and supporting the PCI bus. SMSC supplies Ethernet connectivity solutions for embedded applications in consumer electronics, industrial equipment and enterprise hardware. ARCNET and CircLink(TM), an ARCNET derivative, provide connectivity solutions that are versatile and easy to use, allowing embedded system designers to easily interconnect various sub-systems inside embedded applications. By replacing traditionally slow, wire intensive, hard to use serial communications, ARCNET and CircLink(TM) solutions allow designers to reduce wiring and micro-controller costs, and create a more flexible and modular systems architecture. These products target networking applications requiring a high level of determinism and predictable behavior, such as telecom equipment, robotics and medical equipment, as well as those applications seeking high throughput, such as digital copiers and printers and transportation systems. Product offerings within the Company's networking product line include: o Ethernet products, including the LAN91C111, a 10/100 Non-PCI Ethernet single chip media access controller and physical layer device (MAC and PHY), and the LAN83C183, a 10/100 Mbps TX/FX/10BT Fast Ethernet PHY. o Embedded communications products, including the COM20020I, a universal ARCNET local area network (LAN) controller with 2K x 8 on-board RAM, the COM20022I, a 10mbps ARCNET controller with 2K x 8 on-board RAM, and the TMC20073, a CircLink(TM) real-time communication controller targeted towards industrial and commercial applications. Computing Platform Solutions - SMSC is the world's leading supplier of advanced Input/Output (I/O) products for PC-related computing applications supplied by major original equipment manufacturers (OEMs) and motherboard manufacturers. The Company's broad LPC-based and ISA-based product portfolio provides a variety of integration levels for designers, with unique configurations of serial ports, parallel ports, keyboard controllers, hardware monitoring, infrared ports, real time clocks, general purpose I/O pins, logic integration and power management. The Company is the market leader in providing I/O solutions and embedded controllers for the rapidly expanding mobile PC market, and in supplying I/O solutions for desktop PC applications, featuring I/O and USB hubs, and environmental monitoring and fan control. SMSC has leveraged its analog design expertise to develop a line of stand-alone environmental monitoring and control (EMC) products, providing thermal management, hardware monitoring and voltage supervision, all of which are critical to ensuring the stability and reliability of computing systems. The Company's EMC sensor and fan control products are specifically designed to safeguard today's high-heat, small form factor system designs. The Company's computing platform solutions products also extend into the PC-based server market. Advanced I/O products for server applications build on SMSC's broad I/O and system management expertise and include timers, flash memory interfaces, thermal management and other requirements of server configurations. Product offerings within the Company's computing platform solutions product line include: o Stand-alone desktop I/O products, including the LPC47M10x and the LPC47B27x, which are both 100-pin enhanced Super I/O controllers with LPC interfaces, targeting consumer applications. o Integrated desktop I/O products, including the LPC47M14x, which is a 128-pin enhanced Super I/O controller with an LPC interface and a USB hub, and the LPC47M192, an LPC-based Super I/O controller with hardware monitoring. o Stand-alone mobile I/O products, including the LPC47N227, which is a 100-pin Super I/O controller with LPC interface for notebook PC applications, and the LPC47N237, a 3.3-volt I/O controller for port replicators and docking stations. o Integrated mobile I/O products, including the LPC47N253, a 3.3-volt advanced mobile systems controller with serial peripheral interface (SPI). o Mobile keyboard controllers, including the LPC47N350, an advanced I/O with SPI and LPC docking interface. o Environmental monitoring and control products, including the EMCT03, a triple SMBus temperature monitor, and the EMC6D103, a fan control device with high frequency PWM (pulse width modulation) support and hardware monitoring features. o Server I/O products, including the LPC47S422, an enhanced Super I/O controller with LPC interface for server applications. Competition The Company competes in the semiconductor industry, servicing and providing solutions for a variety of high-speed communication and computer applications. Many of the Company's larger customers conduct business in the personal computer and related peripheral devices industries. Intense competition, rapid technological change, cyclical market patterns, price erosion and periods of mismatched supply and demand have historically characterized these industries. The Company faces competition from several large semiconductor manufacturers, some of which have greater size and financial resources than the Company. The Company's principal competitors in the advanced I/O controller market include National Semiconductor Corporation, Winbond Electronics Corporation and Integrated Technology Express, Inc. (ITE). As SMSC continues to broaden its product offerings, it will likely face new competitors in other markets. Many of the Company's potential competitors have the ability to invest larger dollar amounts into research and development, and some have their own manufacturing facilities, which may give them a cost advantage on large volume products. The principal methods that the Company uses to compete include the introduction of innovative new products, providing industry-leading product quality and customer service, adding new features to its products, improving product performance, striving to ensure availability of product and reducing manufacturing costs. SMSC also cultivates strategic relationships with certain key customers who are technology leaders in its target markets, which provide insight into market trends and opportunities for the Company to better support those customers' needs. The Company believes that it currently competes effectively in the areas discussed in the previous paragraph to the extent they are within its control. However, given the pace at which change occurs in the semiconductor, personal computer and other high-technology industries, SMSC's current competitive capabilities are not a guarantee of future success. Research and Development The semiconductor industry, and the individual markets in which the Company currently competes, are highly competitive, and the Company believes that continued investment in research and development (R&D) is essential to maintaining and improving its competitive position. SMSC has strategic relationships with many of its customers and tailors its solutions to these specific customers' needs. Serving a wide array of world class OEMs, the Company's continued success will be based, among other things, on its ability to meet the individual needs of these customers and to help them speed their own products to market. SMSC's R&D activities are performed by a team of highly-skilled engineers and technicians, and are primarily directed towards the design of new integrated circuits in both mainstream and emerging technologies, the development of new software design tools and blocks of logic, as well as ongoing cost reductions and performance improvements in existing products. In recent years, SMSC has migrated from an organization with a traditional strength and rich history in digital design, to become a supplier with broad engineering and design expertise in digital, analog and mixed-signal solutions. Electronic signals fall into one of two categories - analog or digital. Digital signals are used to represent the "ones" and "zeros" of binary arithmetic, and are either on or off. Analog, or linear, signals represent real-world phenomena, such as temperature, pressure, sound, speed and motion. These signals can be detected and measured using analog sensors, which represent real-world phenomena by generating varying voltages and currents. Mixed-signal products combine digital and analog circuitry into a single device. Mixed-signal solutions can significantly reduce package sizes by integrating system interfaces, reducing external component requirements and lowering power consumption, all of which reduce system costs. Nearly half of SMSC's currently shipping products are mixed-signal devices. SMSC employs engineers with a wide range of experience in digital, mixed-signal and analog MOS/VLSI circuit design, from experienced industry veterans to new engineers recently graduated from top universities. Their activities are supported by state-of-the-art hardware, software, and other product design tools procured from world-class suppliers. The Company's engineering design centers are strategically located in New York, Texas and Arizona to take full advantage of the technological expertise found in each area, and to closely cater to a widespread base of customers located across the country. Manufacturing SMSC provides semiconductor solutions using a fabless manufacturing model, which is increasingly common in the semiconductor industry. Third party contract foundries and package assemblers are engaged to fabricate the Company's products onto silicon wafers, cut these wafers into die and assemble the die into finished packages. This strategy allows the Company to focus its resources on product design and development, marketing and quality assurance. It also reduces fixed costs and capital requirements, and provides the Company access to the most advanced manufacturing capabilities. The Company's primary wafer suppliers are Chartered Semiconductor Manufacturing, Ltd. in Singapore and Taiwan Semiconductor Manufacturing Company, Ltd. (TSMC) in Taiwan. The Company may negotiate additional foundry supply contracts and establish other sources of wafer supply for its products as such arrangements become useful or necessary, either economically or technologically. Processed silicon wafers are shipped to various third party assembly suppliers, most of which are located in the Pacific Rim region, where they are separated into individual chips that are then encapsulated into plastic packages. As is the case with the Company's wafer supply requirements, SMSC employs a number of independent suppliers for assembly purposes. This enables the Company to take advantage of the subcontractor's high volume manufacturing, related cost savings, speed and supply flexibility. It also provides SMSC with timely access to cost-effective advanced process and package technologies. The Company purchases most of its assembly services from Advanced Semiconductor Engineering, Inc., ST Assembly Test Services, Ltd., Orient Semiconductor Electronics, Ltd., and Amkor Technology, Inc. Following assembly, each of the packaged units receives final testing, marking and inspection prior to shipment to customers. Final testing for most of the Company's products is performed at SMSC's own state-of-the-art testing operation in Hauppauge, New York. Final testing services of independent test suppliers are also utilized as necessary, most of which occur in the Pacific Rim region. Customers demand semiconductors of the highest quality and reliability for incorporation into their products. SMSC focuses on product reliability from the initial stages of the design cycle through each specific design process, including production test design. In addition, designs are subject to in-depth circuit simulation at temperature, voltage and processing extremes before initiating the manufacturing process. The Company prequalifies each of its assembly and foundry subcontractors. This prequalification process consists of a series of industry standard environmental product stress tests, as well as an audit and analysis of the subcontractor's quality system and manufacturing capability. Wafer foundry production and assembly services are closely monitored to ensure consistent overall quality, reliability and yield levels. New Brand Identity On April 26, 2004, SMSC unveiled a new global brand identity, including a new logo, a new tagline - "Success by Design," and a new website design at its www.smsc.com homepage. Through its communications initiatives, the Company is placing a new emphasis and focus on building awareness of its significant accomplishments and unique capabilities to serve customers. The new "Success by Design" tagline underscores the Company's mission of being an essential ingredient that fuels its customers' success and highlights its culture which is deliberate in the manner in which it ensures success for its customers, investors, suppliers, employees and other partners. Sales, Marketing and Customer Service SMSC has historically been a successful supplier of Application-Specific Custom Products (ASCPs), tailored to the specific needs of its customers. To address its customers' aggressive cost and time-to-market objectives, the Company is increasingly designing and delivering Application-Specific Standard Products (ASSPs), while remaining focused on retaining its expertise of providing innovative, yet diverse, product features for its customers. The Company's sales and marketing strategy is to achieve design wins with technology leaders in targeted markets through superior sales, field applications and engineering support. Sales managers are dedicated to key OEM customers to ensure the highest level of customer service and to promote close cooperation and communication. The success of its customers is a cornerstone of SMSC's corporate strategy. The Company also serves its customers with a worldwide network of field application engineers. These engineers assist customers in the selection and proper use of its products and are available to answer customer questions and resolve technical issues. The field application engineers are supported by factory application engineers, who work with both the customer's and the Company's factory design and product engineers to develop the requisite support tools and facilitate the smooth introduction of new products. The Company strives to make the design-in of its products as easy as possible for its customers. To facilitate this, SMSC offers a wide variety of support tools, including evaluation boards, sample BIOS, diagnostics programs, sample schematics and PCB layout files, driver programs, data sheets, industry standard specifications and other documentation. These tools are readily available from the Company's sales offices and sales representatives. SMSC's home page on the World Wide Web (www.smsc.com) provides customers with immediate access to its latest product information. In addition, the Company maintains an electronic bulletin board so that registered customers can download software updates as needed. Customers are also provided with reference platform designs for many of the Company's products, which enable easier and faster transitions from the initial prototype designs through final production releases. SMSC markets and sells its products in the United States through a direct sales force, electronics distributors and manufacturers' representatives. Two independent distributors are currently engaged to serve the majority of the North American market. Internationally, products are marketed and sold through regional sales offices located in Germany, Taiwan, China and Korea as well as through a network of independent distributors and representatives. The Company serves the Japanese marketplace primarily through its Tokyo, Japan-based subsidiary, SMSC Japan. In accordance with industry practices, most distributors have certain rights of return and price protection privileges on unsold products until the distributor sells the product. Distributor contracts may be terminated by written notice by either party. The contracts specify the terms for the return of inventories. Returns of product pursuant to termination of these agreements have not been material. Shipments made by SMSC Japan to distributors in Japan are made under agreements that permit limited or no stock return privileges and generally no price protection or other sales price rebates. The Company generates a significant portion of its sales and revenues from international customers. While the demand for the Company's products is primarily driven by the worldwide demand for personal computers, peripheral devices, and embedded systems applications sold by U.S.-based suppliers, a significant portion of the Company's products are sold to manufacturing subcontractors of those U.S.-based suppliers, and to distributors who serve to feed the high technology manufacturing pipeline, located in Asia and the Pacific Rim. The majority of the world's personal computer, personal computer motherboard and other high technology manufacturing activity occurs in that region. The Company expects that international shipments, particularly to Asia and the Pacific Rim regions, will continue to represent a significant portion of its sales and revenues. The information below summarizes sales and revenues to unaffiliated customers for fiscal 2004, 2003 and 2002 by geographic region (in thousands): For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------- North America $ 37,138 $ 14,712 $ 42,913 Asia and the Pacific Rim 168,380 131,903 106,123 Europe 10,335 8,823 10,157 Rest of World 20 79 105 - -------------------------------------------------------------------------------- $215,873 $155,517 $159,298 ================================================================================ Intellectual Property The Company believes that intellectual property is a valuable asset that has been, and will continue to be, important to the Company's success. The Company has received numerous United States patents relating to its technologies and additional patent applications are pending. It is the Company's policy to protect these assets through reasonable means. To protect these assets, the Company relies upon nondisclosure agreements, contractual provisions, and patent and copyright laws. SMSC has patent cross-licensing agreements with more than thirty companies, including such semiconductor manufacturers as IBM, Intel, Micron Technology, NEC and Toshiba, providing access to more than 40,000 U.S. patents. Almost all of the Company's cross-licensing agreements give SMSC the right to use, royalty-free, patented intellectual property of the other companies. In situations where the Company needs to acquire strategic intellectual property not covered by cross-licenses, the Company enters into agreements to purchase or license the required intellectual property. Backlog and Customers The Company's business, and to a large extent much of the semiconductor industry, is characterized by short-term order and shipment schedules, rather than volume purchase contracts. The Company schedules production based upon a forecast of demand for its products. Sales are made primarily pursuant to purchase orders generally requiring delivery within one month, and at times, several months. Typical of industry practice, the Company's backlog may be canceled or rescheduled by the customer on short notice without significant penalty. As a result, the Company's backlog may not be indicative of actual sales and therefore should not be used as a measure of future revenue. From time to time, several key customers can account for a significant portion of the Company's sales and revenues. Sales and revenues from significant customers for fiscal 2004, 2003 and 2002, stated as percentages of total sales and revenues, are summarized as follows: For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------- Customer A 16% 20% 15% Customer B 16% 14% 6% Customer C 12% 10% 29% Customer D 12% 12% 6% The Company expects that its key customers will continue to account for a significant portion of its sales and revenues in fiscal 2005 and for the foreseeable future. Employees At February 29, 2004, the Company employed 546 individuals, including 122 in sales, marketing and customer support, 130 in manufacturing and manufacturing support, 199 in research and product development and 95 in administrative support and building maintenance activities. The Company's future success depends in large part on the continued service of key technical and management personnel and on its ability to continue to attract and retain qualified employees, particularly those highly skilled design, product and test engineers involved in manufacturing existing products and the development of new products. The competition for such personnel is intense. The Company has never had a work stoppage. No employees are represented by a labor organization and the Company considers its employee relations to be good. Additional Information The Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on the Company's web site at www.smsc.com, as soon as reasonably practicable after the filing of such reports with the Securities and Exchange Commission. Information contained on the Company's web site is not part of this report. Other Factors That May Affect Future Operating Results Before deciding to invest in the Company, or to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in the Company's other reports filed or furnished with the SEC, including the Company's reports on Forms 10-Q and 8-K. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties not presently known or that are currently deemed immaterial may also affect the Company's operations. Any of the risks, uncertainties, events or circumstances described below could cause the Company's financial condition or results of operations to be adversely affected. The Semiconductor Industry - The Company competes in the semiconductor industry, which has historically been characterized by intense competition, rapid technological change, cyclical market patterns, price erosion and periods of mismatched supply and demand. The semiconductor industry has experienced significant economic downturns at various times in the past, characterized by diminished product demand and accelerated erosion of selling prices. In addition, many of the Company's competitors in the semiconductor industry are larger and have significantly greater financial and other resources than the Company. The Personal Computer Industry - Sales of many of the Company's products depend largely on sales of personal computers and peripheral devices. Reductions in the rate of growth of the PC market could adversely affect the Company's operating results. In addition, as a component supplier to PC manufacturers, the Company may experience greater demand fluctuation than its customers themselves experience. Also, some of the Company's products are used in PCs for the consumer market, which can be more volatile than other segments of the PC marketplace. The PC industry is characterized by ongoing product changes and improvements, much of which is driven by several large companies whose own business strategies play significant roles in determining PC architectures. Future shifts in PC architectures may not always be anticipated or be consistent with the Company's product roadmaps. Worldwide Economic Environment - Calendar 2001 and 2002 were characterized by slower economic activity, decreased consumer confidence, reduced corporate profits and capital spending and liquidity concerns which, along with international conflicts and terrorist and military activity, resulted in a downturn in worldwide economic conditions. As a result of these unfavorable economic conditions, the Company experienced a slowdown in customer orders in fiscal 2002. The Company's fiscal 2003 and fiscal 2004 order input showed sequential improvement, driven by new design wins and an overall general economic recovery. In addition, recent political and social turmoil related to international conflicts and terrorist acts may place further pressure on economic conditions in the U.S. and worldwide. These unstable political, social and economic conditions make it challenging for the Company, its customers and its suppliers to forecast and plan future business activities. Product Development and Technological Change - The Company's prospects are highly dependent upon the successful development and timely introduction of new products at competitive prices and performance levels, with acceptable margins. The success of new products depends on various factors, including timely completion of product development programs, market acceptance of the Company's and its customers' new products, securing sufficient foundry capacity for volume manufacturing of wafers, achieving acceptable wafer fabrication yields by the Company's independent foundries and the Company's ability to offer these new products at competitive prices. In order to succeed in having the Company's products incorporated into new products being designed by its customers, the Company must anticipate market trends and meet performance, quality and functionality requirements of such customers and must successfully develop and manufacture products that adhere to these requirements. In addition, the Company must meet the timing and price requirements of its customers and must make such products available in sufficient quantities. There can be no assurance that the Company will be able to identify market trends or new product opportunities, develop and market new products, achieve design wins or respond effectively to new technological changes or product announcements by others. The Company's future growth will depend, among other things, upon its ability to continue to expand its product lines. To the extent that the Company attempts to compete in new markets, it may face competition from suppliers that have well-established market positions and products that have already been proven to be technologically and economically competitive. There can be no assurance that the Company will be successful in displacing these suppliers in the targeted applications. Price Erosion - The semiconductor industry is characterized by intense competition. Historically, average selling prices in the semiconductor industry generally, and for the Company's products in particular, have declined significantly over the life of each product. While the Company expects to reduce the average selling prices of its products over time as it achieves manufacturing cost reductions, competitive and other pressures may require the reduction of selling prices more quickly than such cost reductions can be achieved. If not offset by reductions in manufacturing costs or by a shift in the mix of products sold toward higher-margin products, declines in the average selling prices could reduce gross margins. Reliance upon Subcontract Manufacturing - The vast majority of the Company's products are manufactured and assembled by independent foundries and subcontract manufacturers. This reliance upon foundries and subcontractors involves certain risks, including potential lack of manufacturing availability, reduced control over delivery schedules, the availability of advanced process technologies, changes in manufacturing yields and potential cost fluctuations. During downturns in the semiconductor economic cycle, reduction in overall demand for semiconductor products could financially stress certain of the Company's subcontractors. If the financial resources of such independent subcontractors are stressed, the Company may experience future product shortages, quality assurance problems, increased manufacturing costs or other supply chain disruptions. Forecasts of Product Demand - The Company generally must order inventory to be built by its foundries and subcontract manufacturers well in advance of product shipments. Production is often based upon either internal or customer-supplied forecasts of demand, which can be highly unpredictable and subject to substantial fluctuations. Because of the volatility in the Company's markets, there is risk that the Company may forecast incorrectly and produce excess or insufficient inventories. This inventory risk is increased by the trend for customers to place orders with shorter lead times and the customers' ability to cancel or reschedule existing orders. Strategic Relationships with Customers - The Company's future success depends in significant part on strategic relationships with certain of its customers. If these relationships are not maintained, or if these customers develop their own solutions, adopt a competitor's solution, or choose to discontinue their relationships with SMSC, the Company's operating results could be adversely affected. In the past, the Company has relied on its strategic relationships with certain customers who are technology leaders in its target markets. The Company intends to pursue and continue to form these strategic relationships in the future. These relationships often require the Company to develop new products that typically involve significant technological challenges. The customers frequently place considerable pressure on the Company to meet their tight development schedules. Accordingly, the Company may have to devote a substantial portion of its resources to these strategic relationships, which could detract from or delay completion of other important development projects. Customer Concentration - A limited number of customers account for a significant portion of the Company's sales and revenues. The Company's sales and revenues from any one customer can fluctuate from period to period depending upon market demand for that customer's products, the customer's inventory management of the Company's products and the overall financial condition of the customer. Shipments to Distributors - A significant portion of the Company's product sales are made through distributors. The Company's distributors generally offer products of several different suppliers, including products that may be competitive with the Company's products. Accordingly, there is risk that these distributors may give higher priority to products of other suppliers, thus reducing their efforts to sell the Company's products. In addition, the Company's agreements with its distributors are generally terminable at the distributor's option. No assurance can be given that future sales by distributors will continue at current levels or that the Company will be able to retain its current distributors on acceptable terms. A reduction in sales efforts by one or more of the Company's current distributors or a termination of any distributor's relationship with the Company could have an adverse effect on the Company's operating results. Business Concentration in Asia - A significant number of the Company's foundries and subcontractors are located in Asia. Many of the Company's customers also manufacture in Asia or subcontract manufacturing to Asian companies. A significant portion of the world's personal computer component and circuit board manufacturing, as well as personal computer assembly, occurs in Taiwan, and many of the Company's suppliers and customers are based in, or do significant business in, Taiwan. This concentration of manufacturing and selling activity in Asia, and in Taiwan in particular, poses risks that could affect the supply and cost of the Company's products, including currency exchange rate fluctuations, economic and trade policies and the political environment in Taiwan and other Asian communities. Portions of the Asian community have recently experienced health risks associated with the SARS virus, the economic impact of which is still unclear. The Pacific Rim region is also subject to the risk of earthquakes. For example, in September 1999, a major earthquake caused widespread damage and business interruptions in Taiwan. While the September 1999 earthquake did not materially adversely affect the Company's business, future earthquakes or other natural disasters in this region, if they occur, could adversely effect the Company's operating results. Protection of Intellectual Property - The Company has historically devoted significant resources to research and development activities and believes that the intellectual property derived from such research and development is a valuable asset that has been, and will continue to be, important to the Company's success. The Company relies upon nondisclosure agreements, contractual provisions and patent and copyright laws to protect its proprietary rights. No assurance can be given that the steps taken by the Company will adequately protect its proprietary rights. During its history, the Company has executed patent cross-licensing agreements with many of the world's largest semiconductor suppliers, under which the Company receives and conveys various intellectual property rights. Many of these agreements are still effective. The Company could be adversely affected should circumstances arise which cause certain of these agreements to terminate prematurely. Infringement and Other Claims - Companies in the semiconductor industry often aggressively protect and pursue their intellectual property rights. From time to time, the Company has received notices claiming that the Company has infringed upon or misused other parties' proprietary rights. The Company has also in the past received, and may again in the future receive, notices of claims related to business transactions conducted with third parties, including asset sales and other divestitures. Although the Company defends itself vigorously in these actions, and has not incurred material liabilities under such claims in the past, it is possible that the Company may not prevail in such actions, or in any other such actions, if any, in the future. Any damages resulting from such actions may materially and adversely affect the Company's business, financial condition and results of operations. In addition, even if claims against the Company are not valid or successfully asserted, defense against the claims could result in significant costs and a diversion of management and resources. Dependence on Key Personnel - The success of the Company is dependent in large part on the continued service of its key management, engineering, marketing, sales and support employees. Competition for qualified personnel is intense in the semiconductor industry, and the loss of current key employees, or the inability of the Company to attract other qualified personnel, including the inability to offer competitive stock-based and other compensation, could hinder the Company's product development and ability to manufacture, market and sell its products. The Company believes that stock option grants are critical to its ability to attract and retain personnel. Stock option plans are generally subject to shareholder approval. From time to time, the Company seeks approval of new stock option plans from its shareholders, and plans to seek a new approval for a new option plan at its 2004 Annual Shareholder's Meeting. SMSC's ability to hire or retain highly qualified personnel may be adversely impacted by an inability to provide competitive stock option grants or other stock-based compensation if shareholder approval for such plans is not obtained in a timely manner, or at all. Volatility of Stock Price - The market price of the Company's common stock can fluctuate significantly on the basis of such factors as the Company's or its competitors' announcements of new products, quarterly fluctuations in the Company's financial results or in the financial results of other semiconductor companies, changes in the expectations of market analysts or investors, or general conditions in the semiconductor industry or in the financial markets. In addition, stock markets in general have experienced extreme price and volume volatility in recent years. This volatility has often had a significant impact on the stock prices of high technology companies, at times for reasons that appear unrelated to the company's performance. Environmental Regulation - Environmental regulations and standards are established worldwide to control discharges, emissions, and solid wastes from manufacturing processes. Within the United States, federal, state and local agencies establish these regulations. Outside of the United States, individual countries and local governments establish their own individual standards. The Company believes that its activities conform to present environmental regulations and the effects of this compliance have not had a material effect on the Company's capital expenditures, operating results, or competitive position. While to date the Company has not experienced any material adverse impact from environmental issues, no assurances can be given as to the impact of future environmental compliance requirements. Should environmental regulations be amended or an unforeseen circumstance occur, it could subject the Company to fines, require the Company to acquire expensive remediation equipment or to incur other expenses to comply with environmental regulations. - -------------------------------------------------------------------------------- SMSC is a registered trademark, and CircLink is a trademark, of Standard Microsystems Corporation. Product names and company names are the trademarks of their respective holders. Item 2. Properties. - --------------------- SMSC's headquarters are in Hauppauge, New York, where it owns two facilities, and leases a third facility, totaling approximately 175,000 square feet of plant and office space, located on approximately 18 acres of land. Two of these facilities, including the leased facility, totaling 130,000 square feet on 14 acres of land, are used to conduct research, development, product testing, warehousing, shipping, marketing, selling and administrative activities. The Company's other facility in Hauppauge is currently vacant, and the Company has executed a contract to sell the facility. Closing of this sale is expected to occur before the end of calendar 2004. The Company plans to begin construction of an addition to its headquarters 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. In addition, the Company maintains offices in leased facilities in San Jose, California; Austin, Texas; Phoenix, Arizona; Tucson, Arizona; Munich, Germany; Tokyo, Japan; Taipei, Taiwan; Shanghai and Hong Kong, China and Seoul, South Korea. These leases expire at various times through August 2008. Item 3. Legal Proceedings. - ---------------------------- From time to time as a normal incidence of doing business, various claims and litigation may be asserted or commenced against the Company. Due to uncertainties inherent in litigation and other claims, the Company can give no assurance that it will prevail in any such matters, but management believes that their ultimate resolution is not likely to have a material adverse effect on the Company's consolidated financial position. Nevertheless, an adverse outcome of any significant matter could have a material adverse effect on the Company's consolidated results of operations or cash flows in the quarter or annual period in which one or more of these matters are resolved. In June 2003, SMSC was named as a defendant in a patent infringement lawsuit filed by Analog Devices, Inc. (ADI) in the United States District Court for the District of Massachusetts (Analog Devices, Inc. v. Standard Microsystems Corporation, Case Number 03 CIV 11216). The Complaint, as amended, 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. The Company was involved in an arbitration with Accton Technology Corporation (Accton) and SMC Networks, Inc. (Networks) related to claims associated with the purchase of an 80.1% interest in Networks by Accton from SMSC in October 1997. In September 2003, the arbitration panel issued its decision in this action, which directed the release of an escrow account to SMSC and awarded certain other payments among the parties. In December 2003, the parties reached a final settlement of the award, resulting in SMSC receiving $2.7 million in cash, including the escrow account, and realizing a pre-tax gain of $0.3 million. Item 4. Submission of Matters to a Vote of Security Holders. - -------------------------------------------------------------- None. Executive Officers of the Registrant The Company's executive officers and their ages as of April 30, 2004 are as follows: Name Age Position - ------------------------ ------ ---------------------------------------------- Steven J. Bilodeau 45 Chairman of the Board, President and Chief Executive Officer Andrew M. Caggia 55 Senior Vice President and Chief Financial Officer George W. Houseweart 62 Senior Vice President, General Counsel and Secretary Robert E. Hollingsworth 55 Senior Vice President and General Manager, Connectivity Solutions Group Peter S. Byrnes 46 Vice President and General Manager, Computing Platform Solutions Group Mitchell A. Statham 45 Vice President, Worldwide Sales Eric M. Nowling 47 Vice President, Controller and Chief Accounting Officer Steven J. Bilodeau has served as the Company's President and Chief Executive Officer, and as a member of the Company's Board of Directors, since March 1999. Andrew M. Caggia has served as the Company's Senior Vice President and Chief Financial Officer since February 2000, and as a member of the Company's Board of Directors since February 2001. He previously served as Senior Vice President and Chief Financial Officer of General Semiconductor, Inc., from July 1997 through February 2000. George W. Houseweart has served as the Company's Senior Vice President, General Counsel and Secretary since October 2002. Previously, he served as Senior Vice President and General Counsel from January 1999 to October 2002, and as Senior Vice President - Law and Intellectual Property from November 1996 to January 1999. Mr. Houseweart has been an officer of the Company since 1988. Robert E. Hollingsworth has served as Senior Vice President and General Manager, Connectivity Solutions Group since November 2003. Previously, he served as Senior Vice President - Sales and Marketing, from January 2003 through November 2003. He was elected an officer of the Company in January 2003. He served as Senior Vice President and General Manager - Advanced I/O Products from June 2002 to January 2003; as Senior Vice President - Sales and Marketing - PC Products from September 1999 to June 2002; and as Divisional Vice President - Component Products Marketing from January 1997 to September 1999. Peter S. Byrnes has served as Vice President and General Manager, Computing Platforms Solutions Group since November 2003. Previously, he served as Vice President - Operations from June 2000 through November 2003. Prior to that, he served as Vice President - Product Assurance and Manufacturing Engineering from May 1999 to June 2000, and as Vice President - Product Assurance from July 1998 to May 1999. Mr. Byrnes has been an officer of the Company since 1998. Mitchell A. Statham has served as the Company's Vice President, Worldwide Sales since November 2003. Previously, he served as Vice President, Sales from January 2003 through November 2003, and as Vice President, Worldwide Sales, Advanced I/O Products from joining SMSC in June 2002 through January 2003. He was elected an officer of the Company in April 2004. Prior to joining SMSC, he served in various sales management positions with NEC Electronics from February 1999 to March 2002. Eric M. Nowling has served as the Company's Vice President, Controller and Chief Accounting Officer since February 2000. Prior to that, he served as the Company's Vice President - Finance and Chief Financial Officer from September 1997 through February 2000, and as Vice President and Controller (and acting Chief Financial Officer) from February 1997 to September 1997. Mr. Nowling has been an officer of the Company since 1995. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. - -------------------------------------------------------------------------------- The information captioned "Market price per share" and the last two paragraphs appearing in the Company's 2004 Annual Report to Shareholders (the "2004 Annual Report") within Note 18 to the Consolidated Financial Statements, entitled "Quarterly Financial Data (Unaudited)", are incorporated herein by this reference. Except as specifically set forth herein and elsewhere in this Form 10-K, no information appearing in the 2004 Annual Report is incorporated by reference into this report, nor is the 2004 Annual Report deemed to be filed, as part of this report or otherwise, pursuant to the Securities Exchange Act of 1934. Item 6. Selected Financial Data. - ---------------------------------- The information appearing in the 2004 Annual Report under the caption "Selected Financial Data" is incorporated herein by this reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. - -------------------------------------------------------------------------------- The information appearing in the 2004 Annual Report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" is incorporated herein by this reference. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. - --------------------------------------------------------------------- The information appearing in the 2004 Annual Report under the caption "Financial Market Risks" is incorporated herein by this reference. Item 8. Financial Statements and Supplementary Data. - ------------------------------------------------------ The financial statements, notes thereto, Reports of Independent Auditors thereon and quarterly financial data appearing in the 2004 Annual Report are incorporated herein by this reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. - -------------------------------------------------------------------------------- Not applicable. Item 9A. 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 February 29, 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 III Item 10. Directors and Executive Officers of the Registrant. - ------------------------------------------------------------- The information concerning the Company's executive officers required by this item is incorporated herein by reference to the section within Item I of this report entitled "Executive Officers of the Registrant". The information concerning the Company's directors required by this item is incorporated herein by reference to the section entitled "Election of Directors" appearing in the 2004 Proxy Statement related to the 2004 Annual Meeting of Stockholders (the "2004 Proxy Statement"). The information concerning the Company's Section 16(a) beneficial ownership reporting compliance is incorporated herein by reference to the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" appearing in the 2004 Proxy Statement. The information concerning the Company's code of ethics is incorporated herein by reference to the section entitled "Code of Business Conduct and Ethics" appearing in the 2004 Proxy Statement. Item 11. Executive Compensation. - --------------------------------- The information appearing in the 2004 Proxy Statement under the caption "Executive Compensation" is incorporated herein by this reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. - -------------------------------------------------------------------------------- The information concerning (a) the only persons that have reported beneficial ownership of more than 5% of the common stock of the Company, (b) the ownership of the Company's common stock by the Chief Executive Officer and the four other most highly compensated executive officers, and all executive officers and directors as a group, and (c) ownership of the Company's common stock by each of the directors, contained under the caption "Voting Securities of Certain Beneficial Owners and Management" appearing in the 2004 Proxy Statement, is incorporated herein by this reference. The information concerning securities authorized for issuance under equity compensation plans contained under the caption "Equity Compensation Plan Information" appearing in the 2004 Proxy Statement is also incorporated herein by this reference. Item 13. Certain Relationships and Related Transactions. - --------------------------------------------------------- The information appearing in the 2004 Proxy Statement under the caption "Certain Relationships and Related Transactions" is incorporated herein by this reference. Item 14. Principal Accounting Fees and Services. - ------------------------------------------------- The information appearing in the 2004 Proxy Statement under the caption "Principal Accounting Fees and Services" is incorporated herein by this reference. PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. - --------------------------------------------------------------------------- (a) 1. Financial Statements: The following consolidated financial statements of the Company and its subsidiaries, notes thereto, and Reports of Independent Auditors thereon have been incorporated by reference from the 2004 Annual Report pursuant to Part II, Item 8 of this report: Consolidated Balance Sheets as of February 29, 2004 and February 28, 2003 Consolidated Statements of Operations for the three years ended February 29, 2004 Consolidated Statements of Shareholders' Equity for the three years ended February 29, 2004 Consolidated Statements of Cash Flows for the three years ended February 29, 2004 Notes to Consolidated Financial Statements Reports of Independent Auditors 2. Financial Statement Schedules: The following financial statement schedule and Report of Independent Auditors thereon are filed as part of this report on Form 10-K and should be read in conjunction with the Consolidated Financial Statements and notes thereto. Schedule Title - -------- ---------------------------------- II Valuation and Qualifying Accounts Schedules not listed above have been omitted because they are not applicable, not required, or the information required to be set forth therein is included in the Consolidated Financial Statements or notes thereto. 3. Exhibits: Exhibits, which are listed on the Index to Exhibits, are filed as part of this report and such Index to Exhibits is incorporated by reference. (b) Reports on Form 8-K On January 14, 2004, SMSC furnished a report on Form 8-K, relating to its announcement that it had redeemed the minority interest in SMSC Japan from Sumitomo Metal Industries, Ltd., as presented in its press release dated January 14, 2004. SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. STANDARD MICROSYSTEMS CORPORATION --------------------------------- (Registrant) By /s/ ANDREW M. CAGGIA --------------------- Andrew M. Caggia Senior Vice President and Chief Financial Officer, and Director (Principal Financial Officer) Date: May 14, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated. Signature and Title Date ------------------- ---- /s/ STEVEN J. BILODEAU May 14, 2004 ---------------------- Steven J. Bilodeau Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer) /s/ ERIC M. NOWLING May 14, 2004 ------------------- Eric M. Nowling Vice President, Controller and Chief Accounting Officer (Principal Accounting Officer) /s/ ROBERT M. BRILL May 14, 2004 ------------------- Robert M. Brill Director /s/ TIMOTHY P. CRAIG May 14, 2004 -------------------- Timothy P. Craig Director /s/ JAMES A. DONAHUE May 14, 2004 -------------------- James A. Donahue Director /s/ PETER F. DICKS May 14, 2004 ------------------ Peter F. Dicks Director /s/ IVAN T. FRISCH May 14, 2004 ------------------ Ivan T. Frisch Director Schedule II - Valuation and Qualifying Accounts For the Three Years Ended February 29, 2004 (in thousands)
- ---------------------------------------------------------------------------------------------------------------------- Balance at Charged to Charged to Balance at Beginning Costs and Other End of of Period Expenses Accounts Deductions Period - ---------------------------------------------------------------------------------------------------------------------- Year Ended February 29, 2004 Allowance for Doubtful Accounts $ 460 $ 5 $ - $ (27) $ 438 Reserve for Product Returns $ 200 $ 113 $ - $ (248) (b) $ 65 Year Ended February 28, 2003 Allowance for Doubtful Accounts $ 450 $ 10 $ - $ - $ 460 Reserve for Product Returns $ 438 $ 208 $ - $ (446) (b) $ 200 Year Ended February 28, 2002 Allowance for Doubtful Accounts $ 362 $ 110 $ (22) (a) $ - $ 450 Reserve for Product Returns $ 560 $1,446 $ - $ (1,568) (b) $ 438
(a) Represents adjustment of reserve balance based upon evaluation of accounts receivable collectibility. (b) Represents returns of product from customers. Report of Independent Auditors on Financial Statement Schedule To the Board of Directors and Shareholders of Standard Microsystems Corporation: Our audits of the consolidated financial statements referred to in our report dated April 9, 2004 appearing in the February 29, 2004 Annual Report to Shareholders of Standard Microsystems Corporation (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. PricewaterhouseCoopers LLP New York, NY April 9, 2004 THE FOLLOWING REPORT IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP AND HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP. Report of Independent Accountants on Financial Statement Schedule To Standard Microsystems Corporation: We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated financial statements of Standard Microsystems Corporation and subsidiaries, incorporated by reference in this Form 10-K, and have issued our report thereon dated April 4, 2002. Our audits were made for the purpose of forming an opinion on these statements taken as a whole. The accompanying schedule is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. Arthur Andersen LLP New York, NY April 4, 2002 INDEX TO EXHIBITS ----------------- Exhibit No. Description - ----------- ----------- 3.1 Certificate of Incorporation of Standard Microsystems Corporation, as amended and restated, incorporated by reference to Exhibit 3 (a) to the registrant's Form 10-K for the fiscal year ended February 28, 1991. 3.2 By-Laws of Standard Microsystems Corporation, as amended and restated, incorporated by reference to Exhibit 3.1 to the registrant's Form 8-K filed on April 10, 2002. 4.1 Rights Agreement with ChaseMellon Shareholder Services L.L.C., as Rights Agent, dated January 7, 1998, incorporated by reference to Exhibit 1 to the registrant's Registration Statement on Form 8-A filed January 15, 1998. 4.2 Amendment No. 1 to Rights Agreement with ChaseMellon Shareholder Services L.L.C., as Rights Agent, dated January 23, 2001, incorporated by reference to Exhibit 4.2 to the registrant's Form 10-K for the fiscal year ended February 28, 2001. 4.3 Amendment No. 2 to Rights Agreement with ChaseMellon Shareholder Services L.L.C., as Rights Agent, dated April 9, 2002, incorporated by reference to Exhibit 3 to the registrant's Registration Statement on Form 8-A/A filed April 10, 2002. 10.1* Employment Agreement with Steven J. Bilodeau, dated March 18, 1999, incorporated by reference to Exhibit 10.5 to the registrant's Form 10-K for the fiscal year ended February 28, 1999. 10.2* Employment Agreement with Andrew M. Caggia, dated January 7, 2000, incorporated by reference to Exhibit 10.5 to the registrant's Form 10-K for the fiscal year ended February 29, 2000. 10.3* Amendments to Employment Agreements with Steven J. Bilodeau and Andrew M. Caggia, incorporated by reference to Exhibit 10.3 to the registrant's Form 10-K for the fiscal year ended February 28, 2002. 10.4* 1994 Director Stock Option Plan, incorporated by reference to Exhibit A to the registrant's Proxy Statement dated May 31, 1995. 10.5* 2001 Director Stock Option Plan, incorporated by reference to Exhibit B to the registrant's Proxy Statement dated July 11, 2001. 10.6* Amendment to the 2001 Director Stock Option Plan, dated April 4, 2002, incorporated by reference to Exhibit 10.7 to the registrant's Form 10-K for the fiscal year ended February 28, 2002. 10.7* Amendment to the 1994 Director Stock Option Plan, adopted July 14, 1998, incorporated by reference to information appearing on page 11 of the registrant's Proxy Statement dated June 1, 1998. 10.8* Retirement Plan for Directors, incorporated by reference to Exhibit 10.14 to the registrant's Form 10-K for the fiscal year ended February 28, 1995. 10.9* Amendment to the Retirement Plan for Directors, incorporated by reference to Exhibit 10.11 to the registrant's Form 10-K for the fiscal year ended February 28, 2002. 10.10* 1993 Stock Option Plan for Officers and Key Employees, incorporated by reference to Exhibit A to the registrant's Proxy Statement dated May 25, 1993. 10.11* Executive Retirement Plan, incorporated by reference to Exhibit 10(x) to the registrant's Form 10-K for the fiscal year ended February 28, 1994. 10.12* Amendment to the Executive Retirement Plan, incorporated by reference to Exhibit 10.14 to the registrant's Form 10-K for the fiscal year ended February 28, 2002. 10.13* Amendment to the Executive Retirement Plan, dated January 28, 2003, incorporated by reference to Exhibit 10.15 to the registrant's Form 10-K for the fiscal year ended February 28, 2003. 10.14* 1994 Stock Option Plan for Officers and Key Employees, incorporated by reference to Exhibit A to the registrant's Proxy Statement dated May 26, 1994. 10.15* Resolutions adopted October 31, 1994, amending the Retirement Plan for Directors and the Executive Retirement Plan, incorporated by reference to Exhibit 10.18 to the registrant's Form 10-K for the fiscal year ended February 28, 1995. 10.16* Resolutions adopted January 3, 1995, amending the 1994, 1993 and 1989 Stock Option Plans and the 1991 Restricted Stock Plan, incorporated by reference to Exhibit 10.19 to the registrant's Form 10-K for the fiscal year ended February 28, 1995. 10.17* 1996 Restricted Stock Bonus Plan, incorporated by reference to Exhibit 10.18 to the registrant's Form 10-K for the fiscal year ended February 28, 2002. 10.18* 1998 Stock Option Plan for Officers and Key Employees, incorporated by reference to Exhibit A to the registrant's Proxy Statement dated June 1, 1998. 10.19* 1999 Stock Option Plan for Officers and Key Employees, incorporated by reference to Exhibit A to the registrant's Proxy Statement dated June 9, 1999. 10.20* 2000 Stock Option Plan for Officers and Key Employees, incorporated by reference to Exhibit A to the registrant's Proxy Statement dated June 6, 2000. 10.21* 2001 Stock Option and Restricted Stock Plan for Officers and Key Employees, incorporated by reference to Exhibit C to the registrant's Proxy Statement dated June 11, 2001. 10.22* Plan for Deferred Compensation in Common Stock for Outside Directors, dated March 7, 1997, as amended, incorporated by reference to Exhibit 10.23 to the registrant's Form 10-K for the fiscal year ended February 28, 2002. 10.23* Amendment to the Plan for Deferred Compensation in Common Stock for Outside Directors, dated July 10, 2002, incorporated by reference to Exhibit 10.25 to the registrant's Form 10-K for the fiscal year ended February 28, 2003. 10.24* 2002 Inducement Stock Option Plan, incorporated by reference to Exhibit 10.26 to the registrant's Form 10-K for the fiscal year ended February 28, 2003. 10.25* 2003 Director Stock Option Plan, incorporated by reference to Exhibit C to the registrant's Proxy Statement dated July 9, 2003. 10.26* 2003 Stock Option and Restricted Stock Plan, incorporated by reference to Exhibit B to the registrant's Proxy Statement dated July 9, 2003. 10.27* 2003 Inducement Stock Option Plan, incorporated by reference to Exhibit 4.3 to the registrant's Form S-8 filed September 15, 2003. 10.28 Agreement and Plan of Merger among Standard Microsystems Corporation, SMSC Sub, Inc., and Gain Technology Corporation, dated April 29, 2002, incorporated by reference to Exhibit 2.1 to the registrant's Form 8-K filed on June 19, 2002. 13 Portions of the Registrant's Annual Report to Shareholders for the fiscal year ended February 29, 2004, filed herewith. 21 Subsidiaries of the Registrant, filed herewith. 23.1 Consent of PricewaterhouseCoopers LLP, filed herewith. 23.2 Notice regarding consent of Arthur Andersen LLP, filed herewith. 31.1 Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act, filed herewith. 31.2 Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act, filed herewith. 32.1 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. EX-13 2 exhibit_13.txt Exhibit 13 ---------- Portions of Annual Report to Shareholders FINANCIAL TABLE OF CONTENTS Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Shareholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements Reports of Independent Auditors Standard Microsystems Corporation and Subsidiaries SELECTED FINANCIAL DATA (In thousands, except per share data)
As of February 28 or 29, and for the years then ended 2004 2003 2002 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------------ Operating Results Product sales $ 191,969 $ 154,244 $ 128,528 $ 162,008 $ 151,371 Intellectual property revenues 23,904 1,273 30,770 1,420 1,876 - ------------------------------------------------------------------------------------------------------------------------------------ Total sales and revenues 215,873 155,517 159,298 163,428 153,247 Gross profit 109,637 69,424 78,034 66,768 59,363 Research and development 38,793 31,166 31,178 32,580 24,365 Selling, general and administrative 42,168 36,268 32,744 35,369 32,993 Amortization of intangible assets 1,311 1,167 - - - Gains on real estate transactions (1,444) - - - - Restructuring costs - (247) 7,734 - - Operating income (loss) 28,809 1,070 6,378 (1,181) 2,005 Other income (expense) 985 (14,446) 4,308 34,293 3,415 Income (loss) from continuing operations $ 21,542 $ (6,971) $ 7,475 $ 22,164 $ 3,442 Net loss from discontinued operations (24) (500) (1,564) - - Gain (loss) on sales of discontinued operations, net of taxes - - - 4,765 4,151 Cumulative effect of change in accounting principle, net of taxes - - - - (2,924) - ------------------------------------------------------------------------------------------------------------------------------------ Net income (loss) 21,518 (7,471) 5,911 26,929 4,669 Gain on redemption of preferred stock of subsidiary 6,685 - - - - - ------------------------------------------------------------------------------------------------------------------------------------ Net income (loss) applicable to common shareholders $ 28,203 $ (7,471) $ 5,911 $ 26,929 $ 4,669 Diluted net income (loss) per share Income (loss) from continuing operations $ 1.17 $ (0.42) $ 0.44 $ 1.29 $ 0.22 Net income (loss) 1.16 (0.45) 0.35 1.57 0.29 Net income (loss) applicable to common shareholders 1.53 (0.45) 0.35 1.57 0.29 - ------------------------------------------------------------------------------------------------------------------------------------ Diluted weighted average common shares outstanding 18,479 16,538 16,900 17,165 15,915 - ------------------------------------------------------------------------------------------------------------------------------------ Balance Sheet and Other Data Cash and liquid investments $ 173,897 $ 112,897 $ 126,660 $ 109,174 $ 75,405 Working capital 191,199 145,639 154,981 146,382 111,016 Capital expenditures 10,380 5,695 4,488 14,600 10,503 Depreciation and amortization 11,002 10,752 11,614 11,792 9,988 Total assets 310,025 252,607 236,063 239,098 258,508 Long-term obligations 12,104 12,037 6,973 5,812 22,151 Shareholders' equity 262,102 204,012 193,453 194,315 201,792 Book value per common share 14.27 12.17 12.14 12.08 12.80
This selected financial data should be read in conjunction with the Consolidated Financial Statements and related notes, and the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations," contained in this report. The operating results presented above reflect: - The receipts of $22.5 million and $29.6 million of special intellectual property payments in fiscal 2004 and 2002, respectively, as more fully described in Note 7 to the Consolidated Financial Statements included in this report. - Sales of real estate in fiscal 2004, as more fully described in Note 11. - The Company's acqusition of Gain Technology Corporation in fiscal 2003, as more fully described in Note 4. - $16.3 million of investment impairment charges recorded in fiscal 2003, as more fully described in Note 9. - $9.0 million of business restructuring charges recorded in fiscal 2002, as more fully descsribed in Note 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Company's Consolidated Financial Statements and notes thereto contained in this report. Portions of this report may contain forward-looking statements about expected future events and financial and operating results that involve risks and uncertainties. These include the timely development and market acceptance of new products; the impact of competitive products and pricing; the effect of changing economic conditions in domestic and international markets; changes in customer order patterns, including loss of key customers, order cancellations or reduced bookings; and excess or obsolete inventory and variations in inventory valuation, among others. Words such as "believe," "expect," "anticipate" and similar expressions identify forward-looking statements. Such statements are qualified in their entirety by the inherent risks and uncertainties surrounding future expectations and may not reflect the potential impact of any future acquisitions, mergers or divestitures. Standard Microsystems Corporation (the Company or SMSC) competes in the semiconductor industry, which has historically been characterized by intense competition, rapid technological change, cyclical market patterns, price erosion and periods of mismatched supply and demand. In addition, sales of many of the Company's products depend largely on sales of personal computers (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 necessarily 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 Securities and Exchange Commission (SEC). Investors are advised to read the Company's Annual Report on Form 10-K and quarterly reports on Form 10-Q filed with the SEC, particularly those sections entitled Other Factors That May Affect Future Operating Results, for a more complete discussion of these and other risks and uncertainties. OVERVIEW Description of Business SMSC 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 USB 2.0 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. FISCAL 2004 HIGHLIGHTS Strategic Business Agreement 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 1999, the two companies announced a technology exchange agreement (the Agreement) that would allow SMSC to accelerate its then ongoing development of Intel compatible chipset products. The Agreement provided, among other things, for Intel to transfer certain intellectual property related to Intel chipset architectures to SMSC, and provided SMSC the opportunity to supply Intel chipset components along with its own chipset solutions. The Agreement also limited SMSC's rights regarding Northbridges and Intel Architecture Microprocessors under the 1987 agreement. The Agreement included provisions for its termination under certain circumstances. Under one such provision, SMSC could elect to terminate the Agreement should SMSC not achieve certain minimum chipset revenue amounts set forth in the Agreement, unless Intel paid SMSC an amount equal to the shortfall between the minimum revenue amount and the actual revenue for that period. In September 2001, pursuant to this provision, SMSC notified Intel of a chipset revenue shortfall of approximately $29.6 million for the twelve months ended September 21, 2001. In November 2001, the Company received a $29.6 million payment from Intel, which is reported as intellectual property revenue on the Company's Consolidated Statement of Operations for fiscal 2002. In September 2002, SMSC notified Intel of a chipset revenue shortfall for the 2002 twelve-month period. Intel did not make a payment to SMSC of that shortfall within the time frame specified within the Agreement, and SMSC gave Intel notice of termination of the Agreement in accordance with the terms thereof, and the parties commenced discussions regarding their various corporate and intellectual property relationships. 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 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 new relationship, Intel will pay to the Company an aggregate amount of $75 million, of which $20 million and $2.5 million were paid and recognized as intellectual property revenue in the third and fourth quarters of the Company's fiscal 2004, respectively. Of the remaining amount, $7.5 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. Purchase of Minority Interest in SMSC Japan During the fourth quarter of fiscal 2004, SMSC purchased the minority interest in SMSC Japan from Sumitomo Metal Industries, Ltd. (Sumitomo). Prior to this purchase, Sumitomo owned 20% of the issued and outstanding common stock and all of the non-cumulative, non-voting 6% preferred stock of SMSC Japan. The minority interest, which was carried at $11.8 million on SMSC's Consolidated Balance Sheet, was repurchased from Sumitomo for approximately $5.1 million. The excess of the carrying value over the purchase price was recorded as a credit to Additional paid-in capital, and is also presented as a component of Net income applicable to common shareholders on the Company's Consolidated Statement of Operations for fiscal 2004. As a result of this transaction, SMSC Japan is now a wholly owned subsidiary of SMSC. Resolution of Arbitration SMSC, Accton Technology Corporation (Accton) and SMC Networks, Inc. (Networks) had been involved in an arbitration related to claims associated with the purchase of an 80.1% interest in Networks by Accton from SMSC in October 1997. In September 2003, the arbitration panel issued its decision in this action, which directed the release of an escrow account to SMSC and awarded certain other payments among the parties. In December 2003, the parties reached a final settlement of the award, resulting in SMSC receiving $2.7 million in cash, including the escrow account, and realizing a pre-tax gain of $0.3 million, which is included within Loss from discontinued operations. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of sales and revenues and expenses during the reporting period. SMSC believes the following critical accounting policies and estimates are important to the portrayal of the Company's financial condition and operating results, and require critical management judgments and estimates about matters that are inherently uncertain. Although management believes that its judgments and estimates are appropriate and reasonable, actual future results may differ from these estimates, and to the extent that such differences are material, future reported operating results may be affected. Revenue Recognition Sales and revenues and associated gross profit from shipments to the Company's distributors, other than to distributors in Japan, are deferred until the distributors resell the products. Shipments to distributors, other than to distributors in Japan, are made under agreements allowing price protection and limited rights to return unsold merchandise. In addition, SMSC's shipments to its distributors may experience short-term fluctuations as distributors manage their inventories to current levels of end-user demand. Therefore, SMSC considers the policy of deferring revenue on shipments to distributors to be a more meaningful presentation of the Company's operating results. It allows investors to better understand end-user demand for the products that SMSC sells through distribution channels and it better focuses the Company on end-user demand. This policy is a common practice within the semiconductor industry. SMSC relies upon its distributors to supply the Company with distribution sales and inventory information regarding its products, and, although the information is reviewed and verified for accuracy, any errors or omissions made by those distributors and not detected by the Company, if material, could affect operating results. Shipments made by the Company's Japanese subsidiary to distributors in Japan are made under agreements that permit limited or no stock return privileges and no price protection or other sales price rebates. SMSC recognizes revenue from product sales to distributors in Japan, and to original equipment manufacturers (OEMs), at the time of shipment, net of appropriate reserves for product returns and allowances. For these revenues, the Company must make assumptions and estimates of future product returns and sales allowances, and any differences between those estimates and actual results, if material, could affect that period's operating results. Inventories The Company's inventories are comprised of complex, high technology products that may be subject to rapid technological obsolescence and which are sold in a highly competitive industry. Inventories are valued at the lower of first-in, first-out cost or market, and are reviewed for product obsolescence and impairment in value, based upon assumptions of future demand and market conditions. When it is determined that inventory is stated at a higher value than that which can be recovered, the Company writes this inventory down to its estimated realizable value. While the Company endeavors to forecast customer demand and stock commensurate levels of inventory, unanticipated inventory write-downs in the future may be required. Allowance for Doubtful Accounts The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. These estimated losses are based upon historical bad debts, specific customer creditworthiness and current economic trends. If the financial condition of a customer deteriorates, resulting in the customer's inability to make payments within approved credit terms, additional allowances may be required. The Company performs credit evaluations of its customers' financial condition on a regular basis, and has not experienced any material bad debt losses during the past three fiscal years. However, the Company's customer base changes as its business evolves, and past bad debt experience in not necessarily an indicator of future customer payment performance. Valuation of Long-Lived Assets Long-lived assets, including property, plant and equipment, and intangible assets, are monitored and reviewed for impairment in value whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. The determination of recoverability is based on an estimate of undiscounted cash flows expected to result from the use of an asset and its eventual disposition. The estimated cash flows are based upon, among other things, certain assumptions about expected future operating performance, growth rates and other factors. Estimates of undiscounted cash flows may differ from actual cash flows due to factors such as technological changes, economic conditions, and changes in the Company's business model or operating performance. If the sum of the undiscounted cash flows (excluding interest) is below the carrying value, an impairment loss is recognized, measured as the amount by which the carrying value exceeds the fair value of the asset. Goodwill is tested for impairment in value annually, as well as when an event or circumstance occurs indicating a possible impairment in value. Marketable and non-marketable long-term equity investments are also monitored for indications of impairment in value. The Company records an impairment charge against these investments when the investment is judged to have experienced a decline in value that is other than temporary. Judgments regarding the value of non-marketable equity investments are subjective and dependent upon management's assessment of the performance of the investee and its prospects for future success. During the third quarter of fiscal 2003, impairment charges totaling $16.3 million were recorded against two such investments, both of which were subsequently sold during fiscal 2004. As of February 29, 2004, the Company has no significant long-term equity investments. Income Taxes The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, which requires recognition of deferred tax assets and liabilities using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax assets will not be realized. The Company regularly evaluates the realizability of its deferred tax assets by assessing its forecasts of future taxable income and reviewing available tax planning strategies that could be implemented to realize the deferred tax assets. At February 29, 2004, the Company had $21.6 million of deferred tax assets in excess of deferred tax liabilities, all of which are considered fully realizable. Factors that may affect the Company's ability to achieve sufficient future taxable income for purposes of realizing its deferred tax assets include increased competition, a decline in sales and revenues or gross margins, loss of market share, delays in product availability, and technological obsolescence. Legal Contingencies From time to time, the Company is involved in legal actions arising in the ordinary course of business. There can be no assurance that any third-party assertions against the Company will be resolved without costly litigation, in a manner that is not adverse to its financial position, results of operations or cash flows. As of February 29, 2004, no estimate can be made of any possible loss or possible range of loss associated with the resolution of any such contingencies. If additional information becomes available indicating that a loss, or range of losses, is probable, the Company would then record a charge for the minimum estimated liability, which could materially impact operating results and financial condition. RESULTS OF OPERATIONS Sales and Revenues The Company's sales and revenues for fiscal 2004 were $215.9 million, including $192.0 million of product sales and $23.9 million of intellectual property revenues, compared to fiscal 2003 sales and revenues of $155.5 million, including $154.2 million of product sales and $1.3 million of intellectual property revenues. Fiscal 2002 sales and revenues were $159.3 million, including $128.5 million of product sales and $30.8 million of intellectual property revenues. Intellectual property revenues include $22.5 million in fiscal 2004, and $29.6 million in fiscal 2002, respectively, received from Intel pursuant to intellectual property and business relationship agreements. Further details regarding these agreements appear within the Fiscal 2004 Highlights section of this discussion, and within Note 7 to the Company's Consolidated Financial Statements. Product sales increased 24% in fiscal 2004 compared to fiscal 2003, following a 20% increase in fiscal 2003 compared to fiscal 2002. These increases reflect higher product sales in all of SMSC's major product categories, in terms of both units and dollars, compared to the corresponding prior year periods. New design-wins and increased PC demand helped to drive growth in sales of PC I/O products, which increased 14% in fiscal 2004, and 15% in fiscal 2003, respectively, over the comparable year-earlier periods. The Company's non-PC I/O products, which are focused in networking and USB connectivity applications, achieved higher product sales from recent new product introductions, as well as SMSC's ongoing focus on aggressively identifying and pursuing market opportunities in these product lines. Sales of non-PC I/O products increased 55% in fiscal 2004, and 35% in fiscal 2003, respectively, over the comparable year-earlier periods. Non-PC I/O product sales have continued to grow as a percentage of total product sales, increasing to almost 33% in fiscal 2004, compared to 27% in fiscal 2003 and 24% in fiscal 2002. Sales and revenues by geographic region for the past three fiscal years were as follows: (in thousands): For the years ended February 29 or 28, 2004 2003 2002 - ------------------------------------------------------------------------------ North America $ 37,138 $ 14,712 $ 42,913 Asia and the Pacific Rim 168,380 131,903 106,123 Europe 10,335 8,823 10,157 Rest of World 20 79 105 - ------------------------------------------------------------------------------ $ 215,873 $ 155,517 $ 159,298 ============================================================================== Intellectual property revenues received from Intel are included within North America. The Company expects that international shipments, particularly to Asia and the Pacific Rim region, will continue to represent a significant portion of its sales and revenues for the foreseeable future. A significant portion of the world's high technology manufacturing and assembly activity occurs in Asia and the Pacific Rim region, where many of the Company's significant customers conduct business. Gross Profit Gross profit for fiscal 2004 was $109.6 million, or 50.8% of sales and revenues, compared to $69.4 million, or 44.6% of sales and revenues, in fiscal 2003. Gross profit in fiscal 2002 was $78.0 million, or 49.0% of sales and revenues. Excluding the impact of intellectual property revenues, gross profit was 44.7% of sales and revenues in fiscal 2004, compared to 44.2% in fiscal 2003 and 36.8% in fiscal 2002. The improvement in gross profit percentage in fiscal 2004, to 44.7% of sales and revenues, as compared to 44.2% of sales and revenues achieved in fiscal 2003 (excluding intellectual property revenues in both periods), reflects the combination of lower product costs, an increase in unit production, lower inventory obsolescence charges, and the product mix shift towards non-PC I/O products, which generally produce higher gross margins than PC I/O products. The improvement in gross profit percentage in fiscal 2003, to 44.2% of sales and revenues, as compared to 36.8% of sales and revenues achieved in fiscal 2002 (excluding intellectual property revenues in both periods), reflects the same factors as the fiscal 2004 to fiscal 2003 comparison. In addition, gross profit in fiscal 2002 was adversely impacted by $1.3 million of inventory charges associated with the Company's fiscal 2002 restructuring. 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 The semiconductor industry, and the individual markets in which the Company currently competes, are highly competitive, and the Company believes that continued investment in research and development (R&D) is essential to maintaining and improving its competitive position, and to driving its opportunities for future growth. By striving to design innovative solutions and more functionality and features into its products, the Company continues to increase the value of its products for its customers and helps these customers speed their own products to market. The Company's R&D activities are performed by a team of highly-skilled and experienced engineers and technicians, and are primarily directed towards the design of new integrated circuits, the development of new software design tools and blocks of logic, as well as ongoing cost reductions and performance improvements in existing products. R&D expenses for fiscal 2004 were $38.8 million, compared to $31.2 million for both fiscal 2003 and fiscal 2002. The increase in fiscal 2004 reflects the impact of engineering staff additions, investments in advanced design tools and costs associated with development programs in increasingly complex technologies. Fiscal 2003 R&D expenses include increased expenses driven by the Company's June 2002 acquisition of Gain Technology Corporation (Gain), offset by reduced expenditures for PC chipset development activities resulting from the Company's November 2001 restructuring. Selling, General and Administrative Expenses Selling, general and administrative expenses were $42.2 million, or approximately 20% of sales and revenues, for fiscal 2004, compared to $36.3 million, or approximately 23% of sales and revenues, for fiscal 2003. Fiscal 2002 selling, general and administrative expenses were $32.7 million, or 21% of sales and revenues. The dollar increases reflect the impact of additional staff added to expand the Company's sales and marketing capabilities, as well as incremental selling costs, primarily sales commissions and incentives, associated with higher product sales. Fiscal 2003 expenses include the impact of the June 2002 acquisition of Gain, partially offset by reduced expenditures resulting from the Company's November 2001 restructuring. Amortization of Intangible Assets Amortization expense of $1.3 million and $1.2 million in fiscal 2004 and fiscal 2003, respectively, represent the amortization of intangible assets associated with the Company's June 2002 acquisition of Gain. Gains on Real Estate Transactions During the first quarter of fiscal 2004, the Company sold certain portions of its Hauppauge, New York real estate holdings, for aggregate proceeds of $7.0 million, net of transaction costs. These transactions resulted in an aggregate gain of $1.7 million, $1.4 million of which related to property in which the Company 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 has therefore been 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 $0.6 million. Other Income and Expense The decline in interest income, from $3.5 million in fiscal 2002 to $2.0 million in both fiscal 2003 and fiscal 2004, reflects a decline in interest rates on investments over these periods, partially offset by higher levels of investments. During fiscal 2004, the Company sold its remaining equity investment in Chartered Semiconductor Manufacturing, Ltd. (Chartered), realizing losses of $0.7 million, which are included within Other income (expense), net. Other income (expense), net was nominal in fiscal 2003, and totaled $1.7 million in fiscal 2002, including gains of $0.6 million realized from the sale of two underutilized facilities and gains of $1.1 million realized on sales of a portion of an equity investment. Provision for Income Taxes Generally, the Company's income tax rate is a function of the federal, state and foreign statutory tax rates, the impact of certain permanent differences between the book and tax treatment of certain expenses, and the impact of tax-exempt income and various tax credits. The Company's effective income tax rate on income from continuing operations for fiscal 2004 was approximately 27%. By comparison, the effective income tax benefit rate was approximately 48% in fiscal 2003, and the effective income tax rate for fiscal 2002 was approximately 30%. The provision for income taxes for fiscal 2004 includes the impact of tax credits and tax benefits associated with qualified export sales, as well as a benefit of $0.8 million for better than anticipated settlements of previously open tax audits. The provisions for, or benefits from, income taxes from continuing operations have not been reduced for approximately $7.8 million, $1.8 million and $0.6 million of tax benefits in fiscal 2004, 2003 and 2002 respectively, derived from activity in stock-based compensation plans. These tax benefits have been credited to Additional paid-in capital. Discontinued Operations The Company had been involved in certain legal actions relating to past divestitures of divisions and business units. These divestitures were accounted for as discontinued operations and, accordingly, costs associated with these actions are reported within Loss from discontinued operations on the Consolidated Statements of Operations. These costs totaled $0.3 million, $0.8 million and $2.5 million, before applicable income tax benefits, in fiscal 2004, 2003 and 2002, respectively. As of February 29, 2004, each of these actions has been resolved. Under one such action, the Company was involved in an arbitration with Accton Technology Corporation (Accton) and SMC Networks, Inc. (Networks) related to claims associated with the purchase of an 80.1% interest in Networks by Accton from SMSC in October 1997. In September 2003, the arbitration panel issued its decision in this action, which directed the release of an escrow account to SMSC and awarded certain other payments among the parties. In December 2003, the parties reached a final settlement of the award, resulting in SMSC receiving $2.7 million in cash, including the escrow account, and realizing a pre-tax gain of $0.3 million, which is included within Loss from discontinued operations. LIQUIDITY AND CAPITAL RESOURCES The Company currently finances its operations through a combination of existing resources and cash generated by operations. The Company had no bank debt during fiscal 2004, 2003 or 2002. The Company's cash, cash equivalents and liquid investments (including investments in marketable securities with maturities in excess of one year) increased to $173.9 million at February 29, 2004, compared to $112.9 million at February 28, 2003, an increase of $61.0 million. This increase reflects, among other items, the receipt of $22.5 million in intellectual property payments from Intel, $18.9 million of proceeds from exercises of stock options, $7.0 million provided by sales of real estate and $2.1 million provided by sales of the Company's investment in Chartered. Operating activities generated $46.4 million of cash in fiscal 2004, including the $22.5 million of intellectual property payments noted in the previous paragraph. Investing activities consumed $22.0 million of cash for the same period, due principally to a net increase of $15.9 million in short-term and long-term investments, and $5.2 million used to purchase the minority interest in SMSC Japan. Financing activities provided $17.3 million of cash during fiscal 2004, including $18.9 million of proceeds from exercises of stock options. In fiscal 2003, operating activities generated $14.9 million of cash. Investing activities consumed $15.3 million of cash for the same period, including $15.7 million used for the acquisition of Gain and $5.7 million of capital expenditures, partially offset by $5.9 million for maturities, net of purchases, of short-term investments. Financing activities consumed $7.8 million of cash during fiscal 2003, including $10.4 million for purchases of treasury stock and $2.6 million for payments of obligations under capital leases and notes payable, partially offset by $5.2 million generated from the issuance of common stock through exercises of stock options. The Company's inventories were $23.1 million at February 29, 2004, compared to $17.6 million at February 28, 2003, commensurate with expected demand for the Company's products. Accounts receivable decreased from $22.7 million at February 28, 2003 to $21.9 million at February 29, 2004, due to strong collections. Reserves for customer credits and allowances are shown as reductions of accounts receivable. The Company's accounts receivable portfolio remains almost entirely current. Accounts payable increased from $9.1 million at February 28, 2003 to $14.7 million at February 29, 2004, reflecting normal operating purchases for inventory, property, plant and equipment, and engineering tools occurring primarily during February 2004. Capital expenditures for fiscal 2004 were $14.3 million, of which $10.4 million was paid in cash. The current year's capital investments include an expenditure of $3.9 million for advanced design tools, which is being financed by the supplier with payment terms extending through December 2006. During fiscal 2003, the Company acquired $1.9 million of advanced design tools under a similar agreement, which also provided for extended payments. Capital expenditures in fiscal 2004 were higher than the previous two fiscal years, reflecting, among other things, adverse general economic conditions during fiscal 2003 and fiscal 2002, and were predominantly for production test equipment and advanced design tools. Capital expenditures were $5.7 million and $4.5 million for fiscal 2003 and 2002, respectively. The Company anticipates that capital expenditures in fiscal 2005 will exceed those in fiscal 2004, due in part to the Company's plan to begin construction of an addition to its primary facility in Hauppauge, NY, 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 February 29, 2004. For income tax purposes, the Company has $12.4 million of federal net operating loss carryforwards as of February 29, 2004, which 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 during fiscal 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. As of February 29, 2004, the Company had repurchased approximately 1.8 million shares of common stock at a cost of $23.5 million under this program. No shares were repurchased under this program during fiscal 2004. As noted previously, the Company completed its acquisition of Gain in June 2002 for total consideration of $36.1 million, consisting of $17.9 million of common stock, $16.6 million of cash and $1.6 million of acquisition costs. The Company's contractual payment obligations and purchase commitments as of February 29, 2004 were as follows (in thousands): Payment Obligations by Period - -------------------------------------------------------------------------------- Between Between Within 1 1 and 3 3 and 5 Thereafter Total year years years - -------------------------------------------------------------------------------- Operating leases $ 4,092 $ 2,282 $ 1,810 $ - $ - Other obligations 15,775 3,671 6,823 1,546 3,735 Purchase commitments 19,278 18,062 1,216 - - - -------------------------------------------------------------------------------- Total $ 39,145 $ 24,015 $ 9,849 $ 1,546 $ 3,735 ================================================================================ The Company has considered in the past, and will continue to consider, various possible transactions to secure necessary foundry manufacturing capacity, including equity investments in, prepayments to, or deposits with foundries, in exchange for guaranteed capacity or other arrangements which address the Company's manufacturing requirements. The Company may also consider utilizing cash to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. From time to time, in the ordinary course of business, the Company may evaluate potential acquisitions of or investments in such businesses, products or technologies owned by third parties. The Company expects that its cash, cash equivalents, liquid investments, cash flows from operations and its borrowing capacity will be sufficient to finance the Company's operating and capital requirements through the end of fiscal 2005. RECENT ACCOUNTING PRONOUNCEMENTS In January 2003, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standards Board Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, which was amended in December 2003. FIN 46 requires an investor with a majority of the variable interests (primary beneficiary) in a variable interest entity (VIE) to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A VIE is an entity in which the voting equity investors do not have a controlling financial interest or the equity investment at risk is insufficient to finance the entity's activities without receiving additional subordinated financial support from the other parties. The provisions of FIN 46 were effective immediately for all arrangements entered into with new VIEs created after January 31, 2003. For arrangements entered into with VIEs created before January 31, 2003, the provisions of FIN 46 are effective at the end of the first reporting period ending after March 15, 2004. The Company has no interests in VIEs, and therefore does not expect the adoption of FIN 46 to have a material impact on its financial position or results of operations. In December 2003, the Staff of the Securities and Exchange Commission (SEC or the Staff) issued Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition, which supercedes SAB 101, Revenue Recognition in Financial Statements. SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of Emerging Issues Task Force Issue No. 00-21 (EITF 00-21), Accounting for Revenue Arrangements with Multiple Deliverables. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. EITF 00-21 was effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of this standard did not have a material impact on the Company's financial condition or results of operations. 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 February 29, 2004, the Company's $38.7 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% from levels at February 29, 2004, the Company estimates that the fair values 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 the effect of a sudden change in market interest rates. Equity Price Risk - The Company is not exposed to any significant equity price risks at February 29, 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 fluctuations in foreign exchange rates, most of the Company's product sales and all of its arrangements with its foundry, test and assembly vendors are denominated in U.S. dollars. Most transactions in the Japanese market made by the Company's subsidiary, SMSC Japan, are denominated in Japanese yen. SMSC Japan purchases a significant amount of its products for resale from SMSC in U.S. dollars, and from time to time has entered into forward exchange contracts to hedge against currency fluctuations associated with these product purchases. During fiscal 2003, SMSC Japan entered into a contract with a Japanese financial institution to purchase U.S. dollars to meet a portion of its U.S. dollar denominated product purchase requirements. No such contracts were executed during fiscal 2004, and there are no obligations under any such contracts as of February 29, 2004. The Company has never received a cash dividend (repatriation of cash) from SMSC Japan. Standard Microsystems Corporation and Subsidiaries CONSOLIDATED BALANCE SHEETS (In thousands, except per share data) As of February 29 or 28, 2004 2003 - -------------------------------------------------------------------------------- Assets Current assets: Cash and cash equivalents $ 135,161 $ 90,025 Short-term investments 23,136 22,872 Accounts receivable, net of allowance for doubtful accounts of $438 and $460, respectively 21,946 22,738 Inventories 23,162 17,644 Deferred income taxes 15,064 8,545 Other current assets 8,549 8,710 - -------------------------------------------------------------------------------- Total current assets 227,018 170,534 Property, plant and equipment, net 23,430 22,257 Long-term investments 15,600 - Goodwill 29,595 29,773 Intangible assets, net 4,697 6,008 Deferred income taxes 6,493 16,437 Other assets 3,192 7,598 - -------------------------------------------------------------------------------- $ 310,025 $ 252,607 ================================================================================ Liabilities and shareholders' equity Current liabilities: Accounts payable $ 14,679 $ 9,114 Deferred income on shipments to distributors 7,972 5,943 Accrued expenses, income taxes and other liabilities 13,168 9,838 - -------------------------------------------------------------------------------- Total current liabilities 35,819 24,895 - -------------------------------------------------------------------------------- Other liabilities 12,104 12,037 Commitments and contingencies Minority interest in subsidiary - 11,663 Shareholders' equity: Preferred stock, $0.10 par value, authorized 1,000 shares, none issued - - Common stock, $0.10 par value, authorized 30,000 shares, issued 20,191 and 18,590 shares, respectively 2,019 1,859 Additional paid-in capital 181,830 147,655 Retained earnings 99,010 77,492 Treasury stock, 1,820 shares, at cost (23,454) (23,454) Deferred stock-based compensation (1,962) (2,102) Accumulated other comprehensive income 4,659 2,562 - -------------------------------------------------------------------------------- Total shareholders' equity 262,102 204,012 - -------------------------------------------------------------------------------- $ 310,025 $ 252,607 ================================================================================ The accompanying notes are an integral part of these consolidated financial statements. Standard Microsystems Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
For the years ended February 29 or 28, 2004 2003 2002 - ------------------------------------------------------------------------------------------------------------------------ Product sales $ 191,969 $ 154,244 $ 128,528 Intellectual property revenues 23,904 1,273 30,770 - ------------------------------------------------------------------------------------------------------------------------ 215,873 155,517 159,298 Cost of goods sold 106,236 86,093 81,264 - ------------------------------------------------------------------------------------------------------------------------ Gross profit 109,637 69,424 78,034 Operating expenses (income): Research and development 38,793 31,166 31,178 Selling, general and administrative 42,168 36,268 32,744 Amortization of intangible assets 1,311 1,167 - Gains on real estate transactions (1,444) - - Restructuring costs - (247) 7,734 - ------------------------------------------------------------------------------------------------------------------------ Income from operations 28,809 1,070 6,378 Other income (expense): Interest income 1,918 2,069 3,450 Interest expense (112) (166) (133) Impairments of investments - (16,306) (669) Other income (expense), net (821) (43) 1,660 - ------------------------------------------------------------------------------------------------------------------------ Income (loss) before income taxes and minority interest 29,794 (13,376) 10,686 Provision for (benefit from) income taxes 8,051 (6,422) 3,171 Minority interest in net income of subsidiary 201 17 40 - ------------------------------------------------------------------------------------------------------------------------ Income (loss) from continuing operations 21,542 (6,971) 7,475 Loss from discontinued operations (net of income tax benefits of $14, $281, and $918) (24) (500) (1,564) - ------------------------------------------------------------------------------------------------------------------------ Net income (loss) 21,518 (7,471) 5,911 Gain on redemption of preferred stock of subsidiary 6,685 - - - ------------------------------------------------------------------------------------------------------------------------ Net income (loss) applicable to common shareholders $ 28,203 $ (7,471) $ 5,911 ======================================================================================================================== Basic net income (loss) per share: Income (loss) from continuing operations $ 1.25 $ (0.42) $ 0.47 Loss from discontinued operations - (0.03) (0.10) - ------------------------------------------------------------------------------------------------------------------------ Basic net income (loss) per share 1.25 (0.45) 0.37 Gain on redemption of preferred stock of subsidiary 0.39 - - - ------------------------------------------------------------------------------------------------------------------------ Basic net income (loss) applicable to common shareholders $ 1.64 $ (0.45) $ 0.37 ======================================================================================================================== Diluted net income (loss) per share: Income (loss) from continuing operations $ 1.17 $ (0.42) $ 0.44 Loss from discontinued operations - (0.03) (0.09) - ------------------------------------------------------------------------------------------------------------------------ Diluted net income (loss) per share 1.16 (0.45) 0.35 Gain on redemption of preferred stock of subsidiary 0.36 - - - ------------------------------------------------------------------------------------------------------------------------ Diluted net income (loss) applicable to common shareholders $ 1.53 $ (0.45) $ 0.35 ========================================================================================================================
The sum of the income (loss) per share amounts may not total due to rounding. The accompanying notes are an integral part of these consolidated financial statements. Standard Microsystems Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands)
Deferred Accumulated Additional Stock- Other Common Stock Paid-In Retained Treasury Stock based Comprehensive Shares Amount Capital Earnings Shares Amount Compensation Income Total - ------------------------------------------------------------------------------------------------------------------------------------ Balance at February 28, 2001 17,082 $ 1,708 $ 118,218 $ 79,052 (998) $ (8,330) $ (1,703) $ 5,370 $ 194,315 Comprehensive income: Net income - - - 5,911 - - - - 5,911 Other comprehensive loss Change in unrealized gain on investments - - - - - - - (2,683) (2,683) Foreign currency translation adjustment - - - - - - - (1,569) (1,569) ----------- Total other comprehensive loss (4,252) ----------- Total comprehensive income 1,659 Stock options exercised 169 17 1,543 - - - - - 1,560 Tax effect of employee stock plans - - 595 - - - - - 595 Stock-based compensation 26 3 557 - - - (387) - 173 Amortization of deferred stock-based compensa - - - - - - 682 - 682 Purchases of treasury stock - - - - (340) (5,531) - - (5,531) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at February 28, 2002 17,277 1,728 120,913 84,963 (1,338) (13,861) (1,408) 1,118 193,453 Comprehensive loss: Net loss - - - (7,471) - - - - (7,471) Other comprehensive income Change in unrealized gain on investments - - - - - - - (283) (283) Foreign currency translation adjustment - - - - - - - 1,727 1,727 ----------- Total other comprehensive income 1,444 ----------- Total comprehensive loss (6,027) Stock options exercised 489 49 5,139 - - - - - 5,188 Tax effect of employee stock plans - - 1,828 - - - - - 1,828 Stock-based compensation 75 7 1,919 - - - (1,617) - 309 Amortization of deferred stock-based compensation - - - - - - 923 - 923 Issuance of common stock for business acquisition 749 75 17,856 - - - - - 17,931 Purchases of treasury stock - - - - (482) (9,593) - - (9,593) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at February 28, 2003 18,590 1,859 147,655 77,492 (1,820) (23,454) (2,102) 2,562 204,012 Comprehensive income: Net income - - - 21,518 - - - - 21,518 Other comprehensive income Change in unrealized gain on investments - - - - - - - 709 709 Foreign currency translation adjustment - - - - - - - 1,388 1,388 ----------- Total other comprehensive income 2,097 ----------- Total comprehensive income 23,615 Stock options exercised 1,539 154 18,758 - - - - - 18,912 Tax effect of employee stock plans - - 7,778 - - - - - 7,778 Stock-based compensation 62 6 954 - - - (890) - 70 Amortization of deferred stock-based compensation - - - - - - 1,030 - 1,030 Gain on redemption of preferred stock of subidiary - - 6,685 - - - - - 6,685 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at February 29, 2004 20,191 $ 2,019 $ 181,830 $ 99,010 (1,820) $(23,454) $ (1,962) $ 4,659 $ 262,102 - ------------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. Standard Microsystems Corporation and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Cash received from customers and licensees $ 218,127 $ 154,202 $ 152,884 Cash paid to suppliers and employees (173,559) (143,314) (122,655) Interest received 1,777 2,279 4,208 Interest paid (112) (142) (133) Income taxes received (paid) 174 1,888 (5,349) - -------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 46,407 14,913 28,955 - -------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Capital expenditures (10,380) (5,695) (4,488) Acquisition of Gain Technology Corporation, net of cash acquired - (15,669) (2,500) Purchase of minority interest in subsidiary (5,180) - - Sales of property, plant and equipment 7,121 148 2,004 Purchases of short-term investments (30,074) (32,292) (32,595) Maturities of short-term investments 29,810 38,204 13,629 Purchases of long-term investments (15,600) - - Sales of long-term equity investments 2,114 78 1,064 Other 155 (38) (83) - -------------------------------------------------------------------------------------------------------------- Net cash used for investing activities (22,034) (15,264) (22,969) - -------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Proceeds from issuance of common stock 18,912 5,188 1,560 Purchases of treasury stock - (10,375) (4,750) Repayments of obligations under capital leases and notes payable (1,564) (2,617) (1,002) - -------------------------------------------------------------------------------------------------------------- Net cash provided by (used for) financing activities 17,348 (7,804) (4,192) - -------------------------------------------------------------------------------------------------------------- Effect of foreign exchange rate changes on cash and cash equivalents 829 1,038 (691) - -------------------------------------------------------------------------------------------------------------- Net cash provided by (used for) discontinued operations 2,586 (923) (2,583) - -------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 45,136 (8,040) (1,480) Cash and cash equivalents at beginning of year 90,025 98,065 99,545 - -------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 135,161 $ 90,025 $ 98,065 ============================================================================================================== Reconciliation of income (loss) from continuing operations to net cash provided by operating activities: Income (loss) from continuing operations $ 21,542 $ (6,971) $ 7,475 Adjustments to reconcile income (loss) from continuing operations to net cash provided by operating activities, net of the effects of business acquisition: Depreciation and amortization 11,002 10,752 11,614 Gains on sales of investments and property (696) (47) (1,639) Asset impairments - 16,306 5,602 Tax benefits from employee stock plans 7,778 1,828 595 Other adjustments, net 213 (143) 80 Changes in operating assets and liabilities: Accounts receivable 622 (1,411) (5,666) Inventories (5,022) (184) 14,172 Accounts payable and accrued expenses and other liabilities 9,130 753 (1,450) Current and deferred income taxes 472 (3,622) (2,897) Other changes, net 1,366 (2,348) 1,069 - -------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities $ 46,407 $ 14,913 $ 28,955 ==============================================================================================================
The Company acquired $3,894 and $1,876 of design tools in fiscal 2004 and 2003, respectively, through long-term financing provided by suppliers. The accompanying notes are an integral part of these consolidated financial statements. Standard Microsystems Corporation and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. DESCRIPTION OF BUSINESS Standard Microsystems Corporation (the Company or SMSC), a Delaware corporation founded in 1971 and based in Hauppauge, New York, is a worldwide supplier of leading edge digital, mixed-signal and analog integrated circuits for a broad range of high-speed communication and computing applications. The Company's products provide solutions in Advanced Input/Output (I/O) technology, environmental monitoring and control, USB connectivity, networking and embedded control systems. SMSC is the world's leading supplier of Advanced I/O integrated circuits for desktop and mobile personal computers. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The Company's fiscal year ends on the last day in February. The consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of all significant intercompany accounts and transactions. Reclassifications Certain items in the prior years' consolidated financial statements have been reclassified to conform to the fiscal 2004 presentation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. The Company bases the estimates and assumptions on historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. Revenue Recognition The Company recognizes revenue from product sales to original equipment manufacturers (OEMs) and end-users at the time of shipment, net of appropriate reserves for product returns and allowances. The Company's terms of shipment are customarily FOB shipping point. Certain of the Company's products are sold to distributors under agreements providing for price protection and rights to return unsold merchandise. Accordingly, recognition of revenue and associated gross profit on shipments to a majority of the Company's distributors is deferred until the distributors resell the products. Shipments made by the Company's Japanese subsidiary to distributors in Japan are made under agreements that permit limited or no stock return privileges and no price protection or other sales price rebates. Revenue for shipments to distributors in Japan is recognized upon shipment to the distributor. Revenue recognition for special intellectual property payments received in fiscal 2004 and 2002 are discussed within Note 7. The Company recognizes its other intellectual property revenues upon notification of sales of the licensed technology by its licensees. The terms of the Company's licensing agreements generally require licensees to give notification to the Company and to pay royalties no later than 60 days after the end of the quarter during which the sales take place. Cash and Cash Equivalents Cash and cash equivalents consist principally of cash in banks and highly liquid debt instruments purchased with original maturities of three months or less. Investments Short-term investments consist primarily of investments in corporate obligations with maturities of between three and twelve months, at acquisition, and are classified as available-for-sale. The cost of these short-term investments approximates their market value as of February 29, 2004 and February 28, 2003. The Company classifies all marketable debt and equity securities with remaining maturities of greater than one year, at acquisition, as long-term investments. As of February 29, 2004, long-term investments consisted primarily of investments in corporate obligations and are classified as available-for-sale. The cost of these long-term investments approximates their market value as of February 29, 2004. Investments in publicly traded equity securities are classified as available-for-sale and are carried at fair value on the accompanying Consolidated Balance Sheets. Unrealized gains and temporary losses on such securities, net of taxes, are reported in Accumulated other comprehensive income within Shareholders' equity. Impairment charges on these investments are recorded if declines in value are deemed to be other than temporary. Fair Value of Financial Instruments The carrying amounts reported in the Consolidated Balance Sheets for cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value due to their short maturities. The amounts presented for other long-term liabilities also approximate their fair values. Inventories Inventories are valued at the lower of first-in, first-out cost or market. Property, Plant and Equipment Property, plant and equipment are carried at cost and depreciated on a straight-line basis over the estimated useful lives of the buildings (20 to 25 years) and machinery and equipment (3 to 7 years). Upon sale or retirement of property, plant and equipment, the related cost and accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected currently. Cost-Basis Investments Equity investments representing an ownership interest of less than 20% in non-publicly traded companies are carried at cost. Changes in the values of these investments are not recognized unless they are sold, or an impairment in value is deemed to be other than temporary. Long-Lived Assets The Company assesses the recoverability of long-lived assets, including property, plant and equipment and intangible assets, whenever events or changes in circumstances indicate that future undiscounted cash flows expected to be generated by an asset's disposition or use may not be sufficient to support its carrying value. If such cash flows are not sufficient to support the asset's recorded value, an impairment charge is recognized to reduce the carrying value of the long-lived asset to its estimated fair value. Goodwill and Purchased Intangible Assets In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires goodwill and certain other intangible assets to be tested for impairment at least annually, as well as when an event indicating possible impairment may have occurred. Intangible assets other than goodwill that have finite lives are amortized over their estimated useful lives. The Company adopted the provisions of SFAS No. 142 during fiscal 2003. Further discussion of the Company's goodwill and intangible assets is provided within Note 5. Research and Development Expenditures for research and development are expensed in the period incurred. Stock-Based Compensation The Company has in effect several stock-based compensation plans under which incentive stock options, non-qualified stock options and restricted stock awards are granted to employees and directors. All stock options are granted with exercise prices equal to the fair value of the underlying shares on the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and accordingly recognizes no compensation expense for the stock option grants. Additional pro forma disclosures as required under SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, are detailed below. For purposes of pro forma disclosures, the estimated fair market value of the Company's options is amortized as an expense over the options' vesting periods. The fair value of each option grant, as defined by SFAS No. 123, is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model, as well as other currently accepted option valuation models, was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, that significantly differ from the Company's stock option awards. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing models do not necessarily provide a reliable single measure of the fair value of employee stock options. Pro forma information regarding net income (loss) and net income (loss) per share is required by SFAS No. 123, and has been calculated as if the Company has accounted for its stock option plans under the fair value method of SFAS No. 123. The fair value of stock options issued has been estimated at the dates of grant using a Black-Scholes option-pricing model with the following weighted average assumptions: For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------- Dividend yield - - - Expected volatility 62% 64% 63% Risk-free interest rates 2.98% 2.50% 4.17% Expected lives (in years) 4.7 4.9 4.0 - -------------------------------------------------------------------------------- The weighted average Black-Scholes per share values of options granted in fiscal 2004, 2003 and 2002 were $9.65, $11.69 and $7.57, respectively. For purposes of pro forma disclosures, the estimated fair market value of the Company's options is amortized as an expense over the options' vesting periods. Had compensation expense been recorded under the provisions of SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have been the pro forma amounts indicated below (in thousands, except per share data):
For the years ended February 29 or 28, 2004 2003 2002 - --------------------------------------------------------------------------------------------------------- Net income (loss) - as reported $ 21,518 $ (7,471) $ 5,911 Add: Stock-based compensation expense included in net income (loss), net of taxes - as reported 845 627 444 Deduct: Stock-based compensation expense determined using the fair value method for all awards, net of taxes (2,073) (7,419) (6,139) - --------------------------------------------------------------------------------------------------------- Net income (loss) - pro forma $ 20,290 $ (14,263) $ 216 ========================================================================================================= Basic net income (loss) per share - as reported $ 1.25 $ (0.45) $ 0.37 ========================================================================================================= Diluted net income (loss) per share - as reported $ 1.16 $ (0.45) $ 0.35 ========================================================================================================= Basic net income (loss) per share - pro forma $ 1.18 $ (0.86) $ 0.01 ========================================================================================================= Diluted net income (loss) per share - pro forma $ 1.11 $ (0.86) $ 0.01 =========================================================================================================
Income Taxes Deferred income taxes are provided on temporary differences that arise in the recording of transactions for financial and tax reporting purposes and result in deferred tax assets and liabilities. Deferred tax assets are reduced by an appropriate valuation allowance if, in management's judgment, part of the deferred tax asset will not be realized. Tax credits are accounted for as reductions of the current provision for income taxes in the year in which they are earned. Translation of Foreign Currencies The functional currencies of the Company's foreign subsidiaries are their respective local currencies. Assets and liabilities of foreign subsidiaries are translated into U.S. dollars using the exchange rates in effect at the balance sheet date. Results of their operations are translated using the average exchange rates during the period. Resulting translation adjustments are recorded within Accumulated other comprehensive income within Shareholders' equity. Foreign Exchange Contracts The Company purchases most of its materials and transacts most of its international sales, with the exception of certain sales to customers in Japan, in U.S. dollars. The Company's Japanese subsidiary, SMSC Japan, serves the Japanese market and transacts most of its sales to its customers in Japanese yen. SMSC Japan purchases a significant amount of its products for resale from SMSC in U.S. dollars and, from time to time, has entered into forward exchange contracts to hedge against currency fluctuations associated with these product purchases. Gains and losses on such contracts have not been significant. As of February 29, 2004, there are no outstanding commitments under foreign exchange contracts. Other Comprehensive Income The Company's other comprehensive income (loss) consists of foreign currency translation adjustments and unrealized gains and losses on investments. Recent Accounting Pronouncements In January 2003, the FASB issued Financial Accounting Standards Board Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, which was amended in December 2003. FIN 46 requires an investor with a majority of the variable interests (primary beneficiary) in a variable interest entity (VIE) to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. A VIE is an entity in which the voting equity investors do not have a controlling financial interest or the equity investment at risk is insufficient to finance the entity's activities without receiving additional subordinated financial support from the other parties. The provisions of FIN 46 were effective immediately for all arrangements entered into with new VIEs created after January 31, 2003. For arrangements entered into with VIEs created before January 31, 2003, the provisions of FIN 46 are effective at the end of the first reporting period ending after March 15, 2004. The Company has no interests in VIEs, and therefore does not expect the adoption of FIN 46 to have a material impact on its financial position or results of operations. In December 2003, the Staff of the Securities and Exchange Commission (SEC or the Staff) issued Staff Accounting Bulletin No. 104 (SAB 104), Revenue Recognition, which supercedes SAB 101, Revenue Recognition in Financial Statements. SAB 104's primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of Emerging Issues Task Force Issue No. 00-21 (EITF 00-21), Accounting for Revenue Arrangements with Multiple Deliverables. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. EITF 00-21 was effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of this standard did not have a material impact on the Company's financial condition or results of operations. 3. NET INCOME (LOSS) PER SHARE Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) by the sum of the weighted average common shares outstanding during the period plus the dilutive effect of unvested restricted stock awards and shares issuable through stock options. Shares used in calculating basic and diluted net income (loss) per share are reconciled as follows (in thousands): For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------- Average shares outstanding for basic net income (loss) per share 17,226 16,538 16,069 Dilutive effect of stock options and unvested restricted stock awards 1,253 - 831 - -------------------------------------------------------------------------------- Average shares outstanding for diluted net income (loss) per share 18,479 16,538 16,900 - -------------------------------------------------------------------------------- The Company reported a net loss from continuing operations in fiscal 2003, and accordingly, the effect of stock options covering an average of 4,787,000 common shares was antidilutive for that period and was excluded from average shares outstanding used in the calculation of the fiscal 2003 net loss per share. During fiscal 2004 and 2002, stock options covering 1,262,000 and 1,421,000 common shares, respectively, were excluded from the computation of diluted net income per share, because their effects were anti-dilutive. 4. BUSINESS ACQUISITION In June 2002, the Company acquired all of the outstanding common stock of Gain Technology Corporation (Gain), a developer and supplier of high-speed, high-performance analog and mixed-signal communications integrated circuits and proprietary intellectual property cores, based in Tucson, Arizona. Through this acquisition, the Company significantly enhanced its analog and mixed-signal capabilities, by adding highly skilled engineers and designers to its staff, acquiring several new products, and expanding its intellectual property portfolio. The Company acquired Gain for consideration of $36.1 million, consisting of approximately 749,000 shares of SMSC common stock valued at $17.9 million, $16.6 million of cash (net of cash acquired), and $1.6 million of direct acquisition costs, including legal, banking, accounting and valuation fees. The value of the SMSC common stock was determined using the stock's market value for a reasonable period before and after the date the terms of the acquisition were announced. In accordance with the provisions of SFAS No. 141, Business Combinations, the purchase price was allocated to the estimated fair values of assets acquired and liabilities assumed, as set forth in the following table. During fiscal 2004, the Company reduced the amount of goodwill relating to this transaction from $29.8 million to $29.6 million, reflecting the resolution of certain contingencies at amounts different than originally estimated. (in thousands) --------------------------------------------------------------------- Current assets $ 1,708 Property, plant and equipment 1,028 Deferred income taxes 1,086 Other assets 41 Goodwill 29,595 Existing technologies 6,179 Other intangible assets 908 --------------------------------------------------------------------- Total assets acquired 40,545 Current liabilities 3,355 Long-term obligations 1,177 --------------------------------------------------------------------- Total liabilities assumed 4,532 Net assets acquired 36,013 In-process research and development 87 --------------------------------------------------------------------- Total consideration $ 36,100 ===================================================================== The amounts allocated to current technologies are being amortized on a straight-line basis over their estimated useful life of six years. Other intangible assets are also being amortized on a straight-line basis over their respective estimated useful lives, ranging from one to ten years. In accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, the $29.6 million assigned to goodwill is not being amortized. Further information regarding goodwill and other intangible assets is provided within Note 5. The amount assigned to in-process research and development related to those ongoing projects that had not yet proven to be commercially feasible, and for which no alternative future use existed for the related technology. This charge is included within the Company's consolidated operating results for fiscal 2003. The unaudited pro forma results of operations set forth in the following table give effect to the acquisition of Gain as if it had occurred at the beginning of fiscal 2003 and 2002, respectively. Pro forma data is subject to certain assumptions and estimates, and is presented for informational purposes only. This data does not purport to be indicative of the results that would have actually occurred had the acquisition occurred on the basis described above, nor do they purport to be indicative of future operating results. For the years ended February 28, 2003 2002 --------------------------------------------------------------------------- (in thousands, except per share data) Sales and revenues $ 156,755 $ 165,544 Net income (loss) (8,449) 3,317 =========================================================================== Basic net income (loss) per share $ (0.51) $ 0.20 Diluted net income (loss) per share (0.51) 0.19 =========================================================================== 5. GOODWILL AND INTANGIBLE ASSETS As discussed within Note 4, the Company's June 2002 acquisition of Gain Technology Corporation included the acquisition of $7.1 million of finite-lived intangible assets and $29.6 million of goodwill. In accordance with the provisions of SFAS No. 142, this goodwill is not being amortized, but is tested for impairment in value annually, as well as when an event or circumstance occurs indicating a possible impairment in value. The Company's finite-lived intangible assets consisted of the following (in thousands): As of February 28 or 29, 2004 2003 ----------------------------------------------------------------------------- Accumulated Accumulated Cost Amortization Cost Amortization ----------------------------------------------------------------------------- Existing technologies $ 6,179 $ 1,802 $ 6,179 $ 772 Customer contracts 326 57 498 154 Non-compete agreements 410 359 410 153 ----------------------------------------------------------------------------- $ 6,915 $ 2,218 $ 7,087 $ 1,079 ============================================================================= All finite-lived intangible assets are being amortized on a straight-line basis over their estimated useful lives. Existing technologies have been assigned an estimated useful life of six years. Customer contracts have been assigned useful lives of between one and ten years (with a weighted average life of approximately seven years), and non-compete agreements have been assigned useful lives of two years. The weighted average useful life of all intangible assets is approximately six years. Estimated future intangible asset amortization expense for the next five fiscal years is as follows (in thousands): Amortization of Intangible Assets ----------------------------------------- 2005 $ 1,114 2006 1,062 2007 1,062 2008 1,062 2009 290 ========================================= 6. BUSINESS RESTRUCTURING In November 2001, the Company's Board of Directors approved management's plan to exit the PC chipset business, redirect the Company's resources, and increase its focus on leveraging its core technologies toward higher growth, higher margin businesses. This restructuring was announced on December 3, 2001. The decision to exit this business was based upon an assessment of the PC chipset marketplace, and management's conclusions that the opportunities for profitability in this marketplace had declined, and the costs of entry had increased, to a point where further investments in PC chipset technology were not justified. As a result of this restructuring, the Company recorded charges of $9.0 million in fiscal 2002, of which $7.7 million was classified within operating expenses and $1.3 million was classified within cost of goods sold on the Consolidated Statement of Operations. In fiscal 2003, the Company reduced these charges by $0.2 million, after reassessing its remaining obligations under this restructuring plan. A summary of the restructuring charge is as follows (in thousands):
Excess and Non-cancelable Impairments Obsolete Workforce lease of Assets Inventory Reduction obligations Other Charges Total - ----------------------------------------------------------------------------------------------------------------------------- Charged to expense $ 5,340 $ 1,275 $ 309 $ 1,870 $ 215 $ 9,009 Non-cash charges (5,190) (1,275) - - (15) (6,480) Cash payments - - (307) (99) (19) (425) - ----------------------------------------------------------------------------------------------------------------------------- Business restructuring reserve at February 28, 2002 150 - 2 1,771 181 2,104 Cash payments - - - (397) (21) (418) Non-cash charges - - - - (20) (20) Adjustment to expense (150) - (2) - (95) (247) - ----------------------------------------------------------------------------------------------------------------------------- Business restructuring reserve at February 28, 2003 - - - 1,374 45 1,419 Cash payments - - - (414) - (414) Non-cash charges - - - - (45) (45) - ----------------------------------------------------------------------------------------------------------------------------- Business restructuring reserve at February 29, 2004 $ - $ - $ - $ 960 $ - $ 960 =============================================================================================================================
Impairment of Assets All assets identified as specifically utilized in the Company's PC chipset development activities were evaluated for possible future use, and those assets for which there was no alternative future use were written off. Most of these assets consisted of software and intellectual property used in the design and development of integrated circuits, many of which were acquired by non-exclusive, non-transferable licenses. These assets were disposed, which was effected through abandonment of their use. One asset, which was originally acquired specifically to support the Company's PC chipset activities, was determined to have alternative future use within the Company's ongoing operations. An impairment charge of $1.9 million was recorded on this asset, based upon an assessment of its fair value through comparison to market values of assets providing functionality similar to the asset's future use. Excess and Obsolete Inventory The Company's inventory of PC chipset products, built primarily in anticipation of future design wins, was determined to have minimal net realizable value and was written down through cost of goods sold, accordingly. Workforce Reduction As a result of this restructuring, and in line with the sustained economic difficulties of the semiconductor marketplace at the time, the Company eliminated 55 positions, or 11% of its work force, during the third quarter of fiscal 2002. Most of the positions eliminated were within the Company's engineering and development staff. This workforce reduction resulted in a $0.3 million charge for severance benefits. Non-cancelable Lease Obligations The workforce reduction created idle floor space at two of the Company's leased facilities, both of which are subject to long-term, non-cancelable lease obligations. The restructuring charge included $1.9 million to cover the cost of this idle space, which was based upon the ratio of idle floor space to total floor space at each location. The Company completed its restructuring program during the fourth quarter of fiscal 2002. Substantially all of the cash payments related to the workforce reduction were made in that period. Payments related to non-cancelable lease obligations will be paid over their respective terms, through August 2008. The restructuring had minimal impact on product sales, as the Company had yet to achieve significant product sales of PC chipset products. 7. TECHNOLOGY AND PATENT LICENSE AGREEMENTS WITH INTEL CORPORATION In 1987, the Company and Intel Corporation (Intel) entered into an agreement providing for, among other things, a broad, worldwide, non-exclusive patent cross-license, covering manufacturing processes and products, thereby providing each company access to the other's current and future patent portfolios. In September 1999, the two companies announced a technology exchange agreement (the Agreement) that would allow SMSC to accelerate its then ongoing development of Intel compatible chipset products. The Agreement provided, among other things, for Intel to transfer certain intellectual property related to Intel chipset architectures to SMSC, and provided SMSC the opportunity to supply Intel chipset components along with its own chipset solutions. The Agreement also limited SMSC's rights regarding Northbridges and Intel Architecture Microprocessors under the 1987 agreement. The Agreement included provisions for its termination under certain circumstances. Under one such provision, SMSC could elect to terminate the Agreement should SMSC not achieve certain minimum chipset revenue amounts set forth in the Agreement, unless Intel paid SMSC an amount equal to the shortfall between the minimum revenue amount and the actual revenue for that period. In September 2001, pursuant to this provision, SMSC notified Intel of a chipset revenue shortfall of approximately $29.6 million for the twelve months ended September 21, 2001. In November 2001, the Company received a $29.6 million payment from Intel, which is reported as intellectual property revenue on the Company's Consolidated Statement of Operations for fiscal 2002. In September 2002, SMSC notified Intel of a chipset revenue shortfall for the 2002 twelve-month period. Intel did not make a payment to SMSC of that shortfall within the time frame specified within the Agreement, and SMSC gave Intel notice of termination of the Agreement in accordance with the terms thereof, and the parties commenced discussions regarding their various corporate and intellectual property relationships. 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 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 new relationship, Intel will pay to the Company an aggregate amount of $75 million, of which $20 million and $2.5 million were paid and recognized as intellectual property revenue in the third and fourth quarters of the Company's fiscal 2004, respectively. Of the remaining amount, $7.5 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. 8. DISCONTINUED OPERATIONS The Company had been involved in certain legal actions relating to past divestitures of divisions and business units. These divestitures were accounted for as discontinued operations and, accordingly, costs associated with these actions are reported within Loss from discontinued operations on the Consolidated Statements of Operations. These costs totaled $0.3 million, $0.8 million and $2.5 million, before applicable income tax benefits, in fiscal 2004, 2003 and 2002, respectively. As of February 29, 2004, each of these actions has been resolved. Under one such action, the Company was involved in an arbitration with Accton Technology Corporation (Accton) and SMC Networks, Inc. (Networks) related to claims associated with the purchase of an 80.1% interest in Networks by Accton from SMSC in October 1997. In September 2003, the arbitration panel issued its decision in this action, which directed the release of an escrow account to SMSC and awarded certain other payments among the parties. In December 2003, the parties reached a final settlement of the award, resulting in SMSC receiving $2.7 million in cash, including the escrow account, and realizing a pre-tax gain of $0.3 million, which is included within Loss from discontinued operations. 9. SALES AND IMPAIRMENTS OF INVESTMENTS Investment in Chartered Semiconductor During the third quarter of fiscal 2003, the Company recorded a $7.8 million charge for a decline in value, considered to be other than temporary, of its equity investment in Chartered Semiconductor Manufacturing Ltd. (Chartered), based upon a sustained reduction in Chartered's stock price performance. During the first quarter of fiscal 2004, the Company sold its remaining equity investment in Chartered, realizing a loss of $0.7 million, which is included within Other income (expense), net on the Consolidated Statements of Operations. Investment in SMC Networks, Inc. The Company's investment in SMC Networks, Inc. was a residual minority equity interest in a non-public company sold by SMSC in 1997. Based upon a valuation analysis performed by the Company with the assistance of a third party, this investment, which carried an original cost of $8.5 million, was fully written off in the third quarter of fiscal 2003. Subsequently, as part of the December 2003 arbitration settlement with Accton, discussed within Note 8, the Company transferred this investment to Accton for a nominal value. Other Long-Term Equity Investments During fiscal 2002, the Company recorded charges totaling $0.7 million to write down two cost-basis investments in privately held companies. Management concluded that these investments had experienced impairments in value considered to be other than temporary. Both investments now carry no net book value. 10. OTHER BALANCE SHEET DATA (In thousands) As of February 29 or 28, 2004 2003 - -------------------------------------------------------------------------- Inventories: Raw materials $ 910 $ 761 Work-in-process 13,202 7,686 Finished goods 9,050 9,197 - -------------------------------------------------------------------------- $ 23,162 $ 17,644 ========================================================================== Property, plant and equipment: Land $ 1,570 $ 3,434 Buildings and improvements 20,842 29,927 Machinery and equipment 90,195 81,562 - -------------------------------------------------------------------------- 112,607 114,923 Less: accumulated depreciation 89,177 92,666 - -------------------------------------------------------------------------- $ 23,430 $ 22,257 ========================================================================== Accrued expenses, income taxes and other liabilities: Salaries and fringe benefits $ 2,662 $ 2,322 Supplier financing - current portion 1,998 1,054 Other 8,508 6,462 - -------------------------------------------------------------------------- $ 13,168 $ 9,838 ========================================================================== Other liabilities: Retirement benefits $ 6,152 $ 5,811 Supplier financing - long-term portion 1,608 125 Other 4,344 6,101 - -------------------------------------------------------------------------- $ 12,104 $ 12,037 ========================================================================== 11. REAL ESTATE TRANSACTIONS During fiscal 2004, the Company sold certain portions of its Hauppauge, New York real estate holdings, for aggregate proceeds of $7.0 million, net of transaction costs. These transactions resulted in an aggregate gain of $1.7 million, $1.4 million of which related to property in which the Company 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 has therefore been deferred. This deferred gain is being recognized within the Company's operating results as a reduction of rent expense on a straight-line basis over a 30-month period beginning in June 2003, consistent with the term of the lease. As of February 29, 2004, the Company's remaining rent obligation over the term of this lease is approximately $0.6 million. During the first quarter of fiscal 2002, the Company sold two underutilized facilities. Combined proceeds from these sales were $2.1 million, before related expenses, and the sales resulted in a net pre-tax gain of approximately $0.6 million, which is included within Other income (expense), net. 12. SHAREHOLDERS' EQUITY Common Stock Repurchase Program The Company maintains a common stock repurchase program, as approved by its Board of Directors, which authorizes the Company to repurchase up to three million shares of its common stock on the open market or in private transactions. As of February 29, 2004, the Company had repurchased approximately 1.8 million shares of common stock at a cost of $23.5 million under this program, including 482,000 shares repurchased in fiscal 2003 at a cost of $9.6 million and 340,000 shares repurchased in fiscal 2002 for $5.5 million. No shares were repurchased during fiscal 2004. The Company currently holds repurchased shares as treasury stock, reported at cost. Shareholder Rights Plan The Company maintains a Shareholder Rights Plan as part of its commitment to ensure fair value to all shareholders in the event of an unsolicited takeover offer. The Company's current Shareholder Rights Plan was adopted by the Board of Directors in January 1998, replacing the Company's previous plan that had expired on January 12, 1998, and was subsequently amended in December 2000 and in April 2002. Under this plan, the Company's shareholders of record on January 13, 1998 received a dividend distribution of one preferred stock purchase right for each share of common stock then held, and any new stock issued after the record date contains the same rights. In the event of certain efforts to acquire control of the Company, these rights allow shareholders to purchase common stock of the Company at a discounted price. The rights will expire in January 2008, unless previously redeemed by the Company at $0.01 per right. Citigroup, Inc.'s (Citigroup) ownership of the Company's common stock is excluded from requiring distribution of rights under the plan, so long as Citigroup remains a passive investor and its ownership interest does not exceed 28%. As of December 31, 2003, Citigroup was the beneficial owner of approximately 15% of the Company's common stock. 13. INCOME TAXES The provision for (benefit from) income taxes included in the accompanying Consolidated Statements of Operations consists of the following (in thousands): For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------- Current Federal $ 5,647 $ (3,119) $ 5,308 Foreign 365 327 241 State 175 147 176 - -------------------------------------------------------------------------------- 6,187 (2,645) 5,725 Deferred 1,850 (4,058) (3,472) - -------------------------------------------------------------------------------- 8,037 (6,703) 2,253 Less: tax benefits from discontinued operations (14) (281) (918) - -------------------------------------------------------------------------------- $ 8,051 $ (6,422) $ 3,171 - -------------------------------------------------------------------------------- The tax benefits from discontinued operations represent the taxes resulting from net losses related to the Company's previous sale of former divisions, which were accounted for as discontinued operations. These gains and losses are further described in Note 8. The provision for (benefit from) income taxes related to continuing operations differs from the amount computed by applying the U.S. federal statutory tax rate as a result of the following: For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------- Provision for (benefit from) income taxes computed at U.S. federal statutory rate 35.0% (35.0)% 35.0% State taxes, net of federal benefit 0.7 (0.8) 1.0 Differences between foreign and U.S. income tax rates (0.2) 1.5 (0.7) Tax-exempt income (0.7) (1.7) (4.5) Export sales benefit (2.8) (6.5) - Adjustments to prior years' taxes (2.8) - - Tax credits (1.8) (4.6) (1.9) Other (0.4) (0.9) 0.8 - -------------------------------------------------------------------------------- 27.0% (48.0)% 29.7% - -------------------------------------------------------------------------------- Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The components of the Company's deferred income taxes are as follows (in thousands): As of February 29 or 28, 2004 2003 - ------------------------------------------------------------------------ Deferred tax assets (liabilities): Reserves and accruals not currently deductible for income tax purposes $ 12,843 $ 9,965 Inventory valuation 1,498 2,416 Intangible asset amortization (1,358) 379 Restructuring costs 2,160 2,321 Purchased in-process technology 938 1,058 Property, plant and equipment depreciation (83) 347 Impairment charges on investments - 5,707 Net operating losses 4,349 1,449 Other, net 1,210 1,340 - ------------------------------------------------------------------------ Net deferred tax assets $ 21,557 $ 24,982 - ------------------------------------------------------------------------ Income (loss) before income taxes and minority interest includes foreign income of $1.2 million, $0.2 million and $0.7 million for fiscal 2004, 2003 and 2002, respectively. At February 29, 2004, the Company had federal net operating loss carry forwards totaling $12.4 million. Of this amount, $2.3 million is attributable to the June 2002 acquisition of Gain Technology Corporation and is subject to certain limitations under Section 382 of the Internal Revenue Code. The remaining $10.1 million results from the Company's fiscal 2003 operating results, the tax effect of which is reflected on the Consolidated Balance Sheet at February 29, 2004 within the current portion of Deferred income taxes. The Company also expects to claim a tax refund in fiscal 2005 of approximately $5.3 million resulting from the carryback of several capital losses incurred for tax purposes during fiscal 2004. The Company also has $2.2 million of New York State tax credit carryforwards at February 29, 2004, of which $0.1 million will expire in fiscal 2005. The remaining $2.1 million of credit carry forwards expire at various dates in fiscal 2006 through fiscal 2017. 14. MINORITY INTEREST IN SUBSIDIARY The Company conducts its business in the Japanese market through its subsidiary, SMSC Japan. SMSC Japan's original capitalization in fiscal 1987 included a minority investment by Sumitomo Metal Industries, Ltd. of Osaka, Japan (Sumitomo) totaling 2.1 billion yen, or approximately $12.7 million at then-current exchange rates, in exchange for 20% of SMSC Japan's issued and outstanding common stock and all of its non-cumulative, non-voting 6% preferred stock. In January 2004, SMSC Japan redeemed Sumitomo's common and preferred stock investments for combined consideration of 551 million yen, or approximately $5.2 million, of which $3.0 million represented the redemption of the preferred stock investment and $2.2 million was the estimated fair value of Sumitomo's 20% common stock investment. The difference between the carrying value and the redemption price of the preferred stock, totaling $6.7 million, was recorded as a credit to Additional paid-in capital, and is also presented as a component of Net income applicable to common shareholders in the Consolidated Statement of Operations for fiscal 2004. The $2.2 million assigned to Sumitomo's common stock investment in SMSC Japan was allocated to the underlying net assets acquired at their respective fair values, which approximated their carrying values. 15. COMMITMENTS AND CONTINGENCIES Compensation Certain executives and key employees are employed under separate agreements terminating on various dates through fiscal 2006. These agreements provide, among other things, for annual base salaries totaling $1.4 million and $0.2 million in fiscal 2005 and 2006, respectively. Leases The Company and its subsidiaries lease certain facilities and equipment under operating leases. The facility leases generally provide for the lessee to pay taxes, maintenance, and certain other operating costs of the leased property. At February 29, 2004, future minimum lease payments for non-cancelable lease obligations are as follows (in thousands): Minimum Lease Payments - ---------------------------------------------------- 2005 $ 2,282 2006 1,217 2007 370 2008 223 2009 and thereafter - - ---------------------------------------------------- Total minimum lease payments $ 4,092 ==================================================== Total rent expense for all operating leases was $2.6 million, $1.9 million and $1.8 million in fiscal 2004, 2003 and 2002, respectively. Supplier Financing During fiscal 2004, the Company acquired $3.9 million of software and other tools used in product design, for which the supplier provided payment terms of varying quarterly amounts totaling $0.3 million, $2.0 million and $1.6 million in fiscal 2004, 2005 and 2006, respectively. The Company's February 29, 2004 Consolidated Balance Sheet includes the current portion of this obligation within Accrued expenses, income taxes and other liabilities, and the long-term portion within Other liabilities. Litigation From time to time as a normal incidence of doing business, various claims and litigation may be asserted or commenced against the Company. Due to uncertainties inherent in litigation and other claims, the Company can give no assurance that it will prevail in any such matters, but management believes that their ultimate resolution is not likely to have a material adverse effect on the Company's consolidated financial position. Nevertheless, an adverse outcome of any significant matter could have a material adverse effect on the Company's consolidated results of operations or cash flows in the quarter or annual period in which one or more of these matters are resolved. In June 2003, SMSC was named as a defendant in a patent infringement lawsuit filed by Analog Devices, Inc. (ADI) in the United States District Court for the District of Massachusetts (Analog Devices, Inc. v. Standard Microsystems Corporation, Case Number 03 CIV 11216). The Complaint, as amended, 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. 16. BENEFIT AND INCENTIVE PLANS Incentive Savings and Retirement Plan The Company maintains a defined contribution Incentive Savings and Retirement Plan (the Plan) which, pursuant to Section 401(k) of the Internal Revenue Code, permits employees to defer taxation on their pre-tax contributions to the Plan. The Plan permits employees to contribute a portion of their earnings, through payroll deductions, based on earnings reduction agreements. The Company makes matching contributions to the Plan in the form of SMSC common stock. The Company's matching contribution to the plan is equal to two-thirds of the employee's contribution, up to 6% of the employee's earnings. The Company's matching contributions to the Plan totaled $1.1 million, $1.0 million and $0.9 million in fiscal 2004, 2003 and 2002, respectively. Common stock for the Company's matching contributions to the Plan is purchased in the open market. Since its inception, 1,412,000 shares of the Company's common stock have been contributed to the Plan. As of February 29, 2004, 366 of the 467 employees who had satisfied the Plan's eligibility requirements to participate were making contributions to the Plan. Employee Stock Option Plans Under the Company's stock option plans, the Compensation Committee of the Board of Directors is authorized to grant options to purchase shares of common stock. The purpose of these plans is to promote the interests of the Company and its shareholders by providing officers and key employees with additional incentives and the opportunity, through stock ownership, to increase their proprietary interest in the Company and their personal interest in its continued success. Options are granted at prices not less than the fair market value on the date of grant. As of February 29, 2004, 494,000 shares of common stock were available for future grants of stock options, of which 313,000 can also be issued as restricted stock awards. Stock option plan activity is summarized below (shares in thousands):
Weighted Weighted Weighted Fiscal Average Fiscal Average Fiscal Average 2004 Exercise 2003 Exercise 2002 Exercise Shares Prices Shares Prices Shares Prices - ---------------------------------------------------------------------------------------------------------------------- Options outstanding, beginning of year 4,778 $14.87 4,063 $12.52 3,500 $12.17 Granted 1,146 17.94 1,732 21.71 1,138 13.95 Exercised (1,405) 12.01 (407) 10.79 (175) 9.49 Canceled or expired (264) 18.87 (610) 21.30 (400) 14.86 - ---------------------------------------------------------------------------------------------------------------------- Options outstanding, end of year 4,255 $16.40 4,778 $14.87 4,063 $12.52 - ---------------------------------------------------------------------------------------------------------------------- Options exercisable 1,054 $14.16 1,594 $12.27 1,110 $11.40 - ----------------------------------------------------------------------------------------------------------------------
The following table summarizes information relating to currently outstanding and exercisable options as of February 29, 2004 (shares in thousands):
Weighted Average Weighted Weighted Range of Remaining Lives Options Average Exercise Options Average Exercise Exercise Prices (in years) Outstanding Prices Exercisable Prices - ---------------------------------------------------------------------------------------------------------------------- $ 6.75 - $12.69 6.39 984 $10.11 325 $ 9.97 $12.75 - $14.49 6.97 943 14.05 390 13.98 $14.50 - $19.92 8.37 1,347 17.98 266 17.19 $20.00 - $24.40 8.16 853 22.37 69 22.52 $24.55 - $26.98 9.55 128 25.66 4 24.78 - ---------------------------------------------------------------------------------------------------------------------- 4,255 1,054 - ----------------------------------------------------------------------------------------------------------------------
Director Stock Option Plan Under the Company's Director Stock Option Plan, non-qualified options to purchase common stock may be granted to directors at prices not less than the market price of the shares at the date of grant. At February 29, 2004, the expiration dates of the outstanding options under this plan range from July 15, 2007 to January 15, 2014, and the exercise prices range from $8.50 to $30.12 (weighted average $16.41) per share. The following is a summary of activity under the Director Stock Option Plan over the past three fiscal years (shares in thousands):
Weighted Weighted Weighted Fiscal Average Fiscal Average Fiscal Average 2004 Exercise 2003 Exercise 2002 Exercise Shares Prices Shares Prices Shares Prices - -------------------------------------------------------------------------------------------------------------------- Options outstanding, beginning of year 271 $15.03 261 $12.78 213 $12.27 Granted 129 20.52 102 17.29 48 15.02 Exercised (134) 15.33 (92) 11.11 - - Canceled or expired (3) 20.25 - - - - - -------------------------------------------------------------------------------------------------------------------- Options outstanding, end of year 263 $17.52 271 $15.03 261 $12.78 - -------------------------------------------------------------------------------------------------------------------- Options exercisable 181 $16.41 269 $14.98 247 $12.61 - -------------------------------------------------------------------------------------------------------------------- Shares available for future grants, end of year 66 92 194 - --------------------------------------------------------------------------------------------------------------------
Director Deferred Compensation Plan The Company has a deferred compensation plan for its non-employee directors, which requires eligible directors to defer either 50% or 100% of their basic annual compensation. Under this plan, an unfunded account is established for each participating director, which is credited with equivalent units of the Company's common stock on a quarterly basis. These equivalent units track the economic performance of the underlying stock, but carry no voting rights. The deferred compensation earned under this plan is payable when the participant leaves the Company's Board of Directors, for any reason, and, pursuant to a plan amendment implemented in fiscal 2003, is generally required to be paid in the form of common stock. Compensation expense under this plan was $0.3 million in fiscal 2004, and $0.1 million in each of fiscal 2003 and 2002, respectively. The following is a summary of the activity under this plan (units in thousands): For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------- Common stock equivalent units, beginning of year 35 31 25 Common stock equivalent units earned 5 4 6 Distributions (11) - - - -------------------------------------------------------------------------------- Common stock equivalent units, end of year 29 35 31 - -------------------------------------------------------------------------------- Common stock equivalent units available, end of year 50 65 69 - -------------------------------------------------------------------------------- Range of common stock prices used to calculate common stock equivalent units $14.82-$26.45 $16.43-$22.60 $9.73-$17.10 - -------------------------------------------------------------------------------- Restricted Stock Awards The Company provides common stock awards to certain officers and key employees. Awards granted under the plan are typically earned in 25%, 25% and 50% increments on the first, second and third anniversaries of the award, respectively. The shares granted are distributed provided the employee has remained employed by the Company through such anniversary dates; otherwise the unearned shares are forfeited. The market value of these shares at the date of award is recorded as compensation expense ratably over the three-year periods from the respective award dates, as adjusted for forfeitures of awards that did not vest. Deferred compensation expense of $2.0 million and $2.1 million associated with unearned shares under this plan as of February 29, 2004 and February 28, 2003, respectively, is reported within Shareholders' equity on the Company's Consolidated Balance Sheets. Compensation expense for these awards was $1.0 million, $0.9 million and $0.7 million in fiscal 2004, 2003 and 2002, respectively. Through February 29, 2004, 294,000 shares, net of cancellations, have been awarded under this plan, and 150,000 shares are unvested. The Company, at its discretion, can grant restricted stock awards from the shares available under its 2001 and 2003 Stock Option and Restricted Stock Plans. Retirement Plan The Company maintains an unfunded Supplemental Executive Retirement Plan to provide senior management with retirement, disability and death benefits. The Plan's retirement benefits are based upon the participant's average compensation during the three-year period prior to retirement. The Company is the beneficiary of life insurance policies that have been purchased as a method of partially financing these benefits. Based upon the latest available actuarial information, the following table sets forth the components of the Plan's net periodic pension expense, the changes in the Plan's projected benefit obligation, the Plan's funded status and the assumptions used in determining the present value of benefit obligations (dollars in thousands): For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------- Service cost - benefits earned during the year $ 115 $ 100 $ 71 Interest cost on projected benefit obligations 389 358 346 Net amortization and deferral 252 245 241 - -------------------------------------------------------------------------------- Net periodic pension expense $ 756 $ 703 $ 658 - -------------------------------------------------------------------------------- Projected benefit obligation: Beginning of year $ 6,628 $ 6,070 $ 4,914 Service cost - benefits earned during the year 115 100 71 Interest cost 389 358 346 Benefit payments (275) (275) (200) Other 259 375 939 - ------------------------------------------------------------------------------- End of year $ 7,116 $ 6,628 $ 6,070 - ------------------------------------------------------------------------------- As of February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------- Actuarial present value of: Vested benefit obligation $ 4,763 $ 4,586 $ 4,555 Nonvested benefit obligation 670 563 287 - -------------------------------------------------------------------------------- Accumulated benefit obligation 5,433 5,149 4,842 Effect of projected future salary increases 1,683 1,479 1,228 - -------------------------------------------------------------------------------- Projected benefit obligation 7,116 6,628 6,070 Unrecognized gain or (loss) (1,006) (754) (379) Unrecognized net transition asset (1,225) (1,470) (1,715) Additional minimum liability 548 745 867 - -------------------------------------------------------------------------------- Accrued pension cost $ 5,433 $ 5,149 $ 4,843 - -------------------------------------------------------------------------------- Assumptions used in determining actuarial present value of benefit obligations: Discount rate 5.85% 6.00% 6.00% Weighted average rate of compensation increase 7.00% 7.00% 7.00% - -------------------------------------------------------------------------------- 17. INDUSTRY SEGMENT, GEOGRAPHIC, CUSTOMER AND SUPPLIER INFORMATION Industry Segment The Company operates in a single industry segment in which it designs, develops and markets semiconductor integrated circuits for high-speed communication and computing applications. Geographic Information The Company's domestic operations include its worldwide sales and revenues, exclusive of some of its sales and revenues from customers in Japan, and most of its operating expenses. The majority of the Company's sales and revenues and operating profits from customers in Japan are recorded by SMSC Japan. The Company conducts various sales and marketing operations outside of the United States through SMSC Japan, and through subsidiaries in Europe and Asia. The Company's long-lived assets include net property and equipment, and other long-lived assets. The vast majority of the Company's net property and equipment is located in the United States. Export Sales The information below summarizes sales and revenues to unaffiliated customers by geographic region (in thousands): For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------- North America $ 37,138 $ 14,712 $ 42,913 Asia and Pacific Rim 168,380 131,903 106,123 Europe 10,335 8,823 10,157 Rest of World 20 79 105 - -------------------------------------------------------------------------------- $ 215,873 $ 155,517 $ 159,298 - -------------------------------------------------------------------------------- Significant Customers Revenues from significant customers, as percentages of total sales and revenues, are summarized as follows: For the years ended February 29 or 28, 2004 2003 2002 - -------------------------------------------------------------------------------- Customer A 16% 20% 15% Customer B 16% 14% 6% Customer C 12% 10% 29% Customer D 12% 12% 6% Significant Suppliers The Company does not operate a wafer fabrication facility. Two independent semiconductor wafer foundries in Asia currently supply substantially all of the Company's devices in current production. In addition, substantially all of the Company's products are assembled by one of four independent subcontractors in Asia. Concentrations of Credit Risk The Company sells its products to personal computer and electronic equipment manufacturers and their subcontractors, and to electronic component distributors, and maintains individually significant accounts receivable balances from several of its larger customers. One customer accounts for $7.3 million and $6.6 million of the Company's accounts receivable, net of sales allowances, as of February 29, 2004 and February 28, 2003, respectively. The Company performs credit evaluations of its customers' financial condition on a regular basis and, although the Company generally requires no collateral, prepayments or letters of credit may be required from its customers in certain circumstances. Reserves for estimated credit losses are maintained and actual losses were not significant for all years presented. The Company invests its cash, cash equivalents and liquid investments in a variety of financial instruments and, by policy, seeks to limit the credit exposure on these investments through diversification and by restricting the investments to highly rated securities. 18. QUARTERLY FINANCIAL DATA (UNAUDITED) (In thousands, except per share data. The sum of the income (loss) per share amounts may not total due to rounding.)
Quarter ended May 31 Aug. 31 Nov. 30 Feb. 29 - --------------------------------------------------------------------------------------------------------------- Fiscal 2004 Product sales $ 42,488 $ 47,961 $ 52,302 $ 49,218 Intellectual property revenues 233 328 20,447 2,896 - --------------------------------------------------------------------------------------------------------------- 42,721 48,289 72,749 52,114 Gross profit 20,662 21,506 42,399 25,070 Operating income 3,132 1,944 20,268 3,465 Income from continuing operations 1,883 1,506 14,787 3,366 Gain (loss) from discontinued operations (164) (26) (3) 169 Net income 1,719 1,480 14,784 3,535 Gain on redemption of preferred stock of subsidiary - - - 6,685 Net income applicable to common shareholders 1,719 1,480 14,784 10,220 =============================================================================================================== Basic net income per share: Income from continuing operations $ 0.11 $ 0.09 $ 0.84 $ 0.19 Gain (loss) from discontinued operations (0.01) - - 0.01 - --------------------------------------------------------------------------------------------------------------- Basic net income per share 0.10 0.09 0.84 0.20 Gain on redemption of preferred stock of subsidiary - - - 0.37 - --------------------------------------------------------------------------------------------------------------- Basic net income per share applicable to common shareholders $ 0.10 $ 0.09 $ 0.84 $ 0.57 =============================================================================================================== Diluted net income per share: Income from continuing operations $ 0.11 $ 0.08 $ 0.77 $ 0.17 Gain (loss) from discontinued operations (0.01) - - 0.01 - --------------------------------------------------------------------------------------------------------------- Diluted net income per share 0.10 0.08 0.77 0.18 Gain on redemption of preferred stock of subsidiary - - - 0.34 - --------------------------------------------------------------------------------------------------------------- Diluted net income per share applicable to common shareholders $ 0.10 $ 0.08 $ 0.77 $ 0.51 =============================================================================================================== Average shares outstanding: Basic net income per share 16,793 16,863 17,577 18,007 Diluted net income per share 17,331 17,722 19,242 19,887 Market price per share: High $ 16.00 $ 21.50 $ 31.65 $ 36.56 Low 11.71 13.50 19.46 23.70 =============================================================================================================== Quarter ended May 31 Aug. 31 Nov. 30 Feb. 28 - --------------------------------------------------------------------------------------------------------------- Fiscal 2003 Product sales $ 33,828 $ 37,948 $ 40,293 $ 42,175 Intellectual property revenues 179 352 305 437 - --------------------------------------------------------------------------------------------------------------- 34,007 38,300 40,598 42,612 Gross profit 15,072 17,111 17,945 19,296 Operating income 27 231 14 798 Income (loss) from continuing operations 433 568 (9,032) 1,060 Loss from discontinued operations (81) (258) (125) (36) Net income (loss) 352 310 (9,157) 1,024 =============================================================================================================== Basic net income (loss) per share: Income (loss) from continuing operations $ 0.03 $ 0.03 $ (0.54) $ 0.06 Loss from discontinued operations (0.01) (0.01) (0.01) - - --------------------------------------------------------------------------------------------------------------- $ 0.02 $ 0.02 $ (0.55) $ 0.06 =============================================================================================================== Diluted net income (loss) per share: Income (loss) from continuing operations $ 0.02 $ 0.03 $ (0.54) $ 0.06 Loss from discontinued operations - (0.01) (0.01) - - --------------------------------------------------------------------------------------------------------------- $ 0.02 $ 0.02 $ (0.55) $ 0.06 =============================================================================================================== Average shares outstanding: Basic net income per share 16,060 16,631 16,718 16,748 Diluted net income per share 17,811 18,214 16,718 17,905 Market price per share: High $ 27.65 $ 24.90 $ 22.85 $ 22.43 Low 16.30 16.32 11.80 12.99 ===============================================================================================================
The Company's common stock is traded in the over-the-counter market under the Nasdaq symbol: SMSC. Trading is reported in the Nasdaq National Market. There were approximately 717 holders of record of the Company's common stock at February 29, 2004. The present policy of the Company is to retain earnings to provide funds for the operation and expansion of its business. The Company has never paid a cash dividend, and does not expect to pay cash dividends in the foreseeable future. REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Shareholders of Standard Microsystems Corporation: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, shareholders' equity and cash flows present fairly, in all material respects, the financial position of Standard Microsystems Corporation and its subsidiaries at February 29, 2004, and February 28, 2003, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The financial statements of Standard Microsystems Corporation and its subsidiaries as of February 28, 2002, and for the year then ended were audited by other independent accountants who have ceased operations. Those independent accountants expressed an unqualified opinion on those financial statements in their report dated April 4, 2002. PricewaterhouseCoopers LLP New York, NY April 9, 2004 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - THE FOLLOWING REPORT IS A COPY OF A REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP AND HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP. To Standard Microsystems Corporation: We have audited the accompanying consolidated balance sheets of Standard Microsystems Corporation (a Delaware corporation) and subsidiaries as of February 28, 2002 and 2001, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended February 28, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Standard Microsystems Corporation and subsidiaries as of February 28, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended February 28, 2002, in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP New York, NY April 4, 2002 EX-21 3 exhibit_21.txt Exhibit 21 - ---------- SUBSIDIARIES OF THE COMPANY --------------------------- Subsidiary Jurisdiction of Incorporation - ---------- ----------------------------- Standard Microsystems Corporation (Asia) State of Delaware Standard Microsystems GmbH Munich, Germany SMSC North America, Inc. State of Delaware SMSC Analog Technology Center, Inc. State of Arizona SMSC Massachusetts, Inc. State of Delaware SMSC International Ltd. Barbados Standard Microsystems K.K. (doing business as SMSC Japan) Japan EX-23.1 4 exhibit_23-1.txt Exhibit 23.1 - ------------ CONSENT OF INDEPENDENT ACCOUNTANTS ---------------------------------- We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (No. 333 - 81067) and Form S-8 (No. 2 - 78324, No. 33 - 69224, No. 33 - 83400, No. 333 - 09271, No. 333 - 64043, No. 333 - 84237, No. 333 - 47794, No. 333 - 66138, and No. 333-108842) of Standard Microsystems Corporation of our report dated April 9, 2004, relating to the consolidated financial statements which appears in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated April 9, 2004 relating to the financial statement schedule, which appears in this Form 10-K. PricewaterhouseCoopers LLP New York, New York May 12, 2004 EX-23.2 5 exhibit_23-2.txt Exhibit 23.2 - ------------ NOTICE REGARDING CONSENT OF ARTHUR ANDERSEN LLP ----------------------------------------------- Section 11(a) of the Securities Act of 1933, as amended (the Securities Act), provides that in case any part of a registration statement, when such part became effective, contained an untrue statement of a material fact, or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security (unless it is proved that at the time of such acquisition such person knew of such untruth or omission) may sue, among others, every accountant who has with his consent been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, with respect to the statement in such registration statement, report, or valuation, which purports to have been prepared or certified by such accountant. Standard Microsystems Corporation (the Company) and subsidiaries' consolidated financial statements for the fiscal year ended February 28, 2002 included in this Form 10-K, were audited by Arthur Andersen LLP (Arthur Andersen), who issued an audit report dated April 4, 2002 on those consolidated financial statements. This audit report, a copy of which is included in this Form 10-K, is incorporated by reference into the Company's previously filed Registration Statement Nos. 2-78324, , 33-69224, 33-83400, 333-09271, 333-64043, 333-84237, 333-81067, 333-47794, 333-66138 and 333-108842 (collectively, the Registration Statements). On April 30, 2002, the Company dismissed Arthur Andersen as its independent public accountants, and on May 7, 2002, engaged PricewaterhouseCoopers LLP to serve as the Company's independent public accountants. The Company understands that the staff of the Securities and Exchange Commission has taken the position that it will not accept consents from Arthur Andersen if the engagement partner and the manager for the Company's audit are no longer with Arthur Andersen. Both the engagement partner and the manager for the Company's audit are no longer with Arthur Andersen and Arthur Andersen has ceased practicing before the Securities and Exchange Commission. As a result, the Company has been unable to obtain Arthur Andersen's written consent to the incorporation by reference into the Registration Statements of their audit report with respect to the Company's financial statements. Under these circumstances, Rule 437a under the Securities Act permits the Company to file this Form 10-K, which is incorporated by reference into the Registration Statements, without a written consent from Arthur Andersen. Because Arthur Andersen has not consented to the inclusion of their audit report in the Registration Statements, Arthur Andersen will not have any liability under Section 11(a) of the Securities Act for any untrue statements of a material fact contained in the financial statements audited by Arthur Andersen and incorporated by reference into the Registration Statements or any omission of a material fact required to be stated therein. Accordingly, investors will not be able to assert a claim against Arthur Andersen under Section 11(a) of the Securities Act for any purchases of securities under the Registration Statements made on or after the date of this Form 10-K. EX-31.1 6 exhibit_31-1.txt Exhibit 31.1 - ------------ CERTIFICATION ------------- I, Steven J. Bilodeau, certify that: 1. I have reviewed this annual report on Form 10-K of Standard Microsystems Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting Date: May 14, 2004 /s/ STEVEN J. BILODEAU ------------------ Steven J. Bilodeau Chairman of the Board, President and Chief Executive Officer EX-31.2 7 exhibit_31-2.txt Exhibit 31.2 - ------------ CERTIFICATION ------------- I, Andrew M. Caggia, certify that: 1. I have reviewed this report on Form 10-K of Standard Microsystems Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting Date: May 14, 2004 /s/ ANDREW M. CAGGIA ---------------- Andrew M. Caggia Senior Vice President - Finance and Chief Financial Officer EX-32.1 8 exhibit_32-1.txt Exhibit 32.1 - ------------ CERTIFICATION ------------- Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), each of the undersigned officers of Standard Microsystems Corporation (the Company), does hereby certify, to such officer's knowledge, that: The Annual Report on Form 10-K for the fiscal year ended February 29, 2004 of the Company fully complies, in all material respects, with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, and information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: May 14, 2004 By: /s/ Steven J. Bilodeau ---------------------- (signature) Steven J. Bilodeau Chairman of the Board, President and Chief Executive Officer By: /s/ Andrew M. Caggia --------------------- (signature) Andrew M. Caggia Senior Vice President - Finance and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----