UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, DC 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 May 31, 2010





OR








o
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 Incorporation or Organization)
(I.R.S. Employer Identification No.)








80 Arkay Drive,

Hauppauge, New York
11788-3728(Address of Principal Executive Offices)
(Zip Code)





(631) 435-6000


(Registrant’s Telephone Number, Including Area Code)








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 T No o





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T No o





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):








Large accelerated filer T
Accelerated filer oNon-accelerated filer o
Smaller reporting company o(Do not check if a smaller reporting company)





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No T





As of June 30, 2010 there were 22,587,445 shares of the registrant’s common stock outstanding.










STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





TABLE OF CONTENTS








PagePART I — FINANCIAL INFORMATIONItem 1.
Financial Statements
1Condensed Consolidated Balance Sheets as of May 31, 2010 and February 28, 2010
1Condensed Consolidated Statements of Operations for the Three-Month Periods Ended May 31, 2010 and 2009
2Condensed Consolidated Statements of Cash Flows for the Three-Month Periods Ended May 31, 2010 and 2009
3Notes to Condensed Consolidated Financial Statements
4Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
22Item 3.
Quantitative and Qualitative Disclosures About Market Risk
29Item 4.
Controls and Procedures
30PART II — OTHER INFORMATIONItem 1.
Legal Proceedings
31Item 1A.
Risk Factors
31Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
31Item 3.
Defaults Upon Senior Securities
31Item 4.
Removed and Reserved
31Item 5.
Other Information
31Item 6.
Exhibits
31Signature
32Exhibit 31.1Exhibit 31.2Exhibit 32


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PART I





Item 1. — Financial Statements





STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





CONDENSED CONSOLIDATED BALANCE SHEETS


(in thousands)





May 31,

2010


February 28,

2010(Unaudited)ASSETSCurrent assets:Cash and cash equivalents

$
125,340


$
109,141Short-term investments


30,400



30,500Accounts receivable, net


54,466



47,972Inventories


41,375



44,374Deferred income taxes


26,912



23,278Other current assets


6,445



6,613Total current assets


284,938



261,878Property, plant and equipment, net


66,068



66,802Goodwill


53,970



54,414Intangible assets, net


26,752



30,495Long-term investments, net


37,081



42,957Investments in equity securities


7,238



7,238Deferred income taxes


12,451



11,364Other assets


4,143



4,188Total assets

$
492,641


$
479,336LIABILITIES AND SHAREHOLDERS’ EQUITYCurrent liabilities:Accounts payable

$
28,588


$
25,992Deferred income from distribution


20,767



16,125Accrued expenses, income taxes and other current liabilities


52,159



48,424Total current liabilities


101,514



90,541Deferred income taxes


4,858



3,963Other liabilities


21,785



22,944Commitments and contingenciesShareholders’ equity:Preferred stock


—



—Common stock


2,706



2,688Additional paid-in capital


346,035



340,959Retained earnings


117,291



116,664Treasury stock, at cost


(101,199
)


(101,199
)Accumulated other comprehensive (loss) income


(349
)


2,776Total shareholders' equity


364,484



361,888Total liabilities and shareholders’ equity

$
492,641


$
479,336




See Accompanying Notes to Condensed Consolidated Financial Statements


1
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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(in thousands, except per share amounts)





Three Months Ended

May 31,2010


2009(Unaudited)Sales and revenues

$
97,159


$
62,479Costs of goods sold


45,364



34,767Gross profit on sales and revenue


51,795



27,712Operating expenses:Research and development


23,819



18,466Selling, general and administrative


25,353



21,572Restructuring charges


821



221Settlement charge


-



2,050Income (loss) from operations


1,802



(14,597
)Interest income


144



430Interest expense


(29
)


(20
)Other expense, net


(156
)


(294
)Income (loss) before provision for (benefit from) income taxes


1,761



(14,481
)Provision for (benefit from) income taxes


1,134



(5,285
)Net income (loss)

$
627


$
(9,196
)Net income (loss) per share:Basic

$
0.03


$
(0.42
)Diluted

$
0.03


$
(0.42
)Weighted average common shares outstanding:Basic


22,481



21,901Diluted


22,787



21,901




See Accompanying Notes to Condensed Consolidated Financial Statements


2
 Table of Contents


STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(in thousands)





Three Months Ended May 31,2010


2009(Unaudited)Cash flows from operating activities:Net income (loss)

$
627


$
(9,196
)Adjustments to reconcile net income (loss) to net cash provided by operating activities:Depreciation and amortization


5,688



5,301Stock-based compensation


7,739



5,890Deferred income taxes


(3,714
)


(5,892
)Deferred income on shipments to distributors


4,642



3,342Foreign exchange gain (loss)


927



(23
)Excess tax benefits from stock-based compensation


(64
)


(1
)Loss on sale of property, plant, and equipment


47



13Non-cash restructuring charges


-



221Settlement charge


-



2,050Provision for sales returns and allowances


239



79Changes in operating assets and liabilities, net of effects of business acquisitions:Accounts receivable


(7,536
)


(9,874
)Inventories


2,045



9,008Accounts payable, accrued expenses and other current liabilities


(596
)


1,694Accrued restructuring charges


(760
)


(4,187
)Income taxes payable


3,153



5,039Other changes, net


(382
)


(55
)Net cash provided by operating activities


12,055



3,409Cash flows from investing activities:Capital expenditures


(3,174
)


(1,211
)Purchases of short-term and long-term investments


(14,900
)


—Sales of short-term and long-term investments


21,400



8,000Net cash provided by investing activities


3,326



6,789Cash flows from financing activities:Excess tax benefits from stock-based compensation


64



1Proceeds from issuance of common stock


3,316



541Repayments of obligations under supplier financing arrangements


(1,190
)


(506
)Net cash provided by financing activities


2,190



36Effect of foreign exchange rate changes on cash and cash equivalents


(1,372
)


1,291Net increase in cash and cash equivalents


16,199



11,525Cash and cash equivalents at beginning of period


109,141



97,156Cash and cash equivalents at end of period

$
125,340


$
108,681





See Accompanying Notes to Condensed Consolidated Financial Statements


3
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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





1. Basis of Presentation





The accompanying unaudited condensed consolidated financial statements and related disclosures of Standard Microsystems Corporation and subsidiaries (“SMSC” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and the rules and regulations of the United States Securities and Exchange Commission (“SEC”), reflecting all adjustments (consisting only of normal, recurring adjustments) which in management’s opinion are necessary to present fairly the Company’s financial position as of May 31, 2010, results of operations for the three-month periods ended May 31, 2010 and 2009 and cash flows for the three-month periods ended May 31, 2010 and 2009 (collectively, including accompanying notes and disclosures, the “Interim Financial Statements”). The February 28, 2010 balance sheet information has been derived from audited financial statements, but does not include all information or disclosures required by U.S. GAAP.





The preparation of financial statements in conformity with U.S. GAAP 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 sales and revenues and expenses during the reporting period. Actual results may differ from those estimates, and such differences may be material to the Company’s financial statements.





These Interim Financial Statements should be read in conjunction with the audited consolidated financial statements for the fiscal year ended February 28, 2010 included in the Company’s Annual Report on Form 10-K, as filed on April 28, 2010 with the SEC (the “Fiscal 2010 Form 10-K”).





Results of operations for interim periods are not necessarily indicative of results to be expected for the full fiscal year or any future periods.





Certain items in the prior years’ consolidated financial statements have been reclassified to conform to the fiscal 2011 presentation reflected in these Interim Financial Statements. Specifically, the Company reclassified $0.1 million in amortization of technology intangibles previously included in selling, general and administrative costs to cost of goods sold on the consolidated statements of operations in the first quarter of fiscal 2010 to conform to the current period presentation.





2. Recent Accounting Standards





In October 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-13, “ Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements” (“ASU 2009-13”) and ASU 2009-14, “ Software (Topic 985) — Certain Revenue Arrangements That Include Software Elements” (“ASU 2009-14”). ASU 2009-13 modifies the requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered. ASU 2009-13 eliminates the requirement that all undelivered elements must have either: (i) vendor-specific objective evidence, or “VSOE”, or (ii) third-party evidence, or “TPE”, before an entity can recognize the portion of an overall arrangement consideration that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. Overall arrangement consideration will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price. The residual method of allocating arrangement consideration has been eliminated. ASU 2009-14 modifies the software revenue recognition guidance to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality. These new updates are effective for SMSC for revenue arrangements entered into or materially modified in the first quarter of fiscal year 2012. Early adoption is permitted. We are currently evaluating the impact that the adoption of these ASUs will have on our consolidated financial statements.





In January 2010, the FASB issued new standards in ASC 820, “Fair Value Measurements and Disclosures” (“ASC 820”),which require new disclosures on the amount and reason for transfers in and out of Level 1 and 2 fair value measurements. The standards also require disclosure of activities, including purchases, sales, issuances, and settlements within the Level 3 fair value measurements. The standards also clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. The new disclosures regarding Level 1 and 2 fair value measurements and clarification of existing disclosures were adopted by SMSC beginning in the first quarter of fiscal 2011. The adoption of ASC 820 did not have a material effect on our consolidated financial statements.


4
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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





3. Fair Value





In September 2006, the FASB issued a new standard for fair value measurement now codified as ASC Topic 820, “ Fair Value Measurements and Disclosures ” (“ASC 820”),which defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, management considers the principal or most advantageous market in which the Company would transact, and also considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of non-performance.





The Company’s financial instruments are measured and recorded at fair value. The Company’s non-financial assets (including: goodwill; intangible assets; and, property, plant and equipment) are measured at fair value when there is an indicator of impairment and recorded at fair value only when an impairment charge is recognized.





This pronouncement requires disclosure regarding the manner in which fair value is determined for assets and liabilities and establishes a three-tiered value hierarchy into which these assets and liabilities are grouped, based upon significant levels of inputs as follows:





Level 1  — Quoted prices in active markets for identical assets or liabilities.





Level 2  — Observable inputs, other than Level 1 prices, such as quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.





Level 3  — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.





The lowest level of significant input determines the placement of the entire fair value measurement in the hierarchy.





The following table summarizes the composition of the Company’s investments at May 31, 2010 and February 28, 2010 (in thousands) :





Cost


Gross Unrealized Gains


Gross Unrealized Losses


Aggregate Fair Value


Classification on Balance SheetMay 31, 2010













Cash


Short-Term Investments


Investments in equity securities


Long-Term InvestmentsMarketable equity securities

$
143


$
—


$
(43
)

$
100


$
—


$
—


$
—


$
100Non-marketable equity investments


7,238



—



—



7,238



—



—



7,238



—Auction rate securities


40,100



—



(3,119
)


36,981



—



—



—



36,981Short-Term Investments


30,400



—



—



30,400



—



30,400



—



—Money market funds


75,784



—



—



75,784



75,784



—



—



—$
153,665


$
—


$
(3,162
)

$
150,503


$
75,784


$
30,400


$
7,238


$
37,081








Cost


Gross Unrealized Gains


Gross Unrealized Losses


Aggregate Fair Value


Classification on Balance SheetFebruary 28, 2010













Cash


Short-Term Investments


Investments in equity securities


Long-Term InvestmentsMarketable equity securities

$
143


$
—


$
(44
)

$
99


$
—


$
—


$
—


$
99Non-marketable equity investments


7,238



—



—



7,238



—



—



7,238



—Auction rate securities


46,500



—



(3,642
)


42,858



—



—



—



42,858Short-Term Investments


30,500



—



—



30,500



—



30,500



—



—Money market funds


87,108



—



—



87,108



87,108



—



—



—$
171,489


$
—


$
(3,686
)

$
167,803


$
87,108


$
30,500


$
7,238


$
42,957


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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





3. Fair Value  – (continued)





The Company classifies all marketable debt and equity securities with remaining contractual maturities of greater than one year as long-term investments. As of May 31, 2010 the Company held approximately $37.0 million of investments in auction rate securities (net of $3.1 million in unrealized losses) with maturities ranging from 11 years to 31 years, all classified as available-for-sale. Auction rate securities are long-term variable rate bonds tied to short-term interest rates that were, until February 2008, reset through a “Dutch auction” process. As of May 31, 2010, all of the Company’s auction rate securities were “AAA” rated by one or more of the major credit rating agencies.





The cost basis and estimated fair values of available-for-sale securities at May 31, 2010 by contractual maturity are shown below ( in thousands ):





Cost


Estimated

Fair ValueDue in ten through twenty years

$
12,100


$
11,227Due in over twenty years


28,000



25,754Total

$
40,100


$
36,981





Expected maturities of securities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.





The following table details the fair value measurements within the three levels of fair value hierarchy of the Company’s financial assets, including investments, equity securities, cash surrender value of life insurance policies and cash equivalents at May 31, 2010 ( in thousands ):





Total Fair

Value at

5/31/2010


Fair Value Measurements at

Report Date UsingLevel 1


Level 2


Level 3Assets:Marketable equity securities

$
100


$
100


$
—


$
—Non-marketable equity investments


7,238



—



—



7,238Auction rate securities


36,981



—



650



36,331Short-term investment


30,400



30,400



—



—Money market funds


75,784



75,784



—



—Other assets-cash surrender value


1,663



—



1,663



—Total Assets

$
152,166


$
106,284


$
2,313


$
43,569





At May 31, 2010, the Company grouped money market funds and equity securities using a Level 1 valuation because market prices are readily available. Level 2 financial assets and liabilities represent the fair value of cash surrender value of life insurance as well as auction rate securities that have been redeemed at par subsequent to the May 31, 2010 reporting date. At May 31, 2010, the assets grouped for Level 3 valuation were auction rate securities consisting of AAA rated securities mainly collateralized by student loans guaranteed by the U.S. Department of Education under the Federal Family Education Loan Program (“FFELP”), as well as auction rate preferred securities ($6.1 million at par) which are AAA rated and part of a closed end fund that must maintain an asset ratio of 2 to 1.


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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





3. Fair Value  – (continued)





When a determination is made to classify a financial instrument within Level 3, the determination is based upon the lack of significance of the observable parameters to the overall fair value measurement. However, the fair value determination for Level 3 financial instruments may consider some observable market inputs. The following table reflects the activity for the Company’s major classes of assets measured at fair value using Level 3 inputs ( in thousands):





Three Months

Ended

May 31, 2010Balance at March 1, 2010

$
50,096Transfers out to Level 2 (Auction Rate Securities with market inputs)


(650
)Purchases of Level 3 investments


—Sales of Level 3 investments


(6,400
)Total gains and losses:Included in earnings (realized)


—Unrealized gains included in accumulated other comprehensive income


523Balance as of May 31, 2010

$
43,569





Historically, the carrying value (par value) of the auction rate securities approximated fair market value due to the frequent resetting of variable interest rates. Beginning in February 2008, however, the auctions for auction rate securities began to fail and were largely unsuccessful. As a result, the interest rates on the investments reset to the maximum rate per the applicable investment offering statements. The types of auction rate securities generally held by the Company have historically traded at par and are callable at par at the option of the issuer.





The par (invested principal) value of the auction rate securities associated with these failed auctions will not be accessible to the Company until a successful auction occurs, a buyer is found outside of the auction process, the securities are called or the underlying securities have matured. In light of these liquidity constraints, the Company performed a valuation analysis to determine the estimated fair value of these investments. The fair value of these investments was based on a trinomial discount model. This model considers the probability of three potential occurrences for each auction event through the maturity date of the security. The three potential outcomes for each auction are (i) successful auction/early redemption, (ii) failed auction and (iii) issuer default. Inputs in determining the probabilities of the potential outcomes include, but are not limited to, the security’s collateral, credit rating, insurance, issuer’s financial standing, contractual restrictions on disposition and the liquidity in the market. The fair value of each security was then determined by summing the present value of the probability weighted future principal and interest payments determined by the model. The discount rate was determined using a proxy based upon the current market rates for successful auctions within the AAA rated auction rate securities market. The expected term was based on management’s estimate of future liquidity. The illiquidity discount was based on the levels of federal insurance or FFELP backing for each security as well as considering similar preferred stock securities ratings and asset backed ratio requirements for each security.





As a result, as of May 31, 2010, the Company recorded an estimated cumulative unrealized loss of $3.1 million ($3.0 million, net of tax) related to the temporary impairment of the auction rate securities, which was included in accumulated other comprehensive income (loss) within shareholders’ equity. The Company deemed the loss to be temporary because the Company does not plan to sell any of the auction rate securities prior to maturity at an amount below the original purchase value and, at this time, does not deem it probable that it will receive less than 100% of the principal and accrued interest from the issuer. Further, the auction rate securities held by the Company are AAA rated, and the Company considers the credit risk to be negligible. The Company continues to liquidate investments in auction rate securities as opportunities arise. In the three month period ended May 31, 2010, $6.4 million in auction rate securities were liquidated at par in connection with issuer calls. Subsequent to May 31, 2010, an additional $0.7 million in auction rate securities were also liquidated at par, also as a consequence of issuer calls.




The Company does not believe it will be necessary to access these investments to support current working capital requirements. However, the Company may be required to record additional unrealized losses in other comprehensive income in future periods based on then current facts and circumstances. Specifically, if the credit rating of the security issuers deteriorates, or if active markets for such securities are not reestablished, the Company may be required to adjust the carrying value of these investments through impairment charges recorded in the consolidated statements of operations, and any such impairment adjustments may be material.


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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)




4. Comprehensive Loss





The Company’s other comprehensive loss consists of foreign currency translation adjustments from those subsidiaries whose functional currency is other than the U.S. dollar and unrealized gains and losses on investments classified as available-for-sale.





The components of the Company’s comprehensive loss for the three-month period ended May 31, 2010 and 2009 were as follows (in thousands):





Three Months Ended

May 31,2010


2009Net income (loss)

$
627


$
(9,196
)Other comprehensive income (loss):Change in foreign currency translation adjustments


(3,646
)


3,828Change in unrealized gain on marketable equity securities


521



1,244Total comprehensive loss

$
(2,498
)

$
(4,124
)





The components of the Company’s accumulated other comprehensive loss as of May 31, 2010 and February 28, 2010, net of taxes, were as follows (in thousands) :





May 31,

2010


February 28,

2010Unrealized losses on investments

$
(3,055
)

$
(3,576
)Foreign currency items


2,748



6,394Changes in defined benefit plans


(42
)


(42
)Total accumulated other comprehensive (loss) income

$
(349
)

$
2,776





5. Net Income (Loss) Per Share





Basic net income (loss) per share is calculated using the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is calculated using the sum of weighted-average number of common shares outstanding during the period, plus the dilutive effect of shares issuable through stock options.




The shares used in calculating basic and diluted net income (loss) per share for the condensed consolidated statements of operations included within this report are reconciled as follows (in thousands) :





Three Months Ended

May 31,2010


2009Weighted average shares outstanding for basic net income per share


22,481



21,901Dilutive effect of stock options


306



—Weighted average shares outstanding for diluted net income per share


22,787



21,901





Options covering approximately 1.7 million and 3.7 million shares for the three month periods ended May 31, 2010 and 2009, respectively, were excluded from the computation of average shares outstanding for diluted net income (loss) per share because their effects were antidilutive.


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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)




6. Business Combinations





Kleer


On February 16, 2010 SMSC acquired substantially all the assets and certain liabilities of Kleer Corporation and Kleer Semiconductor Corporation (collectively “Kleer”), a designer of high quality, interoperable wireless audio technology addressing headphones and earphones, home audio/theater systems and speakers, portable audio/media players and automotive sound systems. This transaction brings a robust, high-quality audio and low-power radio frequency (“RF”) capability that will allow consumer and automotive OEMs to integrate wireless audio technology into portable audio devices and sound systems without compromising high-grade audio quality or battery life. Under terms of the asset purchase agreement, SMSC paid approximately $5.5 million in cash and additional cash payments of up to $2.0 million may occur upon achievement of certain revenue performance goals as set forth in the agreement. The tangible assets of Kleer at February 16, 2010 included approximately $0.3 million of cash and cash equivalents, resulting in an initial net cash outlay of approximately $5.2 million. The results of Kleer’s operations subsequent to February 16, 2010 have been included in the Company’s consolidated results of operations.





As of the end of each fiscal quarter at which a liability for contingent consideration is recorded, the Company will revalue the contingent consideration obligation to fair value and record increases in the fair value as contingent consideration expense and decreases in the fair value as a reduction of contingent consideration expense. Increases or decreases in the fair value of the contingent consideration obligations can result from changes in discount periods and rates, changes in the timing and amount of revenue estimates and changes in probability adjustments.





The following table summarizes the components of the purchase price (in millions) :





Total Consideration at Fair ValueCash

$
5.5Liability for contingent consideration


0.8$
6.3





The following table summarizes the allocation of the purchase price (in millions) :





Cash and cash equivalents

$
0.3Accounts receivable


0.2Inventories


0.6Customer relationships


0.5Trade name


0.7Technology


1.8Goodwill (of which $3.2M is tax-deductible)


3.3Accounts payable and accrued liabilities


(0.3
)Deferred tax liabilities


(0.8
)$
6.3





The majority of Kleer’s net assets, including goodwill, are located in Luxembourg, and the functional currency of Kleer’s operations is the US Dollar (“USD”). Goodwill represents the excess of the purchase price over the fair values of the net tangible and intangible assets acquired. Kleer technology provides a natural extension to SMSC’s consumer and automotive connectivity portfolio. This technology extends our ability to service our OEM customers with a broad portfolio of solutions. These factors contributed to the recognition of goodwill as a component of the purchase price. In accordance with ASC Topic 350, “ Intangibles — Goodwill and Other”, goodwill is not amortized but is tested for impairment at least annually.





The acquisition of Kleer was not significant to the Company’s consolidated results of operations for the quarter ended May 31, 2010.





K2L


On November 5, 2009, the Company (through its wholly-owned subsidiary, SMSC Europe GmbH) completed the acquisition of 100 percent of the outstanding shares of K2L GmbH (“K2L”), a privately held company located in Pforzheim, Germany that specializes in software development and systems integration support services for automotive networking applications, including MOST®-based systems. The transaction was accounted for as a purchase under ASC 805, whereby the purchase price for K2L has been allocated to the net tangible and identifiable intangible assets acquired, based upon their estimated fair values as of November 5, 2009. The results of K2L’s operations subsequent to November 5, 2009 have been included in the Company’s consolidated results of operations.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)








SMSC acquired all of K2L’s outstanding capital stock in exchange for initial consideration of $6.9 million, consisting of 53,236 shares of SMSC common stock valued for accounting purposes at $1.0 million and $5.9 million of cash. The tangible assets of K2L at November 5, 2009 included approximately $0.6 million of cash and cash equivalents, resulting in an initial net cash outlay of approximately $5.3 million. SMSC's existing cash balances were the source of the cash used in the transaction. For accounting purposes, the value of the SMSC common stock was determined using the stock’s closing market value as of November 5, 2009. In addition, the Company recorded a liability for contingent consideration at the estimated fair value of $2.0 million as of November 5, 2009.





As of the end of each fiscal quarter at which a liability for contingent consideration is recorded, the Company will revalue the contingent consideration obligation to fair value and record increases in the fair value as contingent consideration expense and decreases in the fair value as a reduction of contingent consideration expense. Increases or decreases in the fair value of the contingent consideration obligations can result from changes in discount periods and rates, changes in the timing and amount of revenue estimates and changes in probability adjustments. The maximum amount of contingent consideration that can be earned by the sellers is €2.1 million. Fifty percent of the contingent consideration will be available to be earned in each of calendar years 2010 and 2011 based on the level of achievement of revenue as set forth in the related stock purchase agreement.





The following table summarizes the components of the purchase price (in millions) :





Total Consideration at Fair ValueCash

$
5.9SMSC common stock (53,236 shares)


1.0Liability for contingent consideration


2.0$
8.9





The following table summarizes the allocation of the purchase price (in millions) :





Cash and cash equivalents

$
0.6Accounts receivable


0.8Inventories


0.1Other current assets


0.2Property and equipment


0.3Customer relationships


1.9Trade name


0.2Technology


1.7Goodwill (all non-deductible for tax purposes)


4.8Accounts payable and accrued liabilities


(0.4
)Deferred income


(0.1
)Deferred tax liabilities


(1.1
)Other long-term liabilities


(0.1
)$
8.9





The majority of K2L’s net assets, including goodwill, are located in Germany, and the functional currency of K2L’s operations in Germany is the euro (€ or “EUR”). Accordingly, these EUR-denominated net assets are translated into U.S. dollars at period-end exchange rates and gains or losses arising from translation are included as a component of accumulated other comprehensive income within shareholders’ equity.





Goodwill represents the excess of the purchase price over the fair values of the net tangible and intangible assets acquired. This acquisition significantly expands SMSC’s automotive engineering capabilities by adding an assembled workforce of approximately 30 highly skilled engineers and other professionals, in close proximity to SMSC’s current automotive product design center in Karlsruhe, Germany. These factors contributed to the recognition of goodwill as a component of the purchase price. In accordance with ASC Topic 350, “ Intangibles — Goodwill and Other” , goodwill is not amortized but is tested for impairment at least annually.





The acquisition of K2L was not significant to the Company’s consolidated results of operations for the quarter ended May 31, 2010.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)




Tallika


On September 8, 2009, the Company completed its acquisition of certain assets of Tallika Corporation and 100 percent of the outstanding shares of Tallika Technologies Private Limited (collectively, “Tallika”), a business with a team of approximately 50 highly skilled engineers operating from design centers in Phoenix, Arizona and Chennai, India, respectively. The Company expects this acquisition will add to SMSC’s research and development know-how, notably with respect to its software development capabilities. The Tallika and SMSC teams have previously collaborated on various projects including transceiver development, chip design and pre-silicon verification.





The transaction was accounted for as a purchase under ASC Topic 805, “Business Combinations” (“ASC 805”), whereby the purchase price for Tallika has been allocated to the net tangible and intangible assets acquired, based upon their fair values as of September 8, 2009. The results of Tallika’s operations subsequent to September 8, 2009 have been included in the Company’s consolidated results of operations.





SMSC acquired the Tallika business for $3.4 million, consisting of 57,201 shares of SMSC common stock valued for accounting purposes at $1.3 million and $2.1 million of cash. The tangible assets of Tallika at September 8, 2009 included approximately $0.2 million of cash and cash equivalents, resulting in an initial net cash outlay of approximately $1.9 million. SMSC's existing cash balances were the source of the cash used in the transaction. For accounting purposes, the value of the SMSC common stock was determined using the closing market price as of the date such shares were tendered to the selling parties.





The following table summarizes the components of the purchase price (in millions) :





Total Consideration at Fair ValueCash

$
2.1SMSC common stock (57,201 shares)


1.3$
3.4





The following table summarizes the allocation of the purchase price (in millions) :





Cash and cash equivalents

$
0.2Accounts receivable


0.3Property and equipment


0.1Customer relationships


0.4Goodwill (of which $1.0 million is tax-deductible)


2.4$
3.4





A significant portion of Tallika’s net assets, including goodwill, are located in India, and the functional currency of Tallika’s Chennai, India based operations is the Rupee (“INR”). Accordingly, these INR-denominated net assets are translated into U.S. dollars at period-end exchange rates and unrealized gains or losses arising from translation are included as a component of accumulated other comprehensive income within shareholders’ equity.





Goodwill represents the excess of the purchase price over the fair values of the net tangible and identifiable intangible assets acquired. This acquisition significantly expands SMSC’s engineering, design and software development capabilities by adding an assembled workforce of approximately 50 highly skilled engineers into SMSC’s operations. These factors contributed to the recognition of goodwill as a component of the purchase price. In accordance with ASC Topic 350, “ Intangibles — Goodwill and Other”, goodwill is not amortized but is tested for impairment at least annually.





The acquisition of Tallika was not significant to the Company’s consolidated results of operations for the quarter ended May 31, 2010.





7. Investments





Short-term investments consist of investments in obligations with maturities of between three and twelve months, at acquisition. All of these investments are classified as available-for-sale. The cost of these short-term investments approximate their market values as of May 31, 2010.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)




Long-term investments consist of highly rated auction rate securities (most of which are backed by U.S. Federal or state and municipal government guarantees) and other marketable debt and equity securities held as available-for-sale investments. As of November 30, 2007 and prior period-end dates, investments in auction rate securities were classified as short-term in nature. In the fourth quarter of fiscal 2008, such investments became subject to adverse market conditions, and the liquidity typically associated with the financial markets for such instruments became restricted as auctions began to fail. Given the circumstances, these securities were subsequently classified as long-term (or short-term if stated maturity dates were within one year of the reported balance sheet date), reflecting the restrictions on liquidity and the Company’s intent to hold until maturity (or until such time as the principal investment could be recovered through other means, such as issuer calls and redemptions). See Note 3 — Fair Value for further discussion on related issues and matters, including fair valuation.





With the recent investments in Symwave and Canesta in fiscal 2010, the Company now has investments in non-marketable equity securities of development-stage enterprises (accounted for as cost-basis investments and included in the Investments in equity securities caption of the consolidated balance sheet for May 31, 2010). Such investments are reviewed periodically for potential impairment, at least annually (in the fourth fiscal quarter) or at interim dates if facts and circumstances indicate impairment may have occurred.





8. Goodwill and Intangible Assets





The Company’s February, 2010 acquisition of Kleer included the purchase of $3.0 million of finite-lived intangible assets and goodwill of $3.3 million. The Company’s November, 2009 acquisition of K2L included the purchase of $ 3.8 million of finite-lived intangible assets and goodwill of $4.8 million. The Company’s November, 2009 acquisition of Tallika included the purchase of $0.4 million of finite-lived intangible assets and goodwill of $2.4 million. The Company’s March 2005 acquisition of OASIS SiliconSystems Holding AG (“OASIS”) included the purchase of $42.9 million of finite-lived intangible assets, an indefinite-lived trademark of $5.4 million, and goodwill of $67.8 million. Some or portions of these intangible assets are denominated in currencies other than the U.S. dollar, and these values reflect foreign exchange rates in effect on the dates of the transactions. The Company’s June 2002 acquisition of Tucson, Arizona-based Gain Technology Corporation included the acquisition of $7.1 million of finite-lived intangible assets and $29.4 million of goodwill, after adjustments.





Goodwill is tested for impairment in value annually, as well as when events or circumstances indicate possible impairment in value. The Company performs an annual goodwill impairment review during the fourth quarter of each fiscal year. The Company completed its most recent annual goodwill impairment review during the fourth quarter of fiscal 2010. In accordance with ASC Topic 350, “Intangibles — Goodwill and Other” (“ASC 350”), we compared the carrying value of each of our reporting units that existed at those times to their estimated fair value. For purposes of ASC 350 testing, the Company has three reporting units: the automotive reporting unit, the wireless audio reporting unit and the analog/mixed signal reporting unit. The automotive unit consists of those portions of the business that were acquired in the March 30, 2005 acquisition of OASIS including the infotainment networking technology known as Media Oriented Systems Transport (“MOST”). The wireless audio unit consists of those portions of the business that were acquired in the February 16, 2010 acquisition of Kleer. The analog/mixed signal reporting unit is comprised of most other portions of the business.





The Company considered both the market and income approaches in determining the estimated fair value of the reporting units, specifically the market multiple methodology and discounted cash flow methodology. The market multiple methodology involved the utilization of various revenue and cash flow measures at appropriate risk-adjusted multiples. Multiples were determined through an analysis of certain publicly traded companies that were selected on the basis of operational and economic similarity with the business operations. Provided these companies meet these criteria, they can be considered comparable from an investment standpoint even if the exact business operations and/or characteristics of the entities are not the same. Revenue and EBITDA multiples were calculated for the comparable companies based on market data and published financial reports. A comparative analysis between the Company and the public companies deemed to be comparable formed the basis for the selection of appropriate risk-adjusted multiples for the Company. The comparative analysis incorporates both quantitative and qualitative risk factors which relate to, among other things, the nature of the industry in which the Company and other comparable companies are engaged. In the discounted cash flow methodology, long-term projections prepared by the Company were utilized. The cash flows projected were analyzed on a “debt-free” basis (before cash payments to equity and interest bearing debt investors) in order to develop an enterprise value. A provision, based on these projections, for the value of the Company at the end of the forecast period, or terminal value, was also made. The present value of the cash flows and the terminal value were determined using a risk-adjusted rate of return, or “discount rate.”





Upon completion of the fiscal 2010 assessment, it was determined that the estimated fair values of all reporting units exceeded their respective carrying value, therefore no impairment in value was identified.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)




Changes in the carrying amount of goodwill, net, on a consolidated basis, for the three months ended May 31, 2010 and the twelve months ended February 28, 2010, consist of the following (in thousands):





OASIS


Tallika



K2L


Kleer


Gain Technologies


TOTALThree Months Ended May 31, 2010Balance, beginning of year

$
67,186


$
2,404


$
4,411


$
3,278


$
29,435


$
106,714Accumulated impairment


(52,300
)


—



—



—



—



(52,300
)14,886



2,404



4,411



3,278



29,435



54,414Foreign exchange rate impact


—



(16
)


(428
)


—



—



(444
)Balance, May 31, 2010


67,186



2,388



3,983



3,278



29,435



106,270Accumulated impairment


(52,300
)


—



—



—



—



(52,300
)$
14,886


$
2,388


$
3,983


$
3,278


$
29,435


$
53,970




OASIS


Tallika


K2L


Kleer


Gain Technologies


TOTALYear Ended February 28, 2010Balance, beginning of year

$
67,186


$
—


$
—


$
—


$
29,435


$
96,621Accumulated impairment


(52,300
)


—



—



—



—



(52,300
)14,886



—



—



—



29,435



44,321Goodwill acquired


—



2,404



4,778



3,278



—



10,460Foreign exchange rate impact


—



—



(367
)


—



—



(367
)Balance, end of year


67,186



2,404



4.411



3,278



29,435



106,714Accumulated impairment


(52,300
)


—



—



—



—



(52,300
)$
14,886


$
2,404


$
4,411


$
3,278


$
29,435


$
54,414





All finite-lived intangible assets are being amortized on a straight-line basis, which approximates the pattern in which the estimated economic benefits of the assets are realized, over their estimated useful lives. Existing technologies have been assigned estimated useful lives of between six and nine years, with a weighted-average useful life of approximately eight years. Customer relationships and contracts have been assigned useful lives of between one and fifteen years, with a weighted-average useful life of approximately seven years.





Intangible assets that are denominated in a functional currency other than the U.S. dollar have been translated into U.S. dollars using the exchange rate in effect on the reporting date. As of May 31, 2010 and February 28, 2010, the Company’s identifiable intangible assets consisted of the following:





5/31/2010


2/28/2010Cost


Accumulated Amortization


Cost


Accumulated Amortization(in thousands)Purchased technologies

$
39,150


$
26,671


$
42,767


$
26,675Customer relationships and contracts


12,730



7,280



13,900



7,368Other


3,563



632



2,132



670Total – finite-lived intangible assets


55,443



34,583



58,799



34,713Trademarks and trade names


5,892



—



6,409



—$
61,335


$
34,583


$
65,208


$
34,713





Total amortization expense recorded for finite-lived intangible assets was $1.8 million and $1.5 million for the three month period ended May 31, 2010 and 2009 respectively.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)








Estimated future finite-lived intangible asset amortization expense is as follows (in thousands) :





Period

AmountRemainder of Fiscal 2011

$
5,054Fiscal 2012

$
6,472Fiscal 2013

$
5,914Fiscal 2014

$
1,040Fiscal 2015

$
607Fiscal 2016 and thereafter

$
1,773





9. Other Balance Sheet Data





Inventories, net are valued at standard cost (which approximates the lower of first-in, first-out cost) or market and consist of the following (in thousands) :





May 31,

2010


February 28,

2010Raw materials

$
1,883


$
1,442Work-in-process


15,976



15,924Finished goods


23,516



27,008$
41,375


$
44,374





Property, plant and equipment (in thousands) :





May 31,

2010


February 28,

2010Land

$
578


$
578Buildings and improvements


37,845



38,606Machinery and equipment


122,626



119,241161,049



158,425Less: accumulated depreciation


(94,981
)


(91,623
)$
66,068


$
66,802





Accrued expenses, income taxes and other current liabilities (in thousands):





May 31,

2010


February 28,

2010Compensation, incentives and benefits

$
12,225


$
15,086Stock appreciation rights


20,018



14,579Supplier financing – current portion


4,445



4,274Restructuring charges


331



1,091Accrued rent obligations


2,897



2,959Income taxes payable


5,896



2,261Other


6,347



8,174$
52,159


$
48,424





Other liabilities (in thousands):





May 31,

2010


February 28,

2010Retirement benefits

$
8,297


$
8,349Income taxes


5,284



5,230Supplier financing – long-term portion


6,152



7,153Other


2,052



2,212$
21,785


$
22,944


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





10. Deferred Income from Distribution





Certain of the Company’s products are sold to electronic component distributors under agreements providing for price protection and rights to return unsold merchandise. Accordingly, recognition of revenue and associated gross profit on shipments to a majority of the Company’s distributors are deferred until the distributors resell the products. At the time of shipment to distributors, the Company records a trade receivable for the selling price, relieves inventory for the carrying value of goods shipped, and records this gross margin as deferred income on shipments to distributors on the consolidated balance sheet. This deferred income represents the gross margin on the initial sale to the distributor; however, the amount of gross margin recognized in future consolidated statements of operations will typically be less than the originally recorded deferred income as a result of price allowances. Price allowances offered to distributors are recognized as reductions in product sales when incurred, which is generally at the time the distributor resells the product.





Deferred income on shipments to distributors consists of the following (in thousands):





May 31,

2010


February 28,

2010Deferred sales revenue

$
30,784


$
24,823Deferred COGS


(5,763
)


(4,909
)Provisions for sales returns


1,457



1,625Distributor advances for price allowances


(5,746
)


(5,488
)Other deferred revenue


35



74$
20,767


$
16,125





11. Other Expense, Net





The components of the Company’s other expense, net for the three-month periods ended May 31, 2010 and 2009, respectively, consisted of the following (in thousands):





Three Months Ended

May 31,2010


2009Realized and unrealized foreign currency transaction losses

$
(96
)

$
(283
)Losses on disposal of property


(47
)


(13
)Other miscellaneous (losses) income, net


(13
)


2$
(156
)

$
(294
)





12. Income Taxes





There was no significant change to the liabilities for uncertain tax positions for the three month period ending May 31, 2010. At this time, the Company does not anticipate that liabilities for uncertain tax positions will significantly increase or decrease on or prior to May 31, 2011. All liabilities for uncertain tax positions are classified as long term and included in Other liabilities in the condensed consolidated balance sheet.





The Company will continue its policy of including interest and penalties related to unrecognized tax benefits within the provision for income taxes in the condensed consolidated statements of operations. For the three month period ended May 31, 2010, the Company provided a negligible amount for interest and penalties.





The difference between the effective tax rates of 64.4% for the three months ended May 31, 2010 compared to effective tax rate of 36.5% for the three months ended May 31, 2009 is primarily attributable to certain losses incurred in fiscal 2011 which cannot be benefitted and the expiration of the research and development tax credit on December 31, 2009. The Company files U.S. federal, U.S. state, and foreign tax returns, and is generally no longer subject to tax examinations for fiscal years prior to 2007 (in the case of certain foreign tax returns, calendar year 2004).




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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)








13. Restructuring





In the fourth quarter of fiscal 2010, the Company initiated a restructuring plan that resulted in a charge of $0.6 million for severance and termination benefits for 5 full-time employees, which is included in the caption “Restructuring charges” in the Company’s fiscal 2010 consolidated statements of operations. An additional $0.8 million was incurred in the first quarter of fiscal 2011 for severance and termination benefits for 12 full-time employees relating to this restructuring plan. A reserve for restructuring charges in the amount of $0.2 million is included on the Company’s balance sheet as of May 31, 2010, which includes the restructuring charges to be settled in connection with these separations. The Company expects the payments on these obligations to be completed in the second quarter of fiscal year 2011.





In the second quarter of fiscal 2010, the Company announced a plan to reduce its workforce by approximately sixty-four employees in connection with the relocation of certain of its test floor activities from Hauppauge, New York to third party offshore facilities (Sigurd Microelectronics Corporation) in Taiwan. During fiscal 2010 the Company recorded $1.3 million in asset impairment charges and accrued severance retention bonus obligations relating to this plan. A reserve for restructuring charges for a negligible amount is included on the Company’s balance sheet as of May 31, 2010, which includes the restructuring charges to be settled in connection with these separations. The Company expects the payments on these obligations to be completed in the second quarter of fiscal year 2011.





In the fourth quarter of fiscal 2009, the Company announced a restructuring plan that included a supplemental voluntary retirement program and involuntary separations that would result in approximately a ten percent reduction in employee headcount and expenses worldwide. This action resulted in a charge of $5.2 million for severance and termination benefits for 88 full-time employees, which is included in the caption “Restructuring charges” in the Company’s fiscal 2009 consolidated statements of operations. This amount includes a charge of $2.4 million recorded pursuant to ASC 715,“Compensation – Retirement Benefits” (“ASC 715”) relating to the voluntary retirement program. An additional $0.2 million was incurred in the first quarter of fiscal 2010 relating to this restructuring plan. A reserve for restructuring charges in the amount of $0.1 million is included on the Company’s balance sheet as of May 31, 2010, which includes the restructuring charges and other previously accrued amounts to be settled in connection with these separations. The Company expects the payments on these obligations to be completed by the end of the third quarter of fiscal year 2011.





The following table summarizes the activity related to the accrual for restructuring charges for the quarter ended May 31, 2010 (in thousands):





Balance as of

March 1,

2010


Charges


Payments



Non-Cash

Items


Balance as of

May 31,

2010Q4 Fiscal 2009 Restructuring Plan

$
210


$
—



(63
)



(2
)

$
145Q2 Fiscal 2010 Restructuring Plan


101



—



(77
)



—



24Q4 Fiscal 2010 Restructuring Plan


780



821



(1,344
)



(95
)


162$
1,091


$
821


$
(1,484
)
$

$
(97
)

$
331





The following table summarizes the activity related to the accrual for restructuring charges for the fiscal year ended February 28, 2010 (in thousands) :





Balance as of

March 1,

2009


Charges


Payments


Non-Cash

Items


Balance as of

February 28,

2010Q4 Fiscal 2009 Restructuring Plan

$
5,385


$
221


$
(5,293
)

$
(103
)

$
210Q2 Fiscal 2010 Restructuring PlanEmployee severance and benefits


—



852



(751
)






101Asset impairment charges


—



408



(72
)


(336
)


—Q4 Fiscal 2010 Restructuring Plan


—



642



—



138



780$
5,385


$
2,123


$
(6,116
)

$
(301
)

$
1,091


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14. Benefit and Incentive Plans (including Share-Based Payments)





The Company has several stock-based compensation plans in effect under which incentive stock options and non-qualified stock options (collectively “stock options”), restricted stock awards and stock appreciation rights have been granted to employees and directors. In July 2009, the stockholders approved the 2009 Long Term Incentive Plan (the “LTIP”). The Company has ceased issuing stock options and restricted stock awards under previously established stock option and restricted stock plans, and has ceased issuing SARs, and instead is using the LTIP to issue stock options and restricted stock units to employees and stock options to directors. The Compensation Committee and management continue to evaluate means to effectively promote share ownership by employees and directors while offering industry-competitive compensation packages, including appropriate use of stock-based compensation awards.





Long Term Incentive Plan





Under the LTIP, the Compensation Committee of the Board of Directors is authorized to grant awards of stock options, restricted stock or restricted stock units, or other stock-based awards. The Committee is authorized under the LTIP to delegate its authority in certain circumstances. The purpose of this plan is to promote the interests of the Company and its shareholders by providing officers, directors and key employees with additional incentives and the opportunity, through stock ownership, to better align their interests with the Company’s and enhance their personal interest in its continued success. The maximum number of shares that may be delivered pursuant to awards granted under the LTIP is 1,000,000 plus: (i) any shares that have been authorized but not issued pursuant to previously established plans of the Company as of June 30, 2009, up to a maximum of an additional 500,000 shares; (ii) any shares subject to any outstanding options or restricted stock grants under any plan of the Company that were outstanding as of June 30, 2009 and that subsequently expire unexercised, or are otherwise forfeited, up to a maximum of an additional 3,844,576 shares. The maximum number of incentive stock options that may be granted under the LTIP is 1,500,000. No participant may receive awards under the LTIP in any calendar year for more than 1,000,000 shares equivalents. Based on the above, as of May 31, 2010, awards amounting to 1,024,946 share equivalents may be granted under the LTIP, net of awards issued to date. For disclosure purposes, awards issued under the LTIP are through and including May 31, 2010 reflected in the statistics below by type of award.





Employee and Director Stock Option Plans





Under the Company’s various stock option plans, the Compensation Committee of the Board of Directors had been authorized to grant options to purchase shares of common stock. Stock options under inducement plans were offered only to new employees, and all options were granted at prices not less than the fair market value on the date of grant. The grant date fair values of stock options are recorded as compensation expense ratably over the vesting period of each award, as adjusted for forfeitures of unvested awards. Stock options generally vest over four or five-year periods, and expire no later than ten years from the date of grant. Following shareholder approval of the LTIP, the Company ceased issuing awards under previously established stock option plans.





Stock option plan activity for the three-months ended May 31, 2010 is summarized below (shares and intrinsic value in thousands) :





Fiscal

2011

Shares


Weighted

Average

Exercise

Prices Per

Share


Weighted

Average

Contractual

Term

(in yrs.)


Aggregate

Intrinsic

ValueOptions outstanding, March 1, 2010


3,480


$
22.31Granted


279


$
25.86Exercised


(159
)

$
20.80Canceled, forfeited or expired


(146
)

$
28.34Options outstanding, May 31, 2010


3,454


$
22.41



6.0


$
9,893Options exercisable, May 31, 2010


2,073


$
21.60



4.4


$
6,967





The total remaining unrecognized compensation cost related to SMSC’s employee and director stock option plans is $12.9 million as of May 31, 2010. The weighted-average period over which the cost is expected to be recognized is 1.80 years.


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)




The Company estimates the grant date fair value of stock options by using the Black-Scholes option pricing model. The Black-Scholes model requires certain assumptions, judgments and estimates by the Company to determine fair value, including expected stock price volatility, risk-free interest rate, and expected life. The Company based the expected volatility on historical volatility. Additionally, the Company based the expected life of stock options granted on an actuarial model. There are no dividends expected to be paid on the Company’s common stock over the expected lives estimated.





The weighted-average fair values per share of stock options granted in connection with the Company’s stock option plans have been estimated utilizing the following assumptions:





Three Months Ended

May 31,2010


2009Dividend yield


—



—Expected volatility


47
%


50
%Risk-free interest rates


2.58
%


2.13
%Expected lives (in years)


5.02



5.01







Restricted Stock Awards and Restricted Stock Units
 
 The Company provides common stock awards to certain officers and key employees. The Company previously granted restricted stock awards, at its discretion, from the shares available under its 2001 and 2003 Stock Option and Restricted Stock Plans and its 2005 Inducement Stock Option and Restricted Stock Plan. The shares awarded are typically earned in 25 percent, 25 percent and 50 percent increments on the first, second and third anniversaries of the award, respectively, and are distributed provided the employee has remained employed by the Company through such anniversary dates; otherwise the unearned shares are forfeited. The grant date fair value of these shares at the date of award is recorded as compensation expense ratably on a straight-line basis over the related vesting periods, as adjusted for forfeitures of unvested awards. Restricted stock awards are no longer being granted from previously established restricted stock award plans. Instead, restricted stock units are currently being granted from the LTIP.The restricted stock unit awards are typically earned in 33 percent increments on the first, second and third anniversaries of the award, respectively, and are distributed provided the employee remains employed by the Company through such anniversary dates; otherwise the unearned shares are forfeited. The grant date fair value of these shares at the date of award is recorded as compensation expense ratably on a straight-line basis over the related vesting periods, as adjusted for forfeitures of unvested awards.




Restricted stock activity for the three-months ended May 31, 2010 is set forth below (shares in thousands) :





Number of

Shares


Weighted Average

Grant-Date

Fair ValueRestricted stock shares outstanding, March 1, 2010


90


$
25.42Granted


154


$
26.50Canceled or expired


(1
)

$
27.92Vested


(16
)

$
27.07Restricted stock shares outstanding, May 31, 2010


227


$
26.02





The total unrecognized compensation cost related to SMSC’s restricted stock plans is $4.9 million as of May 31, 2010. The weighted-average period over which the remaining cost is expected to be recognized is 1.78 years. Of the 227,000 restricted stock shares outstanding at May 31, 2010, 154,000 are restricted stock units that are very similar to restricted stock awards except there are no voting rights attached to restricted stock units.  Such units were granted for the first time during the quarter ending May 31, 2010.





Stock Appreciation Rights Plans





In September 2004 and September 2006, the Company’s Board of Directors approved Stock Appreciation Rights Plans (the “2004 Stock Appreciation Rights Plan” and the “2006 Stock Appreciation Rights Plan”, collectively the “Stock Appreciation Rights Plans”), the purpose of which are to attract, retain, reward and motivate employees and consultants to promote the Company’s best interests and to share in its future success. The Stock Appreciation Rights Plans authorize the Board’s Compensation Committee to grant up to six million stock appreciation rights awards to eligible officers, employees and consultants (after amendment to the 2006 Stock Appreciation Rights Plan, effective April 30, 2008). Each award, when granted, provides the participant with the right to receive payment in cash, upon exercise, for the appreciation in market value of a share of SMSC common stock over the award’s exercise price. On July 11, 2006, the Company’s Board of Directors approved the 2006 Director Stock Appreciation Rights Plan. The Company can grant up to 200,000 Director stock appreciation rights under this plan. On April 9, 2008, the Board of Directors authorized an increase in the number of stock appreciation rights issuable pursuant to this plan from 200,000 to 400,000. The exercise price of a stock appreciation right is equal to the closing market price of SMSC stock on the date of grant. Stock appreciation rights awards generally vest over four or five-year periods, and expire no later than ten years from the date of grant. The Company ceased issuing SARs in the second half of calendar year 2009




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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
  Activity under the Stock Appreciation Rights Plans for the three-months ended May 31, 2010 is set forth below (shares and intrinsic value in thousands) :





Fiscal

2011

Shares


Weighted

Average

Exercise

Prices Per

Share


Weighted

Average

Contractual

Term


Aggregate

Intrinsic

ValueStock appreciation rights outstanding, March 1, 2010


4,766


$
24.69Granted


—


$
—Exercised


(87
)

$
17.49Canceled or expired


(119
)

$
26.44Stock appreciation rights outstanding, May 31, 2010


4,560


$
24.79



7.32


$
12,154Stock appreciation rights exercisable, May 31,2010


2,331


$
25.88



6.53


$
5,377





The total unrecognized compensation cost related to SMSC’s Stock Appreciation Rights Plans is $18.4 million as of May 31, 2010. The weighted-average period over which the unrecognized cost is expected to be recognized is 3.69 years.




The weighted-average fair values per share of stock appreciation rights granted in connection with the Company’s Stock Appreciation Rights Plans have been estimated utilizing the following assumptions:





Three Months Ended

May 31,2010


2009Dividend yield


—



—Expected volatility


38 – 48
%


45 – 60
%Risk-free interest rates


0.20 – 2.76
%


0.49 – 2.20
%Expected lives (in years)


0.37 – 5.62



0.87 – 6.22





Stock-Based Compensation Expense





Effective March 1, 2006 the Company adopted guidance now codified as ASC Topic 718, “ Compensation — Stock Compensation ” (“ASC 718”), which requires all share-based payments to employees, including grants of employee stock options, restricted stock awards, restricted stock units and employee stock purchase rights, to be recognized in the financial statements based on their respective grant date fair values (in the case of SARs, current fair values) and does not allow the previously permitted pro forma disclosure-only method as an alternative to financial statement recognition





The following table summarizes the compensation expense for stock options, restricted stock units, restricted stock awards and stock appreciation rights at fair value as measured per the provisions of ASC Topic 718, “ Compensation — Stock Compensation ” (“ASC 718”) included in our condensed consolidated statements of operations (in thousands) :





Three Months Ended

May 31,2010


2009Costs of goods sold

$
831


$
625Research and development


2,279



1,560Selling, general and administrative


4,812



3,651Stock-based compensation expense, before income tax benefit


7,922



5,836Tax benefit


2,852



2,101Stock-based compensation expense, after income tax benefit

$
5,070


$
3,735





Retirement Plans





The Company maintains an unfunded Supplemental Executive Retirement Plan to provide certain members of senior management with retirement, disability and death benefits. The Company’s subsidiary, SMSC Japan, also maintains an unfunded retirement plan, which provides its employees and directors with separation benefits, consistent with customary practices in Japan. Benefits under these defined benefit plans are based upon various service and compensation factors.


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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





The following table sets forth the components of the consolidated net periodic pension expense for the three-month period ended May 31, 2010 and 2009, respectively (in thousands) :





Three Months Ended

May 31,2010


2009Components of net periodic benefit costs:Service cost – benefits earned during the period

$
84


$
108Service cost – benefits forfeited during the period


—



—Interest cost on projected benefit obligations


96



116Amortization of net obligation


—



—Net periodic pension expense

$
180


$
224








May 31,

2010


February 28,

2010Amounts recognized in accumulated other comprehensive income:Transition obligation

$
1


$
1Net income


71



71Prior service cost


—



—Total amount recognized in accumulated other comprehensive loss

$
72


$
72





Annual benefit payments under these plans are expected to be approximately $0.7 million in fiscal 2011, to be funded as general corporate obligations with available cash and cash equivalents. Additionally, the Company is the beneficiary of life insurance policies that have been purchased as a method of partially financing longer-term benefits payable under the Supplemental Executive Retirement Plan. In November, 2009, the Compensation Committee of SMSC’s Board of Directors froze benefits under the Supplemental Executive Retirement Plan for existing participants, and there will be no further eligibility for participation in this plan. The effect of this action is expected to be immaterial to SMSC’s future results of operations.





15. Commitments and Contingencies





Contingent Consideration — Kleer Acquisition





The Company recorded a liability for contingent consideration as part of the purchase price for the acquisition of Kleer at the estimated fair value of $0.8 million as of May 31, 2010. The maximum amount of contingent consideration that can be earned by the sellers is $2.0 million as set forth in the purchase agreement.





Contingent Consideration — K2L Acquisition





The Company recorded a liability for contingent consideration as part of the purchase price for the acquisition of K2L at the estimated fair value of $1.8 million as May 31, 2010. The maximum amount of contingent consideration that can be earned by the sellers is €2.1 million. Fifty percent of the contingent consideration will be available to be earned in each of calendar years 2010 and 2011 based on the level of achievement of revenue as set forth in the purchase agreement.





Litigation





From time to time as a normal incidence of doing business, various claims and litigation may be asserted or commenced against the Company. Due to uncertainties inherent in litigation and other claims, the Company can give no assurance that it will prevail in any such matters, which could subject the Company to significant liability for damages and/or invalidate its proprietary rights. Any lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management’s time and attention, and an adverse outcome of any significant matter could have a material adverse effect on the Company’s consolidated results of operations or cash flows in the quarter or annual period in which one or more of these matters are resolved.


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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)





16. Supplemental Cash Flow Disclosures





The Company financed the acquisition of certain software and other design automation tools used in product development activities using long-term financing provided directly by suppliers. The Company had $10.6 million and $5.4 million of outstanding balances due under such arrangements as of May 31, 2010 and 2009, respectively. During the three-month periods ended May 31, 2010 and 2009, the Company acquired $0.4 million and $1.5 million, respectively, of software with supplier provided financing. The Company made cash payments in respect of these obligations of $1.2 million and $0.5 million for the three-month period ended May 31, 2010 and 2009, respectively.





The Company did not receive any federal, state and foreign tax refunds for the three-month period ending May 31, 2010 and received $4.7 million for the three-month period ended May 31, 2009.  It made cash payments for federal, state and foreign income taxes payable of $2.1 million for the three-month period ended May 31, 2010.





17. Subsequent Event – Acquisition of STS





On June 14, 2010, the Company completed its acquisition of Wireless Audio IP B.V., more commonly known in the industry as STS, a fabless designer of plug-and-play wireless solutions for consumer audio streaming and video applications with a team of approximately 40 highly skilled engineers headquartered in Netherlands and Singapore. This team will bring to SMSC a strong source of engineering capabilities in wireless audio and video development. SMSC paid approximately $22.0 million in cash and additional cash payments of up to $3.0 million may occur upon achievement of certain revenue performance goals as set forth in the agreement.




The Company is currently performing a valuation analysis of the assets and liabilities acquired, the contingent consideration liability and the resulting goodwill.  As a result the Company could not disclose these valuations at this time.


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STANDARD MICROSYSTEMS CORPORATION AND SUBSIDIARIES





QUARTERLY REPORT ON FORM 10-Q


FOR THE QUARTERLY PERIOD ENDED MAY 31, 2010





Item 2. — Management’s Discussion and Analysis of Financial Condition and Results of Operations





General





The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and accompanying notes included in Part I Item 1. —  Financial Statements , of this Quarterly Report on Form 10-Q (“Quarterly Report” or “10-Q”) of Standard Microsystems Corporation (the “Company” or “SMSC”).





Forward-Looking Statements





Portions of this Quarterly Report may contain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are based on management’s beliefs and assumptions, current expectations, estimates and projections. Such statements, including statements relating to the Company’s expectations for future financial performance, are not considered historical facts and are considered forward-looking statements under federal securities laws. Words such as “believe,” “expect,” “anticipate” and similar expressions identify forward-looking statements. Risks and uncertainties may cause the Company’s actual future results to be materially different from those discussed in forward-looking statements. The Company’s risks and uncertainties include (but are not limited to): the timely development and market acceptance of new products; the impact of competitive products and pricing; the Company’s ability to procure capacity from suppliers and the timely performance of their obligations; commodity prices; potential investment losses as a result of liquidity conditions; the effects of changing economic and political conditions in the market domestically and internationally and on its customers; relationships with and dependence on customers and growth rates in the personal computer, consumer electronics and embedded and automotive markets and within the Company’s sales channel; changes in customer order patterns, including order cancellations or reduced bookings; the effects of tariff, import and currency regulation; potential or actual litigation; and excess or obsolete inventory and variations in inventory valuation, among others. In addition, SMSC competes in the semiconductor industry, which has historically been characterized by intense competition, rapid technological change, cyclical market patterns, price erosion and periods of mismatched supply and demand.





The Company’s forward looking statements are qualified in their entirety by the inherent risks and uncertainties surrounding future expectations and may not reflect the potential impact of any future acquisitions, mergers, equity investments or divestitures. All forward-looking statements speak only as of the date hereof and are based upon the information available to SMSC at this time. Such statements are subject to change, and the Company does not undertake to update such statements, except to the extent required under applicable law and regulation. These and other risks and uncertainties, including potential liability resulting from pending or future litigation, are detailed from time to time in the Company’s periodic and current reports as filed with the United States Securities and Exchange Commission (the “SEC”). Readers are advised to review the Company’s most recent Annual Report on Form 10-K and quarterly reports on Form 10-Q as filed subsequently with the SEC, particularly those sections entitled “ Risk Factors ,” for a more complete discussion of these and other risks and uncertainties. Other cautionary statements concerning risks and uncertainties may also appear elsewhere in this Quarterly Report.





Description of Business





SMSC designs and sells a wide range of silicon-based integrated circuits that utilize analog and mixed-signal technologies. The Company’s integrated circuits and systems provide a wide variety of connectivity products that are incorporated by its globally diverse customers into numerous end products in the Personal Computing (“PC”), Consumer Electronics, Industrial and Automotive markets. These products generally provide connectivity, networking, or input/output control solutions including hardware, software, and firmware, for a variety of high-speed communication, computer and related peripheral, consumer electronics, industrial control systems or automotive information applications. The market for these solutions is increasingly diverse, and the Company’s technologies are increasingly used in various combinations and in alternative applications. SMSC has operations in the United States, Canada, Germany, Bulgaria, Sweden, India, Japan, China, Korea, Singapore and Taiwan. Major engineering design centers are located in North America, Asia, Europe and India.





Business Combinations and Other Non-Controlling Equity Investments





On February 16, 2010 SMSC acquired substantially all the assets and certain liabilities of Kleer, a designer of high quality, interoperable wireless audio technology addressing headphones and earphones, home audio/theater systems and speakers, portable audio/media players and automotive sound systems. This transaction brings a robust, high-quality audio and low-power radio frequency (RF) capability that will allow consumer and automotive OEMs to integrate wireless audio technology into portable audio devices and sound systems without compromising high-grade audio quality or battery life. Under terms of the asset purchase agreement, SMSC paid approximately $5.5 million in cash and additional cash payments of up to $2.0 million may occur upon achievement of certain performance goals. The results of Kleer’s operations subsequent to February 16, 2010 have been included in the Company’s consolidated results of operations.


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 Table of Contents




On November 5, 2009, the Company completed the acquisition of 100 percent of the outstanding shares of K2L, a privately held company located in Pforzheim, Germany that specializes in software development and systems integration support services for automotive networking applications, including MOST®-based systems. This acquisition significantly expands SMSC’s automotive engineering capabilities by adding an assembled workforce of approximately 30 highly skilled engineers as well as other professionals, in close proximity to SMSC’s current automotive product design center in Karlsruhe, Germany. SMSC paid approximately $8.9 million to purchase K2L. Additional cash payments of up to €2.1million may occur upon achievement of certain performance goals. The results of K2L’s operations subsequent to November 5, 2009 have been included in the Company’s consolidated results of operations.





On October 13, 2009, SMSC made an initial equity investment of $0.7 million in Canesta, a privately held (venture capital supported) developer of three-dimensional motion sensing systems and devices. On October 15, 2009, SMSC paid an additional $1.3 million into escrow for second and third financing commitments for which it would receive additional equity shares and warrants. On January 26, 2010 the closing for the second financing commitment for $0.7 million took place, and on April 27, 2010 the closing for the third financing commitment for $0.6 million took place. In total, SMSC holds less than 5 percent of the total outstanding equity of Canesta on a fully diluted basis. The purchase of the equity shares has been accounted for as a cost-basis investment and is included in the Investments in equity securities caption on the Company’s consolidated balance sheet.





On August 6, 2009, SMSC made an initial equity investment of $4 million in Symwave, a privately held (venture capital supported) supplier of system solutions for SuperSpeed USB 3.0 devices. On October 9, 2009, SMSC made an additional $1.2 million equity investment in Symwave pursuant to the terms and conditions of the original share purchase agreement. The cumulative purchases of Symwave equity have been accounted for as a cost-basis investment and included in the Investments in equity securities caption on the Company’s consolidated balance sheet. SMSC holds approximately 14.0 percent of the total outstanding equity of Symwave on a fully diluted basis. The objective of this collaboration is to accelerate delivery of USB 3.0 solutions into mobile, consumer and computing segments. As part of the relationship, SMSC has obtained the right to acquire Symwave under certain conditions, and SMSC is represented on Symwave’s Board of Directors by its President and Chief Executive Officer.





On September 8, 2009, the Company completed its acquisition of certain assets and 100 percent of the outstanding shares of Tallika, a business with a team of approximately 50 highly skilled engineers located in design centers Phoenix, Arizona and Chennai, India, respectively. This team brings to SMSC a broad set of technical engineering capabilities, including software development experience and expertise, largely in a low-cost geography. The Tallika and SMSC teams have previously collaborated on various projects including transceiver development, chip design and pre-silicon verification. SMSC paid approximately $3.4 million to purchase Tallika. The results of Tallika’s operations subsequent to September 8, 2009 have been included in the Company’s consolidated results of operations.


Critical Accounting Policies & Estimates





This discussion and analysis of the Company’s financial condition and results of operations is based upon the unaudited condensed consolidated financial statements included in this Quarterly Report, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and applicable SEC regulations for preparation of interim financial statements.





The preparation of financial statements in conformity with U.S. GAAP and SEC rules and regulations 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. Although management believes that its judgments and estimates are appropriate and reasonable, actual future results may differ from these estimates, and to the extent that such differences are material, future reported operating results may be affected.





The Company believes that the critical accounting policies and estimates listed below are important to the portrayal of the Company’s financial condition, results of operations and cash flows, and require critical management judgments and estimates about matters that are inherently uncertain.





•
Revenue Recognition





•
Inventory Valuation


•
Allowance for Doubtful Accounts


•
Valuation of Long-Lived Assets





•
Accounting for Business Combinations


23
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•
Accounting for and Valuation of Share-Based Payments





•
Accounting for Income Taxes and Uncertain Tax Positions





•
Legal Contingencies





•
Valuation of Long-Term Investments





Further information regarding these policies appears within the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2010, as filed with the SEC on April 28, 2010. During the three-month period ended May 31, 2010, there were no significant changes to any critical accounting policies or to the related estimates and judgments involved in applying those policies.





Recent Accounting Standards





In October 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-13, “ Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements” (“ASU 2009-13”) and ASU 2009-14, “ Software (Topic 985) — Certain Revenue Arrangements That Include Software Elements” (“ASU 2009-14”). ASU 2009-13 modifies the requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered. ASU 2009-13 eliminates the requirement that all undelivered elements must have either: (i) vendor-specific objective evidence, or “VSOE”, or (ii) third-party evidence, or “TPE”, before an entity can recognize the portion of an overall arrangement consideration that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. Overall arrangement consideration will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price. The residual method of allocating arrangement consideration has been eliminated. ASU 2009-14 modifies the software revenue recognition guidance to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality. These new updates are effective for SMSC for revenue arrangements entered into or materially modified in the first quarter of fiscal year 2012. Early adoption is permitted. We are currently evaluating the impact that the adoption of these ASUs will have on our consolidated financial statements.


In January 2010, the FASB issued new standards in ASC 820, “Fair Value Measurements and Disclosures” (“ASC 820”),which require new disclosures on the amount and reason for transfers in and out of Level 1 and 2 fair value measurements. The standards also require disclosure of activities, including purchases, sales, issuances, and settlements within the Level 3 fair value measurements. The standards also clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. The new disclosures regarding Level 1 and 2 fair value measurements and clarification of existing disclosures were adopted by SMSC beginning in the first quarter of fiscal 2011. The adoption of ASC 820 did not have a material effect on our consolidated financial statements.





Results of Operations





Overview





Net sales and revenues, gross profit, operating income (loss), and net income (loss) for the three months ended May 31, 2010, February 28, 2010, and May 31, 2009 were as follows (in thousands) :





Three Months

Ended

May 31,

2010


Three Months

Ended

February 28,

2010


Three Months

Ended

May 31,

2009Sales and revenues

$
97,159


$
82,989


$
62,479Gross profit

$
51,795


$
44,688


$
27,712Operating income (loss)

$
1,802


$
1,227


$
(14,597
)Net income (loss)

$
627


$
946


$
(9,196
)





Sales and revenues for the first quarter of fiscal 2011 were $97.2 million, an increase of $14.2 million or 17.1% sequentially over the prior quarter ended February 28, 2010. The strong sales growth was primarily driven by strong Automotive and Analog product sales. Both product lines achieved record revenue levels. In addition, PC, PC peripheral and industrial sales were strong during the first quarter of fiscal 2011.


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 Table of Contents




Sales and revenues increased $34.7 million or 55.5% from sales and revenues of $62.5 million in the first quarter of the prior fiscal year, primarily due to improved Automotive and PC product sales as the economy and demand for automobiles and PC products improved significantly over the prior year.





The Company reported a gross profit of 51.8 million, or 53.3% of sales and revenues for the first quarter of fiscal 2011, an increase of $7.1 million, compared to gross profit of $44.7 million or 53.8% of sales and revenues in the prior quarter ended February, 2010. This increase was primarily due to the benefit of increased production and sales levels, partially offset by the impact of  a credit of $1.0 million to costs of goods sold in the prior quarter for the reduction of accounts payable related to an unreconciled amount within inventory received not invoiced to correct a cumulative error from prior periods.





Gross profit in the first quarter of fiscal 2011 increased $24.1 million to $51.8 million, as compared to gross profit of $27.7 million, or 44.4% of sales and revenues in the first quarter of the prior fiscal year, primarily due to lower production levels in the first quarter of the prior year, which led to significant unabsorbed manufacturing overhead costs. In addition, the depressed economic outlook faced by SMSC’s suppliers beginning in the fourth quarter of fiscal 2009 allowed SMSC to seek aggressive price reductions over the course of the prior fiscal year, particularly in the wafer and assembly area. Further, structural changes in the Company’s supply and logistics chain, most notably the outsourcing of a significant portion of product test activities, began to contribute favorably to gross margin performance beginning in the second quarter of the prior fiscal year.





Operating income of $1.8 million was generated in the first quarter of fiscal 2011, as compared to operating income of $1.2 million in the prior quarter ended February 28, 2010 and operating loss of $14.6 million in the first quarter of the prior year. The increase in operating income compared to the prior quarter ended February 28, 2010 was primarily due to the increase in gross profit of $7.1 million in the first quarter of fiscal 2011, partially offset by an increase in stock based compensation charges of $4.7 million. Expenses related to stock appreciation rights increased sequentially by $4.7 million due to the significant increase in the Company’s stock price in the first quarter of fiscal 2011; the Company’s stock price was relatively flat in the prior quarter ended February 28, 2010. The increase in operating income compared to the first quarter of the prior fiscal year ended May 31, 2009 was primarily attributable to the year-over-year increase in product sales volume in the first quarter of fiscal 2011, partially offset by an increase in stock based compensation of $2.1 million (expenses related to stock appreciation rights increased $2.2 million over the first quarter of fiscal 2010 due to the increase in the Company’s stock price relative to the increase in the first quarter of the prior year).





Net income in the first quarter of fiscal 2011 was $0.6 million, compared to a net income of $0.9 million in the prior quarter ended February 28, 2010, and net loss of $9.2 million in the first quarter of the prior fiscal year, primarily due to the factors mentioned above. In addition, net income in the first quarter of fiscal 2011 was impacted by the $0.4 million decrease in other income related to foreign exchange gains and losses compared to the fourth quarter of the prior fiscal year.


Sales and Revenues





The Company’s sales and revenues for the three months ended May 31, 2010 were $97.2 million, compared to sales and revenues of $62.5 million in the three months ended May 31, 2009. The increase of $34.7 million or 55.5% overall was primarily due to significant improvement in the economy and demand for automobiles and PC products over the prior year. The acquisitions of Kleer and K2L contributed an additional $1.2 million and $0.7 million in revenue, respectively, in the first quarter of fiscal 2011.





Costs of Goods Sold





Costs of goods sold on product sales include: the purchase cost of finished silicon wafers manufactured by independent foundries (including mask and tooling costs); costs of assembly, packaging and mechanical and electrical testing; manufacturing overhead; quality assurance and other support overhead (including costs of personnel and equipment associated with manufacturing support); royalties paid to developers of intellectual property incorporated into the Company’s products; amortization of intangible assets relating to acquired technologies; and adjustments for excess, slow-moving or obsolete inventories. Costs of goods sold associated with other revenues are immaterial, and there are no costs of sales associated with intellectual property revenues.





The Company reported a gross profit of $51.8 million or 53.3% of sales and revenues in the first quarter of fiscal 2011, an increase of $24.1 million, compared to gross profit of $27.7 million, or 44.4% of sales and revenues in the first quarter of fiscal 2010. The increase in gross profit as a percentage of sales and revenues in the first quarter of the current fiscal year compared to the first quarter of the prior fiscal year was primarily due to increased production and sales levels, mix improvements, significant reductions in supply chain costs and structural changes in the Company’s supply and logistics chain, most notably the outsourcing of a significant portion of product test activities beginning in the second quarter of fiscal 2010. In addition, the first quarter of fiscal 2010 was impacted by significant unabsorbed overhead in response to lower demand and production levels.


25
 Table of Contents




Research and Development Expenses





Research and development (“R&D”) expenses consist primarily of salaries and related costs of employees engaged in research, design and development activities, costs related to engineering design tools and computer hardware, subcontractor costs and device prototyping costs. The Company’s R&D activities are performed by highly-skilled and experienced engineers and technicians, and are primarily directed towards the design of new integrated circuits; the development of new software drivers, firmware and design tools and blocks of logic; and investment in new product offerings based on converging technology trends, as well as ongoing cost reductions and performance improvements in existing products.





The Company intends to continue its efforts to develop innovative new products and technologies, and believes that an ongoing commitment to R&D is essential in order to maintain product leadership and compete effectively. Therefore, the Company expects to continue to make significant R&D investments in the future. Recent acquisitions (Tallika, K2L and Kleer, as previously described) have added additional engineering talent and capabilities.





Research and Development expenses were $23.8 million, or 24.5% of sales and revenues, for the three months ended May 31, 2010 compared to $18.5 million, or approximately 29.6% of sales and revenues, for the three months ended May 31, 2009. The increase was primarily due to the increase in engineering headcount and compensation charges associated with the acquisitions of Tallika, K2L and Kleer in the prior fiscal year. In addition, a charge of  $2.3 million relating to stock based compensation charges pursuant to ASC Topic 718 , “Compensation — Stock Compensation ” (“ASC 718”) is included in the current quarterly period, compared with a similar charge of approximately $1.6 million included in results for the three month period ended May 31, 2009.





Selling, General and Administrative Expenses





Selling, general and administrative (“SG&A”) expenses were $25.4 million, or approximately 26.1% of sales and revenues, for the quarter ended May 31, 2010, compared to $21.6 million, or approximately 34.5% of revenues, for the quarter ended May, 2009. The increase of $3.8 million was primarily the result of incentives and bonuses of $1.4 million incurred in the quarter ended May 31, 2010 and not incurred in the first quarter of the prior fiscal year, executive transition costs of $0.4 million, an increase of $1.1 million in stock based compensation charges pursuant to ASC 718 and increases in accounting and consulting fees, travel and entertainment and other administrative costs due to integration of acquisitions.


Restructuring Charges





Restructuring charges of $0.8 million were incurred in the three months ended May 31, 2010, primarily relating to a restructuring plan initiated in the fourth quarter of fiscal 2010 in connection with the integration and reorganization of engineering and corporate overhead resources, primarily for severance obligations and termination benefits for certain employees.





In the fourth quarter of fiscal 2009, the Company initiated a restructuring plan that included a supplemental voluntary retirement program and involuntary separations that resulted in approximately a ten percent reduction in employee headcount and expenses worldwide. This action resulted in a charge of $5.2 million for severance and termination benefits for 88 full-time employees in the fourth quarter of fiscal 2009. An additional $0.2 million was incurred in the first three months of fiscal 2010 relating to this restructuring plan.





Settlement Charge





There were no settlement charges incurred in the three months ended May 31, 2010. A charge of $2.1 million in settlement of the OPTi, Inc. patent infringement lawsuit against the Company was recognized in the three months ended May 31, 2009.





Interest and Other (Expense) Income, Net





The decrease in interest income, from $0.4 million for the three-month period ended May 31, 2009, to $0.1 million for the three-month period ended May 31, 2010, is primarily the result of a decrease in the Company’s overall investment in auction rate securities, as the Company continues to liquidate its positions as opportunities arise in response to market conditions. Funds from liquidated auction rate securities investments as well as funds generated through operating activities are currently being invested in high grade money market accounts, at lower average rates of return.





Interest expense was insignificant for both three-month periods ended May 31, 2010 and 2009, respectively.





Other expenses, net were $0.2 million for the three-month period ended May 31, 2010, compared to other expense, net of $0.3 million for the three-month period ended May 31, 2009. The Company took action in the fourth quarter of fiscal 2009 to minimize the impact of such fluctuations going forward in fiscal 2010 and beyond, primarily by limiting the amount of net U.S. dollar monetary assets held by its foreign affiliates.


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Provision for Income Taxes





The Company’s effective income tax rate reflects statutory federal, state and foreign tax rates, the impact of certain permanent differences between the book and tax treatment of certain expenses, and the impact of tax-exempt income and various income tax credits.





The provision for income taxes for the three-month period ended May 31, 2010 was $1.1 million, or an effective income tax rate of 64.4 percent against a $1.8 million of profit before income taxes. The provision excludes the impact of certain losses in various jurisdictions that could not be benefitted. In addition, as the research and development tax credit expired on December 31, 2009, there is no such tax credit included in the tax provision for the three months ended May 31, 2010.





The benefit from income taxes for the three-month period ended May 31, 2009 was $5.3 million, or an effective income tax rate of 36.5 percent against $14.5 million of losses before income taxes. This benefit included the impact of $0.1 million from tax exempt income and a 0.1 million increase in reserves for uncertain tax positions. Legislation was passed in October, 2008 extending income tax credits related to qualified research and development expenditures in the U.S. incurred through December 31, 2009. Consequently, the effective tax rate for fiscal year 2010 includes ten months of research and development tax credits.


Business Outlook





Our future results of operations and other matters comprising the subject of forward-looking statements contained in this Form 10-Q, included within this MD&A, involve a number of risks and uncertainties — in particular, current economic uncertainty, including tight credit markets, as well as future economic conditions; our goals and strategies; new product introductions; plans to cultivate new businesses; divestitures or investments; revenue; pricing; gross margin and costs; capital spending; depreciation; R&D expense levels; selling, general and administrative expense levels; potential impairment of investments; our effective tax rate; pending legal proceedings; ability to realize the benefits of recent acquisitions;and other operating parameters. In addition to the various important factors discussed above, a number of other important factors could cause actual results to differ materially from our expectations. See the risks described in Part II — Item 1.A. — Risk Factors .





The Company’s Automotive and Analog product lines achieved record revenue levels and we also saw strength in PC, PC peripheral and industrial sales during the first quarter of fiscal 2011.  We currently expect second quarter sales to grow sequentially over first quarter levels.





Liquidity & Capital Resources





The Company currently finances its operations through a combination of existing cash and cash generated by operations. Although the Company takes advantage of supplier financing arrangements for certain long-term agreements, the Company had no secured or unsecured debt during the first quarters of fiscal 2011 or 2010.





The Company’s cash, cash equivalents, short-term and long-term investments (including investments in auction rate securities with maturities in excess of one year) were $192.8 million at May 31, 2010, compared to $182.6 million at February 28, 2010. Positive cash flows from operations and proceeds from the issuance of common stock in connection with the exercise of stock options, partially offset by net cash used for capital expenditures and the repayment of notes payable for advanced design tools acquired under long-term supplier financing arrangements in the first quarter of fiscal 2011, contributed to this increase.





Operating activities generated $12.1 million of cash in the first 3 months of fiscal 2011, compared to $3.4 million of cash generated in the first three months of fiscal 2010. The increase in operating cash flows reflects the impact of a significant increase in revenues and operating profits in the first quarter of fiscal 2011 and a decrease in inventories over the prior year-end levels, partially offset by an increase in accounts receivable as revenues increased over the prior quarter.





Investing activities contributed $3.3 million of cash during the first three months of fiscal 2011, resulting from the redemption of auction rate securities totaling $6.4 million, partially offset by $3.2 million in capital expenditures. Capital expenditures increased in the first three months of fiscal 2011 as compared to the first three months of the prior fiscal year, during which capital expenditures were drastically reduced as a result of corporate cost saving initiatives in fiscal 2010.





Net cash provided by financing activities was $2.2 million in the first three months of fiscal 2011, consisting of $3.3 million of proceeds from issuance of common stock, partially offset by $1.2 million of repayments of obligations under capital leases and notes payable for payments for supplier financed design automation tools used in product development activities.


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Working capital increased $12.1 million, or 7%, to $183.4 million in the first three months of fiscal 2011, primarily due to cash from operations of $12.1 million and the liquidation of $6.4 million in auction rate securities in connection with issuer redemptions, partially offset by capital expenditures.





The Company may consider utilizing cash to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. From time to time, in the ordinary course of business, the Company may evaluate potential acquisitions of or investments in such businesses, products or technologies owned by third parties.





The Company expects that its cash, cash equivalents and cash flows from operations will be sufficient to finance the Company’s operating and capital requirements through the end of fiscal 2011 and for the foreseeable future.


Fair Value of Financial Instruments





The assessment of fair value for our financial instruments is based on the provisions of ASC Topic 820, “ Fair Value Measurements and Disclosures ” (“ASC 820”), which defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. When values are determined using inputs that are both unobservable and significant to the values of the instruments being measured, the Company classifies those instruments as Level 3 under the ASC 820 hierarchy. A financial instrument’s categorization within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.





As of May 31, 2010, the Company held approximately $152.2 million in financial instruments measured at fair value within the three levels of the ASC 820 fair value hierarchy, including investments, equity securities, non-marketable equity investments, cash surrender value of life insurance policies and cash equivalents. The Company classified $43.6 million of investments in auction rate securities and non-marketable equity investments (net of $3.1 million in gross unrealized losses) as Level 3 under the ASC 820 hierarchy (30 percent of financial instruments measured at fair value). Auction rate securities are long-term variable rate bonds tied to short-term interest rates that were, until February 2008, reset through a “Dutch auction” process. As of May 31, 2011, 100 percent of the Company’s auction rate securities were “AAA” rated by one or more of the major credit rating agencies, mainly collateralized by student loans guaranteed by the U.S. Department of Education under the Federal Family Education Loan Program (“FFELP”), as well as auction rate preferred securities ($6.1 million at par) which are AAA rated and part of a closed end fund that must maintain an asset ratio of 2 to 1. Non-marketable equity investments consist of recent investments in Symwave and Canesta, two development-stage enterprises accounted for as cost-basis investments and included in the investments in equity securities caption of the consolidated balance sheet.





Historically, the carrying value (par value) of the auction rate securities approximated fair market value due to the frequent resetting of variable interest rates. Beginning in February 2008, however, the auctions for auction rate securities began to fail and were largely unsuccessful. As a result, the interest rates on the investments reset to the maximum rate per the applicable investment offering statements. The types of auction rate securities generally held by the Company had historically traded at par and are callable at par at the option of the issuer.





The par (invested principal) value of the auction rate securities associated with these failed auctions will not be accessible to the Company until a successful auction occurs, a buyer is found outside of the auction process, the securities are called or the underlying securities have matured. In light of these liquidity constraints and the lack of market-based data, the Company performed a valuation analysis to determine the estimated fair value of these investments. The fair value of these investments is based on a trinomial discount model. This model considers the probability of three potential occurrences for each auction event through the maturity date of the security. The three potential outcomes for each auction are (i) successful auction/early redemption, (ii) failed auction and (iii) issuer default. Inputs in determining the probabilities of the potential outcomes include, but are not limited to, the security’s collateral, credit rating, insurance, issuer’s financial standing, contractual restrictions on disposition and the liquidity in the market. The fair value of each security is determined by summing the present value of the probability weighted future principal and interest payments determined by the model. The discount rate was determined using a proxy based upon the current market rates for successful auctions within the AAA rated auction rate securities market. The expected term was based on management’s estimate of future liquidity. The illiquidity discount was based on the levels of federal insurance or FFELP backing for each security as well as considering similar preferred stock securities ratings and asset backed ratio requirements for each security.





As a result, as of May 31, 2010, the Company recorded an estimated cumulative unrealized loss of $3.1 million related to the temporary impairment of the auction rate securities, which was included in accumulated other comprehensive income (loss) within shareholders’ equity. The Company deemed the loss to be temporary because the Company does not plan to sell any of the auction rate securities prior to maturity at an amount below the original purchase value and, at this time, does not deem it probable that it will receive less than 100 percent of the principal and accrued interest from the issuer. Further, the auction rate securities held by the Company are AAA rated. The Company continues to liquidate investments in auction rate securities as opportunities arise. In the first quarter of fiscal 2011, $6.4 million in auction rate securities were liquidated at par in connection with issuer calls. Subsequent to May 31, 2010, an additional $0.7 million in auction rate securities were also liquidated at par, also as a consequence of issuer calls.


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Given its sufficient cash reserves and positive cash flow from operations, the Company does not believe it will be necessary to access these investments to support current working capital requirements. However, the Company may be required to record additional unrealized losses in accumulated other comprehensive income in future periods based on then current facts and circumstances. Further, if the credit rating of the security issuers deteriorates, or if active markets for such securities are not reestablished, the Company may be required to adjust the carrying value of these investments through impairment charges recorded in the condensed consolidated statements of operations, and any such impairment adjustments may be material.





Commitments and Contingencies





Contingent Consideration — Kleer Acquisition





The Company recorded a liability for contingent consideration as part of the purchase price for the acquisition of Kleer at the estimated fair value of $0.8 million as of May 31, 2010. The maximum amount of contingent consideration that can be earned by the sellers is $2.0 million as set forth in the purchase agreement.





Contingent Consideration — K2L Acquisition





The Company recorded a liability for contingent consideration as part of the purchase price for the acquisition of K2L at the estimated fair value of $1.8 million as of May 31, 2010. The maximum amount of contingent consideration that can be earned by the sellers is €2.1 million. Fifty percent of the contingent consideration will be available to be earned in each of calendar years 2010 and 2011 based on the level of achievement of revenue as set forth in the purchase agreement.





Litigation





From time to time as a normal incidence of doing business, various claims and litigation may be asserted or commenced against the Company. Due to uncertainties inherent in litigation and other claims, the Company can give no assurance that it will prevail in any such matters, which could subject the Company to significant liability for damages and/or invalidate its proprietary rights. Any lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management’s time and attention, and an adverse outcome of any significant matter could have a material adverse effect on the Company’s consolidated results of operations or cash flows in the quarter or annual period in which one or more of these matters are resolved.





Item 3. — Quantitative and Qualitative Disclosures About Market Risk





Interest Rate and Investment Liquidity Risk — The Company’s exposure to interest rate risk relates primarily to its investment portfolio (i.e. with respect to interest income). The primary objective of SMSC’s investment portfolio management is to invest available cash while preserving principal and meeting liquidity needs. In accordance with the Company’s investment policy, investments are placed with high credit-quality issuers and the amount of credit exposure to any one issuer is limited.





As of May 31, 2010, the Company’s $37.1 million of long-term investments consisted primarily of investments in U.S. government agency backed AAA rated auction rate securities. From time to time, the Company has also held investments in corporate, government and municipal obligations with maturities of between three and twelve months at acquisition. Auction rate securities have long-term underlying maturities, but have interest rates that until recently had been reset every 90 days or less at auction, at which time the securities could also typically be repurchased or sold.





In February 2008, the Company began to experience failed auctions on some of its auction rate securities Based on the failure rate of these auctions, the frequency and extent of the failures, and due to the lack of liquidity in the current market for the auction rate securities, the Company determined that the estimated fair value of the auction rate securities no longer approximates par value. The Company used a discounted cash flow model to determine the estimated fair value of these investments as of May 31, 2010, and recorded an unrealized loss of $3.0 million, (net of tax) related to the temporary impairment of the auction rate securities, which is included in accumulated other comprehensive income within shareholders’ equity on the consolidated balance sheet.





Assuming all other assumptions disclosed in Part I — Item 1 — Financial Statements — Note 2 of this Report, being equal, an increase or decrease in the liquidity risk premium (i.e. the discount rate) of 100 basis points as used in the model would decrease or increase, respectively, the fair value of the auction rate securities by approximately $1.0 million. In addition, an increase or decrease in interest rates of 100 basis points would decrease interest income of $0.1 million in the three months ended May 31, 2010 to a negligible amount or increase interest income by $0.4 million.





Equity Price Risk — The Company is not exposed to any significant equity price risks at May 31, 2010.





Foreign Currency Risk — The Company has international operations and is therefore subject to certain foreign currency rate exposures, principally the euro and Japanese Yen. The Company also 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.


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The Company’s most significant foreign subsidiaries, SMSC Japan and SMSC Europe, purchase a significant amount of their products for resale in U.S. dollars, and from time to time have entered into forward exchange contracts to hedge against currency fluctuations associated with these product purchases. Gains or losses on these contracts are intended to offset the gains or losses recorded for statutory and U.S. GAAP purposes from the remeasurement of certain assets and liabilities from U.S. dollars into local currencies. No such contracts were executed during fiscal 2010, and there are no obligations under any such contracts as of May 31, 2010. However, the Company has purchased currencies from time to time throughout the current fiscal year in anticipation of more significant foreign currency transactions, in order to optimize effective rates associated with those settlements.





Operating activities in Europe include transactions conducted in both euros and U.S. dollars. The euro is the functional currency for the Company’s European subsidiaries. Losses recorded from the remeasurement of U.S. dollar denominated assets and liabilities into euros were $0.2 in the first quarter of fiscal 2011, compared with loss of $0.1 million in fiscal 2010. The Company took action in the fourth quarter of fiscal 2009 to minimize the impact of such fluctuations in fiscal 2010 going forward, primarily by limiting the amount of U.S. dollar monetary assets held by SMSC Europe and SMSC Japan. Losses recorded from the remeasurement of U.S. dollar denominated assets and liabilities into Yen for the first quarter of fiscal 2011 were a negligible amount compared with a loss of $0.1 million in the first quarter of fiscal 2010.





Commodity Price Risk — The Company routinely uses precious metals in the manufacturing of its products. Supplies for such commodities may from time-to-time become restricted, or general market factors and conditions may affect pricing of such commodities. In the latter part of fiscal 2008, particularly in the fourth quarter, and in fiscal 2010, the price of gold increased precipitously, and certain of our supply chain partners began and continue to assess surcharges to compensate for the resultant increase in manufacturing costs. The Company is engaged in a project to replace gold with copper in certain of its parts to reduce this exposure. While the Company continues to attempt to mitigate the risk of similar increases in commodities-related costs, there can be no assurance that the Company will be able to successfully safeguard against potential short-term and long-term commodities price fluctuations.





Item4. — Controls and Procedures





The Company has carried out an evaluation under the supervision and with the participation of the Company’s management, including the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon the Company’s evaluation, the Principal Executive Officer and Principal Financial Officer have concluded that, as of May 31, 2010, the disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports the Company files under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to the Company’s management, including the Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding disclosure.





There have been no changes in the Company’s internal control over financial reporting during the Company’s fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


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PART II





Item1. — Legal Proceedings





From time to time as a normal consequence of doing business, various claims and litigation may be asserted or commenced against the Company. In particular, the Company in the ordinary course of business may receive claims that its products infringe the intellectual property of third parties, or that customers have suffered damage as a result of defective products allegedly supplied by the Company. Due to uncertainties inherent in litigation and other claims, the Company can give no assurance that it will prevail in any such matters, which could subject the Company to significant liability for damages and/or invalidate its proprietary rights. Any lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management’s time and attention, and an adverse outcome of any significant matter could have a material adverse effect on the Company’s consolidated results of operations or cash flows in the quarter or annual period in which one or more of these matters are resolved.





Item 1.A. — Risk Factors





Readers of this Quarterly Report on Form 10-Q should carefully consider the risks described in the Company’s other reports filed or furnished with the SEC, including the Company’s prior and subsequent reports on Forms 10-K, 10-Q and 8-K, in connection with any evaluation of the Company’s financial position, results of operations and cash flows.





The risks and uncertainties described in the Company’s most recent Annual Report on Form 10-K, filed with the SEC as of April 28, 2010, are not the only ones facing the Company. Additional risks and uncertainties not presently known, currently deemed immaterial, or those otherwise discussed in this Quarterly Report on Form 10-Q may also affect the Company’s operations. Any of these risks, uncertainties, events or circumstances could cause the Company’s future financial condition, results of operations or cash flows to be adversely affected.





Item 2. — Unregistered Sales of Equity Securities and Use of Proceeds





(a) None.





(b) None.





(c) Issuer Purchases of Equity Securities.





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. The Board of Directors authorized the repurchase of additional shares in one million share increments in July 2000, July 2002, November 2007 and April 2008, bringing the total authorized repurchases to five million shares as of February 28, 2009. As of May 31, 2010, the Company has repurchased approximately 4.5 million shares of its common stock at a cost of $101.2 million under this program, including 1,084,089 shares repurchased at a cost of $28.5 million in fiscal 2009, 1,165,911 shares repurchased at a cost of $40.6 million in fiscal 2008 and 253,300 shares repurchased at a cost of $6.1 million in fiscal 2007.





The Company did not repurchase any shares in the first quarter of fiscal 2011.


Item3. — Defaults Upon Senior Securities





None.





Item 4. — Removed and Reserved




Item 5. — Other Information





None.





Item6. — Exhibits





31.1
—
Certification of Principal Executive Officer pursuant to Rule 13a-14(a) (17 CFR 240.13a-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


31.2
—
Certification of Principal Financial Officer pursuant to Rule 13a-14(a) (17 CFR 240.13a-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.


32.1
—
Certifications of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




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SIGNATURE





Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





STANDARD MICROSYSTEMS CORPORATIONBy:
/s/ Kris Sennesael(Signature)Kris SennesaelVice President and Chief Financial Officer(Principal Financial Officer)





Date: July 7, 2010








EXHIBIT INDEX








Exhibit

No.

Description31.1
—
Certification of Principal Executive Officer pursuant to Rule 13a-14(a) (17 CFR 240.13a-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
—
Certification of Principal Financial Officer pursuant to Rule 13a-14(a) (17 CFR 240.13a-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
—
Certifications of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.







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