-----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, AlgcEExuXYuqhjfBzp2MEOgG8Nm6Umse0Ynq6cAnQqYJmda/Q8hzrbLTq2FH7B3r M5ntVdDoEiyhnL0CqDOrWA== 0000093384-99-000013.txt : 19990624 0000093384-99-000013.hdr.sgml : 19990624 ACCESSION NUMBER: 0000093384-99-000013 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19990228 FILED AS OF DATE: 19990527 FILER: COMPANY DATA: COMPANY CONFORMED NAME: STANDARD MICROSYSTEMS CORP CENTRAL INDEX KEY: 0000093384 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER COMMUNICATIONS EQUIPMENT [3576] IRS NUMBER: 112234952 STATE OF INCORPORATION: DE FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-07422 FILM NUMBER: 99635990 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-K405 1 STANDARD MICROSYSTEMS CORP. 10-K =============================================================================== 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 28, 1999 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) (516) 435-6000 (Registrant's telephone number, including area code) ------------------- Securities registered pursuant to Section 12(b) of the Act: Title of each Class Name of each Exchange on None which registered ------------------------ Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.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. (X) As of May 24, 1999, 15,608,557 shares of the registrant's common stock were outstanding and the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $116,796,000. Documents Incorporated By Reference The documents incorporated by reference into this Form 10-K and the Parts hereof into which such documents are incorporated are listed below: Document Part Those portions of the registrant's 1999 annual report to shareholders (the Annual Report") which are specifically identified herein as incorporated by reference into this Form 10-K. II Those portions of the registrant's proxy statement for the registrant's 1999 Annual Meeting (the "Proxy Statement") which are specifically identified herein as incorporated by reference into this Form 10-K. III Standard Microsystems Corporation Form 10-K For the Fiscal Year Ended February 28, 1999 TABLE OF CONTENTS PART I ITEM 1. Business 2. Properties 3. Legal Proceedings 4. Submission of Matters to a Vote of Security Holders PART II 5. Market for the Registrant's Common Equity and Related Stockholder Matters 6. Selected Financial Data 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 7A. Quantitative and Qualitative Disclosures About Market Risk 8. Financial Statements and Supplementary Data 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure PART III 10. Directors and Executive Officers of the Registrant 11. Executive Compensation 12. Security Ownership of Certain Beneficial Owners and Management 13. Certain Relationships and Related Transactions PART IV 15. Exhibits, Financial Statement Schedule and Reports on Form 8-K PART I ITEM 1. BUSINESS. - ------------------ GENERAL DESCRIPTION OF THE BUSINESS Standard Microsystems Corporation (the "Company", the "Registrant", or "SMSCR") is a Delaware corporation, organized in 1971. As used herein, the term "Company" includes the Company's subsidiaries except where the context otherwise requires. The address of the principal executive office of the Company is 80 Arkay Drive, Hauppauge, New York 11788, and its telephone number at that address is 516-435-6000. The Company maintains offices in the United States, Europe, and Asia. The Company conducts its business in the Japanese market through its majority owned subsidiary, Toyo Microsystems Corporation, (TMC). The Company operates branch offices and facilities for engineering, marketing and the selling of its products in the following locations: Subsidiary Location ------------ ---------- Standard Microsystems Corporation (Asia) Taipei, Taiwan Standard Microsystems GmbH Munich, Germany SMSC Massachusetts, Inc. Westborough, Massachusetts SMSC North America, Inc. Austin and Houston, Texas Standard Microsystems Corporation is a worldwide supplier of metal-oxide-semiconductor/very-large-scale-integrated (MOS/VLSI) circuits for the personal computer (PC) and related industries. The Company's integrated circuits are developed and sold for applications in PC input/output (I/O), PC connectivity, Local Area Networking (LAN), PC systems logic, and embedded networking. SIGNIFICANT DEVELOPMENTS In March 1999, the Company announced the appointment of Steven J. Bilodeau as President and Chief Executive Officer. Mr. Bilodeau succeeds both the Company's previous Chief Executive Officer, Paul Richman, who is continuing in his capacity as the Company's Chairman of the Board, and its previous President, Arthur Sidorsky, who is continuing in his role as Chief Operating Officer until his retirement later this year. Also in March 1999, the Company's Board of Directors approved a plan to divest a majority interest in its Foundry Business Unit. The Foundry Business Unit serves a different customer base than the Company's core integrated circuits business, and generally has been managed as a separate operating unit with its own identifiable assets. In April 1999, the Company signed a Letter of Intent with Inertia Optical Technology Applications, Inc. (IOTA), a privately-held company located in Newark, NJ, to combine the operations of its Foundry Business Unit with IOTA's operations into a new company, Standard MEMS, Inc. Standard MEMS, Inc. will specialize in MicroElectroMechanical Systems (MEMS), which are specialty semiconductor-related products with mechanical properties used in such applications as sensors, ink jet print heads, valves, thin film RC networks, accelerometers and actuators. This operation will operate out of an existing SMSC facility in Hauppauge, New York as well as in several IOTA facilities in New Jersey, California, Massachusetts, Mexico and Germany. Under the terms of the Letter of Intent, Standard MEMS, Inc. will be majority owned by the shareholders of IOTA, with SMSC initially retaining a 38% interest. The Company has committed to reducing its investment in Standard MEMS, Inc. below 20% within one year. Completion of the transaction is subject to executing definitive agreements and final approvals from both Companies' Boards of Directors, and is expected to occur before the end of SMSC's second quarter ending August 31, 1999. The Company's historical financial information has been restated to report the operating results, net assets and cash flows of the Foundry Business Unit and the System Products Division (through September 1997) as discontinued operations for all periods presented. All following discussions and analysis focuses on the Company's continuing operations, as restated, unless otherwise noted. FINANCIAL INFORMATION ABOUT OPERATING SEGMENTS OPERATING SEGMENT The Company is organized and operates in one business segment, designing, developing and marketing semiconductor integrated circuits for the personal computer and related industries. PRINCIPAL PRODUCTS OF THE COMPANY The principal products of the Company are associated with logic control and connectivity for personal computer systems. These products can be grouped into several families, Personal Computer Input/Output controllers (I/O), Personal Computer Connectivity Products, Personal Computer Local Area Networking (PC LAN) devices, Personal Computer Systems Logic, and Embedded Products. The Company's PC I/O integrated circuits accounted for approximately 80% of total revenues in fiscal 1999, 82% in fiscal 1998 and 80% in fiscal 1997. No other product family accounted for more then 10% of the Company's consolidated revenues during the last three fiscal years. PERSONAL COMPUTER INPUT/OUTPUT CONTROLLERS (I/O) are integrated circuits with multiple functions for controlling and interfacing various peripheral and communications functions in a PC, including floppy disk control, serial and parallel port control, keyboard and mouse control, and many other peripheral functions. SMSC has three families of pin-compatible I/O controllers: Super I/O (37C669), Enhanced Super I/O (37C67x, 37B77x, 37M70x, 37B80x, 37M60x, 37B78x, 37B72x), and Ultra I/O (37C93x) devices that offer serial port, ECP (Extended Capabilities Port) and EPP (Enhanced Parallel Port), parallel port, general purpose input/output pins, and Plug-and-Play functionality within an integrated chip. For the PC notebook design environment, SMSC offers two families of PC I/O devices, the FDC37N95x and FDC37N769/FDC37N869. The FDC37N95x product family incorporates an integrated 8051 microcontroller enabling support for both internal keyboard scanning and control as well as very sophisticated Power Management features. The FDC37N769/FDC37N869 family provides notebook PC I/O services for designs where an external keyboard controller has already been selected, and where the designer's interests in PC I/O are more generally focused on the support for the floppy disk, parallel port, serial port, and general purpose input/output pins. Both device families offer support for the Infrared Data Association (IrDA) 1.0 and 1.1 protocol, enabling wireless communications support at speeds of between 115 Kbps and 4 Mbps using this standard technique. PERSONAL COMPUTER CONNECTIVITY products rely on new communications standards utilizing Universal Serial Bus (USB) and IEEE1394 to enable enhanced communications features for both the PC Original Equipment Manufactures (OEM) and PC peripheral device customers. The USB97C100 expands the functionality of USB through the use of patented technology originally developed and delivered in the Company's 10BASE-T LAN products. This technology enables the OEM community to exploit the full bandwidth of USB, enabling its use in applications previously limited to motherboard devices such as floppy disk interfaces, parallel port support, and similar legacy input/output functions. The Company intends to introduce several new devices in this product family this fiscal year, including an enhanced version of the USB97C100 that incorporates a USB hub function and a single-chip USB Ethernet Solution. The Company is in the process of defining similar connectivity products based on a peripheral interface technology known as Device Bay, utilizing the performance capabilities of IEEE 1394 in combination with the control logic required to support the Device Bay environment. Originally developed by Apple Computer under the name "Firewire", the IEEE 1394 standard has become the established mechanism for high speed communications of isochronous data such as audio and video in entertainment applications. The use of this technology in the PC environment enhances the trend towards the convergence of the PC and the entertainment media such as TVs, VCRs, and camcorders. This technology is also an excellent vehicle for use with high speed mass storage devices as a future upgrade from parallel interfaces such as IDE and SCSI. PERSONAL COMPUTER LOCAL AREA NETWORKING (PC LAN) devices enable personal computers to be connected to networks and permit communications among LAN users. Connection to a LAN permits a PC user to send messages to and receive messages from other LAN users and share common resources such as printers, disk drives, files and programs. The Company's PC LAN product line includes the LAN9000, Feast, and EPIC families of Ethernet and Fast Ethernet integrated circuits, covering applications for desktop and notebook PCs. One of the products the Company plans to introduce in fiscal 2000 is the MAC99 (LAN83Cxxx) which is the successor to both the LAN83C171 and the LAN83C175 devices. Both the LAN83C171 and the LAN83C175 are in the EPIC family of Fast Ethernet controllers. The MAC99 will offer advanced Power Management features providing the ideal solution for PCI, Cardbus, LAN on the Motherboard, and mini PCI applications. To complement the FEAST and the EPIC families, SMSC plans to also release a 10/100 Mbps PHY - a complete physical layer solution in a single chip. This device, the LAN83C180, integrates the 10/100 Ethernet Transceiver with a full MII Interface. This chip, with features like Auto Negotiate, Half and Full Duplex, transceiver filters, low power mode, and flow control, is specifically matched to SMSC MACs. PC SYSTEMS LOGIC, also known as core logic, includes the circuits that interface to the microprocessor (CPU) and control the major functions of the PC. The primary PC systems logic components are the North Bridge, or System Controller, and the South Bridge. The North Bridge, which connects directly to the CPU, provides control of the memory and bridges the CPU to the PCI bus, which provides a path between the CPU and all other elements of the PC. The South Bridge resides on the PCI bus and creates the ISA, IDE, and the USB buses as well as other functions like Power Management. The Company's TeXas chipset includes the SLC90E42 North Bridge and the SLC90E46 South Bridge devices. These full-featured devices are designed to industry standards and are compatible with the Intel Pentium as well as the AMD, Cyrix, and IDT CPUs. This new product family was introduced during fiscal 1999. As the PC market continues to expand, there is a greater demand to merge the separate PC systems logic, PC I/O, and graphics controller products into a single solution to offer motherboard designers new levels of integration, space saving, and layout simplification. The Company is developing devices which combine advanced PC I/O functions with parts of the PC systems logic. The Company has not previously offered PC Systems Logic products, and there can be no assurance that the Company's products will compete successfully in the PC Systems Logic marketplace. EMBEDDED NETWORKING devices are used in machine to machine communications. They are found in passenger elevator systems, locomotives, ATM machines, HVAC control systems, factory automation, point-of-sale systems and a wide variety of applications where reliability of communications between machines is of paramount importance. ARCNET protocol devices are used in, and have many characteristics that make it ideal for, industrial and embedded networking environments. This is due to the deterministic nature of ARCNET, its high reliability and fault tolerance, and its adaptability to a wide variety of cabling media and configurations. SMSC introduced its first ARCNET LAN protocol device, the COM9026, in 1981 and has been a market leader in ARCNET devices ever since. GEOGRAPHIC INFORMATION All of the Company's consolidated revenues are recorded by Standard Microsystems in the United States, with the exception of revenues from customers in Japan, which are recorded by Toyo Microsystems Corporation (TMC). The Company conducts various sales and marketing operations outside of the United States through its subsidiaries in Europe and Asia, and TMC in Japan. 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. Included within other long-lived assets is an equity investment of $19,944,000 in Singapore-based Chartered Semiconductor Manufacturing Ltd. EXPORT SALES The information below summarizes sales to unaffiliated customers by geographic region (in thousands): For the years ended February 28, 1999 1998 1997 - --------------------------------------------------------------------------- North America $26,041 $40,570 $57,028 Asia and Pacific Rim 115,146 98,128 113,369 Europe 14,467 9,311 10,060 Rest of World 172 317 461 - --------------------------------------------------------------------------- $155,826 $148,326 $180,918 =========================================================================== MAJOR CUSTOMERS During fiscal 1999, one customer accounted for 11.8% of the Company's revenues. In fiscal 1998, no customer accounted for more then 10% of the Company's revenues. In fiscal 1997, one customer accounted for 13.9% of the Company's revenues. The Company sells its product into the Japanese marketplace through its majority owned subsidiary, Toyo Microsystems Corporation. Toyo Microsystems Corporation also sells local area networking products purchased from SMC Networks, Inc., of which SMSC owns 19.9%. 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. 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 pressures may require the reduction of selling prices more quickly than such cost reductions can be achieved. In addition, the Company sometimes approves price reductions on specific sales opportunities to meet competition. If not offset by reductions in manufacturing costs or by a shift in the mix of products sold toward higher-margined products, declines in the average selling prices can reduce gross margins. Sales of most of the Company's products depend largely on sales of personal computers. Changes in the rate of growth in the PC market could adversely affect the Company's operating results. In addition, as a component supplier to PC manufacturers, the Company often experiences a greater magnitude of demand fluctuation than its customers themselves experience. Also, some of the Company's products are used in PCs for the consumer market, which, in recent years, has tended to be a more volatile market than other segments of the PC marketplace. The principal methods SMSC uses to compete include introduction of new products and added features, price, performance, servicing customers and reducing manufacturing costs. While past performance can be a guide, there is no assurance that the Company can improve or maintain its historical gross profit margins. RESEARCH AND DEVELOPMENT During the fiscal year, which ended February 28, 1999, SMSC spent $17.4 million on research and development ("R&D") activities. This compares with $14.3 million expended during fiscal 1998 and $12.8 million expended during fiscal 1997. The increases in both periods reflect increased engineering staff as well as increases in other development costs. The Company's R&D efforts include new product design, qualification, and a continuous migration to smaller geometries and more advanced process technologies. The Company has been able to maintain and increase its gross margins through these efforts while decreasing average selling prices to meet the competition. The Company has in the past considered, and will in the future continue to consider, the acquisition of other companies or the products and technologies of other companies. Such acquisitions carry additional risks such as a lack of integration with existing products and corporate culture, the potential for large write-offs and the diversion of management attention. There can be no assurance that the Company will be able to respond effectively to new competitive product offering and technological shifts in the future. MANUFACTURING While many of the Company's competitors operate their own semiconductor manufacturing plants, the Company's products are manufactured, assembled and tested by independent foundries and subcontract manufacturers. The Company's 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. The semiconductor industry has at times experienced shortages of manufacturing capacity which has adversely affected the Company's ability to meet the demand for its products. 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 increasing, as customers continue to place orders with increasingly shorter lead times. 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. However, no assurance can be given that the steps taken by the Company will adequately protect its proprietary rights. The Company has patent cross-licensing agreements with more than thirty companies, including such semiconductor manufacturers as Texas Instruments, Intel, IBM, Hitachi and AT&T. Almost all of these cross-licensing agreements give SMSC the right to use, royalty-free, the patented intellectual property of the other companies. In situations where SMSC needs to acquire strategic intellectual property not covered by cross-licenses, the Company enters into purchase agreements with the companies that own the required intellectual property. No assurance can be given that satisfactory license agreements will be obtained if sought by the Company or that failure to obtain any such licenses would not adversely affect the Company's future operations. SALES AND DISTRIBUTION The Company sells the largest portion of its products to original equipment manufacturers (OEMs), of which producers of personal computers are the largest customer group. In addition, products are also sold to distributors of electronic components. In accordance with industry practice, distributor inventory is protected with respect to price on inventories which the distributor may have on hand at the time of a change in the published list price. Also, again in accordance with industry practice, slow moving inventory may be exchanged for other inventory of equal value. 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. BACKLOG 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. In light of industry practice and experience, the Company believes that backlog is not a particularly meaningful indicator of future sales. ENVIRONMENTAL REGULATION Federal, state and local regulations impose various controls on the discharge of certain chemicals and gases used in semiconductor processing. The Company's facilities have been designed to comply with these regulations. However, increasing public attention has focused on the environmental impact of electronics manufacturing operations and, accordingly, there is no assurance that future regulations will not impose significant costs on the Company. EMPLOYEES As of February 28, 1999, of the Company's 538 employees, 426 were employed within the Company's continuing integrated circuits business. Of these 426 employees, 100 were engaged in engineering, including research and development, 91 in marketing and sales, 104 in executive and administrative activities and 131 in manufacturing and manufacturing support. The Company's Foundry Business Unit, now classified as a discontinued operation, had 112 employees as of February 28, 1999, most of whom were engaged in manufacturing or manufacturing support. Many employees are highly skilled and SMSC's success depends upon its ability to retain and attract such employees. 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 satisfactory. - ------------------------------------------------------------------------------- SMSC and Standard Microsystems are registered trademarks of Standard Microsystems Corporation. Product names and company names are the trademarks of their respective holders. ITEM 2. PROPERTIES. - -------------------- The Company owns five facilities, totaling approximately 249,000 square feet of plant and office space, located on approximately 28 acres in Hauppauge, New York, where research, development, product testing, warehousing, shipping, marketing, selling and administrative functions are conducted. In addition, the Company maintains offices in leased facilities in San Jose, California; Westborough, Massachusetts; Austin and Houston, Texas; Munich, Germany; Tokyo, Japan and Taipei, Taiwan. As of February 28, 1999, the Company owned machinery and equipment, property and leasehold improvements with an original cost of $97.6 million and accumulated depreciation and amortization of $62.9 million. ITEM 3. LEGAL PROCEEDINGS. - --------------------------- The Company is subject to various lawsuits and claims in the ordinary course of business. While the outcome of these matters can not be determined, management believes that the ultimate resolution of these matters will not have a material effect on the Company's operations or financial position. During fiscal 1998, 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) for approximately $40,237,000 in cash, $2,012,000 of which was placed into an escrow account. 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 $10,000,000 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 has not been released. In January 1999, the Company filed an action against Accton, SMC Networks, Inc. and other parties in the Supreme Court of the State of New York, 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 $1,685,000 (which is included within other current assets on the Company's consolidated balance sheet) owed to the Company by SMC Networks, Inc. as of February 28, 1999. This action is as yet unresolved. The Company is confident that it negotiated and fully performed the agreements with Accton in good faith. While it is not possible at this time to assess the likelihood of any liability being established, the Company considers these claims to be without merit. The Company will vigorously defend itself against these allegations and expects that the outcome will not be material to the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. - ------------------------------------------------------------- Not applicable. EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------ The following were the executive officers of Standard Microsystems Corporation as of April 30, 1999, their ages as of April 30, 1999, their current titles and positions held during the last five years: Steven J. Bilodeau (age 40) was appointed as the Company's President and Chief Executive Officer in March 1999. Prior to joining SMSC, Mr. Bilodeau held various senior management positions during his 13 years of service with Robotic Vision Systems Inc. (RVSI), most recently as President of RVSI's Semiconductor Equipment Group from 1996 through 1998, and as a member of RVSI's board of directors from 1997 through 1998. Paul Richman (age 56) has served as the Company's Chairman of the Board since 1994. He also served as Chief Executive Officer of the Company from July 1995 to March 1999. Mr. Richman has been an officer of the Company since 1971. Arthur Sidorsky (age 65) has served as the Company's Chief Operating Officer since 1997, and he also served as its President from October 1997 to March 1999. Previously, he served as its Executive Vice President - Component Products Division from 1994 to 1997. Mr. Sidorsky has been an officer of the Company since 1980. George W. Houseweart (age 57) has served as the Company's Senior Vice President and General Counsel since January 1999. Previously, he served as Senior Vice President - Law and Intellectual Property from 1997 to 1999 and as Vice President - Law and Intellectual Property from 1994 to 1997. Mr. Houseweart has been an officer of the Company since 1988. Eric M. Nowling (age 42) has served as the Company's Vice President - Finance and Chief Financial Officer since September 1997; as Vice President and Controller (and acting Chief Financial Officer) from February 1997 to September 1997; as Vice President and Controller from 1995 to 1997; and as Controller from 1994 to 1995. Mr. Nowling has been an officer of the Company since 1995. All officers serve at the pleasure of the Company's Board of Directors. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. - ------------------------------------------------------------------------------- The information captioned "Market Price" and the last two paragraphs appearing in the Company's 1999 Annual Report to Shareholders (the "1999 Annual Report") under the heading "Quarterly Financial Data" are incorporated herein by this reference. Except as specifically set forth herein and elsewhere in this Form 10-K, no information appearing in the 1999 Annual Report is incorporated by reference into this report nor is the 1999 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 1999 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 1999 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 following discussion about the Company's market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. The Company does not use derivative financial instruments for speculative or trading purposes. INTEREST RATE RISK As of February 28, 1999, the Company's short-term investments of $2 million consisted primarily of investments in U.S. treasury, corporate 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 February 28, 1999, the fair value of these short-term investments would decline by an immaterial amount. The Company generally expects to have the ability 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 the effect of a sudden change in market interest rates on short-term investments. FOREIGN CURRENCY EXCHANGE 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, Toyo Microsystems Corporation (TMC), are denominated in Japanese yen. The Company has never received a cash dividend (repatriation of cash) from TMC nor does it have plans to do so in the near future. The Company has not entered into any currency hedging activities. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - ----------------------------------------------------- The financial statements, notes thereto, Report of Independent Public Accountants thereon and quarterly financial data appearing in the 1999 Annual Report are incorporated herein by this reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. - --------------------------------------------------------------------- Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - ------------------------------------------------------------ The information appearing in the Company's Proxy Statement related to the 1999 Annual Meeting of Stockholders (the "1999 Proxy Statement") under the caption "Election of Directors" is incorporated herein by this reference, and reference is made to the information under the heading "Executive Officers of the Registrant" in Part I hereof. ITEM 11. EXECUTIVE COMPENSATION. - --------------------------------- The information appearing in the 1999 Proxy Statement under the caption "Executive Compensation" is incorporated herein by this reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. - ------------------------------------------------------------------------ The information appearing in the 1999 Proxy Statement under the captions "Election of Directors" and "Voting Securities of Certain Beneficial Owners and Management" is incorporated herein by this reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - -------------------------------------------------------- The information appearing in the 1999 Proxy Statement under the caption "Certain Relationships and Related Transactions" is incorporated herein by this reference. Part IV ITEM 14. 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 have been incorporated by reference from the 1999 Annual Report pursuant to Part II, Item 8: Consolidated Statements of Operations for the three years ended February 28, 1999 Consolidated Balance Sheets as of February 28, 1999 and 1998 Consolidated Statements of Shareholders' Equity for the three years ended February 28, 1999 Consolidated Statements of Cash Flows for the three years ended February 28, 1999 Notes to Consolidated Financial Statements Report of Independent Public Accountants 2. Financial Statement Schedules Schedules are omitted because of the absence of conditions requiring them or because the required information is shown on the consolidated financial statements or the notes thereto. 3. Exhibits Exhibits, which are listed on the Exhibit Index, are filed as part of this report and such Exhibit Index is incorporated by reference. Exhibits 10.1 through 10.19 listed on the accompanying Exhibit Index identify management contracts or compensatory plans or arrangements required to be filed as exhibits to this report, and such listing is incorporated herein by reference. (b) Reports on Form 8-K No report on Form 8-K was filed during the last quarter of the period covered by this report. 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/ ERIC M. NOWLING -------------------- Eric M. Nowling Vice President - Finance and Chief Financial Officer (Principal Financial and Accounting Officer) Date: May 27, 1999 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/ PAUL RICHMAN May 27, 1999 ----------------- Paul Richman, Chairman of the Board And Director /s/ STEVEN J. BILODEAU May 27, 1999 ----------------------- Steven J. Bilodeau, President and Chief Executive Officer (Principal Executive Officer) /s/ EVELYN BEREZIN May 27, 1999 ------------------ Evelyn Berezin Director /s/ JAMES R. BERRETT May 27, 1999 -------------------- James R. Berrett Director /s/ ROBERT M. BRILL May 27, 1999 ------------------- Robert M. Brill Director /s/ PETER F. DICKS May 27, 1999 ------------------ Peter F. Dicks Director /s/ KATHLEEN B. EARLEY May 27, 1999 ---------------------- Kathleen B. Earley Director /s/ IVAN T. FRISCH May 27, 1999 ------------------ Ivan T. Frisch Director EXHIBIT INDEX Incorporated By Reference To: Exhibit No. Exhibit Exhibit 3 (a) [3] 3.1 Restated Certificate of Incorporation. Exhibit 3 (b) [12] 3.2 By-Laws, as amended. Exhibit 1 [13] 4.1 Rights Agreement dated January 7,1998, with ChaseMellon Shareholder Services L.L.C., as Rights Agent. Exhibit 10.1[6] 10.1 Employment Agreement with Paul Richman, dated March 1, 1995. Exhibit 10.2 [8] 10.2 Amendment to Employment Agreement with Paul Richman dated July 10, 1995. Exhibit 10.3 [15] 10.3 Amendment Number Two to Employment Agreement with Paul Richman dated January 19,1998. Exhibit 10.3 [12] 10.4 Employment Agreement with Arthur Sidorsky, dated March 1, 1996. * 10.5 Employment Agreement with Steven J. Bilodeau dated March 18, 1999. Registrant's Proxy Statement dated 10.6 1989 Stock Option Plan. June 6, 1989, Exhibit A Registrant's Proxy Statement dated 10.7 1991 Restricted Stock Bonus June 21, 1991, Exhibit A Plan. Registrant's Proxy Statement dated 10.8 Director Stock Option Plan. May 29, 1990, Exhibit A Registrant's Proxy Statement dated 10.9 1994 Director Stock Option Plan. May 31, 1995, Exhibit A Exhibit 10 (m) [4] 10.10 Resolutions adopted February 18, 1992, amending Director Stock Option Plan, 1991 Restricted Stock Bonus Plan and 1989 Stock Option Plan. Registrant's Proxy Statement dated 10.11 Amendment adopted July 14, 1998, June 1, 1998, Page 11. amending the Director Stock Option Plan. Exhibit 10.14 [6] 10.12 Retirement Plan for Directors. Registrant's Proxy Statement dated 10.13 1993 Stock Option Plan for May 25, 1993, Exhibit A Officers and Key Employees. Exhibit 10(x) [5] 10.14 Executive Retirement Plan. Registrant's Proxy Statement dated 10.15 1994 Stock Option Plan for May 26, 1994, Exhibit A Officers and Key Employees. Exhibit 10.18 [6] 10.16 Resolutions adopted October 31, 1994, amending the Retirement Plan for Directors and the Executive Retirement Plan. Exhibit 10.19 [6] 10.17 Resolutions adopted January 3, 1995, amending the 1994, 1993 and 1989 Stock Option Plans and the 1991 Restricted Stock Plan. [14] 10.18 1996 Restricted Stock Bonus Plan. Registrant's Proxy Statement dated 10.19 1998 Stock Option Plan for June 1, 1998, Exhibit A Officers and Key Employees. Exhibit 10.2 [1] 10.20 Patent and Trade Secrets Agreement dated March 12, 1983, with Paul Richman. Exhibit 2 [7] 10.21 Asset Purchase Agreement dated January 9, 1996, among Cabletron Systems, Inc., and SMC Enterprise Networks, Inc. Exhibit 10.30 [8] 10.22 Agreement for Purchase and Sale of Assets among SMSC, EFAR Microsystems, Inc., and the Key Officers identified therein dated February 26, 1996. Registrant's Proxy Statement dated 10.23 1996 Stock Option Plan for July 22, 1996, Exhibit A Officers and Key Employees. Item 7, Exhibit 1 [9] 10.24 Common Stock and Warrant Purchase Agreement, among SMSC and Intel Corporation, dated March 18, 1997. Item 7, Exhibit 2 [9] 10.25 Warrant to Purchase Shares of Common Stock of Standard Microsystems Corporation, among SMSC and Intel Corporation, dated March 18, 1997. Item 7, Exhibit 3 [9] 10.26 Investor Rights Agreement, among SMSC and Intel Corporation, dated March 18, 1997. Exhibit 10.1 [10] 10.27 Amended and Restated Credit Agreement, dated as of May 23, 1997; Subsidiaries Security Agreement, dated as of May 23, 1997; Amended and Restated Guarantee, dated as of May 23, 1997; and Borrower Security Agreement, dated as of May 23, 1997. Exhibit 10.1 [11] 10.28 Stock Purchase Agreement, dated September 30, 1997, among Accton Technology Corporation, Global Business Investments (B.V.I.) Corp., Standard Microsystems Corporation, the Seller Subsidiaries, and AJJA Inc. Exhibit 10.2 [11] 10.29 Stockholders Agreement, dated October 7, 1997, among Standard Microsystems Corporation, Accton Technology Corporation, Global Business Investments (B.V.I.) Corp., and AJJA Inc. Exhibit 10.3 [11] 10.30 Transition Services Agreement, dated October 7, 1997, between AJJA Inc. and Standard Microsystems Corporation. Exhibit 10.4 [11] 10.31 Intellectual Property License Agreement, dated October 7, 1997, between Standard Microsystems Corporation and AJJA Inc. * 13 Portions of Annual Report to Stockholders for year ended February 28, 1999, incorporated by reference. * 21 Subsidiaries of the Registrant * 23 Consent of Arthur Andersen LLP * 27 Financial Data Schedule * Filed herewith. [1] Registrant's Quarterly Report on Form 10-Q for the quarter ended August 31, 1983. [2] Registrant's Annual Report on Form 10-K for fiscal year ended February 29, 1988. [3] Registrant's Annual Report on Form 10-K for fiscal year ended February 28, 1991. [4] Registrant's Annual Report on Form 10-K for fiscal year ended February 29, 1992. [5] Registrant's Annual Report on Form 10-K for fiscal year ended February 28, 1994. [6] Registrant's Annual Report on Form 10-K for fiscal year ended February 28, 1995. [7] Registrant's Current Report on Form 8-K dated January 26, 1996. [8] Registrant's Annual Report on Form 10-K for fiscal year ended February 29, 1996. [9] Schedule 13D filed by Intel Corporation, dated March 27, 1997. [10] Registrant's Quarterly Report on Form 10-Q for quarter ended May 31, 1997. [11] Registrant's Current Report on Form 8-K dated October 7, 1997. [12] Registrant's Annual Report on Form 10-K for fiscal year ended February 28, 1997. [13] Registrant's Registration Statement on Form 8-A dated January 15, 1998. [14] Registrant's Board of Directors resolution dated November 26, 1996, authorizing the Registrant to grant awards of up to 350,000 shares of common stock to employees, similar to those awards provided by the 1991 Restricted Stock Bonus Plan. [15] Registrant's Annual Report on Form 10-K for fiscal year ended February 28, 1998. EX-10.5 2 EXHIBIT 10.5 Exhibit 10.5 EMPLOYMENT AGREEMENT Agreement made as of 18 March 1999 between Standard Microsystems Corporation, a Delaware corporation having an office at 80 Arkay Drive, P.O. Box 18047, Hauppauge, New York 11788 ("Company"), and Steven J. Bilodeau, residing at 9 Merriman Point Road, Center Sandwich, NH 03227 ("Executive"). W I T N E S S E T H: WHEREAS, Company desires to employ Executive as Company's President and Chief Executive Officer, upon the terms and conditions hereinafter in this Agreement set forth, and Executive desires to be so employed; Now, therefore, in consideration of the premises and the mutual covenants and conditions contained herein, the parties hereto agree as follows: 1. Employment. The Company hereby agrees to employ the Executive, and the Executive hereby accepts such employment, upon the terms and conditions hereinafter set forth. 2. Title and Duties. Company shall employ Executive as Company's President and Chief Executive Officer, effective as of the date of execution hereof. Executive will render his services faithfully and to the best of his ability and devote his full business time and attention to the services to be rendered by him hereunder. As quickly as reasonably possible, but in any event not later than 1 January 2000, Executive shall establish a residence in Long Island, New York, but Executive shall not thereafter be required to relocate outside of Long Island, New York. Company shall use best efforts to cause Executive's election and re-election as a director of Company during the Employment Term. 3. Term; Severance; Change in Control. a. The term of employment under this Agreement (the "Employment Term") shall commence as of the date hereof and shall continue through 18 March 2002. Thereafter, the Employment Term shall be automatically extended for one-year periods, unless either party shall give notice ("Contrary Notice"), at least six months prior to the end of the Employment Term, that the Employment Term shall not be so extended. b. Notwithstanding Section 3.a, the Employment Term shall terminate prior to any date otherwise specified in Section 3.a, upon: (i) Executive's death or disability ("disability" shall mean the physical or mental incapacity of the Executive which prevents Executive from performing the Executive's duties as herein provided for a continuous period of 60 days or an aggregate period of 90 days during any consecutive six-month period, and disability shall be deemed to have occurred as of the end of the applicable period); (ii) notice by Company of termination for cause, which shall mean Executive's (w) material dishonesty in the course of employment, (x) willful and material failure to perform his duties hereunder, following delivery of written notice thereof and a reasonable period, not to exceed 30 days from delivery of notice, to cure such failure, or (z) conduct, regardless of whether in the course of employment, constituting a felony or any crime involving moral turpitude; (iii) notice by Company of termination other than for cause. Reduction of compensation or duties, or requirement to relocate outside of Long Island or other breach hereof and failure to cure within 30 days following delivery of written notice thereof by Executive to Company shall be considered notice of termination under this subsection. Contract nonrenewal by Company shall also be considered notice of termination under this subsection; (iv) notice of voluntary termination by Executive within six months after a change in control of Company (for purposes hereof, a "change in control of Company" shall mean an event that Company would be required to report as such pursuant to Securities and Exchange Commission ("SEC") Form 8-K); or (v) notice of voluntary termination by Executive within six months after Company's shareholders fail to elect Executive as a member of the Company's Board of Directors. c. Should Company terminate the Employment Term pursuant to clauses (i) or (iii) of Section 3.b: (i) Company shall pay Executive, in lump sum on the day of termination, an amount equal to one year's Base Salary, any vested or unvested stock grants, any deferred compensation (if any deferred compensation plan shall be adopted in the future), any accrued, unused vacation and unreimbursed business expenses (including automobile and relocation expense, and tax gross up on such automobile and relocation expenses); (ii) Company shall pay any accrued, unpaid Bonus, as hereinafter defined, (i.e., a pro-rated amount of the Bonus that Executive would have earned if Executive remained employed through the then current fiscal year of Company, to be based on the number of weeks employed during the then current fiscal year), payable at the same time such Bonus would have been paid for such fiscal year; (iii) Company shall continue to provide paid coverage for life insurance, and all group health insurance plans under COBRA, provided by Company to Executive as of the date of such termination, for a period of 18 months from the date of termination of the Employment Term, or until Executive shall have sooner obtained full-time employment; (iv) insofar as any stock option granted by Company to Executive would have, but for such termination, become exercisable in accordance with its terms within 13 months of the date of such termination, such option shall become exercisable as of such termination date, remain exercisable during such 13 month period, and expire at the end of such 13 month period. This Section 3.c sets forth Company's entire obligation to Executive in case of termination of the Employment Term on any basis referred to in this Section 3.c. d. Should Company terminate the Employment Term pursuant to clause 3.b (ii), Company's obligations hereunder shall be fully satisfied upon payment by the Company to the Executive of any unpaid Base Salary, accrued, unused vacation time and unreimbursed business expenses through the date of termination, provided, however, that such payment shall not prevent the Company from seeking relief respecting any claim it might have against the Executive hereunder or otherwise. e. In the event of either a change in control of Company or the Company's shareholders' failing to elect Executive as a member of the Board of Directors or removing Executive as a Director once elected, all stock options, all stock grants and deferred compensation (if any deferred compensation plan shall be adopted in the future) shall immediately vest, and, should Executive terminate the Employment Term pursuant to clause 3.b.(iv) or (v), Executive shall be entitled to the payments and insurance coverage referred to in clauses 3.c(i), (ii) and (iii). 4. Annual compensation. a. In consideration of the services to be rendered by Executive hereunder, the Company shall pay to the Executive: (i) an annual base salary of $350,000, which may be increased, but not decreased without Executive's consent, from time to time, by Company's Board of Directors, based upon Compensation Committee review and recommendation ("Base Salary"); and (ii) a management incentive bonus ("Bonus"), with respect to fiscal year 2000 equal to 80 percent of Base Salary, i.e., $280,000 (the "Guaranteed Bonus"), payable in cash immediately upon execution hereof or at the time requested by Executive, and any additional earned Bonus for fiscal year 2000 (under the plan described below) and a Bonus with respect to each succeeding fiscal year, determined in accordance with Company's EVC Plan payable within 75 days following the end of such fiscal year. Should Company terminate the Employment Term for cause, or should Executive terminate the Employment Term voluntarily (other than on account of Company's material breach hereof or pursuant to clauses (iv) or (v) of Section 3.b), in either case prior to 1 March 2000, Executive shall pay to Company, on the date of such termination, as liquidated damages, and not as penalty, an amount equal to the product obtained by multiplying the Guaranteed Bonus (insofar as paid to Executive) by a fraction, the numerator of which shall be the number of whole calendar days remaining in Company's fiscal year 2000, and the denominator of which shall be 365 (such fraction, the "Forfeiture Fraction."). The Bonus plan is defined by the Board of Directors for each fiscal year, and, during the Company's fiscal year 2000, it shall be based on the Company achieving specific changes in economic profit generated or Economic Value Contributed ("EVC"). The fiscal year 2000 EVC plan for the Company will be provided in a separate document. However, some of the major provisions of the plan provide for an EVC target, indexing Company EVC performance to the market, and additional bonus payment for over target EVC performance not to exceed 75% of the at-plan Bonus amount, i.e., for fiscal year 2000 not to exceed $210,000 over the Bonus amount of $280,000 specified in 4.a. (ii). The target Bonus for Executive will remain at 80% of Base Salary for the Company's fiscal years 2001 and 2002; however, the basis on which Bonus is earned may be modified by the Board of Directors. Any Bonus plan approved by the Board of Directors for Executive will be consistent with the management incentive bonus plan for other Company executives. b. Any Bonus payable respecting fiscal year 2001 shall be paid 75% in cash, and the balance shall be paid in shares of Company common stock having a total Market Value, as hereinafter defined, equal to 25% of the amount of such Bonus. Any Bonus payable respecting any subsequent fiscal year shall be paid 50% in cash, and the balance shall be paid in shares of Company common stock having a total Market Value equal to 50% of the amount of such Bonus. All common stock so issued shall be subject to the same transfer restrictions and forfeiture under the same conditions as shall apply generally to Company bonus awards of Company common stock, except as otherwise provided herein in paragraphs 3 and 6. Executive shall have the right to demand registration for all vested stock and Company shall use best effort to cause such registration at Company expense to be effective. c. For purposes hereof, Market Value of a share of Company common stock shall mean the closing sale price of such a share on the date that Company's independent accountants shall have completed the audit for the fiscal year respecting which the Bonus shall be paid. 5. Benefits; Expenses. Executive shall be entitled to such benefits as are provided generally to Company's senior executive officers. In addition, Executive shall receive a $1,200 per month car allowance, plus all expenses, including insurance, repairs and maintenance, fuel and normal travel expenses (i.e. tolls, parking, etc.). All the preceding expenses are fully tax protected. On or about 1 January 2000, Executive will be provided with a Company-leased car (STS or similar), at which time the $1,200 per month car allowance will cease, but the other expenses will continue to be reimbursed and any reportable income associated with the use or expense of the leased car will be fully tax protected. Company shall furnish Executive with individual supplemental life insurance coverage in the amount of $312,500 and individual disability income coverage. Company shall furnish and maintain continuously directors and officers liability insurance coverage during employment, and will continue to indemnify and advance legal expenses on behalf of Executive, during Employment Term and after termination for actions occurring during the Employment Term to the extent permitted by law. Executive shall accrue vacation time at a rate of twenty days per year. Company will grant Executive, effective the date hereof, options to purchase 280,000 shares of Company Common Stock with four-year (25% per year) vesting and ten-year expiration. Executive's benefit under the Executive Retirement Plan shall vest 50% after five years of service and pro-ratably over the next five years as to the remaining 50%. 6. Relocation Assistance. Company shall reimburse travel and living expenses in the Hauppauge, NY area for Executive through 31 December 1999 and pay packing and moving expenses incident to relocation of Executive's household to the Hauppauge area. Any tax ramifications of the above travel, living, packing or moving expenses will be reimbursed. On execution hereof, Company shall issue to Executive 20,000 shares of Company common stock, and use best efforts to register the shares for resale by 30 June 1999. Should Company terminate the Employment Term for cause, or should Executive terminate the Employment Term voluntarily (other than on account of Company's material breach hereof or pursuant to 3.b.(iv) or 3.b.(v)), in either case prior to 1 March 2000 or upon purchase of a home on Long Island, whichever is earlier, Executive shall, as liquidated damages, and not as penalty, transfer to Company a number of shares of Company common stock equal to 20,000 multiplied by the Forfeiture Fraction, or an amount equal to the product obtained by multiplying 20,000 by the Forfeiture Fraction and multiplying that amount by the mean of the closing sale prices of the Company common stock on the first ten trading days following effectiveness of the registration of the shares for resale. At Executive's request prior to 1 January 2000, Company shall lend Executive up to $60,000, on an unsecured basis, and up to an additional $100,000, secured by the common stock referred to in the second preceding sentence, to defray relocation costs. Any such loan(s) shall be repayable five years from issuance and bear the same interest as is earned on Company cash deposits in its bank accounts, payable quarterly. 7. Other Considerations. Company shall provide up to ten days off for Executive to participate in Robotic Vision Systems, Inc.'s pending patent suit litigation. Company shall permit Executive to hold up to two outside directorships with companies not competing with Company. 8. Intellectual Property. a. Assignment of Inventions. (i) Subject to paragraph (a)(ii) below, Executive hereby assigns and agrees to assign to Company, or to any business concern controlled by or under common control with Company ( "Company Affiliate") as Company shall specify, all of Executive's right, title and interest in and to any inventions, formulas, techniques, processes, ideas, algorithms, discoveries, designs, developments and improvements which Executive may make, reduce to practice, conceive, invent, discover, design or otherwise acquire during Executive's employment by Company or any Company Affiliate, whether or not made during regular working hours, relating to the actual or anticipated business, products, research or development of Company or any Company Affiliate (collectively, "Inventions"). (ii) The foregoing shall not apply to, and Executive shall not be required to assign any of Executive's rights in, an invention that Executive developed entirely on Executive's own time without using any equipment, supplies, facilities, computer programs, or trade secret(s) and/or other proprietary and/or confidential information of Company or any Company Affiliate, except for those inventions that either: (1) relate directly or indirectly at the time of conception or reduction to practice of the invention, to the business of Company or any Company Affiliate, or to the actual or contemplated products, research or development of Company or any Company Affiliate, or (2) result from any work performed by Executive for Company or any Company Affiliate. b. Trade Secrets. Executive shall regard and preserve as confidential: (x) all trade secrets and/or other proprietary and/or confidential information belonging to Company or any Company Affiliate; and (y) all trade secrets and/or other proprietary and/or confidential information belonging to a third party which have been confidentially disclosed to Company or any Company Affiliate, which trade secrets and/or other proprietary and/or confidential information described in (x) and (y) above (collectively, "Confidential Information") have been or may be developed or obtained by or disclosed to Executive by reason of Executive's employment. Executive shall not, without written authority from Company to do so, use for Executive's own benefit or purposes, or the benefit or purpose of any person or entity other than Company or any Company Affiliate, nor disclose to others, either during Executive's employment with Company or thereafter, except as required in the course of employment with Company or any Company Affiliate, or except as required by law, any Confidential Information (Executive, as CEO, shall have the usual and customary discretion to determine when disclosure is required for the benefit of Company). This provision shall not apply to Confidential Information that has been voluntarily disclosed to the public by Company or any Company Affiliate, or otherwise entered the public domain through lawful means. Confidential Information shall include, but not be limited to, all nonpublic information relating to any of the following regarding Company or any Company Affiliate: (1) business, research, development and marketing plans, strategies and forecasts; (2) business; (3) products (whether existing, in development, or being contemplated); (4) customers' identities, usages, and requirements; (5) reports; (6) formulas; (7) specifications; (8) designs, software and other technology; (9) research and development programs; and (10) terms of contracts. c. Works of Authorship. Executive agrees that any original works of authorship, including, without limitation, all documents, blueprints, drawings, mask works and computer programs (including, without limitation, all software, firmware, object code, source code, documentation, specifications, revisions, supplements, modules, and upgrades), conceived, created, performed or produced during the term of Executive's employment with Company or any Company Affiliate, and all foreign and domestic, registered and unregistered, copyrights and mask work rights and applications for registrations therefor related to any such work of authorship, in each case, whether or not made during regular working hours, relating to the actual or anticipated business, products, research or development of Company or any Company Affiliate (collectively, "Works of Authorship") shall be the exclusive property of Company or any Company Affiliate as Company shall specify. To the extent that Executive has or obtains any right, title or interest in or to any Works of Authorship, Executive hereby assigns and agrees to assign to Company or any Company Affiliate as Company shall specify, all of such right, title and interest therein and thereto. This paragraph does not include any publicly available materials, unless such materials shall have become public in violation of this Agreement. d. Disclosure. Executive shall promptly and fully disclose any and all Inventions and Works of Authorship to Company's General Counsel or other official as Company's Board of Directors may designate for such purpose. e. Further Assistance. Executive shall, during Executive's employment with Company or any Company Affiliate and at any time thereafter, upon the request of and at the expense of Company or such Company Affiliate, but at no additional compensation to Executive: do all acts and things including, but not limited to, making and executing documents, applications and instruments and giving information and testimony, in each case, deemed by Company from time to time, in its sole discretion, to be necessary or appropriate (1) to vest, secure, defend, protect or evidence the right, title and interest of Company in and to any and all Inventions, Works of Authorship and Confidential Information; and (2) to obtain for Company, in relation to all such, letters patent, design registrations, copyright registrations and/or mask work registrations, in the United States and any foreign countries, and/or any reissues, renewals and/or extensions thereof. f. Previous Obligations. Executive represents and warrants to Company that Executive has no continuing obligation with respect to assignment of inventions, developments or improvements to any previous employer(s), other than Robotic Vision Systems, Inc. respecting any invention, development, or improvement made prior to 1 March 1999, nor does Executive claim any existing title in any previous unpatented inventions, developments or improvements within the scope of this Section 8. except as may be set forth on an Exhibit hereto acknowledged on the face thereof as an Exhibit hereto by an authorized representative of Company. g. Return of Documents. All media on which any Inventions, Works of Authorship or Confidential Information may be recorded or located, including, without limitation, documents, samples, models, blueprints, photocopies, photographs, drawings, descriptions, reproductions, cards, tapes, discs and other storage facilities (collectively, "Documentation") made by Executive or that come into Executive's possession by reason of Executive's employment are the property of Company and shall be returned to Company by Executive upon termination of employment. Executive will not deliver, reproduce, or in any way allow any Documentation to be delivered or used by any third party without the written direction or consent of a duly authorized representative of Company. 9. Competition. Executive covenants and agrees that (a) for so long as he shall be employed by Company or any Company affiliate, he shall not, directly or indirectly, as principal, partner, agent, servant, employee, stockholder, or otherwise, anywhere in the world (the "Territory"), engage or attempt to engage in any business activity competitive with the business being conducted or, to the knowledge of Executive prior to Notice of Termination or actual termination, whichever is earlier, being planned to be conducted by Company or any Company affiliate, and (b) for one year after termination, Executive shall not, in the Territory, so engage or attempt to engage in any business activity competitive with any business conducted or planned to be conducted by any of Company or any Company affiliate within one year prior to termination. The foregoing shall not prohibit Executive, his affiliates, spouse, and children from owning beneficially any publicly traded security, so long as the beneficial ownership by all of them, when combined with the beneficial ownership of such publicly traded security by any person (as defined above) of which any of them is a member, constitutes less than 5% of the class of such publicly traded security. Executive recognizes that the foregoing territorial and time limitations are reasonable and properly required for the adequate protection of the business of Company and that in the event that any such territorial or time limitation is deemed to be unreasonable in any proceeding to enforce these provisions or otherwise, Executive agrees to request, and to submit to, the reduction of said territorial or time limitation to such an area or period as shall be deemed reasonable by the relevant tribunal. In the event that Executive shall be in violation of the foregoing restrictive covenants, then the time limitation thereof shall be extended for a period of time during which such breach or breaches shall occur. The existence of any claim or cause of action by Executive against Company, if any, whether predicated upon this Agreement or otherwise, shall not constitute a defense to the enforcement by Company of the foregoing restrictive covenants. 10. Miscellaneous. a. Executive agrees that a remedy at law for any breach or proposed or attempted breach of the provisions of Sections 8 or 9 shall be inadequate and that Company shall be entitled to injunctive relief with respect to such breach or proposed or attempted breach, in addition to any other remedy it might have. The provisions of Sections 8 and 9 shall be enforceable notwithstanding the existence of any claim or cause of action of Executive against Company or any Company Affiliate, whether predicated on such Section or otherwise. b. Except as otherwise provided herein, the agreements, assignments and appointments made by Executive hereunder and the obligations of Executive herein shall survive the termination of Executive's employment with Company, whether by Executive or Company. c. This Agreement may be modified only by a written instrument duly executed by the parties hereto. No term or provision of this Agreement shall be deemed waived, and no breach excused, unless such waiver or consent shall be in writing and signed by the parties hereto. The failure of either party or any Company Affiliate at any time to enforce performance of any provision of this Agreement shall in no way affect such person's rights thereafter to enforce the same, nor shall the waiver by any such person of any breach of any provision hereof be deemed to be a waiver of any other breach of the same or any other provision hereof. d. If any provision of this Agreement, or the application of such provision, is held invalid, the remainder of this Agreement and the application of such provision to persons or circumstances other than those as to which it is held invalid shall not be affected thereby. e. Any notice authorized or required to be given hereunder shall be deemed given or made, if in writing, upon personal delivery, by telecopier on the date that transmission is confirmed electronically, if such confirmation occurs by 4:00PM on such date and such date is a business day, or otherwise, on the first business day thereafter, or three days after mailing by certified or registered mail, return receipt requested, to the Company, at the address set forth at the top of the first page, to the attention of Mr. Paul Richman, Chairman of the Board, or to the Executive at the address to which this letter is addressed, as set forth above, or such other address of which either party shall give notice to the other. f. This agreement shall be governed by the laws of the state of New York, applicable to an agreement negotiated, signed, and wholly to be performed in such state. g. Any dispute arising hereunder (including but not limited to interpretation or performance) shall be resolved in New York, NY by arbitration before a single arbitrator in accordance with the rules of the American Arbitration Association, except that the arbitrator shall be an active member of the New York bar specializing for at least 15 years in general corporate law and contracts practice, who shall apply the terms of this agreement and make findings of fact and conclusions of law in making the arbitration award. IN WITNESS WHEREOF, the undersigned have executed this agreement on the dates below as of the date first written above. STANDARD MICROSYSTEMS CORPORATION /s/ Steven J. Bilodeau By: /s/ Paul Richman - ---------------------- --------------------- Steven J. Bilodeau Paul Richman Chairman of the Board Date: March 18, 1999 Date: March 18, 1999 EX-13 3 EXHIBIT 13 Exhibit 13 PAGE 11: FINANCIAL REVIEW Selected Financial Data 12 Management's Discussion and Analysis 13 Consolidated Balance Sheets 20 Consolidated Statements of Operations 21 Consolidated Statements of Shareholders' Equity 22 Consolidated Statements of Cash Flows 23 Notes to Consolidated Financial Statements 24 Report on Management's Responsibilities 38 Report of Independent Public Accountants 38
Standard Microsystems Corporation and Subsidiaries Page 12 SELECTED FINANCIAL DATA (In thousands, except share data) As of February 28 or 29, and for the years then ended 1999 1998 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------- Operating Results Revenues $ 155,826 $ 148,326 $ 180,918 $ 138,882 $ 117,415 Operating income (loss) 6,439 (561) (7,214) 6,632 17,593 ========================================================================================================================= Net income (loss) from continuing operations $ 6,003 $ (1,105) $ (4,613) $ 3,596 $ 11,066 Net income (loss) from discontinued operations (5,255) (18,846) (16,684) 8,005 14,101 Gain (loss) on sales of discontinued operations (13,293) 1,030 -- -- -- Extraordinary item -- -- -- -- (944) - ------------------------------------------------------------------------------------------------------------------------ Net income (loss) $ (12,545) $ (18,921) $ (21,297) $ 11,601 $ 24,223 ======================================================================================================================== Basic net income (loss) per share Continuing operations $ 0.38 $ (0.07) $ (0.33) $ 0.27 $ 0.85 Discontinued operations (1.17) (1.15) (1.21) 0.60 1.08 Extraordinary item -- -- -- -- (0.07) - ------------------------------------------------------------------------------------------------------------------------ Basic net income (loss) per share $ (0.79) $ (1.22) $ (1.54) $ 0.87 $ 1.86 ======================================================================================================================== Diluted net income (loss) per share Continuing operations $ 0.38 $ (0.07) $ (0.33) $ 0.27 $ 0.83 Discontinued operations (1.17) (1.15) (1.21) 0.59 1.06 Extraordinary item -- -- -- -- (0.07) - ------------------------------------------------------------------------------------------------------------------------ Diluted net income (loss) per share $ (0.79) $ (1.22) $ (1.54) $ 0.86 $ 1.82 ======================================================================================================================== Weighted average common shares outstanding Basic net income (loss) per share 15,789 15,519 13,838 13,372 13,032 Diluted net income (loss) per share 15,824 15,519 13,838 13,515 13,305 ======================================================================================================================== Balance Sheet Data Cash and short-term investments $ 70,071 $ 55,758 $ 8,382 $ 18,459 $ 29,478 Working capital 99,582 83,784 45,164 36,718 48,320 Total assets 201,967 210,049 217,240 244,228 200,699 Long-term obligations (excluding current obligations) 7,816 7,297 11,584 4,593 915 Shareholders' equity 158,434 172,377 171,797 193,502 173,983
PAGES 13 through 19: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Standard Microsystems Corporation (the Company) is a worldwide supplier of MOS/VLSI integrated circuits (ICs) for the personal computer, peripherals and embedded systems markets. The Company is most prominent as one of the world's leading suppliers of input/output (I/O) circuits for personal computers. I/O circuits perform many of the basic input/output functions required in every personal computer, including floppy disk control, keyboard control and BIOS, parallel port control and serial port control. The Company also supplies ICs for local area networking applications, connectivity applications and embedded control systems. Most of the Company's IC products are manufactured by world-class semiconductor foundries and assemblers. Standard Microsystems Corporation sells its ICs to a worldwide customer base, which includes most of the world's leading personal computer and personal computer motherboard manufacturers. The Company's I/O circuits reside on the motherboards of personal computer products made by Compaq Computer Corporation, Dell Computer Corporation, IBM, Intel Corporation, Hewlett-Packard Company and most other leading personal computer manufacturers. The Company is based in Hauppauge, New York and maintains offices in the United States, Europe and Asia. The Company conducts its business in the Japanese market through its majority owned subsidiary, Toyo Microsystems Corporation. DISCONTINUED OPERATIONS Over the past several years, the Company has carefully reviewed its various divisions and business units, evaluating each unit's opportunities for future growth and success in the various markets in which that unit has participated. This has resulted in a strategy of refocusing the Company's resources on its core semiconductor integrated circuits business, which is where the Company believes it has its most valuable assets and its best growth opportunities. In this regard, the Company divested itself of its local area networking hardware business in 1997, and, in April 1999, announced the intention to divest its Foundry Business Unit. In March 1999, the Company's Board of Directors approved a plan for the Company to divest its Foundry Business Unit, which has been experiencing operating losses over the past several years. In April 1999, the Company signed a Letter of Intent to combine the operations of its Foundry Business Unit with the operations of privately-held Inertia Optical Technology Applications, Inc. (IOTA) of Newark, NJ. Both businesses specialize in MicroElectroMechanical Systems (MEMS), which are specialty semiconductor-related products with mechanical properties used in such applications as sensors, ink jet print heads, valves, thin film RC networks, accelerometers and actuators. The combined businesses, to be named Standard MEMS, Inc. (SMI), will focus on leveraging the strengths of each business to create a broad supplier of MEMS, and will operate out of an existing SMSC facility in Hauppauge, New York, as well as in several IOTA facilities in New Jersey, California, Massachusetts, Mexico and Germany. Under the terms of the Letter of Intent, SMI will be majority owned by the shareholders of IOTA, with SMSC initially retaining a 38% interest. The Company has committed to reducing its investment in SMI below 20% within one year. Completion of the transaction is subject to executing definitive agreements and final approvals from both company's Boards of Directors, and is expected to occur before the end of SMSC's second quarter ending August 31, 1999. Following several years of reduced revenues and significant operating losses, during the third quarter of fiscal 1998, the Company reorganized its System Products Division, which designed, produced and marketed products used in the local area networking of personal computers, into a new corporation called SMC Networks, Inc. Concurrent with this reorganization, the Company sold an 80.1% interest in the new corporation to Taiwan-based Accton Technology Corporation (Accton), for $40.2 million in cash, resulting in a pre-tax gain of $1.6 million. The Company retained a 19.9% ownership interest in SMC Networks, Inc., and carries this investment at cost on its consolidated balance sheets. The Company is currently involved in a dispute with Accton, an Accton affiliate, and SMC Networks, Inc. regarding this transaction, as described in Note 11 of the Notes to Consolidated Financial Statements. The foundation of the Company's business since its establishment in 1971 has been semiconductor integrated circuit technology. The decision to exit the local area networking hardware business in fiscal 1998, and the recently announced intention to divest its MEMS business, has positioned the Company exclusively as a supplier of semiconductor integrated circuits and will allow the Company to better devote management attention and resources to this core business. The Company's historical financial information has been restated to report the operating results, net assets and cash flows of the Foundry Business Unit, and the System Products Division through September 1997, as discontinued operations for all periods presented. The following discussion and analysis focuses on continuing operations, as restated, unless otherwise noted. REVENUES The Company's revenues increased 5% to $155.8 million in fiscal 1999, compared to $148.3 million in fiscal 1998. The Company believes it gained market share, and now considers itself to be the worldwide leader, in shipments of I/O integrated circuits, as evidenced by a unit shipment increase of almost 30% in fiscal 1999 to more than 36 million units. Declines in average selling prices resulted in net revenue growth from I/O circuits of about 2%. Overall, revenues from shipments of I/O circuits contributed about 80% and 82% of the Company's revenues in fiscal 1999 and 1998, respectively. Combined revenues from local area networking and embedded control devices were level in fiscal 1999, compared to fiscal 1998. The Company introduced a line of connectivity products during fiscal 1999, offering devices supporting new communications standards for both personal computer and PC peripheral applications. Connectivity products are expected to provide increasing revenues in fiscal 2000. Despite a 1% increase in the number of integrated circuits shipped in fiscal 1998 compared to fiscal 1997, a significant decline in average selling prices resulted in a 20% decline in consolidated integrated circuit revenues in fiscal 1998 compared to fiscal 1997. During the second half of fiscal 1997, average selling prices for many of the Company's I/O circuits experienced unusually large declines, primarily because of significant market price reductions implemented by several of the Company's competitors. Excess semiconductor manufacturing capacity in the Pacific Rim during this period resulted in several competitors' producing I/O circuits which the Company believed violated the terms of these competitors' licenses under the Company's patents. These circuits were aggressively priced and marketed during the second half of fiscal 1997. Despite the resolution of the licensing issues with certain competitors in early fiscal 1998 (which included certain competitive devices being withdrawn from the market), average selling prices, while stabilized, generally did not recover to previous levels. International shipments accounted for 83% of the Company's revenues in fiscal 1999, compared to 73% in fiscal 1998 and 68% in fiscal 1997. While the demand for the Company's products is primarily driven by the worldwide demand for personal computers and peripheral devices, Asia and the Pacific Rim was by far the most significant international market for the Company's products during each of these periods, primarily reflecting the high concentration of the world's personal computer and personal computer motherboard manufacturing activity in this region. The Company expects that international shipments, particularly to the Asia and Pacific Rim region, will continue to represent a significant portion of its revenues. GROSS PROFIT The Company's gross profit margin increased from 30.0% in fiscal 1998 to 35.9% in fiscal 1999. This improvement was driven primarily by reduced product material costs and a shift to higher-margined products, partially offset by lower average selling prices. During fiscal 1999, the Company was able to reduce product costs through lower foundry wafer prices, lower contract assembly costs, the adoption of finer geometry fabrication processes and the redesign of products to reduce die sizes. Partially offsetting these factors, the Company recorded a $1.7 million charge to cost of goods sold during the fourth quarter of fiscal 1999 to reduce the carrying value of certain slow-moving and obsolete inventory to its net realizable value. The Company's gross profit margin increased from 24.2% in fiscal 1997 to 30.0% in fiscal 1998. Fiscal 1997 gross profit was adversely impacted by sharply reduced selling prices on I/O devices, particularly during the second half of the fiscal year, which were only partially offset by reductions in manufacturing costs. In addition, unexpected reductions in order input and the accelerated selling price reductions during that period resulted in excessive inventory and market price reductions of certain parts below cost. As a result, a $4.9 million charge to cost of goods sold was recorded during the fourth quarter of fiscal 1997 to reduce the carrying value of certain inventory to net realizable value. The gross profit margin improvement in fiscal 1998 reflects stabilized market conditions (as compared to the second half of fiscal 1997) which moderated the rate of decline in average selling prices, sales of new, higher-margined products and manufacturing cost reductions. The Company's products generally experience declines in average selling prices and gross margins over their life cycles. In order to offset declines in average selling prices, the Company must continue to reduce the costs of products through product and manufacturing design changes, volume discounts, yield improvements and lower costs negotiated with subcontract manufacturers. The Company's gross profit margin is also dependent on its ability to introduce new, competitive products, which generally command higher margins early in their life cycles. RESEARCH AND DEVELOPMENT EXPENSES Research and development (R&D) expenses increased to $17.4 million in fiscal 1999, a 22% increase over $14.3 million of R&D expenses in fiscal 1998, after a 12% increase in fiscal 1998 from $12.8 million of R&D expenses in fiscal 1997. The increases in both periods reflect increased engineering staff as well as increases in other development costs. During this three year period, the Company expanded its R&D resources through the February 1996 acquisition of the assets and staff of San Jose, California-based EFAR Microsystems, Inc., the October 1996 establishment of a design center in Westborough, Massachusetts, and the expansion of its Austin, Texas design center. The Company's fiscal 2000 engineering efforts will focus on continuing enhancements and cost reductions to its I/O product line and also on expansion into microprocessor chipset, and other, technologies. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses were $30.6 million in fiscal 1999, a slight decrease from $30.7 million reported in fiscal 1998. This decline is primarily the result of lower administrative overhead accomplished primarily through staff attrition and reductions in professional services and other general administrative expenses, driven by the Company's October 1997 decision to exit the local area networking business. These declines were partially offset by higher direct selling and marketing expenses associated with higher fiscal 1999 revenues. Fiscal 1998 selling, general and administrative expenses of $30.7 million were 20% below the $38.2 million reported in fiscal 1997. Most of this decline reflects lower direct selling expenses, including sales commissions, associated with the lower fiscal 1998 revenues, as well as lower general and administrative overhead. WRITE-DOWN OF INVESTMENT During fiscal 1997 and fiscal 1998, the Company acquired a minority equity interest of less than 20% in privately held Accelerix Incorporated of Carp, Ontario, Canada (Accelerix) for $1.7 million. Accelerix is a semiconductor design company specializing in high performance graphics accelerators for personal computers. During the fourth quarter of fiscal 1999, due to the anticipated sale of this investment below cost, the Company concluded that this investment was permanently impaired in value. Accordingly, the Company recorded a $1.6 million write-down of this investment to reflect its fair market value at February 28, 1999. OTHER INCOME AND EXPENSE The increase in interest income in fiscal 1999 compared to fiscal 1998, and in fiscal 1998 compared to fiscal 1997, resulted from higher average cash and cash equivalent balances available for investment during the respective periods. During the second quarter of fiscal 1998, a net charge of $2.0 million was recorded for the settlement of a class action litigation initiated against the Company and certain of its officers and directors in 1995. Please refer to Note 11 of Notes to Consolidated Financial Statements for additional details. INCOME TAXES The Company's effective income tax rate for fiscal 1999 was 30%. The effective income tax benefit rates were 37% and 36% in fiscal 1998 and fiscal 1997, respectively. The Company's reduced effective income tax rate in fiscal 1999 primarily reflects the impact of tax-exempt interest income earned on the Company's short-term investments. Generally, the Company's income tax rate includes the federal and state statutory tax rates, the impact of certain permanent differences between the book and tax accounting treatment of certain expenses, and various tax credits. The fiscal 1998 and fiscal 1997 tax benefit rates included relatively low benefit rates for state income taxes as several states in which the Company operates do not allow net operating loss carrybacks. LIQUIDITY AND CAPITAL RESOURCES The Company's cash, cash equivalents and short-term investments increased from $55.8 million at the end of fiscal 1998 to $70.1 million at the end of fiscal 1999. Working capital increased to $99.6 million at February 28, 1999 from $83.8 million at February 28, 1998. Operating activities generated $14.6 million of cash in fiscal 1999, compared to $16.2 million generated in fiscal 1998. A significant portion of the fiscal 1998 cash generated by operating activities was derived from a $12.7 million reduction in inventories during that period. In fiscal 1995, the Company entered into an agreement with Lucent Technologies, Inc. (Lucent) whereby the Company purchased approximately $16.0 million of wafer manufacturing equipment for installation at Lucent's Madrid, Spain, facility. In September 1998, the Company and Lucent mutually terminated this agreement, whereby Lucent purchased the wafer manufacturing equipment from the Company for $8.2 million, the equipment's then net book value. Of these proceeds, $6.2 million was paid in cash, with the remaining $2.0 million to be paid in ten equal quarterly installments beginning in December 1998. In October 1998, the Company's Board of Directors authorized the Company to repurchase up to one million shares of its common stock on the open market or in private transactions. During the third quarter of fiscal 1999, the Company repurchased 521,000 shares of common stock at a cost of $3.0 million. These shares are currently held as treasury stock. Inventory turnover continued to improve during fiscal 1999, following similar improvement in fiscal 1998, resulting in a decline in inventories to $13.8 million at February 28, 1999 from $16.9 million at February 28, 1998. Inventories were $29.7 million at February 28, 1997. The net operating loss generated by the Company in fiscal 1998 (most of which was attributable to discontinued operations) was carried-back for income tax purposes, resulting in fiscal 1999 refunds of $18.1 million of income taxes paid in prior periods. Most of these refunds are included in "Net cash provided by (used for) discontinued operations" on the accompanying Consolidated Statements of Cash Flows. During fiscal 1998, the Company's cash and short-term investments increased significantly, from $8.4 million at February 28, 1997 to $55.8 million at February 28, 1998. Several significant transactions contributed to this increase, including a $14.7 million equity investment in the Company by Intel Corporation, the sale of an 80.1% interest in the Company's former System Products Division to Accton Technology Corporation for $36.8 million in cash, after expenses, and the release from escrow of the remaining $7.1 million of proceeds from a fiscal 1996 sale of a business unit. As noted above, in March 1997, Intel Corporation acquired 1.5 million newly issued shares of the Company's common stock for $9.50 per share, or $14.7 million, resulting in an ownership interest in the Company of slightly below 10%. Intel was also issued a three-year warrant to purchase an additional 1.5 million shares at prices that increase annually during the term of the warrant. Through February 28, 1999, Intel had not exercised this warrant. The Company maintains a combined $10.0 million revolving line of credit with two banks, which permits the Company to borrow funds on a revolving basis, primarily to finance working capital needs. There have been no borrowings under this credit line since October 1997. The Company intends to either modify or extend this existing credit line, or execute a new credit line, prior to the existing line's July 1999 expiration. The majority of the $10.8 million of capital expenditures incurred in fiscal 1999 were for expanding the Company's semiconductor test operation and acquiring intellectual property used in the design of the Company's products. There were no material commitments for capital expenditures as of February 28, 1999. Fiscal 2000 capital expenditures are expected to approximate fiscal 1999 capital expenditures with further expenditures planned for semiconductor test equipment and engineering tools. 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 through the end of fiscal 2000. YEAR 2000 DISCUSSION Many computer programs were designed to perform data computations on the last two digits of the numerical value of a year. When computations referencing the year 2000 are performed, these programs may interpret "00" as the year 1900 and could either corrupt the date-related computations or not process them at all. As a result, many software and computer systems may need to be upgraded or replaced in order to comply with such year 2000 requirements. The Company has a comprehensive Year 2000 project designed to identify and assess the risks associated with its information systems, products, operations and suppliers that are not Year 2000 compliant, and to develop, test and implement remediation and contingency plans to mitigate these risks. The Company's Year 2000 project is addressing risks in the areas of business application software, technical infrastructure, end-user computing, engineering and development tools, supplier and service provider compliance, manufacturing tools, facilities infrastructure and the Company's products. In addition, the Company provides its customers with information on its Year 2000 project and progress made towards Year 2000 compliance. Several years ago, the Company installed certain Year 2000 compliant information systems, and has moved a substantial portion of its core business applications to this platform. The Company is currently installing additional new information systems and expects all internal information systems to achieve Year 2000 compliance during the middle of calendar year 1999. The Company is also assessing the impact of the Year 2000 issue on its products, and has not identified, and does not expect to identify, any material issues in that regard. Because most of the Company's information systems achieved Year 2000 compliance with the transition to a new information system several years ago, the Company has not yet incurred any material expenditures to specifically address Year 2000 issues. Going forward, the Company is committed to expending the resources necessary to address this issue, but at this time, does not anticipate any material expenditures for the resolution of Year 2000 issues relating to either its own information systems or its products. However, the Company could be adversely impacted by Year 2000 issues faced by significant vendors, suppliers and service organizations with which the Company conducts business. Based solely on responses received to date from these parties, the Company has no reason to believe that there will be any material adverse impact on the Company's financial condition or results of operations relating to any Year 2000 issues of such parties. However, if the responses received from these third parties are not accurate or happen to change, then there could be an unforeseen material adverse impact on the Company's financial condition and results of operations. The Company is continuing to reasonably assess the impact, if any, that third parties which may not be Year 2000 compliant may have on its operations, and expects to complete this assessment by the end of June 1999. OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS Certain statements and information contained in this annual report constitute "forward-looking statements" within the meaning of the Federal Securities laws. These forward-looking statements involve risks and uncertainties that may cause actual results and performance to be different from those expressed or implied in such statements. 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. According to most generally available market research, worldwide semiconductor revenues actually declined in calendar 1998 as compared to calendar 1997. 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 most of the Company's products depend largely on sales of personal computers and peripheral devices. Reductions in the rate of growth in the PC market could adversely affect the Company's operating results. In addition, as a component supplier to PC manufacturers, the Company often experiences greater demand fluctuation than its customers themselves experience. Also, some of the Company's products are used in PCs for the consumer market, which, in recent years, has tended to be more volatile than other segments of the PC marketplace. 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. 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 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. In order to help accomplish these goals, the Company has considered in the past, and will continue to consider in the future, the acquisition of other companies or the products and technologies of other companies. Such acquisitions carry additional risks, such as a lack of integration with existing products and corporate culture, the potential for large write-offs and the diversion of management attention. 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 on, among other things, its ability to continue to expand its product line. The Company's future product plans include entering the microprocessor chipset marketplace, offering products for applications that are presently served by other suppliers. Some of these suppliers 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. Moreover, functionality currently performed by the Company's standalone input/output integrated circuits is increasingly being integrated into microprocessor chipsets. This may not only impede the Company's efforts to penetrate the microprocessor chipset market, but may also displace the Company's products in the applications that they presently serve. 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 pressures may require the reduction of selling prices more quickly than such cost reductions can be achieved. In addition, the Company sometimes approves price reductions on specific sales opportunities to meet competition. If not offset by reductions in manufacturing costs or by a shift in the mix of products sold toward higher-margined 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, assembled and tested 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. 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 increasingly shorter lead times. Shipments to Distributors - Almost 35% of the Company's fiscal 1999 revenues were made through distributors, the largest of which are located in the Far East. 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 a materially 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 their manufacturing to Asian companies. This concentration of manufacturing and selling activity in Asia poses risks that could affect demand for and supply of the Company's products, including currency exchange rate fluctuations, economic and trade policies and the political environment within Asian communities. The recent economic conditions in this region have been characterized by idle production capacity, unemployment, bank failures, reduced consumer spending and currency devaluation. Any of these factors could reduce demand for the products in which the Company's integrated circuits are used. 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. Customer Concentration - A limited number of customers account for a significant portion of the Company's revenues. The Company's 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. 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, could hinder the Company's product development and ability to manufacture, market and sell its products. 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 recently experienced extreme price and volume volatility. 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 performance of the specific companies. Standard Microsystems Corporation and Subsidiaries Page 20 CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)
As of February 28, 1999 1998 - -------------------------------------------------------------------------- Assets Current assets: Cash and cash equivalents $ 68,071 $ 47,155 Short-term investments 2,000 8,603 Accounts receivable, net of allowance for doubtful accounts of $1,111 and $1,011, respectively 22,608 18,126 Inventories 13,785 16,850 Deferred tax benefits 8,154 6,226 Other current assets 9,142 5,731 - -------------------------------------------------------------------------- Total current assets 123,760 102,691 - -------------------------------------------------------------------------- Property, plant and equipment: Land 3,832 3,832 Buildings and improvements 29,846 28,879 Machinery and equipment 63,890 71,675 - -------------------------------------------------------------------------- 97,568 104,386 Less: accumulated depreciation 62,916 64,122 - -------------------------------------------------------------------------- Property, plant and equipment, net 34,652 40,264 - -------------------------------------------------------------------------- Other assets 38,219 37,688 Net assets of discontinued operations 5,336 29,406 - -------------------------------------------------------------------------- $201,967 $210,049 ========================================================================== Liabilities and Shareholders' Equity Current liabilities: Accounts payable $ 8,873 $ 10,288 Accrued expenses and other liabilities 14,453 8,066 Current portion of obligations under capital leases 852 553 - -------------------------------------------------------------------------- Total current liabilities 24,178 18,907 - -------------------------------------------------------------------------- Long-term debt -- -- Obligations under capital leases 3,017 2,524 Other liabilities 4,799 4,773 Commitments and contingencies Minority interest in subsidiary 11,539 11,468 Shareholders' equity: Preferred stock, $.10 par value Authorized 1,000,000 shares, none outstanding -- -- Common stock, $.10 par value Authorized 30,000,000 shares Outstanding 16,045,000 and 15,926,000 shares, respectively 1,605 1,593 Additional paid-in capital 108,665 107,306 Retained earnings 47,454 59,999 Treasury stock, 521,000 shares, at cost (2,957) -- Accumulated other comprehensive income 3,667 3,479 - -------------------------------------------------------------------------- Total shareholders' equity 158,434 172,377 - -------------------------------------------------------------------------- $201,967 $210,049 ========================================================================== The accompanying notes are an integral part of these consolidated financial statements.
Standard Microsystems Corporation and Subsidiaries Page 21 CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
For the years ended February 28, 1999 1998 1997 Revenues $ 155,826 $ 148,326 $ 180,918 Cost of goods sold 99,846 103,863 137,163 - -------------------------------------------------------------------------------------------- Gross profit 55,980 44,463 43,755 - -------------------------------------------------------------------------------------------- Operating expenses: Research and development 17,437 14,298 12,808 Selling, general and administrative 30,550 30,726 38,161 Write-down of investment 1,554 -- -- - -------------------------------------------------------------------------------------------- 49,541 45,024 50,969 - -------------------------------------------------------------------------------------------- Income (loss) from operations 6,439 (561) (7,214) - -------------------------------------------------------------------------------------------- Other income (expense): Interest income 2,667 1,151 523 Interest expense (279) (249) (619) Other income (expense), net (167) (1,978) 174 - -------------------------------------------------------------------------------------------- 2,221 (1,076) 78 - -------------------------------------------------------------------------------------------- Income (loss) before provision for income taxes and minority interest 8,660 (1,637) (7,136) Provision for (benefit from) income taxes 2,586 (603) (2,544) Minority interest in net income of subsidiary 71 71 21 - -------------------------------------------------------------------------------------------- Income (loss) from continuing operations 6,003 (1,105) (4,613) - -------------------------------------------------------------------------------------------- Discontinued operations: Income (loss) from discontinued operations (net of income tax benefits of $2,956, $10,113 and $9,182) (5,255) (18,846) (16,684) Gain (loss) on sales of discontinued operations (net of income taxes of ($1,908) and $555) (13,293) 1,030 -- - -------------------------------------------------------------------------------------------- Net loss $ (12,545) $ (18,921) $ (21,297) ============================================================================================ Basic and diluted net loss per share: Income (loss) from continuing operations $ 0.38 $ (0.07) $ (0.33) Loss from discontinued operations (0.33) (1.21) (1.21) Gain (loss) on sales of discontinued operations (0.84) 0.06 -- - -------------------------------------------------------------------------------------------- Basic and diluted net loss per share $ (0.79) $ (1.22) $ (1.54) ============================================================================================
The accompanying notes are an integral part of these consolidated financial statements. Standard Microsystems Corporation and Subsidiaries Page 22 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands)
Accumulated Other Common Stock Paid-In Retained Treasury Stock Comprehensive Total Shares Amount Capital Earnings Shares Amount Income - -------------------------------------------------------------------------------------------------------------------------------- Balance at February 29, 1996 13,711 $1,371 $ 84,737 $100,217 -- $ -- $ 7,177 $193,502 Comprehensive loss: Net loss -- -- -- (21,297) -- -- -- (21,297) Other comprehensive loss Unrealized loss on investment -- -- -- -- -- -- (1,273) (1,273) Foreign currency translation adjustment -- -- -- -- -- -- (1,510) (1,510) --------- Total other comprehensive loss (2,783) --------- Total comprehensive loss (24,080) Shares issued under incentive savings and retirement plan 110 11 1,351 -- -- -- -- 1,362 Stock options exercised 61 6 425 -- -- -- -- 431 Tax effect of employee stock plans -- -- 42 -- -- -- -- 42 Restricted stock grants to employees, net (6) -- 540 -- -- -- -- 540 - -------------------------------------------------------------------------------------------------------------------------------- Balance at February 28, 1997 13,876 1,388 87,095 78,920 -- -- 4,394 171,797 Comprehensive loss: Net loss -- -- -- (18,921) -- -- -- (18,921) Other comprehensive loss Unrealized loss on investment -- -- -- -- -- -- (333) (333) Foreign currency translation adjustment -- -- -- -- -- -- (582) (582) --------- Total other comprehensive loss (915) --------- Total comprehensive loss (19,836) Shares issued under incentive savings and retirement plan 114 11 1,163 -- -- -- -- 1,174 Stock options exercised 386 39 3,444 -- -- -- -- 3,483 Tax effect of employee stock plans -- -- 709 -- -- -- -- 709 Restricted stock grants to employees, net 7 1 426 -- -- -- -- 427 Investment by Intel Corporation, net 1,543 154 14,469 -- -- -- -- 14,623 - -------------------------------------------------------------------------------------------------------------------------------- Balance at February 28, 1998 15,926 1,593 107,306 59,999 -- -- 3,479 172,377 Comprehensive loss: Net loss -- -- -- (12,545) -- -- -- (12,545) Other comprehensive income (loss) Unrealized loss on investment -- -- -- -- -- -- (334) (334) Foreign currency translation adjustment -- -- -- -- -- -- 522 522 --------- Total other comprehensive income 188 --------- Total comprehensive loss (12,357) Shares issued under incentive savings and retirement plan 95 10 778 -- -- -- -- 788 Stock options exercised 23 2 184 -- -- -- -- 186 Tax effect of employee stock plans -- -- 16 -- -- -- -- 16 Restricted stock grants to employees, net 1 -- 381 -- -- -- -- 381 Purchases of treasury stock -- -- -- -- (521) (2,957) -- (2,957) - -------------------------------------------------------------------------------------------------------------------------------- Balance at February 28, 1999 16,045 $1,605 $108,665 $ 47,454 (521) $(2,957) $ 3,667 $158,434 ================================================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. Standard Microsystems Corporation and Subsidiaries Page 23 CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
For the years ended February 28, 1999 1998 1997 - ---------------------------------------------------------------------------------------------------- Cash flows from operating activities: Cash received from customers $ 151,998 $ 143,884 $ 188,430 Cash paid to suppliers and employees (139,735) (128,039) (193,175) Interest received 2,737 1,216 515 Interest paid (279) (261) (634) Income taxes received (paid) (92) 1,360 (287) Cash paid for litigation settlement -- (2,000) -- - ------------------------------------------------------------------------------------------------------ Net cash provided by (used for) operating activities 14,629 16,160 (5,151) - ------------------------------------------------------------------------------------------------------ Cash flows from investing activities: Capital expenditures (10,847) (3,854) (8,654) Sales of machinery and equipment 6,464 53 54 Purchases of short-term investments (5,002) (8,603) -- Sales of short-term investments 11,605 -- -- Escrow investment (110) (2,047) -- Release of escrow investment -- 7,110 -- Investment in Accelerix Incorporated -- (250) (1,483) Other (454) -- (531) - ------------------------------------------------------------------------------------------------------ Net cash provided by (used for) investing activities 1,656 (7,591) (10,614) - ------------------------------------------------------------------------------------------------------ Cash flows from financing activities: Proceeds from issuance of common stock 363 18,405 431 Purchases of treasury stock (2,957) -- -- Borrowings under line of credit agreements -- 33,960 47,731 Repayments of borrowings under line of credit agreements -- (40,960) (40,731) Repayments of obligations under capital leases (654) (152) -- - ------------------------------------------------------------------------------------------------------ Net cash provided by (used for) financing activities (3,248) 11,253 7,431 - ------------------------------------------------------------------------------------------------------ Effect of foreign exchange rate changes on cash and cash equivalents 170 (544) (1,068) - ------------------------------------------------------------------------------------------------------ Net cash provided by (used for) discontinued operations 7,709 (17,282) (675) - ------------------------------------------------------------------------------------------------------ Net cash provided by sale of discontinued operation -- 36,777 -- - ------------------------------------------------------------------------------------------------------ Net increase (decrease) in cash and cash equivalents 20,916 38,773 (10,077) Cash and cash equivalents at beginning of year 47,155 8,382 18,459 - ------------------------------------------------------------------------------------------------------ Cash and cash equivalents at end of year $ 68,071 $ 47,155 $ 8,382 ====================================================================================================== Reconciliation of income (loss) from continuing operations to net cash provided by (used for) operating activities: Income (loss) from continuing operations $ 6,003 $ (1,105) $ (4,613) Adjustments to reconcile income (loss) from continuing operations to net cash provided by (used for) operating activities: Depreciation and amortization 10,544 11,328 10,462 Other adjustments, net 2,340 1,328 1,442 Changes in operating assets and liabilities: Accounts receivable (4,183) (4,359) 7,449 Inventories 3,171 12,716 (6,392) Accounts payable and accrued expenses and other liabilities (3,558) (3,740) (10,984) Other changes, net 312 (8) (2,515) - ------------------------------------------------------------------------------------------------------ Net cash provided by (used for) operating activities $ 14,629 $ 16,160 $ (5,151) ====================================================================================================== Noncash Investing and Financing Activities: During fiscal 1999 and fiscal 1998, the Company financed certain capital expenditures totaling $1,447,000 and $3,229,000, respectively, through capital lease obligations. During fiscal 1999, the Company sold certain equipment for $8,224,000, of which installment payments of $790,000 and $592,000 are receivable in fiscal 2000 and 2001, respectively.
The accompanying notes are an integral part of these consolidated financial statements. Page 24-38 Standard Microsystems Corporation and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Standard Microsystems Corporation (SMSC) and its subsidiaries (the Company). All significant intercompany accounts and transactions have been eliminated. RECLASSIFICATIONS Certain items shown have been reclassified to conform to the fiscal 1999 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. Actual results could differ from those estimates. 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. SHORT-TERM INVESTMENTS Marketable debt and equity securities are reported at fair value. Unrealized gains and losses on short-term investments are either included within net income for those securities classified as trading securities, or included as a separate component of shareholders' equity for those securities classified as available-for-sale. As of February 28, 1999, short-term investments consist primarily of investments in U.S. Treasury, corporate and municipal obligations with maturities of between three and twelve months and are classified as available-for-sale. The cost of these short-term investments approximates their market value as of February 28, 1999. 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-term maturities. The amounts presented for long-term debt, obligations under capital leases and other long-term liabilities also approximate fair value. INVENTORIES Inventories are valued at the lower of first-in, first-out cost or market and consist of the following (in thousands): As of February 28, 1999 1998 - ------------------------------------------------ Inventories: Raw materials $ 475 $ 295 Work-in-process 9,310 10,240 Finished goods 4,000 6,315 - ------------------------------------------------ $ 13,785 $ 16,850 ================================================ During the fourth quarter of fiscal 1999, the Company recorded a $1,750,000 charge to cost of goods sold to write-down certain slow-moving and obsolete inventory to net realizable value. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are carried at cost and are 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 of less than 20% in non-publicly traded companies are carried at cost. Changes in the value of these investments are not recognized unless an impairment in value is deemed to be other than temporary. INVESTMENT IN EQUITY SECURITIES As of February 28, 1999 and 1998, an investment in a publicly traded equity security, classified as available-for-sale, is carried at fair value within other assets on the accompanying consolidated balance sheets. A corresponding unrealized gain, net of taxes, is reported as a separate component of shareholders' equity. LONG-LIVED ASSETS The Company reviews long-lived assets for impairment in value using a gross cash flow basis and will reserve for impairment whenever events or circumstances indicate that the carrying amount of the assets may not be fully recoverable. REVENUE RECOGNITION Revenue from product sales is recognized at the time of shipment. Sales to distributors are generally subject to agreements allowing limited rights of return and price protection with respect to unsold products held by the distributor. Reserves for estimated returns and allowances are provided at the time revenue is recognized. Such reserves are recorded based upon historical rates of returns and allowances, distributor inventory levels and other factors. STOCK-BASED COMPENSATION The Company grants stock options to employees with exercise prices equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees and accordingly, recognizes no compensation expense for the stock option grants. Additional pro forma disclosures as required under Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, are presented within these Notes to Consolidated Financial Statements. 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 it is management's judgment that 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 the related expenditures are incurred. TRANSLATION OF FOREIGN 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 as a separate component of shareholders' equity. NET INCOME (LOSS) PER SHARE The Company adopted the provisions of SFAS No. 128, Earnings per Share, beginning with the consolidated financial statements for the fiscal year ended February 28, 1998. This pronouncement requires the reporting of two net income per share figures; basic net income per share and diluted net income per share. Basic net income per share is calculated by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the sum of the weighted-average common shares outstanding during the period plus the dilutive effect of shares issuable through stock options and warrants. All net income (loss) per share figures presented herein have been restated in accordance with the provisions of SFAS No. 128. Shares used in calculating basic and diluted net income (loss) per share are reconciled as follows (in thousands): 1999 1998 1997 - ------------------------------------------------------------------------ Average shares outstanding for basic net income (loss) per share 15,789 15,519 13,838 Dilutive effect of stock options 35 -- -- - ------------------------------------------------------------------------ Average shares outstanding for diluted net income (loss) per share 15,824 15,519 13,838 ======================================================================== The Company reported a net loss from continuing operations in both fiscal 1998 and fiscal 1997, and accordingly, the effect of stock options and warrants was anti-dilutive for those periods and was therefore excluded from the calculation of average common shares outstanding for diluted net income (loss) per share. COMPREHENSIVE INCOME During the first quarter of fiscal 1999, the Company adopted SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 separates comprehensive income into two components: net income and other comprehensive income. Other comprehensive income refers to revenues, expenses, gains and losses that, under generally accepted accounting principles, are recorded as elements of shareholders' equity and are excluded from net income. The Company's other comprehensive income consists of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, and unrealized gains and losses on a long-term equity investment. The changes in accumulated other comprehensive income for the three years ended February 28, 1999 were as follows (in thousands):
Unrealized Foreign Currency Accumulated Other Gain on Translation Comprehensive Investment Adjustment Income - ------------------------------------------------------------------------------------- Balance at February 29, 1996 $ 2,226 $ 4,951 $ 7,177 Period change (1,273) (1,510) (2,783) - ------------------------------------------------------------------------------------- Balance at February 28, 1997 953 3,441 4,394 Period change (333) (582) (915) - ------------------------------------------------------------------------------------- Balance at February 28, 1998 620 2,859 3,479 Period change (334) 522 188 - ------------------------------------------------------------------------------------- Balance at February 28, 1999 $ 286 $ 3,381 $ 3,667 =====================================================================================
NEW ACCOUNTING PRONOUNCEMENTS In March 1998, the Accounting Standards Executive Committee issued Statement of Position (SOP) 98-1, Accounting for Costs of Computer Software Developed or Obtained for Internal Use. SOP 98-1 provides guidance on when costs related to software developed or obtained for internal use should be capitalized or expensed. SOP 98-1 is effective beginning in fiscal 2000, and the Company does not expect this new statement to materially impact its consolidated financial statements. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999 and will not require retroactive restatement of prior period financial statements. The Company does not presently make use of derivative instruments. 2. DISCONTINUED OPERATIONS In March 1999, the Company's Board of Directors approved a plan to divest a majority interest in its Foundry Business Unit (FBU). This business unit specializes in the production of MicroElectroMechanical Systems (MEMS), which are specialty semiconductor-related products with mechanical properties used in such applications as sensors, ink jet print heads, valves, thin film RC networks, accelerometers and actuators. The FBU serves a different customer base than the Company's integrated circuits business, and is generally managed as a separate operating unit with its own identifiable assets. This business unit has been experiencing operating losses over the past several years, and this action is intended to enable both the Company and the Foundry Business Unit, as reorganized, to better devote management attention and resources to the core strategies of each business. In April 1999, the Company signed a Letter of Intent with Inertia Optical Technology Applications, Inc. (IOTA) of Newark, NJ, to combine the operations of the Company's Foundry Business Unit with the operations of privately-held IOTA into a new company, Standard MEMS, Inc. IOTA, like the Company's FBU, specializes in MEMS devices. Standard MEMS, Inc. will operate out of an existing SMSC facility in Hauppauge, New York as well as in several IOTA facilities in New Jersey, California, Massachusetts, Mexico and Germany. Under the terms of the Letter of Intent, Standard MEMS, Inc. will be majority owned by the shareholders of IOTA, with SMSC initially retaining a 38% interest. The Company has committed to reducing its investment in Standard MEMS, Inc. below 20% within one year. Completion of the transaction is subject to executing definitive agreements and final approvals from both Company's Boards of Directors, and is expected to occur before the end of SMSC's second quarter ending August 31, 1999. As a result of this transaction, SMSC will report the operating results, net assets and cash flows of the Foundry Business Unit as a discontinued operation and has recorded a pre-tax charge of $15,200,000 in the fourth quarter ended February 28, 1999. This charge covers write-downs of certain assets, operating losses expected to occur before completion of the transaction, and other costs associated with the transaction. Summarized financial information for this discontinued operation is as follows (in millions): As of February 28, and for the years then ended 1999 1998 1997 - ---------------------------------------------------------------------------- Revenues $10.3 $7.4 $15.6 - ---------------------------------------------------------------------------- Income (loss) before income taxes (8.2) (5.3) 0.2 - ---------------------------------------------------------------------------- Net income (loss) (5.3) (3.4) 0.1 - ---------------------------------------------------------------------------- Current assets 5.1 5.9 4.8 - ---------------------------------------------------------------------------- Total assets 6.6 13.0 13.2 - ---------------------------------------------------------------------------- Current liabilities 1.3 0.7 2.0 - ---------------------------------------------------------------------------- Net assets 5.3 12.3 11.2 ============================================================================ In October 1997, the Company executed an agreement with Accton Technology Corporation of Hsinchu, Taiwan (Accton) whereby the Company transferred substantially all of the assets comprising its System Products Division to a newly formed, wholly-owned subsidiary, SMC Networks, Inc., and then sold 80.1% of SMC Networks, Inc.'s outstanding common stock to Global Business Investments (B.V.I.) Corp., a newly formed, wholly-owned subsidiary of Accton. The System Products Division supplied hardware and software products for the local area network (LAN) marketplace. In consideration for the sale of stock, the Company received $40,237,000 in cash, of which $2,012,000 was placed in an escrow account, scheduled for release on January 2, 1999, to secure the Company's indemnity obligations under the agreement. As a result of this transaction, the Company realized a pre-tax gain of $1,585,000, after related costs, in the third quarter of fiscal 1998. The Company's remaining 19.9% minority interest in SMC Networks, Inc. is carried at a cost of $8,452,000 within other assets on the accompanying consolidated balance sheets. The Company is currently involved in a dispute with Accton, its affiliate and SMC Networks, Inc. regarding this transaction, as described in Note 11 within these Notes to Consolidated Financial Statements. The net assets, operating results and cash flows of the System Products Division are presented as a discontinued operation in the accompanying consolidated financial statements for all periods presented. Summarized financial information for this discontinued operation is as follows (in millions): As of February 28, and for the years then ended 1998 1997 - ------------------------------------------------------------------------ Revenues $65.5 $157.6 - ------------------------------------------------------------------------ Loss before income taxes (23.1) (26.1) - ------------------------------------------------------------------------ Net loss (15.4) (16.8) - ------------------------------------------------------------------------ Current assets 19.1 57.7 - ------------------------------------------------------------------------ Total assets 19.1 80.6 - ------------------------------------------------------------------------ Current liabilities 2.0 14.8 - ------------------------------------------------------------------------ Net assets 17.1 65.8 ======================================================================== The net assets of the discontinued operation as of February 28, 1998 consisted primarily of income tax refunds receivable attributable to the loss generated by the discontinued operation in fiscal 1998, all of which were received during fiscal 1999. 3. COST BASIS INVESTMENTS INVESTMENT IN ACCELERIX INCORPORATED During fiscal 1997 and fiscal 1998, the Company acquired a minority equity interest of less than 20% in privately held Accelerix Incorporated of Carp, Ontario, Canada, (Accelerix) for $1,733,000. Accelerix is a semiconductor design company specializing in high performance graphics accelerators for personal computers. The Company and Accelerix also entered into an agreement providing the Company with rights to market, second source and enhance certain of Accelerix's technology. During the fourth quarter of fiscal 1999, due to the anticipated sale of this investment below cost, the Company concluded that this investment was permanently impaired in value. Accordingly, the Company has recorded a $1,554,000 write-down of this investment to reflect its fair market value at February 28, 1999. INVESTMENT IN CHARTERED SEMICONDUCTOR MANUFACTURING LTD. In March 1995, the Company entered into an agreement with Singapore-based Chartered Semiconductor Manufacturing Ltd. (Chartered), whereby the Company acquired a minority equity interest of less than 2% in Chartered for $19,944,000 during fiscal 1996. Under the terms of this agreement, the Company is allocated sub-micron wafer production capacity for ten years in Chartered's wafer fabrication facility. This investment is reported at cost on the accompanying consolidated balance sheets. Changes in the value of this investment are not recognized unless an impairment in its value is deemed to be other than temporary. 4. SALE OF EQUIPMENT In September 1994, the Company entered into an agreement with Lucent Technologies, Inc. (Lucent) whereby the Company purchased approximately $16 million of wafer manufacturing equipment for installation at Lucent's Madrid, Spain, facility. The agreement provided that a portion of Lucent's wafer production capacity during the five year period which began in March 1996 would be reserved for the Company's requirements at favorable pricing. In September 1998, the Company and Lucent mutually terminated this agreement, whereby Lucent purchased the wafer manufacturing equipment from the Company for $8,224,000, its then-current book value. Of these proceeds, $6,250,000 was paid in cash, with the remaining $1,974,000 to be paid in ten equal quarterly installments beginning in December 1998. No gain or loss was recognized by the Company on this sale. While Lucent's wafer production and pricing obligations to the Company have been terminated, the Company intends to continue using Lucent as a supplier. 5. OTHER BALANCE SHEET DATA (In thousands): As of February 28, 1999 1998 - --------------------------------------------------- Other current assets: Escrow deposit $ 2,157 $ 2,048 Other 6,985 3,683 - --------------------------------------------------- $ 9,142 $ 5,731 =================================================== Other assets: Common stock of Chartered Semiconductor Mfg. Ltd. $19,944 $19,944 Common stock of SMC Networks, Inc. 8,452 8,452 Deferred tax benefits 5,323 3,880 Other assets 4,500 5,412 - --------------------------------------------------- $38,219 $37,688 =================================================== Accrued expenses and other liabilities: Salaries and fringe benefits $ 2,908 $ 3,697 Royalties 138 1,162 Professional fees 251 1,179 Income taxes payable 1,161 42 Disposition costs 8,260 52 Other 1,735 1,934 - --------------------------------------------------- $14,453 $ 8,066 =================================================== Other liabilities: Retirement benefits $ 4,682 $ 4,401 Other 117 372 - --------------------------------------------------- $ 4,799 $ 4,773 =================================================== 6. OTHER INCOME (EXPENSE) (In thousands): For the years ended February 28, 1999 1998 1997 - -------------------------------------------------------------------- Litigation settlement $ -- $ (2,000) $ -- Other income (expense), net (167) 22 174 - -------------------------------------------------------------------- Total other income (expense), net $ (167) $(1,978) $ 174 ==================================================================== 7. LINE OF CREDIT The Company maintains a $10,000,000 line of credit with several banks, which permits the Company to borrow funds on a revolving basis, primarily to finance working capital needs. This line of credit is secured by accounts receivable with the interest rate on borrowings at either the banks' prime rate or LIBOR plus 225 basis points (depending on the maturity of the borrowing). Any unused portion of the credit line bears an annual fee of 0.375%. As of February 28, 1999 there are no borrowings outstanding under this line of credit, and there have been no borrowings under this credit facility since October 1997. This line of credit expires in July 1999. 8. SHAREHOLDERS' EQUITY COMMON STOCK REPURCHASE PROGRAM In October 1998, the Company's Board of Directors approved a common stock repurchase program, allowing the Company to repurchase up to one million shares of its common stock on the open market or in private transactions. During the third quarter of fiscal 1999, the Company repurchased 521,000 shares of common stock at a cost of $2,957,000. These shares are currently held as treasury stock. INVESTMENT BY INTEL CORPORATION In March 1997, the Company and Intel Corporation (Intel) entered into a Common Stock and Warrant Purchase Agreement (the Agreement) whereby Intel purchased approximately 1,543,000 of newly issued shares of the Company's common stock for $9.50 per share, or approximately $14,654,000. Intel also received a three-year warrant to purchase an additional 1,543,000 shares at a price per share which increased from $10.45, to $11.40, and then to $12.35 on March 18, 1997, 1998 and 1999, respectively. As of February 28, 1999, Intel had not exercised its warrant. The Agreement provides Intel with certain rights, including a right of first refusal upon certain proposed sales of common stock by the Company, demand registration rights with respect to shares acquired under the Agreement, a right for Intel to designate a representative to serve on the Company's board of directors, and anti-dilution rights. The Agreement also imposes certain restrictions upon Intel, including a limitation on Intel's ability to acquire additional shares of the Company's common stock (referred to as a standstill arrangement), and restrictions on the transfer of shares acquired pursuant to the Agreement. The standstill arrangement would terminate in the event of certain third-party tender offers for the Company's common stock. SHAREHOLDER RIGHTS PLAN In January 1998, the Company's Board of Directors adopted a new Shareholder Rights Plan, replacing the Company's previous plan which expired on January 12, 1998. 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. 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 $.01 per right. Like the previous plan, the new Shareholder Rights Plan continues the Company's commitment to ensuring fair value to all shareholders in the event of an unsolicited takeover offer. 9. 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 28, 1999 1998 1997 - ------------------------------------------------------------------------ Current Federal $ 661 $(17,597) $(8,700) Foreign 140 55 507 State 68 376 877 - ------------------------------------------------------------------------ 869 (17,166) (7,316) Deferred (3,147) 7,005 (4,410) - ------------------------------------------------------------------------ (2,278) (10,161) (11,726) - ------------------------------------------------------------------------ Less: tax benefits from discontinued operations (4,864) (9,558) (9,182) - ------------------------------------------------------------------------ $ 2,586 $ (603) $(2,544) ======================================================================== The provision for (benefit from) income taxes 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 28, 1999 1998 1997 - ------------------------------------------------------------------------ Provision for (benefit from) income taxes computed at the statutory rate 35.0% (35.0)% (35.0)% State taxes 1.3 (2.0) (1.9) Differences between foreign and U.S. income tax rates (0.9) 1.0 2.4 Tax exempt income (5.5) (2.0) (1.2) Other - 1.2 0.1 - ------------------------------------------------------------------------ 29.9% (36.8)% (35.6)% ======================================================================== The tax effects of temporary differences that result in deferred tax benefits are as follows (in thousands): As of February 28, 1999 1998 - ----------------------------------------------------------------------- Reserves and accruals not currently deductible for income tax purposes $ 5,868 $ 3,164 Intangible asset amortization 3,714 4,343 Inventory valuation 1,837 1,202 Purchased in-process technology 1,715 1,949 Property, plant and equipment depreciation 320 (367) Other 23 (185) - ----------------------------------------------------------------------- $ 13,477 $10,106 ======================================================================= Income (loss) before provision for income taxes includes foreign income of $363,000, $412,000 and $214,000 for fiscal 1999, 1998 and 1997, respectively. The net operating losses reported by the Company in fiscal 1998 and 1997, the majority of which were generated by the discontinued operations, were carried back against taxable profits reported in prior periods and resulted in income tax refunds of $18,092,000 and $7,921,000 received in fiscal 1999 and 1998, respectively. Most of the refunds received are included within the Net cash provided by (used for) discontinued operations caption in the consolidated statements of cash flows. Income tax benefits of $16,000, $709,000 and $42,000 related to the Company's stock option plans for fiscal 1999, 1998 and 1997, respectively, have been credited to additional paid-in capital. The Company has $2,120,000 of New York State tax credit carryforwards at the end of fiscal 1999, of which $100,000 will expire in fiscal 2000. The remaining $2,020,000 of credit carryforwards expire at various dates in fiscal 2001 through fiscal 2008. 10. MINORITY INTEREST IN SUBSIDIARY Sumitomo Metal Industries, Ltd. Of Osaka, Japan (SMI) owns 20% of the issued and outstanding common stock and all of the non-cumulative, non-voting 6% preferred stock of the Company's subsidiary, Toyo Microsystems Corporation (TMC). The Company and SMI have agreed to declare a preferred dividend if TMC should realize net income of at least five times the total amount of preferred dividends which would be payable on all preferred stock then outstanding. The annual preferred dividend would be equal to 6% of the subscription price of 2.16 billion yen, or approximately $1,089,000 at an exchange rate of 119 yen per dollar. In the event that a third party acquires a majority of the outstanding common stock of the Company, SMI has the option to require the Company to purchase SMI's interest in TMC. 11. COMMITMENTS AND CONTINGENCIES COMPENSATION Certain executives and key employees are employed under separate agreements terminating on various dates through fiscal 2002. These agreements provide, among other things, for annual base salaries and guaranteed incentives totaling $1,892,000, $881,000 and $350,000 in fiscal 2000, 2001 and 2002, respectively. CAPITAL LEASES The Company leases certain equipment under long-term capital leases, some of which include options to purchase the equipment for a nominal cost at the termination of the lease. Included within property and equipment are the following assets held under capital leases (in thousands): As of February 28, 1999 1998 - --------------------------------------------------------- Machinery and equipment $ 4,676 $ 3,229 Less: accumulated depreciation (824) (81) - --------------------------------------------------------- $ 3,852 $ 3,148 ========================================================= Future minimum lease payments for assets under capital leases for the next five fiscal years are as follows (in thousands): 2000 $ 1,136 - --------------------------------------------------------- 2001 1,136 - --------------------------------------------------------- 2002 1,136 - --------------------------------------------------------- 2003 940 - --------------------------------------------------------- 2004 204 - --------------------------------------------------------- Total minimum lease payments 4,552 Less: amount representing interest 683 - --------------------------------------------------------- Present value of minimum lease payments 3,869 Less: current portion 852 - --------------------------------------------------------- Long-term obligation $ 3,017 ========================================================= OPERATING LEASES The Company leases certain vehicles, facilities and equipment. Minimum rentals under these leases for each of the next five fiscal years are as follows (in thousands): 2000 $ 378 - --------------------------------------------------------- 2001 279 - --------------------------------------------------------- 2002 243 - --------------------------------------------------------- 2003 121 - --------------------------------------------------------- 2004 -- - --------------------------------------------------------- Total rent expense was $1,335,000, $1,354,000 and $908,000 in fiscal 1999, 1998 and 1997, respectively. LITIGATION AND SETTLEMENTS The Company is subject to various lawsuits and claims in the ordinary course of business. While the outcome of these matters can not be determined, management believes that the ultimate resolution of these matters will not have a material effect on the Company's operations or financial position. As indicated in Note 2 to these Consolidated Financial Statements, during fiscal 1998, 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) for approximately $40,237,000 in cash, $2,012,000 of which was placed into an escrow account. 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 $10,000,000 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 has not been released. In January 1999, the Company filed an 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 $1,685,000 (which is included within other current assets on the Company's consolidated balance sheets) owed to the Company by SMC Networks, Inc. as of February 28, 1999. The Company is confident that it negotiated and fully performed the agreements with Accton in good faith. While it is not possible at this time to assess the likelihood of any liability being established, the Company considers these claims to be without merit. The Company will vigorously defend itself against these allegations and expects that the outcome will not be material to the Company. In June 1995, several actions were filed against the Company and certain of its officers and directors. These complaints were consolidated into a class action on behalf of the purchasers of the Company's common stock between September 19, 1994 and June 2, 1995. The consolidated complaint asserted claims under federal securities laws and alleged that the price of the Company's common stock had been artificially inflated during the class action period by false and misleading statements and the failure to disclose certain information. The Company, its officers and its directors strongly denied all of these allegations. On September 10, 1997, the Company and counsel for the class action plaintiffs agreed to settle the consolidated action in its entirety. Although the Company believes that the claims asserted in the class action were without merit, management concluded that the best interests of its shareholders were served by settling the action due to the continuing costs of the defense, the distraction of management's attention and the uncertainties inherent in any litigation. As a result of this settlement, the Company recorded a net pre-tax charge of $2,000,000 in the second quarter of fiscal 1998. 12. 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 earnings reduction contributions to the Plan. The Plan permits employees to contribute up to 15% of their earnings, through payroll deductions, based on earnings reduction agreements. The Company's contribution, which is equal to one-half of the employee's contribution up to 6%, is invested in the common stock of the Company and totaled $630,000, $804,000 and $983,000 in fiscal 1999, 1998 and 1997, respectively. The Company has authorized unissued common stock reserved for issuance to the Plan. As of February 28, 1999, there were 142,000 shares remaining in reserve for this plan. Since its inception, 1,056,000 shares of the Company's common stock have been contributed to the Plan. As of February 28, 1999, 331 of the 452 employees who had satisfied the Plan's eligibility requirements to participate were making salary deduction contributions. EMPLOYEE STOCK OPTION PLANS Under the Company's stock option plans, the Compensation Committee of the Board of Directors is authorized to grant stock options to purchase 2,856,000 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 28, 1999, 1,486,000 shares of common stock were available for future grants. Stock option plan activity is summarized below (shares in thousands):
Fiscal Weighted Fiscal Weighted Fiscal Weighted 1999 Average 1998 Average 1997 Average Shares Exercise Shares Exercise Shares Exercise Price Price Price - ------------------------------------------------------------------------------------------------------------------ Options outstanding, beginning of year 881 $10.38 1,357 $ 9.82 1,383 $17.53 Granted 719 9.04 235 10.16 1,799 10.61 Exercised (30) 9.00 (386) 9.02 (61) 7.07 Canceled or expired (200) 14.02 (325) 9.63 (1,764) 16.76 - ------------------------------------------------------------------------------------------------------------------ Options outstanding, end of year 1,370 $ 9.18 881 $10.38 1,357 $ 9.82 ================================================================================================================== Options exercisable 417 $ 9.14 395 $10.79 387 $10.62 ==================================================================================================================
The following table summarizes information relating to currently outstanding and exercisable options as of February 28, 1999 (shares in thousands):
Weighted Average Weighted Weighted Range of Remaining Life Options Average Options Average Exercise Prices (in years) Outstanding Exercise Price Exercisable Exercise Price - ----------------------------------------------------------------------------------------------------- $6.25 - $8.75 8.71 292 $ 8.24 13 $ 8.52 $8.81 - $8.88 7.38 25 8.84 2 8.88 $9.00 5.02 521 9.00 372 9.00 $9.13 7.92 2 9.13 1 9.13 $9.50 - $17.19 8.85 530 9.88 29 11.18 =====================================================================================================
Effective March 1, 1996, the Company elected to disclose the pro forma effects of SFAS No. 123, Accounting for Stock-Based Compensation. As allowed under the provisions of this statement, the Company will continue to apply APB Opinion No. 25 and related interpretations to accounting for the stock options awarded under these plans. Accordingly, no compensation cost has been recognized for these stock options. Had compensation cost for these plans been determined consistent with 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 28, 1999 1998 1997 - ------------------------------------------------------------------------- Net loss: As reported $(12,545) $(18,921) $(21,297) Pro forma (14,731) (21,540) (23,295) - ------------------------------------------------------------------------- Diluted net loss per share: As reported $ (0.79) $ (1.22) $ (1.54) Pro forma (0.93) (1.39) (1.68) ========================================================================= The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: For the years ended February 28, 1999 1998 1997 - ---------------------------------------------------------------------- Dividend yield - - - Expected volatility 65% 58% 57% Risk-free interest rates 5.37% 5.70% 5.71%-6.27% Expected lives (in years) 4 4 1-4 ====================================================================== The weighted average Black-Scholes values of options granted in fiscal 1999, 1998 and 1997 were $4.84, $5.18 and $3.65, respectively. The values produced by this model are limited by the inclusion of highly subjective assumptions, which greatly affect the calculated values. 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 28, 1999, the expiration dates of the outstanding options range from July 7, 1999 to July 14, 2008, and the exercise prices range from $8.75 to $14.88 (average $12.65) per share. The following is a summary of activity under the Director Stock Option Plan over the past three fiscal years (in thousands): For the years ended February 28, 1999 1998 1997 - -------------------------------------------------------------------------- Shares under option, beginning of year 210 186 144 Options granted during the year 33 33 50 Options canceled or terminated (15) (9) (8) Options exercised -- -- -- - --------------------------------------------------------------------------- Shares under option, end of year 228 210 186 =========================================================================== Options exercisable, end of year 212 177 87 =========================================================================== Shares available for future grants, end of year 91 109 133 =========================================================================== DIRECTOR DEFERRED COMPENSATION PLAN In March 1997, the Company implemented a deferred compensation plan for its non-employee directors effective following the Company's July 1997 annual meeting of shareholders. The plan permits eligible directors to defer 50% or 100% of their basic annual compensation, which is otherwise paid in cash. 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 the first day of such quarter. 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 is paid in either common stock or an equivalent amount of cash, at the election of the participant. The following is a summary of the activity under this plan (units in thousands):
For the years ended February 28, 1999 1998 - ------------------------------------------------------------------------------------------------- Common stock equivalent units, beginning of year 7 - Common stock equivalent units earned during the year 12 7 - ------------------------------------------------------------------------------------------------- Common stock equivalent units, end of year 19 7 ================================================================================================= Common stock equivalent units available, end of year 81 93 ================================================================================================= Range of common stock prices used to calculate common stock equivalent units $6.88 - $10.00 $8.63 - $15.63 =================================================================================================
RESTRICTED STOCK BONUS PLANS The Company maintains two Restricted Stock Bonus Plans. Each provides for common stock awards to certain officers and key employees. The fair market value of shares awarded under the 1991 Plan to an employee in any year is limited to 20% of the employee's base salary, and are earned in equal installments on the second, third and fourth anniversaries of the award. Awards granted under the 1996 plan are earned in 25%, 25%, and 50% increments on the first, second and third anniversaries of the award, respectively. The shares granted under each plan are distributed provided the employee has remained employed by the Company's through such anniversary dates; otherwise the unearned shares are forfeited. The maximum number of shares issuable under the 1996 Plan is 350,000, of which 31,000, net of cancellations, have been awarded as of February 28, 1999. No new shares can be issued under the 1991 Plan, and as of February 28, 1999, 29,000 shares remain unearned under this plan. The market value of these shares at the date of award, net of cancellations, is recorded as compensation expense ratably over three or four year periods from the respective award dates. This compensation expense was $354,000, $363,000 and $385,000 in fiscal 1999, 1998 and 1997, respectively. RETIREMENT PLANS In March 1994, the Company adopted an unfunded Supplemental Executive Retirement Plan to provide senior management with retirement, disability and death benefits. The 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 on the latest available actuarial information, the following table sets forth the components of the net periodic pension expense, the funded status and the assumptions used in determining the present value of benefit obligations (dollars in thousands): For the years ended February 28, 1999 1998 1997 - ------------------------------------------------------------------------------ Service cost - benefits earned during the year $ 30 $ 56 $ 76 Interest cost on projected benefit obligations 347 361 275 Net amortization and deferral 245 258 245 - ------------------------------------------------------------------------------ Net periodic pension expense $ 622 $ 675 $ 596 ============================================================================== As of February 28, 1999 1998 1997 - ------------------------------------------------------------------------------ Actuarial present value of: Vested benefit obligation $3,789 $3,158 $3,040 Nonvested benefit obligation 122 449 377 - ------------------------------------------------------------------------------ Accumulated benefit obligation 3,911 3,607 3,417 Effect of projected future salary increases 1,360 1,227 1,612 - ------------------------------------------------------------------------------ Projected benefit obligation 5,271 4,834 5,029 Unrecognized net loss (308) (156) (596) Unrecognized net transition asset (2,451) (2,696) (2,941) Additional minimum liability 1,398 1,624 1,925 - ------------------------------------------------------------------------------ Accrued pension cost $3,910 $3,606 $3,417 ============================================================================== Assumptions used in determining actuarial present value of benefit obligations: Discount rate 7.25% 7.25% 7.25% Weighted-average rate of compensation increase 7.00% 7.00% 7.00% ============================================================================== During fiscal 1993, the Company adopted an unfunded retirement plan for the non-employee members of its Board of Directors. The plan provides for annual benefit payments equal to the annual retainer in effect at the date of retirement, for a period of years equal to the lesser of the director's years of service or ten years. The cost of this plan is accrued over the directors' estimated remaining years of service, of which $99,000, $118,000 and $174,000 was accrued during fiscal 1999, 1998 and 1997, respectively. EXECUTIVE INCENTIVES The Company's Board of Directors has provided that certain executives receive incentive compensation based upon certain revenues, earnings and other performance measures. Incentive compensation of $549,000, $537,000 and $560,000 was earned in fiscal 1999, 1998 and 1997, respectively. 13. INDUSTRY SEGMENT, GEOGRAPHIC AND CUSTOMER INFORMATION As of February 28, 1999, the Company adopted SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information. SFAS No. 131 establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas and major customers. INDUSTRY SEGMENT The Company operates predominantly in one industry segment in which it designs, develops and markets semiconductor integrated circuits for the personal computer, peripheral and embedded systems markets. GEOGRAPHIC INFORMATION The Company's domestic operations include its worldwide revenues, exclusive of its revenues from customers in Japan, and most of its operating expenses. Revenues and operating profits from customers in Japan are recorded by TMC. The Company conducts various sales and marketing operations outside of the United States through TMC in 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. Included within other long-lived assets is an equity investment of $19,944,000 in Singapore-based Chartered Semiconductor Manufacturing Ltd. EXPORT SALES The information below summarizes sales to unaffiliated customers by geographic region (in thousands): For the years ended February 28, 1999 1998 1997 - ------------------------------------------------------------------------------- North America $ 26,041 $ 40,570 $ 57,028 Asia and Pacific Rim 115,146 98,128 113,369 Europe 14,467 9,311 10,060 Rest of World 172 317 461 - ------------------------------------------------------------------------------- $155,826 $148,326 $180,918 =============================================================================== MAJOR CUSTOMERS During fiscal 1999, one customer accounted for 11.8% of the Company's revenues. During fiscal 1998, no customer accounted for more then 10% of the Company's revenues. During fiscal 1997, one customer accounted for 13.9% of the Company's revenues. CONCENTRATIONS OF CREDIT RISK The Company sells its products to personal computer manufacturers and their subcontractors and to distributors, and maintains individually significant accounts receivable balances from several of its larger customers. The Company performs credit evaluations of its customers' financial condition on a regular basis and although the Company generally requires no collateral, letters of credit may be required from its customers in certain circumstances. Reserves for estimated credit losses are maintained and actual losses have been within the Company's expectations. 14. QUARTERLY FINANCIAL DATA (UNAUDITED) (In thousands, except per share data)
Quarter ended May 31 Aug. 31 Nov. 30 Feb. 28 - ----------------------------------------------------------------------------------------------- Fiscal 1999 Revenues $35,284 $37,865 $42,745 $39,932 Operating income (loss) 2,690 2,637 2,336 (1,224) Net income from continuing operations 2,018 1,972 1,886 127 Net loss from discontinued operation (1,573) (1,367) (1,083) (1,232) Loss on sale of discontinued operation - - - (13,293) Net income (loss) 445 605 803 (14,398) =============================================================================================== Basic net income (loss) per share Continuing operations $ 0.13 $ 0.12 $ 0.12 $ 0.01 Discontinued operation (0.10) (0.08) (0.07) (0.08) Loss on sale of discontinued operation - - - (0.86) - ----------------------------------------------------------------------------------------------- $ 0.03 $ 0.04 $ 0.05 $ (0.93) =============================================================================================== Diluted net income (loss) per share Continuing operations $ 0.13 $ 0.12 $ 0.12 $ 0.01 Discontinued operation (0.10) (0.08) (0.07) (0.08) Loss on sale of discontinued operation - - - (0.86) - ----------------------------------------------------------------------------------------------- $ 0.03 $ 0.04 $ 0.05 $ (0.93) =============================================================================================== Average shares outstanding Basic net income (loss) per share 15,946 15,978 15,745 15,511 Diluted net income (loss) per share 16,034 16,031 15,748 15,519 Market price High $ 11.88 $ 11.13 $ 8.00 $ 9.94 Low 8.63 6.25 4.63 6.00 =============================================================================================== Fiscal 1998 Revenues $34,101 $39,446 $40,668 $34,111 Operating income (loss) (3,784) (291) 1,911 1,603 Net income (loss) from continuing operations (2,312) (1,511) 1,370 1,348 Net loss from discontinued operations (5,868) (7,728) (4,422) (828) Gain on sale of discontinued operation - - 1,030 - Net income (loss) (8,180) (9,239) (2,022) 520 =============================================================================================== Basic net income (loss) per share Continuing operations $ (0.15) $ (0.10) $ 0.09 $ 0.08 Discontinued operations (0.39) (0.50) (0.28) (0.05) Gain on sale of discontinued operation - - 0.06 - - ----------------------------------------------------------------------------------------------- $ (0.54) $ (0.60) $ (0.13) $ 0.03 =============================================================================================== Diluted net income (loss) per share Continuing operations $ (0.15) $ (0.10) $ 0.08 $ 0.08 Discontinued operations (0.39) (0.50) (0.27) (0.05) Gain on sale of discontinued operation - - 0.06 - - ----------------------------------------------------------------------------------------------- $ (0.54) $ (0.60) $ (0.13) $ 0.03 =============================================================================================== Average shares outstanding Basic net income (loss) per share 15,056 15,490 15,701 15,910 Diluted net income (loss) per share 15,056 15,490 16,165 15,979 Market price High $ 10.75 $ 12.75 $ 18.13 $11.00 Low 8.25 8.50 10.13 8.00 ===============================================================================================
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 1,075 holders of record of the Company's common stock at April 21, 1999. The Company has never paid a cash dividend. The present policy of the Company is to retain earnings to provide funds for the operation and expansion of its business. The Company does not expect to pay cash dividends in the foreseeable future. =============================================================================== REPORT ON MANAGEMENT'S RESPONSIBILITIES The consolidated financial statements of Standard Microsystems Corporation and its subsidiaries have been prepared under the direction of management in conformity with generally accepted accounting principles, consistently applied. The statements include amounts that reflect management's objective estimates and judgments. Standard Microsystems Corporation and its subsidiaries maintain accounting systems and related internal accounting controls which, in the opinion of management, provide reasonable assurance, at appropriate cost, that assets are properly controlled and safeguarded and that transactions are executed in accordance with management's authorization and are recorded and reported properly. The audit committee of the Board of Directors is composed solely of directors who are not officers or employees of the Company. The committee meets periodically with representatives of management and the independent public accountants. The independent public accountants have free access to the committee, without management present, to discuss the results of their audit work, adequacy of internal financial controls and the quality of the financial reporting. The committee also recommends to the directors the appointment of the independent public accountants. The independent public accountants provide an objective, independent review as to management's discharge of its responsibilities as they relate to the integrity of reported operating results and financial condition. Arthur Andersen LLP, independent public accountants, has audited the consolidated financial statements in this annual report. =============================================================================== REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of Standard Microsystems Corporation: We have audited the accompanying consolidated balance sheets of Standard Microsystems Corporation (a Delaware corporation) and subsidiaries as of February 28, 1999 and 1998, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended February 28, 1999. 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 generally accepted auditing standards. 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, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended February 28, 1999, in conformity with generally accepted accounting principles. April 21, 1999 ARTHUR ANDERSEN LLP New York, New York EX-21 4 EXHIBIT 21 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 Massachusetts, Inc. State of Delaware SMSC International Ltd. Barbados EX-23 5 EXHIBIT 23 Exhibit 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in or incorporated by reference in this Form 10-K, into the Company's previously filed Registration Statements on Form S-8 (File nos. 2-78324, 33-35590, 33-45011, 33-69224, 33-83400, 333-09271and 333-64043). ARTHUR ANDERSEN LLP May 27, 1999 New York, New York EX-27 6 ART. 5 FDS FOR YEAR-END 10-K
5 1,000 YEAR FEB-28-1999 FEB-28-1999 68,071 2,000 22,608 1,111 13,785 123,760 97,568 62,916 201,967 24,178 0 0 0 1,605 156,829 201,967 155,826 155,826 99,846 99,846 49,541 100 279 8,660 2,586 6,003 (18,548) 0 0 (12,545) (0.79) (0.79)
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