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| SMSC > SEC Filings for SMSC > Form 10-Q on 13-Jan-2004 | All Recent SEC Filings |
13-Jan-2004
Quarterly Report
The following discussion should be read in conjunction with the Company's consolidated condensed 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, among others, 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. 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 and peripheral devices, and reductions in the rate of growth of the PC and non-PC 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 will not necessarily inform investors of such changes, except as required by law. 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 filed with the SEC, particularly the section 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 is a designer and worldwide supplier of advanced digital, mixed-signal and analog semiconductor solutions for a broad range of communications and computing applications in the areas of Advanced Input/Output (I/O), USB connectivity, networking and embedded communications and control systems. The Company 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 prominent as the world's leading supplier of Advanced I/O integrated circuits for desktop and mobile personal computers. Advanced I/O circuits contain a variety of individual functions ranging from legacy PC I/O to leading edge system management, including flash memory, infrared communications support, a real-time clock, and power management.
The Company serves the networking and connectivity markets with its families of integrated Ethernet and USB 2.0 products, along with other products, that provide solutions for the needs of network printers, set-top boxes, home gateway products, automobile navigation systems, cellular base stations, USB peripheral devices and a variety of other machine-to-machine communications applications.
The Company's headquarters are located in Hauppauge, New York, and SMSC operates design and validation centers in New York, Austin, Texas, Tucson, Arizona and Phoenix, Arizona, and has sales offices in the United States, Europe, Taiwan, Korea and China. The Company conducts most of its business in the Japanese market through its majority-owned subsidiary, SMSC Japan.
Strategic Business Agreement
As previously reported, the Company and Intel Corporation (Intel) entered into an agreement in 1987 providing for, among other things, a broad, worldwide, non-exclusive patent cross-license, covering manufacturing processes and products, thereby providing each company access to the other's current and future patent portfolios.
In September 2003, the Company and Intel announced that they had enhanced their intellectual property and business relationship. The companies agreed to collaborate on certain future 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 was paid and recognized as intellectual property revenue in the third quarter of the Company's fiscal 2004, $10 million will be paid in each of calendar years 2004 and 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.
Critical Accounting Policies and Estimates
This discussion and analysis of the Company's financial condition and results of operations is based upon the unaudited consolidated condensed financial statements included in this report, which have been prepared in accordance with accounting principles for interim financial statements generally accepted in the United States. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of sales and revenues and expenses during the reporting period.
The Company believes that the critical accounting policies and estimates listed below are important to the portrayal of the Company's financial condition and operating results, and require critical management judgments and estimates about matters that are inherently uncertain. Although management believes that its judgments and estimates are appropriate and reasonable, actual future results may differ from these estimates, and to the extent that such differences are material, future reported operating results may be affected.
o Revenue recognition o Inventory valuation o Determination of the allowance for doubtful accounts receivable o Valuation of long-lived assets o Accounting for deferred income tax assets o Legal contingencies
Further information regarding these policies appears within the "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Company's annual report on Form 10-K for the fiscal year ended February 28, 2003 filed with the SEC on May 29, 2003. During the nine-month period ended November 30, 2003, there were no significant changes to any critical accounting policies or to the related estimates and judgments involved in applying these policies.
Results of Operations -
Sales and Revenues
Sales and revenues for the three months ended November 30, 2003 were $72.7 million, an increase of approximately 79% compared to $40.6 million reported in the third quarter of the prior fiscal year. For the nine months ended November 30, 2003, sales and revenues were $163.8 million, compared to $112.9 million in the prior year nine-month period, an increase of 45%. Sales and revenues for the three- and nine-month periods ended November 30, 2003 include the initial $20.0 million payment from Intel under the above-described agreement. The Company received no similar payment in the prior-year periods. Without that payment, the increase in sales and revenues over the comparable year-earlier periods would have been 30% for the three-month period and 27% for the nine-month period. These increases reflect higher product sales in the current year periods in all of the Company's major product categories, in terms of both units and dollars, compared to the corresponding prior year periods. Increased PC demand has helped drive increased unit PC I/O shipments. The Company's non-PC products, which are primarily focused in networking and USB connectivity applications, achieved higher product sales from recent new product introductions, as well as the Company's ongoing focus on aggressively identifying and pursuing new market opportunities in these product lines.
Sales and revenues from customers outside of North America accounted for approximately 68% and 81% of the Company's sales and revenues for the three and nine- month periods ended November 30, 2003, respectively, the largest portion of which was to the Asia and Pacific Rim region. These percentages were 94% and 92%, respectively, excluding the $20 million intellectual property payment. The comparable percentages for the three- and nine-month periods in the prior fiscal year were 91% and 90%, respectively. The Company expects that international shipments, particularly to the Asia and Pacific Rim region, will continue to represent a significant portion of its sales and revenues.
Gross Profit
Gross profit for the three months ended November 30, 2003 was $42.4 million, or 58.3% of sales and revenues, compared to $17.9 million, or 44.2% of sales and revenues, for the three months ended November 30, 2002. For the nine months ended November 30, 2003, gross profit was $84.6 million, or 51.6% of sales and revenues, compared to $50.1 million, or 44.4% of sales and revenues, in the prior year nine-month period. Without the $20.0 million intellectual property payment from Intel, gross profit would have been 42.5% and 44.9% of sales and revenues for the three- and nine-month periods ended November 30, 2003, respectively.
The gross profit percentage in the current year's third quarter, without the $20.0 million payment, was impacted by significant shipments of a low-margin part that is no longer shipping in significant volumes. For the current year nine-month period, the improvement in gross profit percentage reflects the $20.0 million intellectual property payment.
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 the 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.
The Company's research and development 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 were $10.2 million, or approximately 14% of sales and revenues (19% without the $20 million intellectual property payment), for the three months ended November 30, 2003, compared to $8.0 million, or approximately 20% of sales and revenues, for the three months ended November 30, 2002. This dollar increase reflects the impact of engineering staff additions, investments in advanced semiconductor design tools and costs associated with development programs in advanced semiconductor geometries.
For the nine months ended November 30, 2003, R&D expenses were $28.6 million, compared to $22.7 million for the nine months ended November 30, 2002, which equaled approximately 20% of sales and revenues in both periods, after excluding the $20.0 million intellectual property payment from sales and revenues for the current-year period. This increase reflects the impact of the factors noted in the three-month discussion within the preceding paragraph, as well as the impact of the Company's June 2002 acquisition of Gain Technology Corporation (Gain), which added 35 highly skilled engineers and designers to the Company's staff.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $11.6 million, or approximately 16% of sales and revenues, for the three months ended November 30, 2003, compared to $9.5 million, or approximately 23% of sales and revenues, for the three months ended November 30, 2002. For the current nine-month period, selling, general and administrative expenses were $31.0 million, or approximately 19% of sales and revenues, compared to $26.4 million, or approximately 23% of sales and revenues, in the prior year nine-month period. 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 in the current year periods. The increases also reflect $0.8 million of expenses associated with completion of the agreement with Intel. Excluding those expenses and excluding the $20 million intellectual property payment from sales and revenues, selling, general and administrative expenses would have been 20% and 21% of sales and revenues for the three- and nine-month periods ended November 30, 2003, respectively.
Amortization of Intangible Assets
For the three and nine months ended November 30, 2003, the Company recorded amortization expenses of $0.3 million and $1.0 million, respectively, for intangible assets associated with the June 2002 acquisition of Gain. Comparable amortization expense was $0.4 million and $0.8 million, respectively, in the three and nine months ended November 30, 2002.
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 $0.7 million.
Other Income and Expense
During the first quarter of 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 expense, net, for the nine months ended November 30, 2003.
Provision For Income Taxes
The Company's provision for income taxes from continuing operations in the third quarter of fiscal 2004 was $5.9 million, resulting in an effective income tax rate of 28.5%. The benefit from income taxes from continuing operations in the prior fiscal year's third quarter was $6.9 million, resulting in an effective income tax benefit rate of 43.2%. For the nine months ended November 30, 2003, the provision for income taxes from continuing operations was $7.6 million, for an effective rate of 29.3%, compared to a benefit of $6.5 million, for an effective income tax benefit rate of 44.8%, in last year's nine-month period. The Company expects its effective tax rate on income from continuing operations to be approximately 20.0% in fiscal 2004, excluding the income tax effects of special real estate and equity investment sales, special intellectual property revenues and tax benefits related to prior years. Income taxes on the aforementioned special transactions are recorded when they occur, at the Company's incremental income tax rate of approximately 36.0%. The overall expected fiscal 2004 effective tax rate on income from continuing operations, including all special transactions, is expected to be between 27.0% and 28.0%.
The Company's effective income tax rate primarily reflects statutory Federal and state income tax rates, adjusted for the impact of tax-exempt interest income and anticipated income tax credits. Excluding the tax effect of special transactions in both fiscal years, the higher effective rate expected for fiscal 2004, compared to fiscal 2003, recognizes the impact of higher income from continuing operations expected in the current year, which in turn dilutes the percentage impact of income tax credits and tax-exempt interest income on the Company's provision for income taxes.
The provision for income taxes from continuing operation for the nine months ended November 30, 2003 has not been reduced by approximately $5.6 million of income tax benefits related to the Company's stock option plans. This tax benefit has been credited to additional paid-in capital.
Discontinued Operations
The Company has been 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. This divestiture was accounted for as a discontinued operation, and accordingly, costs associated with this action, net of income taxes, are reported as a Loss from discontinued operations on the Consolidated Statements of Operations. These costs were nominal during the three months ended November 30, 2003, compared to $0.1 million for the three months ended November 30, 2002, after applicable income tax benefits. These costs totaled $0.2 million and $0.5 million in the nine-month periods ended November 30, 2003 and 2002, respectively, after applicable income tax benefits.
In September 2003, the arbitration panel issued its decision in this action, which directed the release of a $2.5 million 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 and realizing a gain of $0.1 million, after income taxes, which will be reported as a Gain on discontinued operations in the quarter ending February 29, 2004.
Liquidity and Capital Resources -
The Company currently finances its operations through a combination of existing resources and cash generated by operations.
The Company's cash, cash equivalents and short-term investments increased to $161.9 million as of November 30, 2003, compared to $112.9 million at February 28, 2003. This increase reflects, among other things, receipt of a $20.0 million intellectual property payment, $13.7 million of proceeds from stock issuances under the Company's stock option plans, $7.0 million of cash provided by sales of real estate and $2.1 million of cash provided by sales of the Company's investment in Chartered.
Operating activities generated $34.3 million of cash, including the $20.0 million intellectual property payment, during the nine months ended November 30, 2003. Investing activities consumed $12.1 million of cash for the same period, due principally to $13.9 million of net purchases of short-term investments. Financing activities provided $12.4 million of cash during the first nine months of fiscal 2004, including $13.7 million of proceeds from the issuance of stock under the Company's stock option plans.
The Company's inventories were $21.6 million at November 30, 2003, 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 $21.5 million at November 30, 2003, despite the increase in sales and revenues in the three-month periods preceding those dates, due to strong collections. The Company's accounts receivable portfolio remains almost entirely current.
Capital expenditures for the nine months ended November 30, 2003 were $8.7 million, of which $7.6 million was paid in cash. The current year's capital investments include an expenditure of $4.3 million for advanced design tools, which is being financed on a short-term basis by the supplier with payment terms extending through March 1, 2004. As of November 30, 2003, this obligation totals $1.1 million, which is reported within Accounts payable. There were no material commitments for capital expenditures as of November 30, 2003.
During the first nine months of fiscal 2004, the Company did not acquire any additional treasury stock through its common stock repurchase program, under which approximately 1.2 million shares remain authorized for repurchase. As of November 30, 2003, the Company held approximately 1.8 million shares of treasury stock, at a cost of $23.5 million.
The Company has considered in the past, and will continue to consider, various possible transactions to secure necessary foundry manufacturing capacity, including equity investments in, prepayments to, or deposits with foundries, in exchange for guaranteed capacity or other arrangements which address the Company's manufacturing requirements. The Company may also consider utilizing cash to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. From time to time, in the ordinary course of business, the Company may evaluate potential acquisitions of or investment in such businesses, products or technologies owned by third parties.
The Company expects that its cash, cash equivalents, short-term investments, cash flows from operations and its borrowing capacity will be sufficient to finance the Company's operating and capital requirements for at least the next 12 months.
Recent Accounting Pronouncements -
In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." EITF Issue No. 00-21 requires revenue arrangements with multiple deliverables to be divided into separate units of accounting if the deliverables in the arrangement meet certain criteria. The arrangement's consideration should be allocated among the separate units of accounting based on their relative fair values. Applicable revenue recognition criteria should be considered separately for each unit. The provisions of EITF Issue No. 00-21 are 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.
In December 2002, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an Amendment of SFAS No. 123", which is effective for financial statements for fiscal years ending after December 15, 2002, with early adoption permitted. SFAS No. 148 will enable companies that choose to adopt the fair value based method to report the full effect of employee stock options in their financial statements immediately upon adoption, and to make available to investors better and more frequent disclosure about the cost of employee stock options. The Company will continue to apply the disclosure-only provisions of both SFAS No. 123 and SFAS No. 148.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The adoption of this standard did not have a material impact on the Company's financial condition or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity, and requires that an issuer classify a financial instrument that is within its scope as a liability (or as an asset, in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of SFAS No. 150 and still existing at the beginning of the interim period of adoption. The adoption of this standard did not have a material impact on the Company's financial condition or results of operations.
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