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 (“RSAs”), restricted stock units (“RSUs”) and stock appreciation rights (“SARs”) have been granted to employees and directors. In July 2009, the shareholders 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 RSUs. 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. After amendment on July 28, 2011 the maximum number of shares that may be delivered pursuant to awards granted under the LTIP is 2,000,000 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. As of August 31, 2011, awards amounting to 1,286,091 share equivalents are available for grant under the LTIP.

Employee and Director Stock Option Plans

Under the Company's various 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 is summarized below (in thousands, except per share data):

	Shares			Weighted Average Exercise Price per Share		Weighted Average Contractual Term (in yrs.)		Aggregate Intrinsic Value
Options outstanding, March 1, 2011		3,075		$	22.75
Granted		222		$	24.96
Exercised		(116	)	$	18.08
Canceled, forfeited or expired		(147	)	$	29.91
Options outstanding, August 31, 2011		3,034		$	22.74		5.7	$	4,568
Options exercisable, August 31, 2011		1,980		$	22.50		4.4	$	3,443

The following table summarizes information relating to outstanding and exercisable options as of August 31, 2011 (shares in thousands):

Range of Exercise Prices		Weighted Average Remaining Lives		Options Outstanding		Weighted Average Exercise Prices		Options Exercisable		Weighted Average Exercise Prices
$	10.56 - $17.62		4.7		792	$	16.37		628	$	16.46
$	18.29 - $22.35		5.1		876	$	20.44		613	$	20.55
$	22.40 - $27.76		7.9		779	$	25.29		271	$	25.68
$	27.90 - $36.13		5.1		587	$	31.36		468	$	31.33
			5.7		3,034	$	22.74		1,980	$	22.50

The following table summarizes information relating to currently outstanding and exercisable options:

	As of August 31,
	2011		2010
Total remaining unrecognized compensation cost (in thousands)	$	7,969	$	11,790
Weighted average period over which cost is expected to be recognized (in years)		1.5		1.7

The fair value of stock options granted in connection with the Company's stock incentive plans have been estimated utilizing the following assumptions:

	Three Months Ended August 31,						Six Months Ended August 31,
	2011			2010			2011			2010
Dividend yield		-			-			-			-
Expected volatility		43	%		46	%		43 - 44	%		46-47	%
Risk-free interest rates		1.6 - 1.8	%		1.8-2.0	%		1.6 - 2.1	%		1.8-2.6	%
Expected lives (in years)		5.0			5.0			5.0			5.0

Restricted Stock Awards/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, and as part of the Company's management incentive plan, 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 were typically earned in 25%, 25% and 50% 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 unvested 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 estimated forfeitures of unvested awards. Restricted stock shares are no longer being granted from previously established restricted stock award plans. Instead, restricted stock units are currently being granted from the LTIP. Restricted stock units are typically earned in 33% 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 unvested 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 estimated forfeitures of unvested awards.

Restricted stock activity is set forth below (shares in thousands):

	Shares			Weighted Average Grant-Date Fair Value
Restricted stock shares/units outstanding, March 1, 2011		424		$	23.79
Granted		262		$	24.60
Canceled or expired		(41	)	$	26.84
Vested		(78	)	$	25.60

Restricted stock shares/units outstanding, August 31, 2011		567		$	23.70

The following table summarizes information relating to RSAs and RSUs activity:

	As of August 31,
	2011		2010
Total unrecognized compensation cost (in thousands)	$	11,115	$	5,301
Weighted average period over which cost is expected to be recognized (in years)		1.6		1.7

Stock Appreciation Rights Plans

In September 2004 and September 2006, the Company's Board of Directors approved Stock Appreciation Rights (“SAR”) Plans (the “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 Plans authorize the Board's Compensation Committee to grant up to six million SAR awards to eligible officers, employees and consultants (after amendment to the 2006 SARs 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 SARs under this plan. On April 9, 2008, the Board of Directors authorized an increase in the number of SARs issuable pursuant to this plan from 200,000 to 400,000. The exercise price of a SAR is equal to the closing market price of SMSC stock on the date of grant. SAR awards generally vest over four or five-year periods, and expire no later than ten years from the date of grant. The Company has currently ceased issuing SARs to employees and Directors and is using the LTIP instead.

The Company recognizes compensation expense or benefit for SARs using a graded vesting methodology, adjusting for changes in fair value from period to period. Compensation expense also includes adjustments for any exercises of SARs to record any differences between total cash paid at settlement and previously recognized compensation expenses. Prior to the adoption of guidance now codified as ASC Topic 718, “Compensation - Stock Compensation” (“ASC 718”), the Company recognized compensation expense for SARs based on the excess of the award's market value over its exercise price over the term of the award.

The total unrecognized compensation cost related to SMSC's stock appreciation rights plan is $5.8 million as of August 31, 2011. The weighted average period over which the cost is expected to be recognized is 2.8 years.

Activity under the Plans is summarized below (in thousands, except per share data):

	Shares			Weighted Average Exercise Price per Share		Weighted Average Contractual Term (in yrs.)		Aggregate Intrinsic Value
Stock appreciation rights outstanding, March 1, 2011		4,249		$	24.96
Granted		-		$	-
Exercised		(134	)	$	17.21
Canceled or expired		(139	)	$	26.55
Stock appreciation rights outstanding, August 31, 2011		3,976		$	25.16		6.0	$	6,235
Stock appreciation rights exercisable, August31, 2011		2,853		$	26.18		5.6	$	3,793

Activity under the Stock Appreciation Rights Plan is summarized below:

	As of August 31,
	2011		2010
Total unrecognized compensation cost (in thousands)	$	5,802	$	9,924
Weighted average period over which cost is expected to be recognized (in years)		2.8		3.5

The fair value of SARs granted in connection with the Plans has been estimated utilizing the following assumptions:

	Three Months Ended August 31,						Six Months Ended August 31,
	2011			2010			2011			2010
Dividend yield		-			-			-			-
Expected volatility		38 - 46	%		37-51	%		28 – 46	%		37-53	%
Risk-free interest rates		0.18 - .85	%		0.04-1.87	%		0.01 –1.69	%		0.04-2.76	%
Expected lives (in years)		1.5 - 4.5			0.02-5.37			0.5 – 4.7			0.02-5.62

Employee Stock Purchase Plan

The Company's 2010 Employee Stock Purchase Plan (the “Purchase Plan”), effective November 1, 2010, provides for the issuance of up to 1,100,000 shares of common stock to eligible employees. The Purchase Plan provides for eligible employees to purchase whole shares of common stock at a price of 85% of the lesser of: (a) the fair market value of a share of common stock on the first date of the purchase period or (b) the fair market value of a share of common stock on the last date of the purchase period. Stock-based compensation expense for the Purchase Plan is recognized over the vesting period of six months on a straight-line basis. In the first quarter of fiscal 2012 the Company issued 54,933 shares and had 1,045,067 shares available for future grants and issuances under the Purchase Plan. The Company recognized expense of $0.1 million and $0.3 million in the three and six months ended August 31, 2011, respectively.

Stock-Based Compensation (Benefit) Expense

The following table summarizes the compensation (benefit) expense for stock options, 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 August 31,						Six Months Ended August 31,
	2011			2010			2011			2010
Costs of goods sold	$	(1,005	)	$	(451	)	$	(681	)	$	381
Research and development		(2,743	)		(1,498	)		(1,688	)		780
Selling, general and administrative		(5,503	)		(3,264	)		(3,466	)		1,539
Stock-based compensation (benefit) expense, before income taxes	$	(9,251	)	$	(5,213	)	$	(5,835	)	$	2,700

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.

The following table sets forth the components of the consolidated net periodic pension expense (in thousands):

	Three Months Ended August 31,				Six Months Ended August 31,
	2011		2010		2011		2010

Service cost – benefits earned during the period	$	53	$	88	$	132	$	171
Interest cost on projected benefit obligations		91		96		182		192
Net periodic pension expense	$	144	$	184	$	314	$	363

The following table sets forth the amounts (gross, before tax) recognized in accumulated other comprehensive income (in thousands):

	As of August 31, 2011		As of February 28, 2011

Transition obligation	$	1	$	1
Net actuarial income		659		659
Total amount recognized in accumulated other comprehensive income	$	660	$	660

Annual benefit payments under these plans are expected to be approximately $0.7 million in fiscal 2012, to be funded as general corporate obligations with available cash and cash equivalents. Payments to date on these plans for the six months ended August 31, 2011 were $0.4 million. 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.