10-Q 1 f10q_2qtr-2002.txt FORM 10Q_2NDQTR FY2003 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------------------------------------- FORM 10-Q ------------------------------------------------------- [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended August 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-7422 ----------------------------------------------------------------- STANDARD MICROSYSTEMS CORPORATION ------------------------------------------------------------------ (Exact name of registrant as specified in its charter) DELAWARE 11-2234952 ------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 80 ARKAY DRIVE, HAUPPAUGE, NEW YORK, 11788 -------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 631-435-6000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ____X____ No ________ As of August 31, 2002, there were 16,706,359 shares of the registrant's common stock outstanding. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) (In thousands) August 31, February 28, 2002 2002 ---- ---- Assets Current assets: Cash and cash equivalents $ 63,800 $ 98,065 Short-term investments 39,476 28,595 Accounts receivable, net 21,774 21,828 Inventories 23,990 17,585 Deferred income taxes 11,775 8,582 Other current assets 5,863 4,317 -------------------------------------------------------------------------------- Total current assets 166,678 178,972 -------------------------------------------------------------------------------- Property, plant and equipment, net 24,472 24,170 Goodwill 30,412 - Intangible assets, net 6,727 - Investment in Chartered Semiconductor 5,267 9,992 Deferred income taxes 8,263 7,196 Other assets 14,408 15,733 -------------------------------------------------------------------------------- $ 256,227 $ 236,063 ================================================================================ Liabilities and shareholders' equity Current liabilities: Accounts payable $ 11,238 $ 8,477 Deferred income on shipments to distributors 5,904 6,225 Accrued expenses, income taxes and other liabilities 11,057 9,289 -------------------------------------------------------------------------------- Total current liabilities 28,199 23,991 -------------------------------------------------------------------------------- Other liabilities 8,185 6,973 Minority interest in subsidiary 11,644 11,646 Shareholders' equity: Preferred stock - - Common stock 1,849 1,728 Additional paid-in capital 144,019 119,505 Retained earnings 85,625 84,963 Treasury stock, at cost (22,980) (13,861) Accumulated other comprehensive income (loss) (314) 1,118 -------------------------------------------------------------------------------- Total shareholders' equity 208,199 193,453 ------------------------------------------------------------------------------- $ 256,227 $ 236,063 ================================================================================ See Notes to Consolidated Financial Statements. STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share data)

Three Months Ended Six Months Ended ------------------------- ------------------------- August 31, August 31, ------------------------- ------------------------- 2002 2001 2002 2001 ---- ---- ---- ---- Revenues $ 38,300 $ 30,389 $ 72,307 $ 61,225 Cost of goods sold 21,189 18,206 40,124 37,266 -------------------------------------------------------------------------------------------------------------- Gross profit 17,111 12,183 32,183 23,959 Operating expenses: Research and development 7,774 7,565 14,625 16,007 Selling, general and administrative 8,659 7,657 16,853 15,503 Amortization of intangible assets 447 - 447 - -------------------------------------------------------------------------------------------------------------- Income (loss) from operations 231 (3,039) 258 (7,551) Interest income 533 990 1,114 2,059 Other income (expense), net (7) 548 (22) 1,612 -------------------------------------------------------------------------------------------------------------- Income (loss) before provision for income taxes and minority interest 757 (1,501) 1,350 (3,880) Provision for (benefit from) income taxes 197 (651) 351 (1,436) Minority interest in net income (loss) of subsidiary (8) 19 (2) 49 -------------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations 568 (869) 1,001 (2,493) Loss from discontinued operations (net of income tax benefits of $145, $164, $191 and $296) (258) (307) (339) (552) -------------------------------------------------------------------------------------------------------------- Net income (loss) $ 310 $ (1,176) $ 662 $ (3,045) ============================================================================================================== Basic net income (loss) per share: Income (loss) from continuing operations $ 0.03 $ (0.05) $ 0.06 $ (0.15) Loss from discontinued operations (0.01) (0.02) (0.02) (0.04) -------------------------------------------------------------------------------------------------------------- Basic net income (loss) per share $ 0.02 $ (0.07) $ 0.04 $ (0.19) ============================================================================================================== Diluted net income (loss) per share: Income (loss) from continuing operations $ 0.03 $ (0.05) $ 0.06 $ (0.15) Loss from discontinued operations (0.01) (0.02) (0.02) (0.04) -------------------------------------------------------------------------------------------------------------- Diluted net income (loss) per share $ 0.02 $ (0.07) $ 0.04 $ (0.19) ============================================================================================================== Weighted average common shares outstanding: Basic 16,631 16,107 16,365 16,098 Diluted 18,214 16,107 18,008 16,098 See Notes to Consolidated Financial Statements.

STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) Six Months Ended August 31, --------------------------- 2002 2001 ---------- -------- Cash flows from operating activities: Cash received from customers and licensees $ 72,660 $ 56,103 Cash paid to suppliers and employees (71,707) (61,352) Interest received 1,103 2,996 Interest paid (76) (77) Income taxes paid (138) (514) ------------------------------------------------------------------------------- Net cash provided by (used for) operating activities 1,842 (2,844) ------------------------------------------------------------------------------- Cash flows from investing activities: Capital expenditures (3,208) (2,630) Acquisition of Gain Technology Corporation (15,669) - Purchases of short-term investments (18,292) (4,000) Sales of short-term investments 7,600 13,629 Other 210 3,127 ------------------------------------------------------------------------------- Net cash provided by (used for) investing activities (29,359) 10,126 ------------------------------------------------------------------------------- Cash flows from financing activities: Proceeds from issuance of common stock 4,377 675 Purchases of treasury stock (9,900) (1,633) Repayments of obligations under capital leases and notes payable (1,585) (491) ------------------------------------------------------------------------------- Net cash used for financing activities (7,108) (1,449) ------------------------------------------------------------------------------- Effect of foreign exchange rate changes on cash and cash equivalents 956 (44) Net cash used for discontinued operations (596) (869) ------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (34,265) 4,920 Cash and cash equivalents at beginning of period 98,065 99,545 ------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 63,800 $ 104,465 =============================================================================== Reconciliation of income (loss) from continuing operations to net cash provided by (used for) operating activities: Income (loss) from continuing operations $ 1,001 $ (2,493) Adjustments to reconcile income (loss) from continuing operations to net cash provided by (used for) operating activities: Depreciation and amortization 5,030 6,005 Gains on sales of investments and property (53) (1,689) Other adjustments, net 8 62 Changes in operating assets and liabilities: Accounts receivable 783 (3,194) Inventories (6,111) 5,582 Accounts payable and accrued expenses and other liabilities 810 (6,001) Other changes, net 374 (1,116) ------------------------------------------------------------------------------- Net cash provided by (used for) operating activities $ 1,842 $ (2,844) =============================================================================== During the six months ended August 31, 2002, the Company acquired $1,876 of design tools through long-term financing provided by the supplier. See Notes to Consolidated Financial Statements. STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Organization and Basis of Presentation The accompanying unaudited condensed consolidated financial information of Standard Microsystems Corporation and subsidiaries, referred to herein as "SMSC" or "the Company", has been prepared in accordance with generally accepted accounting principles and reflects all adjustments, consisting only of normal recurring adjustments, which in management's opinion are necessary to state fairly the Company's financial position, results of operations and cash flows as of and for the three and six months ended August 31, 2002 and 2001. The February 28, 2002 Consolidated Balance Sheet was derived from audited financial statements on that date. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates, and such differences may be material to the financial statements. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended February 28, 2002 included in the Company's Annual Report on Form 10-K, as filed on April 26, 2002 with the Securities and Exchange Commission. The results of operations for the three and six months ended August 31, 2002 are not necessarily indicative of the results to be expected for any future periods. 2. Balance Sheet Data Inventories are valued at the lower of first-in, first-out cost or market and consist of the following (in thousands): Aug. 31, 2002 Feb. 28, 2002 ---------------------------------------------------------- Raw materials $ 793 $ 465 Work in process 10,527 5,820 Finished goods 12,670 11,300 ---------------------------------------------------------- $ 23,990 $ 17,585 ========================================================== Property, plant and equipment consists of the following (in thousands): Aug. 31, 2002 Feb. 28, 2002 ---------------------------------------------------------------------- Land $ 3,434 $ 3,434 Buildings and improvements 29,504 29,257 Machinery and equipment 80,033 76,121 ---------------------------------------------------------------------- 112,971 108,812 Less: accumulated depreciation 88,499 84,642 ---------------------------------------------------------------------- $ 24,472 $ 24,170 ====================================================================== 3. Net Income (Loss) Per Share Basic net income (loss) per share is calculated using the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed using the weighted-average number of common shares outstanding during the period, plus the dilutive effect of shares issuable through stock options. The shares used in calculating basic and diluted net income (loss) per share are reconciled as follows (in thousands): Three Months Ended Six Months Ended August 31, August 31, ------------------------------------- 2002 2001 2002 2001 -------- ------- ------- ------- Average shares outstanding for basic net income (loss) per share 16,631 16,107 16,365 16,098 Dilutive effect of stock options 1,583 - 1,643 - --------------------------------------------------------------------------- Average shares outstanding for diluted net income (loss) per share 18,214 16,107 18,008 16,098 =========================================================================== Stock options excluded from the computation of diluted net income (loss) per share because their effect was antidilutive were as follows (in thousands): Three Months Ended Six Months Ended August 31, August 31, ------------------------------------- 2002 2001 2002 2001 -------- ------- ------- ------- Number of shares under option excluded from the computation of diluted net income (loss) per share 890 4,254 558 4,213 =========================================================================== 4. Comprehensive Income (Loss) The Company's other comprehensive income (loss) consists of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, and unrealized gains and losses on equity investments classified as available-for-sale. The components of the Company's comprehensive income (loss) for the three and six month periods ended August 31, 2002 and 2001 were as follows (in thousands): Three Months Ended Six Months Ended August 31, August 31, ------------------------------------- 2002 2001 2002 2001 -------- ------- ------- ------- Net income (loss) $ 310 $(1,176) $ 662 $(3,045) Other comprehensive income (loss): Change in foreign currency translation adjustment 752 141 1,718 (149) Change in unrealized loss on investments (3,119) (1,154) (3,150) (1,407) --------------------------------------------------------------------------- Total comprehensive loss $(2,057) $(2,189) $ (770) $(4,601) =========================================================================== 5. Business Acquisition In June 2002, the Company acquired all of the outstanding common stock of Gain Technology Corporation (Gain), a developer and supplier of high-speed, high-performance analog and mixed-signal communications integrated circuits and proprietary intellectual property cores, based in Tucson, Arizona. Gain now operates as SMSC Analog Technology Center, Inc. (ATC). Through this acquisition, the Company has significantly enhanced its analog and mixed-signal capabilities, by adding 35 highly-skilled engineers and designers, acquiring several new products, and expanding its intellectual property portfolio. The Company acquired ATC for initial consideration of $36.1 million, consisting of approximately 749,000 shares of SMSC common stock valued at $17.9 million, $16.6 million of cash (net of cash acquired), and $1.6 million of direct acquisition costs, including legal, banking, accounting and valuation fees. The value of the SMSC common stock was determined using the stock's market value for a reasonable period before and after the date the terms of the acquisition were announced. Up to $17.5 million of additional consideration, payable in SMSC common stock and cash, may be issued to ATC's former shareholders during fiscal 2004 upon satisfaction of certain future performance goals. Any additional consideration paid will be recorded as goodwill. In accordance with the provision of Statement of Financial Accounting Standard (SFAS) No. 141, Business Combinations, the purchase price was allocated to the estimated fair values of assets acquired and liabilities assumed, as set forth in the following table. The fair values assigned to intangible assets and in-process research and development were determined with the assistance of a third-party appraisal. (in thousands) ---------------------------------------------------------------- Current assets $ 1,575 Property, plant and equipment 1,114 Deferred income taxes 1,033 Other assets 41 Goodwill 30,412 Current technologies 6,179 Other intangible assets 908 ---------------------------------------------------------------- Total assets acquired 41,262 Current liabilities 3,358 Long-term obligations 1,356 Other liabilities 535 ---------------------------------------------------------------- Total liabilities assumed 5,249 Net assets acquired 36,013 In-process research and development 87 ---------------------------------------------------------------- Total initial consideration $ 36,100 ================================================================ The amounts allocated to current technologies are being amortized on a straight-line basis over their estimated useful life of six years. Other intangible assets are also being amortized on a straight-line basis over their respective estimated useful lives, ranging from one to ten years. In accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, the $30.4 million assigned to goodwill will not be amortized. Further information regarding goodwill and other intangible assets is provided within Note 9 included herein. The amount assigned to in-process research and development relates to those ongoing projects that have not yet proven to be commercially feasible, and for which no alternative future use currently exists for the related technology. This charge is included within the Company's consolidated operating results for the three months ended August 31, 2002. The pro forma results of operations set forth below give effect to the acquisition of ATC as if it had occurred at the beginning of fiscal 2002. Pro forma data is subject to certain assumptions and estimates, and is presented for informational purposes only. This data does not purport to be indicative of the results that would have actually occurred had the acquisition occurred on the basis described above, nor do they purport to be indicative of future operating results. Six Months Ended August 31, -------------------- (in thousands, except per share data) 2002 2001 -------- --------- Revenues $ 73,545 $ 65,162 Net loss (205) (3,743) ====================================================================== Basic and fully diluted net loss per share $ (0.01) $ (0.22) ====================================================================== 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 and 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 a charge of $9.0 million in fiscal 2002, including $5.3 million for impairments in asset values, $1.3 million for excess and obsolete inventory, $1.9 million for long-term, non-cancelable lease obligations, $0.3 million for a workforce reduction of 55 people, and $0.2 million in other costs. The following is a summary of the changes in restructuring liabilities for the six months ended August 31, 2002 (in thousands): Business Business Restructuring Restructuring Reserve as of Non-Cash Cash Reserve as of February 28, 2002 Charges Payments August 31, 2002 --------------------------------------------------------------------------- Workforce reduction $ 2 $ (2) $ - $ - Non-cancelable lease obligations 1,771 - 195 1,576 Other charges 181 2 6 177 --------------------------------------------------------------------------- $ 1,954 $ - $ 201 $ 1,753 =========================================================================== The Company completed its restructuring program during the quarter ended February 28, 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. 7. Discontinued Operations The Company has been involved in several legal actions relating to past divestitures of divisions and business units. These divestitures were accounted for as discontinued operations, and accordingly, costs associated with these actions, one of which has continued into fiscal 2003, are reported as a Loss from discontinued operations on the Consolidated Statements of Operations. These costs totaled $0.3 million, after applicable income tax benefits, for both the three and six month periods ended August 31, 2002, and $0.3 million and $0.6 million, after applicable income tax benefits, for the corresponding year-earlier periods. 8. Shareholders' Equity In July 2002, the Company's Board of Directors approved an increase in the number of shares authorized for repurchase under the Company's common stock repurchase program by one million shares, bringing the total number of shares authorized under the program to three million. This program allows the Company to repurchase shares of its common stock on the open market or in private transactions. As of August 31, 2002, the Company has repurchased approximately 1.8 million shares of common stock at a cost of $23.0 million under this program, including 446,000 shares repurchased in the first six months of fiscal 2003 at a cost of $9.1 million. The Company also paid $0.8 million in early March 2002 to settle 45,000 treasury shares acquired at the end of February 2002. The Company currently holds repurchased shares as treasury stock, reported at cost. 9. Goodwill and Intangible Assets In July 2001, the Financial Accounting Standards Board issued 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 and written down only when determined to be impaired, replacing the previous accounting practice of ratably amortizing these items over their estimated useful lives. Intangible assets other than goodwill that have a finite life are amortized over their useful lives. This statement applies to existing goodwill and intangible assets, beginning with fiscal years starting after December 15, 2001. As noted within Note 5, the Company's June 2002 acquisition of Gain Technology Corporation included the acquisition of $7.1 million of finite-lived intangible assets and $30.4 million of goodwill. In accordance with the provisions of SFAS No. 142, this goodwill is not amortized, but is tested for impairment in value annually, as well as when an event or circumstance occurs indicating a possible impairment in value. As of August 31, 2002, the Company's finite-lived intangible assets consisted of the following (in thousands): Accumulated Cost Amortization Net --------------------------------------------------------------------------- Existing technologies $ 6,179 $ 258 $ 5,921 Customer contracts 498 51 447 Non-compete agreements 410 51 359 --------------------------------------------------------------------------- $ 7,087 $ 360 $ 6,727 =========================================================================== All 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 remainder of fiscal 2003, and for the five fiscal years thereafter, is as follows (in thousands): Period Amount -------------------------------------------------- Remainder of fiscal 2003 $ 720 Fiscal 2004 1,310 Fiscal 2005 1,114 Fiscal 2006 1,062 Fiscal 2007 1,062 Fiscal 2008 1,062 ================================================== 10. Technology and Patent License 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 between the two companies, covering manufacturing processes and products, thereby providing each company access to the other's current and future patent portfolios. In September 1999, the two companies announced a technology exchange agreement (the Agreement) that would allow SMSC to accelerate its ongoing development of Intel-compatible chipset products. Chipset products are integrated circuits that communicate with the microprocessor (CPU) and assist in controlling the flow of information within a personal computer or similar application. The Agreement provides, among other things, for Intel to transfer certain intellectual property related to Intel chipset architectures to SMSC, and provides SMSC the opportunity to supply Intel chipset components along with its own chipset solutions. The Agreement also limits SMSC's rights regarding Northbridges and Intel Architecture Microprocessors under the 1987 agreement. The Agreement includes provisions for its termination under certain circumstances. Under one such provision, beginning in the third year of the Agreement and annually thereafter, SMSC can elect to terminate the Agreement should SMSC not achieve certain minimum chipset revenue amounts set forth in the Agreement, unless Intel pays SMSC an amount equal to the shortfall between the minimum revenue amount and the actual revenue for that period. Should the Agreement terminate under this provision, the limitations imposed by the Agreement on the Northbridge rights under the 1987 agreement terminate immediately, and the limitations imposed by the Agreement on the microprocessor rights under the 1987 agreement terminate 12 months later. Should Intel elect to make the revenue amount shortfall payment, the provisions of the Agreement will remain in force for the subsequent 12-month period, for which another minimum revenue amount will be applicable, and at the end of which a similar termination event may arise. Minimum chipset revenue amounts are $30 million, $45 million, and $60 million for the 12 months ending September 21, 2001, 2002, and 2003, respectively, and increase by 10% for each succeeding 12-month period following 2003, until expiration of the Agreement in July 2007. In September 2002, SMSC notified Intel of a chipset revenue shortfall of approximately $44.9 million for the 2002 12-month period. Intel's payment of this amount, if so elected, must occur within 60 days of this notification. There can be no assurance whatsoever that Intel will elect to pay this revenue shortfall, or any future revenue shortfalls, to SMSC under the Agreement. 11. Litigation The Company is subject to various lawsuits and claims in the ordinary course of business. While the outcome of these matters cannot be determined, management believes that their ultimate resolution will not have a material effect on the Company's operations or financial position. In October 1997, the Company sold an 80.1% interest in SMC Networks, Inc., a then-newly formed subsidiary comprised of its former local area networking division, to an affiliate of Accton Technology Corporation (Accton). In consideration for the sale, the Company received $40.2 million in cash, of which $2.0 million was placed in an escrow account, scheduled for release in January 1999, to secure the Company's indemnity obligations under the agreement. The Company's 19.9% minority interest in SMC Networks, Inc. is carried at a cost of $8.5 million within Other assets on the accompanying Consolidated Balance Sheets. In December 1998, Accton notified the Company and the escrow agent of Accton's intention to seek indemnification and damages from the Company in excess of $10.0 million by reason of alleged misrepresentations and inadequate disclosures relating to the transaction and other alleged breaches of covenants and representations in the related agreements. Based upon those allegations, the escrow account was not released to the Company as scheduled in January 1999. In January 1999, SMSC filed an action in the Supreme Court of New York (the Action) against Accton, SMC Networks, Inc. and other parties, seeking the release of the escrow account to the Company on the grounds that Accton's allegations are without merit, and seeking payment of approximately $1.6 million (the majority of which is included within Other assets on the Company's Consolidated Balance Sheets at August 31, 2002 and February 28, 2002) owed to the Company by SMC Networks, Inc. In November 1999, the Court issued an order staying the Action and directed the parties to arbitration under the arbitration provisions of the original transaction agreements. The parties are proceeding with arbitration and, in July 2000, the Company asserted various claims against Accton and its affiliates, including claims for fraud, improper transfer of profits, mismanagement, breach of fiduciary duties and payment default. The Company remains confident that it negotiated and fully performed its obligations under the Agreements with Accton in good faith and considers the claims against it to be without merit. The Company is vigorously defending itself against the allegations made by Accton and, although it is not possible at this time to assess the likelihood of any liability being established, expects that the outcome will not be material to the Company. Furthermore, the Company is pursuing recovery of damages and other relief from Accton pursuant to the Company's claims, but the likelihood of any such recovery also cannot currently be established. 12. New Accounting Pronouncements In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, Accounting for Exit or Disposal Activities. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized at their fair values when the liabilities are incurred. Under previous guidance, liabilities for certain exit costs were recognized at the date that management committed to an exit plan, which is generally before the actual liabilities are incurred. As SFAS No. 146 is effective only for exit or disposal activities initiated after December 31, 2002, the Company does not currently expect the adoption of this statement to have a material impact on its financial statements. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Company's Consolidated Financial Statements and footnotes thereto contained in this report. Overview -------- Description of Business Standard Microsystems Corporation (the Company or SMSC) is a designer and worldwide supplier of advanced digital and analog Input/Output (I/O) system and connectivity solutions for a broad range of communications and computing applications in the areas of Advanced I/O, Connectivity, Local Area Networking and Embedded Control Systems. The Company is a fabless semiconductor supplier whose products are manufactured by third party world-class 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 prominent as the leading supplier of Advanced Input/Output (I/O) integrated circuits for desktop and mobile personal computers. Advanced I/O circuits contain a variety of individual functions and unique I/O controllers delivered in a single package, including floppy disk control, keyboard control and BIOS, parallel and serial port control, and often flash memory, infrared communications support, a real time clock, system management and power management. The Company serves the Universal Serial Bus (USB) connectivity market with its family of connectivity products, which provide solutions using both USB 1.1 and USB 2.0 technologies. Embedded Networking products are designed to serve a variety of machine-to-machine communications applications, such as set-top boxes, home gateway products, printers and wireless communication interfaces. The Company's headquarters are in Hauppauge, New York, and SMSC operates design centers in New York, Austin, Texas, San Jose, California, Tucson, Arizona and Phoenix, Arizona and has sales offices in the United States, Europe, Taiwan and China. The Company conducts most of its business in the Japanese market through its majority-owned subsidiary, SMSC Japan. Business Acquisition In June 2002, the Company acquired all of the outstanding common stock of Gain Technology Corporation (Gain), a developer and supplier of high-speed, high-performance analog and mixed-signal communications integrated circuits and proprietary intellectual property cores, based in Tucson, Arizona. Gain now operates as SMSC Analog Technology Center, Inc., (ATC). Total initial consideration paid for the acquisition of ATC was approximately $36.1 million, consisting of approximately 749,000 shares of SMSC common stock, valued at $17.9 million, $16.6 million of cash, and $1.6 million of direct acquisition costs. Through this acquisition, the Company has significantly enhanced its analog and mixed-signal capabilities, by adding 35 highly-skilled engineers and designers, acquiring several new products, and expanding its intellectual property portfolio. The Company's new GT3200 device, acquired through the ATC acquisition, is the first in a family of high-performance analog physical layer (PHY) and high-speed serial data communication devices specifically designed for the new USB 2.0 connectivity standard. It is fully certified by the USB-IF consortium and complements the Company's new line of Hi-Speed USB 2.0 products, which include the USB97C201 True Speed ATA/ATAPI/CF Bridge Controller for external disk drives, and the USB97C210 Memory Card Controller for USB memory card readers. Leveraging ATC's assets and expertise, the Company plans to pursue additional product opportunities in high-speed, high-performance serial transceiver integrated circuit (IC) markets. Results of Operations --------------------- Revenues The Company's revenues for the three months ended August 31, 2002 were $38.3 million, compared to $30.4 million for the three months ended August 31, 2001. For the six month period ended August 31, 2002, the Company's revenues were $72.3 million, compared to $61.2 million for the year-earlier six month period. The increases in both the three and six month periods of fiscal 2003, compared to the corresponding fiscal 2002 periods, reflect higher unit volume shipments, driven by Advanced I/O product design-wins achieved in fiscal 2002. The Company believes it increased its Advanced I/O market share during fiscal 2002 on the strength of these key design-wins. Partially offsetting the increased Advanced I/O revenues, in both the three and six month periods, was a year to year decrease in embedded products revenue, as the ongoing technology slump continues to restrain demand for the broad applications served by these products. However, revenues from embedded products have now increased for three consecutive quarters, possibly signaling that demand for these products has begun to recover. The three month period ended August 31, 2002 also includes a revenue contribution of less than $1 million related to the acquisition of ATC. Revenues from customers outside of North America accounted for 89% of the Company's revenues for both the three and six month periods ended August 31, in both fiscal 2003 and 2002. The Company expects that international shipments, particularly to the Asia and Pacific Rim region, will continue to represent a significant portion of its revenues. From time to time, several key customers can account for a significant portion of the Company's revenues. Revenues from one customer represented 23% and 21% for the three and six month periods ended August 31, 2002, and 18% for both the three and six month periods ended August 31, 2001, of the Company's revenues for those respective periods. Revenues from a second customer represented 10% and 13% for the three and six month periods ended August 31, 2002, and 14% and 13% for the three and six month periods ended August 31, 2001, of the Company's revenues for those respective periods. Revenues from a third customer represented 12% and 11% of the Company's revenues for the three and six months ended August 31, 2002, respectively. Revenues from a fourth customer represented 10% of the Company's revenues for both the three and six months ended August 31, 2002, respectively. No other customer represented more than 10% of the Company's revenues in those periods. The Company expects that its key customers will continue to account for a significant portion of its revenues for the remainder of fiscal 2003 and for the foreseeable future. Gross Profit Gross profit for the three months ended August 31, 2002 was $17.1 million, or 44.7% of revenues, compared to $12.2 million, or 40.1% of revenues, for the three months ended August 31, 2001. For the six month period ended August 31, 2002, gross profit was $32.2 million, or 44.5% of revenues, compared to $24.0 million, or 39.1% of revenues, for the year-earlier six month period. This improvement in gross profit in fiscal 2003, compared to fiscal 2002, reflects the combination of lower product costs, new product introductions, and an increase in unit production. Revenues for the first half of fiscal 2003 include several new Advanced I/O devices, and, as is typical of this family of products, these products command higher gross profit margins than mature products. Record unit production during the first half of fiscal 2003 resulted in more efficient use of fixed manufacturing overhead costs. Research and Development Expenses The Company's research and development expenses (R&D) consist of circuit design, development and validation, product engineering, software development and related support activities. The Company's ongoing commitment to research and development is essential to maintaining product leadership in existing product lines and to providing innovative product offerings, which, in turn, drive the Company's opportunities for future growth. R&D expenses were $7.8 million and $14.6 million for the three and six months ended August 31, 2002, respectively, compared to $7.6 million and $16.0 million for the three and six months periods ended August 31, 2001, respectively. R&D expenses for the three months ended August 31, 2002 include $1.5 million of costs incurred by ATC, the acquisition of which added approximately 35 engineers and designers to the Company's staff. This increase in R&D expenses associated with the addition of ATC was partially offset by the impact of the Company's November 2001 restructuring, which reduced annual R&D expenses by approximately $5.0 million. That restructuring, further details regarding which appear within Note 6 to the Consolidated Financial Statements included within this report, among other things, reduced R&D expenses for engineering staff, prototype costs and other development activities associated with PC chipset development programs. Selling, General and Administrative Expenses Selling, general and administrative expenses were $8.7 million and $16.9 million, or 22.6% and 23.3% of revenues, for the three and six month periods ended August 31, 2002, respectively. These expenses compare to $7.7 million and $15.5 million, or 25.2% and 25.3% of revenues, reported for the three and six month periods ended August 31, 2001, respectively. Contributing to the dollar increase in the current year's three and six month periods, as compared to the prior year's comparable periods, were additional selling, general and administrative costs associated with the operation of ATC, and incremental selling costs associated with the higher revenues during these periods. Partially offsetting these increases was the impact of the Company's November 2001 business restructuring, which reduced annual selling, general and administrative expenses by approximately $0.9 million. Amortization of Intangible Assets For the three months ended August 31, 2002, the Company recorded $0.3 million of intangible asset amortization and a charge of $0.1 million for in-process research and development expenses, associated with the June 2002 acquisition of ATC. Other Income and Expense Interest income of $0.5 million and $1.1 million for the three and six month periods ended August 31, 2002, respectively, declined from $1.0 million and $2.1 million reported for the corresponding year-earlier periods. These decreases reflect lower interest rates on short-term investments during the current year periods compared to the prior year periods. Other income (expense), net, was negligible for the three and six month periods ended August 31, 2002. Other income (expense), net totaled $0.5 million for three months ended August 31, 2001, and included $0.6 million of gains on sales of a portion of an equity investment, partially offset by $0.1 million of interest and other expenses. Other income (expense), net totaled $1.6 million for the six month period ended August 31, 2001, and included 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, partially offset by $0.1 million of interest and other expenses. Income Taxes The Company's income tax rate includes the federal, state and foreign statutory tax rates, the impact of certain permanent differences between the book and tax treatment of certain expenses, the impact of tax-exempt income and various tax credits. The Company recorded a provision for income taxes from continuing operations for the six months ended August 31, 2002 at its expected effective rate for fiscal 2003 of approximately 26.0%. By comparison, the effective income tax benefit rate was approximately 37.0% for the six months ended August 31, 2001. The expected effective income tax rate for fiscal 2003 primarily reflects the impact of tax-exempt interest income and income tax credits anticipated for fiscal 2003. Discontinued Operations The Company has been involved in several legal actions relating to past divestitures of divisions and business units. These divestitures were accounted for as discontinued operations, and accordingly, costs associated with these actions, one of which has continued into fiscal 2003, are reported as a Loss from discontinued operations on the Consolidated Statements of Operations. These costs totaled $0.3 million, after applicable income tax benefits, for both the three and six month periods ended August 31, 2002. For the three and six month periods ended August 31, 2001, these costs were $0.3 million and $0.6 million, respectively, after applicable income tax benefits. Liquidity and Capital Resources ------------------------------- The Company currently finances its operations through a combination of existing resources and cash generated by operations. The Company's cash, cash equivalents and short-term investments decreased to $103.3 million as of August 31, 2002, compared to $126.7 million at February 28, 2002. This decrease reflects $15.7 million of cash used for the acquisition of ATC, and $9.9 million used for purchases of treasury stock. Further details for these activities are provided in the discussion below. Operating activities generated $1.8 million of cash for the six months ended August 31, 2002. Investing activities consumed $29.4 million of cash for the same period, including the $15.7 million used in the acquisition of ATC, $3.2 million used for capital expenditures and $10.6 million for net purchases of short-term investments. Financing activities consumed $7.1 million of cash during the first six months of fiscal 2003, including the $9.9 million for purchases of treasury stock and $1.6 million for debt payments, partially offset by $4.4 million generated from the issuance of common stock through exercises of stock options. The Company's inventories increased by $6.4 million during the first six months of fiscal 2003, as the Company stages for higher revenues anticipated in the second half of the fiscal year. Capital expenditures for the six months ended August 31, 2002 were $3.2 million. Capital expenditures in fiscal 2003 are expected to exceed the $4.5 million incurred in fiscal 2002, based upon management's current expectations regarding the level of economic activity in the high technology sector during this period. Capital expenditures are typically incurred to support the Company's semiconductor test operation and to acquire hardware, software and other tools used in the design of the Company's products. There were no material commitments for capital expenditures as of August 31, 2002. The Company completed its acquisition of ATC in June 2002, which resulted in the use of approximately $15.7 million of cash. Up to $17.5 million of additional consideration, payable in SMSC common stock and cash, may be issued to ATC's former shareholders during fiscal 2004 upon satisfaction of certain future performance goals. Through this acquisition, the Company assumed certain long-term obligations of ATC, including long-term obligations to vendors, unsecured notes payable and obligations under capital leases. The Company's long-term debt, including the long-term portion of these ATC obligations, totaled approximately $1.1 million at August 31, 2002. During the six months ended August 31, 2002, the Company purchased 446,000 shares of treasury stock at a cost of $9.1 million under its stock repurchase program. The Company also paid $0.8 million in early March 2002 to settle 45,000 treasury shares acquired at the end of February 2002. The exercise of stock options by employees and directors generated $4.4 million of cash during the same six month period. 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 expects that its cash, cash equivalents, short-term investments, cash flows from operations and its borrowing capacity will be sufficient to finance the Company's operating and capital requirements for at least the next 12 months. Recent Accounting Pronouncements -------------------------------- In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, Accounting for Exit or Disposal Activities. SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized at their fair values when the liabilities are incurred. Under previous guidance, liabilities for certain exit costs were recognized at the date that management committed to an exit plan, which is generally before the actual liabilities are incurred. As SFAS No. 146 is effective only for exit or disposal activities initiated after December 31, 2002, the Company does not currently expect the adoption of this statement to have a material impact on its financial statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Financial Market Risks ---------------------- Interest Rate Risk - The Company's exposure to interest rate risk relates primarily to its investment portfolio. The primary objective of the Company's investment portfolio management is to invest available cash while preserving principal and meeting liquidity needs. In accordance with the Company's investment policy, investments are placed with high credit-quality issuers and the amount of credit exposure to any one issuer is limited. As of August 31, 2002, the Company's $39.5 million of short-term investments consisted primarily of investments in corporate, government and municipal obligations with maturities of between three and twelve months. If market interest rates were to increase immediately and uniformly by 10 percent from levels at August 31, 2002, the fair value of these short-term investments would decline by an immaterial amount. The Company generally expects to hold its fixed income investments until maturity and, therefore, would not expect operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates on short-term investments. Equity Price Risk - The Company is exposed to an equity price risk on its investment in Chartered Semiconductor Manufacturing, Ltd. For every 10% adverse change in the market value of Chartered Semiconductor common stock, the Company would experience a decrease of approximately $0.5 million to its August 31, 2002 investment value. This investment has experienced a decline in market value, and as of August 31, 2002, its fair value is approximately $5.4 million below its historical cost of $10.7 million. However, the Company currently does not believe this decrease to be other than temporary, due to the short duration of the decline. In the event that the decline in market value of this investment is determined to be other than temporary, a charge to earnings would be recorded for all or a portion of the unrealized loss, and a new cost basis in the investment would be established. The Company has sold call options covering this investment in the past and may do so in the future to reduce some of this market risk. No call options were sold covering this investment during the six months ended August 31, 2002. Foreign Currency Risk - The Company has international sales and expenditures and is, therefore, subject to certain foreign currency rate exposure. The Company conducts a significant amount of its business in Asia. In order to reduce the risk from fluctuation in foreign exchange rates, most of the Company's product sales and all of its arrangements with its foundry, test and assembly vendors are denominated in U.S. dollars. Transactions in the Japanese market made by the Company's majority-owned subsidiary, SMSC Japan, are denominated in Japanese yen. SMSC Japan purchases a significant amount of its products for resale from Standard Microsystems Corporation in U.S. dollars, and from time to time enters into forward exchange contracts to hedge against currency fluctuations associated with these product purchases. During March 2002, SMSC Japan entered into a contract with a Japanese financial institution to purchase U.S. dollars to meet a portion of its U.S. dollar denominated product purchase requirements. Gains and losses on this contract were not significant. The contract is scheduled to expire in March 2003. The Company has never received a cash dividend (repatriation of cash) from SMSC Japan nor does it expect to receive such a dividend in the near future. Other Factors That May Affect Future Operating Results ------------------------------------------------------ As a supplier of semiconductors, the Company competes in a challenging business environment, which is characterized by intense competition, rapid technological change and cyclical business patterns. Except for the historical information contained herein, the matters discussed in this report are forward-looking statements. The Company faces a variety of risks and uncertainties in conducting its business, some of which are out of its control, and any of which, were they to occur, could impair the Company's operating performance. For a more detailed discussion of risk factors, please refer to the Company's report on Form 10-K filed with the Securities and Exchange Commission on April 26, 2002. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures Disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports filed under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Within the 90 days prior to the filing of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required. (b) Changes in Internal Controls There were no changes in the Company's internal controls or in other factors that could have significantly affected those controls subsequent to the date of the Company's most recent evaluation. PART II - OTHER INFORMATION ITEM 4. Submission of Matters to a Vote of Security Holders The following matters were submitted to a vote of security holders at the registrant's July 10, 2002 annual meeting of shareholders. (1) The following were elected directors, each receiving the number of votes set opposite their respective names: Broker For Withheld Non-Votes Steven J. Bilodeau 12,499,292 1,693,478 -- Peter F. Dicks 12,381,176 1,811,594 -- Each of the following directors, who were not up for reelection at the annual meeting of shareholders, will continue to serve as directors: James R. Berrett, James J. Boyle, Robert M. Brill, Andrew M. Caggia and Ivan T. Frisch. (2) The 2002 Stock Option and Restricted Stock Plan was not approved by the following vote: Broker For Against Abstain Non-Votes 5,345,033 6,111,574 603,581 2,132,582 (3) The selection of PricewaterhouseCoopers as the Company's auditors for the year ended February 28, 2003 was ratified by the following vote: Broker For Against Abstain Non-Votes 14,100,550 69,322 22,898 -- ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits 99.1 Certifications of Chief Executive Officer and Chief Financial Officers pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002. (b) Reports on Form 8-K On June 19, 2002, the Company filed a Current Report on Form 8-K under Item 5 - Other Events, reporting the June 3, 2002 acquisition of Gain Technology Corporation. No financial statements were included within this filing. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. STANDARD MICROSYSTEMS CORPORATION DATE: October 15, 2002 /s/ Andrew M. Caggia ------------------------ (Signature) Andrew M. Caggia Senior Vice President - Finance (duly authorized officer) and Chief Financial Officer (principal financial officer) CERTIFICATIONS I, Steven J. Bilodeau, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Standard Microsystems Corporation; 2. Based on my knowledge, this quarterly 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures 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 quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: October 15, 2002 By: /s/ Steven J. Bilodeau --------------------------- (signature) Steven J. Bilodeau Chairman of the Board, President and Chief Executive Officer I, Andrew M. Caggia, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Standard Microsystems Corporation; 2. Based on my knowledge, this quarterly 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures 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 quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: October 15, 2002 By: /s/ Andrew M. Caggia -------------------------- (signature) Andrew M. Caggia Senior Vice President - Finance and Chief Financial Officer