10-Q 1 f10q_3qtr-2001.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------------------------------------- FORM 10-Q ------------------------------------------------------- [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended November 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-7422 ----------------------------------------------------------------- STANDARD MICROSYSTEMS CORPORATION ------------------------------------------------------------------ (Exact name of registrant as specified in its charter) DELAWARE 11-2234952 ------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 80 ARKAY DRIVE, HAUPPAUGE, NEW YORK, 11788 -------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 631-435-6000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ____X____ No ________ As of November 30, 2001, there were 16,069,817 shares of the registrant's common stock outstanding. PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share and per share data)

November 30, February 28, 2001 2001 ----- ---- (Unaudited) Assets Current assets: Cash and cash equivalents $ 130,556 $ 99,545 Short-term investments 3,600 9,629 Accounts receivable, net of allowance for doubtful accounts of $450 and $362, respectively 22,103 16,776 Inventories 19,847 31,999 Deferred income taxes 7,409 8,718 Other current assets 4,482 7,080 ------------------------------------------------------------------------------------------------- Total current assets 187,997 173,747 ------------------------------------------------------------------------------------------------- Property, plant and equipment, net 25,642 35,492 Investment in Chartered Semiconductor 9,690 13,001 Deferred income taxes 7,517 2,019 Other assets 13,332 14,839 ------------------------------------------------------------------------------------------------- $ 244,178 $ 239,098 ================================================================================================= Liabilities and shareholders' equity Current liabilities: Accounts payable $ 7,848 $ 11,721 Deferred income on shipments to distributors 5,716 6,672 Accrued expenses, income taxes and other liabilities 15,600 8,972 ------------------------------------------------------------------------------------------------- Total current liabilities 29,164 27,365 ------------------------------------------------------------------------------------------------- Other liabilities 6,854 5,812 Commitments and contingencies Minority interest in subsidiary 11,634 11,606 Shareholders' equity: Preferred stock, $.10 par value authorized 1,000,000 shares, none outstanding - - Common stock, $.10 par value authorized 30,000,000 shares, issued 17,178,000 and 17,082,000 shares, respectively 1,718 1,708 Additional paid-in capital 117,879 116,515 Retained earnings 85,086 79,052 Treasury stock, 1,108,000 and 998,000 shares, respectively, at cost (9,963) (8,330) Accumulated other comprehensive income 1,806 5,370 ------------------------------------------------------------------------------------------------- Total shareholders' equity 196,526 194,315 ------------------------------------------------------------------------------------------------- $ 244,178 $ 239,098 =================================================================================================

See Notes to Condensed Consolidated Financial Statements. STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In thousands, except per share data)

Three Months Ended Nine Months Ended ------------------------------------------------------- November 30, November 30, --------------------------- ------------------------- 2001 2000 2001 2000 ---- ---- ---- ---- Sales and revenues: Product sales $ 34,644 $ 46,616 $ 95,274 $ 129,829 Licensing revenues 29,970 314 30,565 1,216 ----------------------------------------------------------------------------------------------------------------- 64,614 46,930 125,839 131,045 Cost of goods sold 24,315 27,502 61,581 77,305 ----------------------------------------------------------------------------------------------------------------- Gross profit 40,299 19,428 64,258 53,740 Operating expenses: Research and development 8,793 8,991 24,800 24,361 Selling, general and administrative 9,896 9,160 25,399 26,650 Restructuring costs 8,019 - 8,019 - ----------------------------------------------------------------------------------------------------------------- Income from operations 13,591 1,277 6,040 2,729 Interest income 813 1,550 2,872 4,193 Other income (expense), net (481) 202 1,131 27,712 ----------------------------------------------------------------------------------------------------------------- Income before provision for income taxes and minority interest 13,923 3,029 10,043 34,634 Provision for income taxes 4,749 775 3,313 12,468 Minority interest in net income (loss) of subsidiary (21) 42 28 82 ----------------------------------------------------------------------------------------------------------------- Income from continuing operations 9,195 2,212 6,702 22,084 Gain on sale of (loss from) discontinued operations (net of income taxes of ($64), - , ($360) and $2,799) (116) - (668) 4,765 ----------------------------------------------------------------------------------------------------------------- Net income $ 9,079 $ 2,212 $ 6,034 $ 26,849 ================================================================================================================= Basic net income per share: Income from continuing operations $ 0.57 $ 0.14 $ 0.42 $ 1.39 Gain on sale of (loss from) discontinued operations (0.01) - (0.04) 0.30 ----------------------------------------------------------------------------------------------------------------- Basic net income per share $ 0.56 $ 0.14 $ 0.38 $ 1.69 ================================================================================================================= Diluted net income per share: Income from continuing operations $ 0.56 $ 0.13 $ 0.40 $ 1.29 Gain on sale of (loss from) discontinued operations (0.01) - (0.04) 0.28 ----------------------------------------------------------------------------------------------------------------- Diluted net income per share $ 0.55 $ 0.13 $ 0.36 $ 1.57 ================================================================================================================= Weighted average common shares outstanding: Basic 16,071 15,983 16,090 15,890 Diluted 16,525 17,574 16,799 17,111

See Notes to Condensed Consolidated Financial Statements. STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)

Nine Months Ended November 30, ------------------------------ 2001 2000 ----------- ------------ Cash flows from operating activities: Cash received from customers and licensees $ 119,229 $ 124,817 Cash paid to suppliers and employees (93,744) (114,261) Interest received 3,806 2,980 Interest paid (108) (166) Income taxes paid (556) (7,199) --------------------------------------------------------------------------------------------- Net cash provided by operating activities 28,627 6,171 --------------------------------------------------------------------------------------------- Cash flows from investing activities: Capital expenditures (3,637) (10,100) Sales of property, plant and equipment 2,022 696 Sales of long-term investments and options 1,063 37,127 Purchases of short-term investments (7,600) (10,632) Sales of short-term investments 13,629 3,003 Other (64) (99) --------------------------------------------------------------------------------------------- Net cash provided by investing activities 5,413 19,995 --------------------------------------------------------------------------------------------- Cash flows from financing activities: Proceeds from issuance of common stock 686 2,599 Purchases of treasury stock (1,633) (2,827) Repayments of obligations under capital leases (703) (686) --------------------------------------------------------------------------------------------- Net cash used for financing activities (1,650) (914) --------------------------------------------------------------------------------------------- Effect of foreign exchange rate changes on cash and cash equivalents (330) (198) Net cash provided by (used for) discontinued operation (1,049) 12,370 --------------------------------------------------------------------------------------------- Net increase in cash and cash equivalents 31,011 37,424 Cash and cash equivalents at beginning of period 99,545 73,405 --------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 130,556 $ 110,829 ============================================================================================= Reconciliation of income from continuing operations to net cash provided by operating activities: Income from continuing operations $ 6,702 $ 22,084 Adjustments to reconcile income from continuing operations to net cash provided by operating activities: Depreciation and amortization 9,343 8,843 Gains on sales of investments and property (1,659) (27,850) Asset revaluations 5,337 - Other adjustments, net 116 (117) Changes in operating assets and liabilities: Accounts receivable (5,295) (6,588) Inventories 12,024 (8,670) Accounts payable and accrued expenses and other liabilities 3,169 13,292 Other changes, net (1,110) 5,177 --------------------------------------------------------------------------------------------- Net cash provided by operating activities $ 28,627 $ 6,171 =============================================================================================

STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Basis of Presentation The accompanying unaudited condensed consolidated financial information of Standard Microsystems Corporation and subsidiaries, referred to herein as "SMSC" or "the Company", has been prepared in accordance with generally accepted accounting principles and reflects all adjustments, consisting only of normal recurring adjustments, which in management's opinion are necessary to state fairly the Company's financial position, results of operations and cash flows as of and for the three and nine months ended November 30, 2001 and 2000. The February 28, 2001 Consolidated Balance Sheet was derived from audited financial statements on that date. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates, and such differences may be material to the financial statements. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended February 28, 2001 included in the Company's Annual Report on Form 10-K, as filed on May 25, 2001 with the Securities and Exchange Commission. The results of operations for the three and nine months ended November 30, 2001 are not necessarily indicative of the results to be expected for any future periods. Certain fiscal 2001 items have been reclassified to conform to the fiscal 2002 presentation. 2. Balance Sheet Data Inventories are valued at the lower of first-in, first-out cost or market and consist of the following (in thousands): Nov. 30, 2001 Feb. 28, 2001 ------------------------------------------------------------ Raw Materials $ 490 $ 558 Work in Process 10,339 22,859 Finished Goods 9,018 8,582 ------------------------------------------------------------ $ 19,847 $ 31,999 ============================================================ Property, plant and equipment consists of the following (in thousands): Nov. 30, 2001 Feb. 28, 2001 -------------------------------------------------------------------- Land $ 3,434 $ 3,434 Buildings and Improvements 29,223 29,540 Machinery and Equipment 76,676 82,794 -------------------------------------------------------------------- 109,333 115,768 Less: accumulated depreciation 83,691 80,276 -------------------------------------------------------------------- $ 25,642 $ 35,492 ==================================================================== 3. Net Income (Loss) Per Share Basic net income (loss) per share is based upon the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed using the weighted-average common shares outstanding during the period, plus the dilutive effect of shares issuable through stock options. The shares used in calculating basic and diluted net income (loss) per share are reconciled as follows (in thousands): Three Months Ended Nine Months Ended November 30, November 30, --------------------------------------- 2001 2000 2001 2000 -------- -------- -------- ---------- Average shares outstanding for basic net income (loss) per share 16,071 15,983 16,090 15,890 Dilutive effect of stock options 454 1,591 709 1,221 --------------------------------------------------------------------------- Average shares outstanding for diluted net income (loss) per share 16,525 17,574 16,799 17,111 =========================================================================== 4. Comprehensive Income The Company's other comprehensive income consists of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, and unrealized gains and losses on long-term equity investments. The components of the Company's comprehensive income (loss) for the three and nine month periods ended November 30, 2001 and 2000 were as follows (in thousands): Three Months Ended Nine Months Ended November 30, November 30, ---------------------------------------- 2001 2000 2001 2000 -------- ---------- --------- -------- Net income $ 9,079 $ 2,212 $ 6,034 $ 26,849 Other comprehensive income (loss): Change in foreign currency translation adjustment (537) (567) (685) (311) Change in unrealized gain on investments (1,471) (16,888) (2,879) (32,269) ----------------------------------------------------------------------------- Total comprehensive income (loss) $ 7,071 $(15,243) $ 2,470 $ (5,731) ============================================================================= 5. Business Restructuring In November 2001, the Company's Board of Directors approved management's plan to exit the PC chipset business, redirect the Company's resources, and increase its focus on leveraging its core technologies toward higher growth, higher margin businesses. This restructuring was announced on December 3, 2001. In line with this decision and the sustained economic difficulties of the semiconductor marketplace, during the third quarter of fiscal 2002, the Company eliminated 55 positions, or 11% of its work force, primarily within engineering and development staff. The Company recorded pretax charges of $9.3 million during the third quarter to reflect the costs of this restructuring. The components of the restructuring charges were as follows (in thousands): Cost of Restructuring goods sold costs --------------------------------------------------------------------- Excess and obsolete inventory $ 1,275 $ - Write-down of assets - 5,340 Non-cancelable lease obligations - 1,870 Workforce reduction - 309 Other charges - 500 --------------------------------------------------------------------- $ 1,275 $ 8,019 ===================================================================== 6. Discontinued Operations The Company is involved in several legal actions relating to past divestitures of divisions and business units. These divestitures were accounted for as discontinued operations, and accordingly, costs associated with these actions are reported as a Loss from discontinued operations on the Consolidated Statement of Income. These costs totaled $180,000 and $1,028,000, before applicable income tax benefits of $64,000 and $360,000, for the three and nine month periods ended November 30, 2001, respectively. During the first quarter of fiscal 2001, the Company sold the majority of its ownership interest in Standard MEMS, Inc. and realized an after-tax gain of $4,765,000, which appears as a Gain on sale of discontinued operations on the Consolidated Statement of Income for the nine months ended November 30, 2000. Standard MEMS, Inc. was organized in June 1999, upon the Company's sale of the assets of its former Foundry Business Unit to New Jersey-based IOTA, Inc. 7. Sales of Facilities During the first quarter of fiscal 2002, the Company sold two underutilized facilities. Combined proceeds from these sales were $2,105,000, before related expenses, and the sales resulted in a net pre-tax gain of approximately $600,000, which is included within Other income (expense), net. 8. New Accounting Pronouncements In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires the use of the purchase method of accounting for all business combinations initiated after June 30, 2001, thereby eliminating use of the pooling-of-interests method. SFAS No.142 requires goodwill and certain other intangible assets to be tested for impairment at least annually and written down only when impaired, replacing the current accounting practice of ratably amortizing these items. Intangible assets other than goodwill that have a finite life will be amortized over their useful lives. This statement will apply to existing goodwill and intangible assets, beginning with fiscal years starting after December 15, 2001. Early adoption of the statement will be permitted for companies with fiscal years beginning after March 15, 2001, for which first quarter financial statements have not been issued. The Company currently does not expect these pronouncements to have any impact on its results of operations or financial position. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations". This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 25, 2002. The Company currently does not expect this pronouncement to have any impact on its results of operations or financial position. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets". This statement establishes a single accounting model, based upon the framework established in SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", for long-lived assets to be disposed of by sale and addressed significant implementation issues. This statement will be effective for fiscal years beginning after December 15, 2001. The Company currently does not expect this pronouncement to have any impact on its results of operations or financial position. 9. Technology and Patent License Agreements with Intel Corporation In 1987, the Company and Intel Corporation (Intel) entered into an agreement providing for, among other things, a broad, worldwide, non-exclusive patent cross-license between the two companies, covering manufacturing processes and products, thereby providing each company access to the other's current and future patent portfolios. In September 1999, the two companies announced a technology exchange agreement (the Agreement) that would allow SMSC to accelerate its ongoing development of Intel-compatible chipset products. Chipset products are integrated circuits that communicate with the microprocessor (CPU) and assist in controlling the flow of information within a personal computer or similar application. The Agreement provides, among other things, for Intel to transfer certain intellectual property related to Intel chipset architectures to SMSC, and provides SMSC the opportunity to supply Intel chipset components along with its own chipset solutions. The Agreement also limits SMSC's rights regarding Northbridges and Intel Architecture Microprocessors under the 1987 agreement. The Agreement includes provisions for its termination under certain circumstances. Under one such provision, beginning in the third year of the Agreement and annually thereafter, SMSC can elect to terminate the Agreement should SMSC not achieve certain minimum chipset revenue amounts set forth in the Agreement, unless Intel pays SMSC an amount equal to the shortfall between the minimum revenue amount and the actual revenue for that period. Should the Agreement terminate under this provision, the limitations imposed by the Agreement on the Northbridge rights under the 1987 agreement terminate immediately, and the limitations imposed by the Agreement on the microprocessor rights under the 1987 agreement terminate 12 months later. Should Intel elect to make the revenue amount shortfall payment, the provisions of the Agreement will remain in force for the subsequent 12-month period, for which another minimum revenue amount will be applicable, and at the end of which a similar termination event may arise. Minimum chipset revenue amounts are $30 million, $45 million, and $60 million for the 12 months ending September 21, 2001, 2002, and 2003, respectively, and increase by 10% for each succeeding 12-month period following 2003, until expiration of the Agreement in July 2007. In September 2001, SMSC notified Intel of a chipset revenue shortfall of approximately $29.6 million for the 12 months ended September 21, 2001. In November 2001, the Company received a $29.6 million payment from Intel, which is reported as licensing revenue on the Company's Consolidated Statements of Income for the three and nine months ended November 30, 2001. There can be no assurance whatsoever that Intel will elect to pay any future revenue shortfalls to SMSC under the Agreement. 10. Litigation In October 2000, Standard Microsystems Corporation was named as a defendant, along with several other semiconductor suppliers, in a patent infringement lawsuit filed by U.S. Philips Corporation (Philips) in the United States District Court for the Southern District of New York (U.S. Philips Corporation v. Analog Devices, Inc., et al, Case Number 00 CIV. 7426). The Complaint filed in the suit alleged that some of the Company's products infringe one Philips patent, and was seeking injunctive relief and unspecified damages. In November 2001, the Company and Philips agreed to settle the dispute and to file a joint motion to dismiss all claims. As part of the settlement, the parties have entered into a nonexclusive licensing agreement under which SMSC is a licensee of the previously disputed Philips' patent rights. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included in Item 1 of this Quarterly Report, and the audited consolidated financial statements, related notes and Management's Discussion and Analysis for the fiscal year ended February 28, 2001, contained in the Company's 2001 Annual Report. The following discussion and analysis may contain forward-looking statements. These forward-looking statements are based upon information currently available to management and are subject to certain risks and uncertainties. Actual future results could differ significantly from those expressed or implied by these forward-looking statements. These risks and uncertainties include, without limitation, those described within this discussion, and also under the heading "Other Factors That May Affect Future Operating Results" within the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on May 25, 2001. Business Restructuring and Other Non-Recurring Charges On December 3, 2001 the Company announced that it was exiting the PC chipset business, and had eliminated 55 positions or 11% of its worldwide workforce, primarily within its engineering and development staff. The Company had been investing significant resources, particularly during the past several years, in the development and marketing of PC chipset products. This decision follows a series of changes over the past two years in the industry outlook for the PC chipset business, including excess industry capacity and eroding margins. In addition, the current, unprecedented semiconductor market downturn has prevented SMSC from remaining profitable while continuing its significant investment in PC chipset products. By exiting the PC Chipset business, the Company believes that it can better focus on and leverage its core technologies toward higher growth, higher margin businesses, targeting more predictable returns on investment. The Company's operating results for the three months ended November 30, 2001 include charges of $9.3 million for costs associated with this restructuring, including $1.3 million for excess and obsolete inventories which is reported within Cost of goods sold. The Company also incurred approximately $1.4 million of other non-recurring charges during the third quarter of fiscal 2002. These charges included costs of a litigation settlement, professional fees, and the write-down of an equity investment. Licensing Revenue In November 2001, the Company received a $29.6 million payment from Intel Corporation, under the terms of its September 1999 chipset agreement with Intel. Further details in this regard are provided within this discussion under the caption "Technology and Patent License Agreements with Intel Corporation" below. This payment was recorded as licensing revenue in the third quarter of fiscal 2002. Revenues Revenues for the third quarter of fiscal 2002 were $64.6 million, compared to $46.9 million for the third quarter of fiscal 2001. This increase in revenues primarily reflects the aforementioned $29.6 million payment from Intel Corporation. Product sales (exclusive of licensing revenue) for the three-month period ending November 30, 2001 were $34.6 million, compared to $46.6 million for the three-month period ending November 30, 2000. This reduction in product sales was due to lower unit volumes shipped compared to the preceding year's three-month period, reflecting the current year's broad, ongoing slowdown in demand for semiconductor products. Revenues for the nine months ended November 30, 2001 were $125.8 million, compared to $131.0 million reported for the nine months ended November 30, 2000. Product sales for the current year's nine-month period were was $95.3 million, compared to $129.8 million for the nine-month period ending November 30, 2000. Consistent with the third quarter's revenue comparison, revenue from product sales decreased as a result of lower unit shipments. International product sales were approximately 92% of total product sales for the three months ended November 30, 2001, compared to 77% for the three months ended November 30, 2000. For the nine-month period ended November 30, 2001, international product sales were 89% of total product sales, compared to 75% for the nine-month period ended November 30, 2000. Asia and the Pacific Rim region continues to represent the dominant location for the Company's shipments, reflecting the region's high concentration of the world's electronic manufacturing and assembly activity. Several of the Company's customers have increased their manufacturing activity in this region during the past year. Product sales from Asia and the Pacific Rim region were 83% of total product sales for the three-month period ending November 30, 2001, compared to 62% for the three-month period ending November 30, 2000. For the current year's nine-month period, product sales from Asia and the Pacific Rim region were 80% of total product sales, compared to 61% in the prior year's nine-month period. Gross Profit Gross profit was $40.3 million in the third quarter of fiscal 2002, compared to $19.4 million in the corresponding year-earlier quarter. For the nine months ended November 30, 2001, gross profit was $64.3 million, compared to $53.7 million for the prior year's nine month period. Included within gross profit for both the three and nine month periods of fiscal 2002 is the $29.6 million licensing payment from Intel Corporation, as well as $1.3 million of inventory obsolescence charges resulting from the Company's exit from the PC chipset business. Excluding these items, gross profit for the three months ending November 30, 2001 was $12.0 million, or 34.3% of revenues (as adjusted for the payment from Intel), compared to $19.4 million, or 41.4% of revenues for the year earlier three-month period. For the nine months ended November 30, 2001, gross profit, as adjusted, was $35.9 million, or 37.3% of adjusted revenues, compared to $53.7 million, or 41.0% of revenues, for the corresponding year-earlier nine-month period. This reduction in gross profit percentage for both the three and nine month periods is principally due to a $1.6 million inventory obsolescence charge recorded in the third quarter of fiscal 2002 resulting from reduced customer demand, including reduced demand for several high-volume products by one of the Company's larger customers. In addition, there has been a modest shift in product mix away from higher margined embedded products and towards lower margined Advanced I/O devices during fiscal 2002. The reduced customer demand is indicative of current overall business conditions within the semiconductor marketplace, not of a reduction of the Company's share of the markets it serves. On the contrary, the Company believes that it has gained market share in the Advanced I/O marketplace during the past year, reflecting several new high-volume design wins. Operating Expenses Research and development expenses were $8.8 million in the third quarter of fiscal 2002, compared to $9.0 million in the corresponding year-earlier quarter. For the nine months ended November 30, 2001, research and development expenses were $24.8 million, compared to $24.4 million for the first nine months of the prior fiscal year. Research and development expenses are expected to decline in the fourth quarter of fiscal 2002, to between $6.5 million and $7.0 million, as a result of the previously described business restructuring. Selling, general and administrative expenses were $9.9 million in the third quarter of fiscal 2002, compared to $9.2 million for the prior year's third quarter. The increase in the current year's third quarter reflects higher professional fees as well as the impact of a litigation settlement. For the nine months ended November 30, 2001, selling, general and administrative expenses were $25.4 million, compared to $26.6 million for the corresponding year-earlier period. The decline in fiscal 2002, compared to fiscal 2001, reflects lower commission and incentive costs associated with lower revenues in fiscal 2002. Selling, general and administrative costs are expected to be between $7.5 million and $8.0 million in the fourth quarter of fiscal 2002. As noted earlier, the Company recorded an $8.0 million restructuring charge in the third quarter of fiscal 2002 resulting from its decision to exit the PC chipset business. Other Income and Expense Interest income was $0.8 million and $2.9 million in the three and nine-month periods ended November 30, 2001, respectively, compared to $1.6 million and $4.2 million in the corresponding year-earlier periods. These decreases reflect lower interest rates on cash and short-term cash equivalent investments held by the Company. Other income (expense), net, totaled $(0.5) million and $1.1 million in the three and nine month periods ended November 30, 2001, respectively, compared to $0.2 million and $27.7 million in the corresponding year-earlier periods. Other income (expense), net for the current three-month period includes the write-down of an equity investment accounted for on the cost method, reflecting management's judgement of a permanent impairment in its value. Other income (expense) for the nine months ended November 30, 2001 includes gains on the sale of long-term equity investments and also includes gains of $0.6 million on the sale of two underutilized facilities. Other income (net) for the three and nine month periods ending November 30, 2000 includes gains realized on sales of a portion of the Company's investment in Singapore-based Chartered Semiconductor Manufacturing Ltd. (Chartered), as well as proceeds from sales of call options covering a portion of its Chartered stock holdings. The gains totaled $24.2 million for the nine months ended November 30, 2000, while proceeds from sales of call options were $0.7 million and $2.2 million for the three and nine-month periods ended November 30, 2000. Income Taxes The Company recorded a tax provision of $4.7 million and $3.3 million for the three and nine-month periods ending November 30, 2001, respectively, compared to $0.8 million and $12.5 million in the comparable year-earlier periods. Generally, the Company's income tax rate includes the federal, state and foreign statutory tax rates, the impact of certain permanent differences between the book and tax accounting treatment of certain expenses, the impact of tax-exempt income and various tax credits. Discontinued Operations The Company is involved in several legal actions relating to past divestitures of divisions and business units. These divestitures were accounted for as discontinued operations, and accordingly, costs associated with these actions totaling $0.1 million and $0.6 million, net of income taxes, for the three and nine-month periods ending November 30, 2001, respectively, are reported as a Loss from discontinued operations on the Consolidated Statement of Operations. During the nine-month period ending November 30, 2000, the Company sold most of its ownership interest in Standard MEMS, Inc. and realized an after-tax gain of $4.8 million. Standard MEMS, Inc. was organized in June 1999, upon the Company's sale of the assets of its former Foundry Business Unit to New Jersey-based IOTA, Inc. Technology and Patent License Agreements with Intel Corporation In 1987, the Company and Intel Corporation (Intel) entered into an agreement providing for, among other things, a broad, worldwide, non-exclusive patent cross-license between the two companies, covering manufacturing processes and products, thereby providing each company access to the other's current and future patent portfolios. In September 1999, the two companies announced a technology exchange agreement (the Agreement) that would allow SMSC to accelerate its ongoing development of Intel-compatible chipset products. Chipset products are integrated circuits that communicate with the microprocessor (CPU) and assist in controlling the flow of information within a personal computer or similar application. The Agreement provides, among other things, for Intel to transfer certain intellectual property related to Intel chipset architectures to SMSC, and provides SMSC the opportunity to supply Intel chipset components along with its own chipset solutions. The Agreement also limits SMSC's rights regarding Northbridges and Intel Architecture Microprocessors under the 1987 agreement. The Agreement includes provisions for its termination under certain circumstances. Under one such provision, beginning in the third year of the Agreement and annually thereafter, SMSC can elect to terminate the Agreement should SMSC not achieve certain minimum chipset revenue amounts set forth in the Agreement, unless Intel pays SMSC an amount equal to the shortfall between the minimum revenue amount and the actual revenue for that period. Should the Agreement terminate under this provision, the limitations imposed by the Agreement on the Northbridge rights under the 1987 agreement terminate immediately, and the limitations imposed by the Agreement on the microprocessor rights under the 1987 agreement terminate 12 months later. Should Intel elect to make the revenue amount shortfall payment, the provisions of the Agreement will remain in force for the subsequent 12-month period, for which another minimum revenue amount will be applicable, and at the end of which a similar termination event may arise. Minimum chipset revenue amounts are $30 million, $45 million, and $60 million for the 12 months ending September 21, 2001, 2002, and 2003, respectively, and increase by 10% for each succeeding 12-month period following 2003, until expiration of the Agreement in July 2007. In September 2001, SMSC notified Intel of a chipset revenue shortfall of approximately $29.6 million for the 12 months ended September 21, 2001. In November 2001, the Company received a $29.6 million payment from Intel, which is reported as licensing revenue on the Company's Consolidated Statements of Income for the three and nine months ended November 30, 2001. There can be no assurance whatsoever that Intel will elect to pay any future revenue shortfalls to SMSC under the Agreement. Liquidity and Capital Resources The Company's cash, cash equivalents and short-term investments were $134.2 million as of November 30, 2001, compared to $109.2 million as of February 28, 2001. During the first nine months of fiscal 2002, operating activities generated $28.6 million of cash, while investing activities provided $5.4 million, and financing activities consumed $1.7 million. Discontinued operations consumed $1.0 million of cash. The cash provided by the operating activities primarily reflects the licensing payment of $29.6 million received from Intel Corporation in November 2001. The cash provided by investment activities includes $6.0 million (net) from the maturity of short-term investments, as well as $2.0 million from the sale of underutilized real estate and $1.1 million from sales of long-term equity investments. During the current year's nine-month period, the Company purchased 110,000 shares of treasury stock for $1.6 million. The purchases of capital equipment were $3.6 million for the first nine months of fiscal 2002. Total fiscal 2002 capital expenditures are expected to be below the $14.6 million of such expenditures incurred in fiscal 2001. Accounts receivable increased to $22.1 million at November 30, 2001, compared to $16.8 million at February 28, 2001, reflecting an increase in product sales in the third quarter of fiscal 2002 as compared to the fourth quarter of fiscal 2001. The Company's accounts receivable are substantially all current as of November 30, 2001. The Company's inventories decreased by approximately $12.2 million, to $19.8 million, during the first nine months of fiscal 2002. This reduction includes a $1.3 million write-down of inventory from exiting the PC chipset business, and the Company's continued realignment of inventories with current demand. The decline in accounts payable, from $11.7 million at February 28, 2001 to $7.8 million at November 30, 2001, resulted from a lower volume of inventory purchases. The increase in accrued expenses, income taxes and other liabilities to $15.6 million at November 30, 2001, compared to $9.0 million at February 28, 2001, reflects a $5.0 million increase in income taxes payable. 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 believes that its existing cash, cash equivalents and investments on hand, together with cash that it expects to generate from its operations, will be sufficient to meet future operating and capital needs for at least the next twelve months. Other Factors That May Affect Future Operating Results The Company's operating results are subject to general economic conditions and a variety of risks characteristic of the semiconductor and related industries. For a further discussion of such risks, see "Other Factors That May Affect Future Operating Results" included within Part I, Item 1 - "Business" in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended February 28, 2001. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk - The Company's exposure to interest rate risk relates primarily to its investment portfolio. The primary objective of the Company's investment portfolio management is to invest available cash while preserving principal and meeting liquidity needs. In accordance with the Company's investment policy, investments are placed with high credit-quality issuers and the amount of credit exposure to any one issuer is limited. The majority of the Company's short-term investments have original maturities of three months or less and are therefore classified as cash equivalents. As of November 30, 2001, the Company's $3.6 million of short-term investments consisted of fixed-income investments with maturities of between three and six months. The Company periodically holds fixed-income investments in corporate and municipal obligations with maturities of between three and twelve months. These securities, like all fixed income instruments, are subject to interest rate risk and will vary in value as market interest rates fluctuate. If market interest rates were to increase immediately and uniformly by 10% the fair value of these short-term investments would decline by an immaterial amount. The Company has 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. Equity Price Risk - The Company is exposed to an equity price risk on its investment in Chartered Semiconductor Manufacturing, Ltd. and other publicly traded equity investments. For every 10% adverse change in the market value of Chartered Semiconductor common stock, the Company would experience a decrease of approximately $1.1 million to its November 30, 2001 investment value. The Company has sold call options on this security in the past and may do so in the future to reduce some of this market risk. Foreign Currency Risk - The Company has international sales and expenditures and is therefore subject to certain foreign currency rate exposure. The Company conducts a significant amount of its business in Asia. In order to reduce the risk from fluctuation in foreign exchange rates, most of the Company's product sales and all of its arrangements with its foundry, test and assembly vendors are denominated in U.S. dollars. Transactions in the Japanese market made by Toyo Microsystems Corporation (TMC), the Company's majority owned subsidiary, are denominated in Japanese yen. The Company has never received a cash dividend (repatriation of cash) from TMC nor does it expect to receive such a dividend in the near future. The Company has not entered into any significant foreign currency hedging activities. PART II - OTHER INFORMATION ITEM 1. Legal Proceedings In October 2000, Standard Microsystems Corporation was named as a defendant, along with several other semiconductor suppliers, in a patent infringement lawsuit filed by U.S. Philips Corporation (Philips) in the United States District Court for the Southern District of New York (U.S. Philips Corporation v. Analog Devices, Inc., et al, Case Number 00 CIV. 7426). The Complaint filed in the suit alleged that some of the Company's products infringe one Philips patent, and was seeking injunctive relief and unspecified damages. In November 2001, the Company and Philips agreed to settle the dispute and to file a joint motion to dismiss all claims. As part of the settlement, the parties have entered into a nonexclusive licensing agreement under which SMSC is a licensee of the previously disputed Philips' patent rights. In October 1997, the Company sold an 80.1% interest in SMC Networks, Inc., a then-newly-formed subsidiary comprised of its former local area networking division, to an affiliate of Accton Technology Corporation (Accton). In consideration for the sale, the Company received $40.2 million in cash, of which $2.0 million was placed in an escrow account, scheduled for release in January 1999, to secure the Company's indemnity obligations under the agreement. 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 million by reason of alleged misrepresentations and inadequate disclosures relating to the transaction and other alleged breaches of covenants and representations in the related agreements. Based upon those allegations, the escrow account was not released to the Company as scheduled in January 1999. In January 1999, SMSC filed an action in the Supreme Court of New York (the Action) against Accton, SMC Networks, Inc. and other parties, seeking the release of the escrow account to the Company on the grounds that Accton's allegations are without merit, and seeking payment of approximately $1.6 million (the majority of which is included within other assets on the Company's Consolidated Balance Sheet at February 28, 2001) owed to the Company by SMC Networks, Inc. In November 1999, the Court issued an order staying the Action and directed the parties to arbitration under the arbitration provisions of the original transaction agreements. In July 2000, the Company asserted various claims against Accton and its affiliates, including claims for fraud, improper transfer of profits, mismanagement, breach of fiduciary duties and payment default. The parties are now proceeding with arbitration of this dispute. The Company remains confident that it negotiated and fully performed its obligations under the Agreements with Accton in good faith and considers the claims against it to be without merit. The Company is vigorously defending itself against the allegations made by Accton and, although it is not possible at this time to assess the likelihood of any liability being established, expects that the outcome will not be material to the Company. Furthermore, the Company is pursuing recovery of damages and other relief from Accton pursuant to the Company's claims, but the likelihood of any such recovery also cannot currently be established. ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits None. (b) Reports on Form 8-K None. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. STANDARD MICROSYSTEMS CORPORATION DATE: January 14, 2002 /S/ Andrew M. Caggia ------------------------ (Signature) Andrew M. Caggia Senior Vice President - Finance (duly authorized officer) and Chief Financial Officer (principal financial officer)