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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 27, 2003
Commission File No. 1-8139
ZARLINK SEMICONDUCTOR INC.
(Exact name of registrant as specified in its charter)
CANADA NONE
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
400 March Road,
Ottawa, Ontario, Canada K2K 3H4
(Address of principal executive offices) (Postal Code)
(613)-592-0200
(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 [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) Yes [X] No [ ]
As at August 1, 2003 there were 127,273,898 Common Shares of Zarlink
Semiconductor Inc., no par value, issued and outstanding.
ZARLINK SEMICONDUCTOR INC.
TABLE OF CONTENTS
Item No. Page No.
- -------- --------
PART I - FINANCIAL INFORMATION (Unaudited).....................................3
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.....................................3
Consolidated Balance Sheets (Unaudited)..........................3
Consolidated Statements of Loss (Unaudited)......................4
Consolidated Statements of Cash Flows (Unaudited)................5
Notes to the Consolidated Financial Statements
(Unaudited).....................................................6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.....................................................14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS..........22
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES...................................22
PART II - OTHER INFORMATION...................................................23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.....................................23
Signatures....................................................................23
Certification Pursuant to Section 302 (a) of the
Sarbanes-Oxley Act of 2002..................................................24
Certification Pursuant to Section 302 (a) of the
Sarbanes-Oxley Act of 2002..................................................25
2
PART I - FINANCIAL INFORMATION (Unaudited)
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Zarlink Semiconductor Inc.
CONSOLIDATED BALANCE SHEETS
(In millions of U.S. dollars, U.S. GAAP)
June 27, March 28,
2003 2003
-------- ---------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 39.2 $ 23.5
Short-term investments 62.3 89.5
Restricted cash 6.2 6.2
Trade accounts receivable, less allowance for doubtful accounts of $ 0.8 27.8 20.3
(March 28, 2003 - $1.1)
Other receivables 3.6 4.2
Inventories 23.2 24.0
Deferred income tax assets - net 1.3 1.0
Prepaid expenses and other 10.4 7.3
-------- --------
174.0 176.0
Fixed assets - net 53.8 56.4
Deferred income tax assets - net 10.3 10.4
Other assets - net of deferred gain of $ 16.1 (March 28, 2003 - $15.8) 4.6 4.8
-------- --------
$ 242.7 $ 247.6
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 13.6 $ 10.1
Employee-related accruals 14.5 15.5
Income and other taxes payable 13.8 13.0
Provisions for exit activities 3.4 4.2
Other accrued liabilities 11.4 12.6
Deferred credits 0.7 1.1
Current portion of long-term debt 0.4 0.6
-------- --------
57.8 57.1
Long-term debt 0.1 0.2
Pension liabilities 15.4 14.3
Deferred income tax liabilities - net 2.3 2.0
-------- --------
75.6 73.6
-------- --------
Redeemable preferred shares, unlimited shares authorized; 1,451,600 shares
issued and outstanding (March 28, 2003 - 1,451,600) 18.5 18.9
-------- --------
Commitments (Note 10)
Shareholders' equity:
Common shares, unlimited shares authorized; no par value; 127,273,898 shares
issued and outstanding (March 28, 2003 - 127,265,316) 768.3 768.3
Additional paid-in capital 2.1 2.1
Deficit (589.5) (582.8)
Accumulated other comprehensive loss (32.3) (32.5)
-------- --------
148.6 155.1
-------- --------
$ 242.7 $ 247.6
======== ========
(See accompanying notes to the consolidated financial statements)
3
Zarlink Semiconductor Inc.
CONSOLIDATED STATEMENTS OF LOSS
(In millions of U.S. dollars, except per share amounts, U.S. GAAP)
(Unaudited)
Three Months Ended
June 27, June 28,
2003 2002
--------- ---------
Revenue $ 53.7 $ 48.0
Cost of revenue 28.1 25.9
--------- ---------
Gross margin 25.6 22.1
--------- ---------
Expenses:
Research and development 19.2 20.4
Selling and administrative 11.6 12.1
Stock compensation recovery -- (1.6)
--------- ---------
30.8 30.9
--------- ---------
Operating loss (5.2) (8.8)
Other income (expense) - net (0.7) 0.5
Interest expense -- (0.1)
--------- ---------
Loss before income taxes (5.9) (8.4)
Income tax expense 0.3 0.3
--------- ---------
Net loss for the period $ (6.2) $ (8.7)
========= =========
Net loss attributable to common shareholders after preferred share dividends $ (6.7) $ (9.2)
========= =========
Net loss per common share:
Basic and diluted $ (0.05) $ (0.07)
========= =========
Weighted average number of common shares outstanding (millions):
Basic and diluted 127.3 126.6
========= =========
(See accompanying notes to the consolidated financial statements)
4
Zarlink Semiconductor Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions of U.S. dollars, U.S. GAAP)
(Unaudited)
Three Months Ended
June 27, June 28,
2003 2002
-------- --------
Cash flows from operating activities:
Net loss for the period $ (6.2) $ (8.7)
Depreciation of fixed assets 3.6 3.1
Amortization of other assets 0.3 0.3
Stock compensation recovery -- (1.6)
Deferred income taxes 0.1 --
Change in pension liability 1.1 --
Other non-cash changes in operating activities -- 0.3
Decrease (increase) in working capital:
Accounts receivable (7.4) 2.1
Inventories 0.8 2.7
Prepaid expenses and other (3.0) 1.9
Accounts payable and accrued liabilities 1.3 (4.7)
Deferred credits (0.2) (0.1)
-------- --------
Total (9.6) (4.7)
-------- --------
Cash flows from investing activities:
Purchased short-term investments (62.3) (86.0)
Matured short-term investments 89.5 46.5
Expenditures for fixed and other assets (1.2) (2.7)
Proceeds from disposal of fixed and other assets 0.4 --
Increase in long-term investments -- (0.4)
-------- --------
Total 26.4 (42.6)
-------- --------
Cash flows from financing activities:
Repayment of capital lease liabilities (0.2) (0.7)
Payment of dividends on preferred shares (0.5) (0.5)
Issue of common shares -- 0.6
Repurchase of preferred shares (0.4) (0.2)
-------- --------
Total (1.1) (0.8)
-------- --------
Effect of currency translation on cash and cash equivalents -- 3.4
-------- --------
Increase (decrease) in cash and cash equivalents 15.7 (44.7)
Cash and cash equivalents, beginning of period 23.5 75.6
-------- --------
Cash and cash equivalents, end of period $ 39.2 $ 30.9
======== ========
(See accompanying notes to the consolidated financial statements)
5
Zarlink Semiconductor Inc.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(In millions of U.S. dollars, except per share amounts, U.S. GAAP)
(Unaudited)
1. Basis of presentation
These unaudited interim consolidated financial statements have been
prepared by Zarlink Semiconductor Inc. ("Zarlink" or the "Company") in
United States (U.S.) dollars, unless otherwise stated, and in accordance
with accounting principles generally accepted in the U.S. for interim
financial statements and with the instructions to Form 10-Q and Regulation
S-X pertaining to interim financial statements. Accordingly, these interim
consolidated financial statements do not include all information and
footnotes required by generally accepted accounting principles ("GAAP")
for complete financial statements. In the opinion of management of the
Company, the unaudited interim consolidated financial statements reflect
all adjustments, which consist only of normal and recurring adjustments,
necessary to present fairly the financial position at June 27, 2003, and
the results of operations and cash flows of the Company for the three
month periods ended June 27, 2003 and June 28, 2002, respectively, in
accordance with U.S. GAAP, applied on a consistent basis. The consolidated
financial statements include the accounts of Zarlink and its wholly owned
subsidiaries. Intercompany transactions and balances have been eliminated.
Separate Canadian GAAP financial statements are also prepared and
presented to shareholders.
These financial statements should be read in conjunction with the
financial statements and notes thereto contained in the Company's Annual
Report on Form 10-K for the year ended March 28, 2003. The Company's
fiscal year-end is the last Friday in March.
The results of operations for the periods presented are not necessarily
indicative of the results to be expected for the full year or future
periods.
2. Change in functional currency
Since the third quarter of Fiscal 2002, the Company has presented its
financial statements in U.S. dollars. However, the Company has
historically measured the parent company's financial statements in
Canadian dollars and its subsidiaries' financial statements in their
respective local currencies. Effective March 29, 2003, the beginning of
Fiscal 2004, as a result of the Company's increased economic activities
denominated in U.S. dollars, the U.S. dollar has become the functional
currency across the Company's operations.
Prior to March 29, 2003, the financial statements of the foreign
subsidiaries were measured using the local currency as the functional
currency. All balance sheet amounts were translated using the exchange
rates in effect at the applicable period end, and income statement amounts
were translated using the weighted average exchange rates for the
applicable period. Any gains and losses resulting from the changes in
exchange rates from year to year were reported as a separate component of
other comprehensive loss included in Shareholders' Equity.
Effective March 29, 2003, the carrying value of monetary balances
denominated in currencies other than U.S. dollars were remeasured at the
balance sheet date rates of exchange. The gains or losses resulting from
the remeasurement of these amounts have been reflected in earnings in the
respective periods. Non-monetary items and any related amortization of
such items are measured at the rates of exchange in effect when the assets
were acquired or obligations incurred. All other income and expense items
have been remeasured at the average rates prevailing during the period.
3. Recently issued accounting pronouncements
On April 30, 2003, the FASB issued Statement of Financial Accounting
Standard No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities". The amendments set forth in SFAS 149
improve financial reporting by requiring that contracts with comparable
characteristics be accounted for similarly. In particular, this statement
clarifies under what circumstances a contract with an initial net
investment meets the characteristic of a derivative as discussed in SFAS
133. In addition, it clarifies when a derivative contains a financing
component that warrants special reporting in the statement of cash flows.
SFAS 149 amends certain other existing pronouncements. Those changes will
result in more consistent reporting of contracts that are derivatives in
their entirety or that contain embedded derivatives that warrant separate
accounting. This Statement
6
is effective for contracts entered into or modified after June 30, 2003,
except as stated below, and for hedging relationships designated after
June 30, 2003. The guidance will be applied prospectively. The provisions
of this Statement that relate to Statement 133 Implementation Issues that
have been effective for fiscal quarters that began prior to June 15, 2003,
will continue to be applied in accordance with their respective effective
dates. In addition, certain provisions relating to forward purchases or
sales of when-issued securities or other securities that do not yet exist,
should be applied to existing contracts as well as new contracts entered
into after June 30, 2003. The Company has not yet evaluated the impact of
this new pronouncement on its financial position, results of operations or
cash flows.
On May 15, 2003, the FASB issued Statement of Financial Accounting
Standard No. 150 ("SFAS 150"), "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". The
Statement improves the accounting for certain financial instruments that,
under previous guidance, issuers could account for as equity. SFAS 150
requires that those instruments be classified as liabilities in the
statements of financial position, whereas previously such instruments may
have been classified as equity or as temporary equity. In addition to its
requirements for the classification and measurement of financial
instruments in its scope, SFAS 150 also requires disclosures about
alternative ways of settling the instruments and the capital structure of
entities, all of whose shares are mandatorily redeemable. Most of the
guidance in SFAS 150 is effective for all financial instruments entered
into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
Company has not yet evaluated the impact of this new pronouncement on its
financial position, results of operations or cash flows.
4. Stock-based compensation
Pro forma information regarding net income (loss) and net income (loss)
per share is required by SFAS 123 for awards granted or modified after
April 1, 1995, as if the Company had accounted for its stock-based awards
to employees under the fair value method of SFAS 123. The fair value of
the Company's stock-based awards to employees was estimated using a
Black-Scholes option pricing model. The Black-Scholes option valuation
model was developed for use in estimating the fair value of traded options
that have no vesting restrictions and are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions
including the expected stock price volatility. Because the Company's
employee stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
Three Months Ended
June 27, June 28,
2003 2002
-------- -------
Net loss, as reported $ (6.2) $ (8.7)
Adjustments:
Stock compensation recovery as reported -- (1.6)
Pro forma stock compensation expense (3.1) (3.3)
--------------------
Pro forma net loss $ (9.3) $(13.6)
--------------------
Net loss per common share, as reported
Basic and diluted $ (0.05) $ (0.07)
--------------------
Pro forma net loss per common share:
Basic and diluted $ (0.08) $ (0.11)
--------------------
Based upon the fair value method of accounting for stock compensation
expense, the pro forma net loss for the quarter ended June 27, 2003, was
increased by $3.1 as compared to the net loss, as reported ($4.9 for the
quarter ended June 28, 2002).
7
Pro forma financial information required by SFAS 123 has been determined
as if the Company had accounted for its employee stock options using the
Black-Scholes fair value option pricing model with the following
weighted-average assumptions for the three month fiscal periods ended June
27, 2003 and June 28, 2002:
Three Months Ended
June 27, June 28,
2003 2002
-----------------------
Weighted average fair value price of the options granted during the $ 2.31 $ 3.43
quarter
Risk free interest rate 3.19% 4.68%
Dividend yield Nil Nil
Volatility factor of the expected market price of the Company's
common stock 0.682 0.561
Weighted-average expected life of the options 3.3 Years 3.5 years
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period on a
straight-line basis.
5. Inventories
June 27, March 28,
2003 2003
--------- ---------
Raw materials $ 2.3 $ 2.6
Work-in-process 18.5 18.3
Finished goods 2.4 3.1
------- -------
$ 23.2 $ 24.0
======= =======
6. Fixed assets
June 27, March 28,
2003 2003
------- ---------
Cost $ 164.7 $ 163.7
Accumulated depreciation 110.9 107.3
------- -------
$ 53.8 $ 56.4
======= =======
7. Other assets
June 27, March 28,
2003 2003
------- ---------
Note receivable, non-interest bearing $ 16.2 $ 15.9
Less: Deferred gain (16.1) (15.8)
------- -------
0.1 0.1
Patents, trademarks, and other intangible assets:
Cost 9.8 9.5
Accumulated amortization (5.3) (5.0)
------- -------
Patents, trademarks, and other intangible assets - net 4.5 4.5
Other -- 0.2
------- -------
$ 4.6 $ 4.8
======= =======
The amortization of patents, trademarks and other intangible assets
amounted to $0.3 for the quarterly period ended June 27, 2003 (June 28,
2002 - $0.3).
8
8. Provisions for exit activities
June 27, March 28,
2003 2003
------- ---------
Restructuring provisions $ 2.6 $ 2.9
Provision for disposal of discontinued operations -- 0.1
Provision for disposal of foundry businesses 0.8 1.2
----- -----
$ 3.4 $ 4.2
===== =====
The remaining restructuring provision relates mostly to idle and excess
space as a result of exit activities implemented and completed in Fiscal
2002 and Fiscal 2001.
The following table summarizes the continuity of these restructuring
provisions for the three months ended June 27, 2003:
Lease and
Workforce contract
reduction settlement Total
--------- ---------- ---------
Balance, March 28, 2003 $ 0.3 $ 2.6 $ 2.9
Cash drawdowns during quarter (0.1) (0.2) (0.3)
------ ------ ------
Balance, June 27, 2003 $ 0.2 $ 2.4 $ 2.6
====== ====== ======
9. Guarantees
Performance guarantees are contracts that contingently require the
guarantor to make payments to the guaranteed party based on another
entity's failure to perform under an obligating agreement. The Company has
an outstanding performance guarantee related to a managed services
agreement ("project agreement") undertaken by the Systems business, which
was sold to companies controlled by Dr. Terence H. Matthews on February
16, 2001 and is now operated as Mitel Networks Corporation ("Mitel"). This
performance guarantee remained with the Company following the sale of the
Systems business to Dr. Matthews. The project agreement and the Company's
performance guarantee extend until July 16, 2012. The terms of the project
agreement continue to be fulfilled by Mitel. The maximum potential amount
of future undiscounted payments the Company could be required to make
under the guarantee, at June 27, 2003, was $33.0 (20.0 British Pounds),
assuming the Company is unable to secure the completion of the project.
The Company is not aware of any factors as at June 27, 2003 that would
prevent the project's completion under the terms of the agreement. In the
event that Mitel is unable to fulfill the commitments of the project
agreement, the Company believes that an alternate third-party contractor
could be secured to complete the agreement requirements. At June 27, 2003,
the carrying value of this guarantee was nil.
The Company periodically has entered into agreements with customers and
suppliers that include limited intellectual property indemnifications that
are customary in the industry. These guarantees generally require the
Company to compensate the other party for certain damages and costs
incurred as a result of third party intellectual property claims arising
from these transactions. The nature of the intellectual property
indemnification obligations prevents the Company from making a reasonable
estimate of the maximum potential amount it could be required to pay to
its customers and suppliers. Historically, the Company has not made any
significant indemnification payments under such agreements and no amount
has been accrued in the accompanying consolidated financial statements
with respect to these indemnification obligations.
In connection with the sale of the Systems business on February 16, 2001,
the Company provided to the purchaser certain income tax indemnities with
an indefinite life and with no maximum liability for the taxation periods
up to February 16, 2001, the closing date of the sale. As at June 27,
2003, the taxation years 2000 to February 16, 2001 are subject to audit by
taxation authorities.
As at June 27, 2003, the Company has guaranteed a custom bond amounting to
$2.6 to a third party on behalf of a subsidiary.
9
The Company records a liability based upon its historical experience with
warranty claims. The table below presents a reconciliation of the changes
in the Company's product warranty accrual for the quarter ended June 27,
2003:
Three Months Ended
June 27, 2003
------------------
Balance, March 28, 2003 $ --
Accruals for new and pre-existing warranties 0.5
Payments made during the quarter --
-----
Balance, June 27, 2003 $ 0.5
=====
10. Commitments
The Company had letters of credit outstanding as at June 27, 2003 of
approximately $6.2 (June 28, 2002 - $3.2). Cash and cash equivalents of
$6.2 have been pledged as security against certain outstanding letters of
credit, which expire within 12 months, and are presented as restricted
cash.
As a result of the non-cash write-down of the Mitel investment in the
fourth quarter of Fiscal 2003, the Company did not meet a quarterly
financial covenant under the Company's credit facility during the first
quarter of Fiscal 2004. A waiver was obtained from the bank in respect of
the financial covenant.
11. Redeemable Preferred Shares
There were 21,900 preferred shares purchased during the three months ended
June 27, 2003 for cash consideration of $0.4. At June 27, 2003, there were
31,800 repurchased preferred shares, including 9,900 shares repurchased
during Fiscal 2003, that had not been cancelled by the end of the quarter.
During the first quarter of Fiscal 2004, the Company paid dividends on its
redeemable preferred shares of $0.5 and declared a quarterly dividend of
$0.37 (Cdn $0.50) per share.
12. Capital stock
a) The Company has not declared or paid any dividends on its common
shares.
b) On June 6, 2002, the Company announced its intention to continue its
normal course issuer bid program for up to 6,358,203 common shares
(5 percent of 127,164,078 common shares issued and outstanding at
May 31, 2002) between June 10, 2002 and June 9, 2003. No shares were
repurchased under the normal course issuer bid program in the period
ended June 9, 2003. The program was not renewed.
c) A summary of the Company's stock option activity is as follows:
Three Months Ended
----------------------------
June 27, June 28,
2003 2002
------------- ----------
Outstanding Options:
Balance, beginning of period 10,828,557 10,914,962
Granted 106,500 63,300
Exercised (8,582) (93,818)
Forfeited (646,022) (37,287)
-------------- -----------
Balance, end of period 10,280,453 10,847,157
============== ===========
Available for grant at June 27, 2003 were 4,253,644 (March 28, 2003 -
3,714,122) common shares. The exercise price of outstanding stock options
ranges from $2.52 to $27.69 per share with exercise periods extending to
June 2008. The exercise price of stock options was based on prices in
Canadian dollars translated at the U.S. dollar exchange rate on June 27,
2003.
d) The net loss per common share figures were calculated based on the
net loss after the deduction of preferred share dividends and using
the weighted monthly average number of shares outstanding during the
respective periods. Diluted earnings per share is computed in
accordance with the treasury stock method based on the average
number of common shares and dilutive common share equivalents.
10
The following potentially dilutive common share equivalents have been
excluded from the computation of diluted loss per share because they were
anti-dilutive due to the reported net loss for the periods presented:
Three Months Ended
----------------------
June 27, June 28,
2003 2002
-------- ---------
Stock options 612,952 774,049
Restricted shares -- 570,897
-------- ---------
Total 612,952 1,344,946
======== =========
The following stock options were excluded from the computation of common
share equivalents because the options' exercise price exceeded the average
market price of the common shares, thereby making them anti-dilutive:
Three Months Ended
--------------------------
June 27, June 28,
2003 2002
----------- -----------
Number of outstanding options 7,698,178 7,789,298
Average exercise price per share $ 10.63 $ 10.69
The average exercise price of stock options was based on prices in
Canadian dollars translated at the U.S. dollar exchange rate on June 27,
2003.
13. Accumulated other comprehensive income (loss)
The components of other comprehensive income (loss) were as follows:
Three Months Ended
June 27, June 28,
2003 2002
-------- --------
Net loss for the period $ (6.2) $ (8.7)
Other comprehensive income (loss):
Realized net derivative loss on cash flow hedges 0.1 0.1
Unrealized net derivative gains (losses) on cash flow hedges 0.1 (0.5)
Change in cumulative translation adjustment -- 12.3
------ -------
Other comprehensive income (loss) for the period $ (6.0) $ 3.2
====== =======
The changes to accumulated other comprehensive loss for the three months
ended June 27, 2003 were as follows:
Realized
and
Unrealized
Cumulative Net Gain
Translation (Loss) on
Account Derivatives Total
---------- ---------- -------
Balance, March 28, 2003 $ (32.4) $ (0.1) $ (32.5)
Change during the three months ended June 27,
2003 - 0.2 0.2
------- ------ -------
Balance, June 27, 2003 $ (32.4) $ 0.1 $ (32.3)
======= ====== =======
The Company recorded a decrease in other comprehensive loss in the three
months ended June 27, 2003 of $0.2 which was attributable to the change in
the value of outstanding foreign currency forward contracts related to the
Company's hedging program that were designated as cash flow hedges. For
the three months ended June 28, 2002, the Company recorded an increase in
other comprehensive loss of $0.4 related to losses on derivatives. The
Company estimates that $0.1 of net derivative gain included in other
comprehensive loss will be reclassified into earnings within the next 3
months.
11
14. Other income (expense) (net)
Three Months Ended
June 27, June 28,
2003 2002
-------- --------
Interest income $ 0.3 $ 0.9
Foreign exchange loss (1.0) (0.4)
------ ------
Other income (expense) - net $ (0.7) $ 0.5
====== ======
15. Information on business segments
Business Segments
The Company's operations are comprised of three reportable business
segments - Network Communications, Consumer Communications, and Ultra
Low-Power Communications. Reportable segments are business units that
offer different products and services, employ different production
processes and methods of distribution, sell to different customers, and
are managed separately because of these differences.
The Company targets the communications industry with products that
specialize in broadband connectivity solutions over wired, wireless and
optical media, as well as through ultra low-power communications
solutions. The Network Communications business segment offers products
that provide connectivity to the enterprise and metro segments such as
feeder, aggregation and transmission applications, and products that
address the multi-protocol physical and network layers. The Consumer
Communications business segment offers products that allow users to
connect to the network. These products include wireless (for example,
cellular chipsets) and infotainment applications (for example, set-top
boxes and digital TV). The Ultra Low-Power Communications business
provides ASIC solutions for applications such as pacemakers, hearing aids
and portable instruments.
The Chief Executive Officer ("CEO") is the chief operating decision maker
in assessing the performance of the segments and the allocation of
resources to the segments. The CEO evaluates the financial performance of
each business segment and allocates resources based on operating income.
The Company does not allocate stock compensation expense, special charges
or gains, interest income or interest expense or income taxes to its
reportable segments. In addition, total assets are not allocated to each
segment as they are primarily tracked by legal entity only; however,
depreciation of fixed assets is allocated to the segments based on the
estimated asset usage. The accounting policies of the reportable segments
are the same as those of the Company as reflected in the consolidated
financial statements.
Three Months Ended June 27, 2003 Network Consumer Ultra Low-Power Unallocated
Communications Communications Communications Costs Total
-------------- -------------- --------------- ------------ -------
Total external sales revenue $ 29.3 $ 13.4 $ 11.0 $ -- $ 53.7
Amortization of buildings and equipment 1.8 1.1 0.7 -- 3.6
Segment's operating income (loss) from
continuing operations (2.4) (3.8) 1.0 -- (5.2)
Three Months Ended June 28, 2002 Network Consumer Ultra Low-Power Unallocated
Communications Communications Communications Costs Total
-------------- -------------- --------------- ------------ -------
Total external sales revenue $ 28.4 $ 12.6 $ 7.0 $ -- $ 48.0
Amortization of buildings and equipment 2.5 0.6 0.1 3.2
Stock compensation recovery -- -- -- (1.6) (1.6)
Segment's operating loss from continuing
operations (5.3) (5.1) -- 1.6 (8.8)
16. Subsequent event
On July 16, 2003, the Company announced further cost reductions as it
finalizes its outsourcing programs and streamlines operations. The Company
expects to record additional charges of approximately $8.0 related to
reducing its global workforce by approximately 120 employees across all
regions and business units, and the cost of further outsourcing
initiatives.
12
17. Comparative figures
Certain of the Fiscal 2003 comparative figures have been reclassified to
conform to the presentation adopted in Fiscal 2004.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(in millions of U.S. dollars, except per share amounts, and in accordance with
U.S. GAAP)
Overview
For almost 30 years, Zarlink Semiconductor has delivered the integrated circuit
(IC) building blocks that drive the capabilities of voice, enterprise, broadband
and wireless communications. Zarlink is a global provider of microelectronics
for voice and data networks, consumer and ultra low-power communications, and
high-performance analog.
The following discussion and analysis explains trends in Zarlink's financial
condition and results of operations for the three months ended June 27, 2003,
compared with the corresponding period in the previous fiscal year. This
discussion is intended to help shareholders and other readers understand the
dynamics of Zarlink's business and the key factors underlying its financial
results. This discussion should be read in conjunction with the consolidated
financial statements and notes thereto included elsewhere in this Form 10-Q, and
with the Company's audited consolidated financial statements and notes thereto
for the fiscal year ended March 28, 2003.
Forward-Looking Statements
Certain statements in this Quarterly Report on Form 10-Q contain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 (the "Reform Act") that are based on current expectations, estimates and
projections about the industries in which the Company operates, management's
beliefs and assumptions made by management. These statements are not guarantees
of future performance and involve certain risks, uncertainties and assumptions,
which are difficult to predict. Accordingly, actual outcomes and results may
differ materially from results forecasted or suggested in such forward-looking
statements.
Such risks, uncertainties and assumptions include, among others, the following:
increasing price and product/service competition by foreign and domestic
competitors, including new entrants; rapid technological developments and
changes; the ability to continue to introduce competitive new products on a
timely, cost-effective basis; delays in product development; the mix of
products/services; the ability to ensure continuity of supply from outside
fabrication services; changes in environmental and other domestic and foreign
governmental regulations; protection and validity of patent and other
intellectual property rights; import protection and regulation; industry
competition; industry capacity and other industry trends; the ability of the
Company to attract and retain key employees; demographic changes and other
factors referenced in the Company's Annual Report on Form 10-K for the fiscal
year ended March 28, 2003.
The above factors are representative of the risks, uncertainties and assumptions
that could affect the outcome of the forward-looking statements. In addition,
such statements could be affected by general industry and market conditions and
growth rates, general domestic and international economic conditions, including
interest rate and currency exchange rate fluctuations and other risks,
uncertainties and assumptions, as described in the Company's Annual Report on
Form 10-K for the fiscal year ended March 28, 2003, including those identified
under "Forward-Looking Statements and Risk Factors". In making these
forward-looking statements, which are identified by words such as "will",
"expects", "intends", "anticipates" and similar expressions, the Company claims
the protection of the safe-harbor for forward-looking statements contained in
the Reform Act. The Company undertakes no obligation to update publicly any
forward-looking statements whether as a result of new information, future events
or otherwise.
14
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 27, 2003
Summary of Results from Operations Three Months Ended
(millions of U.S. dollars, except per share amounts) June 27, 2003 June 28, 2002
------------- -------------
Consolidated revenue $ 53.7 $ 48.0
Network Communications segment revenue 29.3 28.4
Consumer Communications segment revenue 13.4 12.6
Ultra Low-Power Communications segment revenue 11.0 7.0
Operating income (loss) (5.2) (8.8)
Network Communications segment operating loss (2.4) (5.3)
Consumer Communications segment operating loss (3.8) (5.1)
Ultra Low-Power Communications segment operating income 1.0 --
Unallocated recovery -- 1.6
Net loss for the period (6.2) (8.7)
Net loss per common share - basic and diluted (0.05) (0.07)
Weighted average common shares outstanding - millions 127.3 126.6
Revenue in the first quarter of Fiscal 2004 was $53.7, an increase of 12%, from
the first quarter of Fiscal 2003. The market continues to pose challenges as
semiconductor sales volumes continue to be affected by the prolonged downturn
impacting the semiconductor industry. The Company experienced lower sequential
bookings in the first quarter of Fiscal 2004, as expected with the seasonal
trends for lower shipments through the summer months, but booking levels
continue to remain above those levels experienced during the same period in
Fiscal 2003.
In the first quarter of Fiscal 2004, the Company recorded a net loss, after
preferred share dividends, of $6.7, or $0.05 per share. This compares to a net
loss, after preferred share dividends, of $9.2, or $0.07 per share, in the first
quarter of Fiscal 2003.
The Company also announced that it would implement further cost reductions in
the second quarter of Fiscal 2004 as it finalizes its outsourcing programs and
streamlines operations. The Company expects to record additional charges of
approximately $8.0 related to reducing its global workforce by approximately 120
employees across all regions and business units, and the cost of further
outsourcing initiatives. The savings that these reductions are expected to
generate will be largely realized in the third quarter of Fiscal 2004.
Zarlink's operations are comprised of three reportable business segments -
Network Communications, Consumer Communications, and Ultra Low-Power
Communications. Zarlink targets the network and consumer communications
industries with offerings that specialize in broadband connectivity solutions
over wired, wireless and optical media. Zarlink's Ultra Low-Power communications
segment provides ultra low-power ASIC solutions for applications such as
pacemakers, hearing aids and portable instruments. Zarlink sells its products
through both direct and indirect channels of distribution. Factors affecting the
choice of distribution include, among others, end-customer type, the level of
product complexity, the stage of product introduction, geographic presence and
location of markets, and volume levels.
Network Communications
Network Communications June 27, June 28,
(millions of U.S. dollars) 2003 2002
-------- --------
Revenue: $ 29.3 $ 28.4
------ ------
As a % of total revenue 55% 59%
Operating loss $ (2.4) $ (5.3)
------ ------
Zarlink's Network Communications segment specializes in microelectronic
solutions for broadband connectivity over wired and optical media. The product
line enables voice and data convergence for high-speed internet systems,
switching systems, and subscriber access systems. In simple terms, Network
Communications semiconductor products connect network equipment together.
15
Revenue for the first quarter of Fiscal 2004 totaled $29.3, up 3% from $28.4 in
the first quarter of Fiscal 2003. Despite the revenue improvement in the first
quarter of Fiscal 2004, as compared to the first quarter of Fiscal 2003, reduced
capital spending in the market continues to impact demand by networking
companies. Revenue improvements in the first quarter of Fiscal 2004 were a
result of increased revenue from the Company's TDM Switching, Voice and Packet
Processing, and Optical products.
The segment's operating loss improved to $2.4 in the first quarter of Fiscal
2004 from an operating loss of $5.3 in Fiscal 2003, partially due to improved
margins on a stronger mix of products sold.
Consumer Communications
Consumer Communications June 27, June 28,
(millions of U.S. dollars) 2003 2002
-------- --------
Revenue: $ 13.4 $ 12.6
------ ------
As a % of total revenue 25% 26%
Operating loss $ (3.8) $ (5.1)
------ ------
Zarlink's Consumer Communications products allow users to connect to the
network. These products include wireless (for example, cellular chipsets) and
infotainment applications (for example, terrestrial and satellite set-top boxes
and digital TV).
Revenue for the first quarter of Fiscal 2004 totaled $13.4, up 6% from $12.6 in
the first quarter of Fiscal 2003, as a result of improved shipments of the
Company's tuners and demodulators.
The segment's operating loss decreased to $3.8, in the first quarter of Fiscal
2004 from an operating loss of $5.1 in the first quarter of Fiscal 2003, due
principally to cost control initiatives.
Ultra Low-Power Communications
Ultra Low-Power Communications June 27, June 28,
(millions of U.S. dollars) 2003 2002
-------- --------
Revenue: $ 11.0 $ 7.0
------ -----
As a % of total revenue 20% 15%
Operating income $ 1.0 $ --
------ -----
Zarlink's Ultra Low-Power Communications business provides ASIC and ASSP
solutions for applications such as cardiac pacemakers, hearing aids, portable
instruments and personal area communications devices.
Revenue for the first quarter of Fiscal 2004 totaled $11.0, up 57% from $7.0 in
the first quarter of Fiscal 2003 as a result of inventory corrections and stock
replenishment activities initiated by Zarlink's customers in the latter part of
Fiscal 2003. The Company's hearing aid components contributed to the largest
increase in revenues in the quarter, as compared to the same period in Fiscal
2003, and revenue improvements were also realized on the Company's pacemaker
circuits.
16
GEOGRAPHIC REVENUE
Revenue, based on the geographic location of customers, was distributed as
follows:
Three Months Ended
-------------------------------------------
June 27, % of June 28, % of
(millions of U.S. dollars) 2003 Total 2002 Total
-------------------------------------------
Asia/Pacific $ 22.5 42% $ 16.7 35%
Europe 16.8 31 16.3 34
United States 12.3 23 9.8 20
Canada 1.6 3 4.2 9
Other Regions 0.5 1 1.0 2
------- --- ------- ---
Total $ 53.7 100% $ 48.0 100%
======= === ======= ===
Asia/Pacific
Asia/Pacific sales increased by 35% during the first quarter of Fiscal 2004
compared to the first quarter of Fiscal 2003, and continue to represent the
largest geographic segment of customer revenues. The increase in the first
quarter of Fiscal 2004 was driven primarily from the Network and Consumer
Communication segments, with moderate improvements from the Ultra Low-Power
Communications segment.
Europe
European sales increased by 3% in the first quarter of Fiscal 2004 compared to
the first quarter of Fiscal 2003 due to improved revenues in the Network and
Ultra Low-Power Communications segments offset by declines in the revenues from
the Consumer Communications segments in the first quarter of Fiscal 2004.
United States
Sales to customers in the United States increased by 26% during the first
quarter of Fiscal 2004 compared to the first quarter of Fiscal 2003. The
increase was due primarily to improved Ultra Low-Power and Consumer
Communications product sales.
Canada
Canadian sales decreased by 62% in the first quarter of Fiscal 2004 over the
same period in Fiscal 2003 due to lower Network Communications segment sales to
Canadian customers.
GROSS MARGIN
Three Months Ended
---------------------
June 27, June 28,
(millions of U.S. dollars) 2003 2002
-------- --------
Gross margin $ 25.6 $ 22.1
As a percentage of revenue 48% 46%
Gross margin improved by two percentage points in the first quarter of Fiscal
2004 compared to the same period in Fiscal 2003. The improvement in margin was a
result of lower overall manufacturing costs and a favorable product mix,
particularly in the Network Communication segment.
17
OPERATING EXPENSES
Research and Development ("R&D")
Three Months Ended
---------------------
June 27, June 28,
(millions of U.S. dollars) 2003 2002
-------- --------
R&D expenses $ 19.2 $ 20.4
As a percentage of revenue 36% 43%
R&D expenses decreased by 6%, or $1.2, in the first quarter of Fiscal 2004 from
the same period in Fiscal 2003, primarily due to the timing of certain material
spending and cost reduction initiatives implemented in Fiscal 2003. The Company
continues to refocus its R&D resources on programs and products that demonstrate
superior potential for near- and medium-term revenue. Management expects that
R&D spending will decrease over the balance of Fiscal 2004 as a result of
optimizing electronic design automation and cost control.
The Company continued its investment in research and development to develop and
launch new products, with 11 new products being released in the first quarter of
Fiscal 2004. The impact of new products on revenue in the year of introduction
is not normally significant. However, management believes that new product
introductions are critical to supporting future revenue growth. For example,
initial shipments of the Company's new DTV chip commenced in the first quarter
of Fiscal 2004.
In the Network Communications product line, R&D activities focused on the
following areas:
o Time Division Multiplex ("TDM") switch development to set new
industry standards in terms of channel density, levels of
integration, feature sets and power density;
o Development of Voice Processing products for today's emerging
Carrier Class Gateways and Voice over IP (Internet Protocol)
Networks for mobile telephony, addressing the problem of voice echo
cancellation in the system. New products will include Zarlink
technology to improve convergence time and voice quality thereby
allowing the product to consume even less power and also enable
better power consumption for voice transmitted through the mobile
network;
o Planned development of higher speed Phase Lock Loops ("PLL") for
Network Timing & Synchronization. These high speed PLLs will be used
to provide the timing for transporting information over SONET/SDH
links that operate up to 622 Mbits/s;
o Meeting convergence with TDM/IP Processing in Packet Processing, and
Ethernet Switching for backplanes, linecard, edge/metro and Virtual
Private Network ("VPN") switches in Packet Switching;
o Utilization of its analog and mixed signal expertise for Timing,
Synthesizers, Interface drivers, and Amplifiers for its High
Performance Analog product development; and
o Very Short Reach ("VSR") parallel optical solutions targeted at
terabit speeds and higher.
In the Consumer Communications product line, R&D activities focused on the
following areas:
o Providing a 2G cellular phone radio transceiver chip, compliant with
2G standards for Time Division Multiple Access ("TDMA")/Advanced
Mobile Phone Service/System ("AMPS"), and developing a 2-chip radio
solution for 3rd generation GSM/Wideband Code Division Multiple
Access ("WCDMA") cellular phones;
o Providing tuner, demodulator and peripheral chips for satellite,
cable and terrestrial digital set-top boxes, integrated digital
televisions and adapter boxes; and
o Development of the most highly integrated system-on-a-chip solution
for integrated Digital Terrestrial Televisions, Digital Terrestrial
Set-top boxes, adapter boxes and media centers, compliant with the
Digital Video Broadcasting - Terrestrial ("DVB-T") standard.
In the Ultra Low-Power Communications business segment, R&D activities focused
on semiconductor solutions and technologies for a variety of in-vivo and
audiological applications, including:
o High performance custom Coder/Decoders ("CODECs") and digital signal
processing ("DSP") chips for major hearing aid companies;
o Application-specific standard products ("ASSPs") as opposed to
custom ASICs;
o Surge protection chips used in implantable pacemakers and
defibrillators for cardiac rhythm management;
18
o High performance, ultra low-power audio converters (CODECs),
technology also used in digital hearing aids, for high growth
communications and entertainment applications; and
o Ultra low-power integrated circuits supporting short-range wireless
communications for healthcare and other applications, including
implantable and in-vivo systems.
Selling and Administrative ("S&A")
Three Months Ended
---------------------
June 27, June 28,
(millions of U.S. dollars) 2003 2002
-------- --------
S&A Expenses $ 11.6 $ 12.1
As a percentage of revenue 22% 25%
In the first quarter of Fiscal 2004, S&A expenses decreased by $0.5, or 4%
compared to the first quarter of Fiscal 2003, principally as a result of cost
reduction activities implemented through Fiscal 2003. S&A expenses in the first
quarter of Fiscal 2004 included $0.2 of severance, as the Company continued its
cost reduction activities. The Company anticipates a reduction in S&A expenses
by the third quarter of Fiscal 2004, as it implements certain cost reductions
programs in the second quarter of Fiscal 2004.
Stock Compensation
The Company records stock compensation expense arising from certain stock
options subjected to option exchange programs. In prior years, the Company also
recorded stock compensation expense arising from retention conditions associated
with the stock awarded to certain employees of Vertex Networks, Incorporated,
which was acquired in July 2000.
During the three months ended June 27, 2003, there was no stock compensation
recorded, as the intrinsic value of options under the exchange program was nil.
During the three months ended June 28, 2002, the Company recorded a stock
compensation recovery of $1.6 related to the amortization of intrinsic value of
unexercised stock options modified by the option exchange programs, net of the
vesting of restricted stock. No further stock compensation expense will be
recorded against the formerly restricted shares.
OTHER INCOME (EXPENSE)
Other income (expense) was comprised of interest income, and foreign exchange
losses.
Interest income was $0.3 for the three months ended June 27, 2003 as compared to
$0.9 in the same period of Fiscal 2003. The decrease compared to the first
quarter of Fiscal 2003 was mainly due to reduced average cash balances and lower
interest rates.
Foreign exchange losses in the first quarter of Fiscal 2004 amounted to $1.0 as
compared to losses of $0.4 for the same period in Fiscal 2003. In Fiscal 2004,
net losses were recorded on monetary assets and liabilities denominated in
currencies other than the U.S. dollar functional currency, and according to
month-end market rates. In Fiscal 2003, the losses were related to foreign
exchange hedging losses.
INTEREST EXPENSE
Interest expense was nil for the three months ended June 27, 2003, compared with
$0.1 for the first quarter of Fiscal 2003. The interest expense related to
capital leases.
INCOME TAXES
Income tax expense for the first quarter of Fiscal 2004 was $0.3, comprised of
domestic income and capital taxes, compared with an expense of $0.3 for the
corresponding period in Fiscal 2003.
The Company has a valuation allowance against its deferred tax assets at June
27, 2003 of $121.3 (March 28, 2003 - $106.0). The increase relates mainly to
losses incurred in the Company's foreign jurisdictions and temporary differences
in the Company's foreign and domestic operations. Management has determined that
sufficient uncertainties exist regarding the realization of certain of its
deferred tax assets.
19
BACKLOG
June 27, June 28,
(millions of U.S. dollars) 2003 2002
-------- --------
90-Day Backlog $ 32.5 $ 38.5
Generally, manufacturing lead times for semiconductor products are longer
because of the nature of the production process. However, as orders are
sometimes booked and shipped within the same fiscal quarter (often referred to
as "turns"), order backlog is not necessarily indicative of a sales outlook for
the quarter or year.
As usual, the activity over the summer is slower, as was evidenced by lower
bookings through the first quarter of Fiscal 2004. As a result of lower bookings
during the quarter in both the Network and Ultra Low-Power Communication
segments, the backlog has decreased as compared against recent quarters.
Bookings also continue to be affected by the continued downturn in the
communications semiconductor industry, described elsewhere in this Management's
Discussion and Analysis.
NET LOSS
The Company recorded a net loss, after preferred share dividends, of $6.7, or
$0.05 per share, in the first quarter of Fiscal 2004. This compares to a net
loss, after preferred share dividends, of $9.2, or $0.07 per share, in the same
period in Fiscal 2003.
The net loss for the three months ended June 27, 2003, was primarily a result of
low revenues, caused by the continued downturn in the semiconductor industry.
LIQUIDITY AND CAPITAL RESOURCES
At June 27, 2003, cash, cash equivalents, short-term investments and restricted
cash balances totaled $107.7, down from $119.2 at March 28, 2003. Cash and cash
equivalents at June 27, 2003, included in the amount above, totaled $39.2 (March
28, 2003 - $23.5).
Cash used in operations before working capital changes amounted to $1.1 during
the first three months of Fiscal 2004, as compared to $6.6 used in the first
three months of Fiscal 2003. Since March 28, 2003, the Company's working
capital, as reflected in the consolidated statements of cash flows, increased by
$8.5, mainly as a result of increases in accounts receivable and other prepaid
expenses totaling $10.4 and a reduction in deferred credits of $0.2. The
increase in accounts receivable was a result of the timing of sales late in the
quarter, resulting in the cash inflow not occurring until the second quarter of
Fiscal 2004. The increase in other prepaid expenses was due to scheduled
payments for certain design tool licenses. These increases in working capital
were offset by reducing inventories by $0.8 and an increase in accounts payable
and other accrued liabilities totaling $1.3. Management expects to further draw
down inventory levels through the remainder of Fiscal 2004 by reducing cycle
times and managing inventories on a build-to-order basis. In comparison, the
Company's working capital decreased by $1.9 during the first three months of
Fiscal 2003, mainly as a result of reductions in inventories and improved cash
collections against trade receivables.
Cash provided from investing activities was $26.4 for the three months ended
June 27, 2003, primarily from matured short-term investments totaling $89.5,
offset by purchases of short-term investments of $62.3. Cash balances were
reduced by purchases of fixed and other assets amounting to $1.2 during the
first three months of the year, offset by proceeds from disposal of fixed assets
of $0.4. The fixed asset additions were primarily related to continuing
improvements to existing test equipment and the Company's information technology
resources. Management expects quarterly capital spending to remain flat through
the rest of Fiscal 2004 in comparison to the first quarter of this year.
Additions to fixed and other assets during the first three months of Fiscal 2003
mainly consisted of continuing improvements to information technology resources.
Net purchases of short-term investments in the amount of $39.5 also contributed
to the net cash outflow from investing activities during the first three months
of Fiscal 2003.
Cash used in financing activities during the first three months of Fiscal 2004
was $1.1. The use of cash was primarily the result of repayment of $0.2 of
capital leases, the repurchase of $0.4 of the Company's redeemable preferred
shares, and the payment of $0.5 for dividends on the preferred shares. Cash used
in financing activities in the first three months of Fiscal 2003 was $0.8. The
use of cash was primarily the result of the repayment of $0.7 of capital lease
liabilities, the repurchase of $0.2 of preferred shares, and the payment of $0.5
for dividends on the preferred shares, offset by $0.6 of new common shares
issued from exercised stock options.
20
During Fiscal 2002, the Company took steps to wind up its defined benefit
pension plan in the United Kingdom and replaced it with a defined contribution
plan. The Company expects to make a final payment of approximately $2.3 later in
Fiscal 2004 after the final adjustments are calculated.
During the first three months of Fiscal 2004, the Company declared and paid
dividends of $0.5 on its redeemable preferred shares based on a $0.37 (Cdn$0.50)
per share dividend. In addition, the Company purchased 21,900 preferred shares
under its purchase obligation during this period. As at June 27, 2003, the
Company has repurchased 31,800 preferred shares that had not yet been cancelled
by the transfer agent.
On June 6, 2002, the Company announced its Board of Directors had authorized the
continuation of its normal course issuer bid program to repurchase up to
6,358,203 common shares, representing 5% of the 127,164,078 common shares issued
and outstanding at May 31, 2002. The purchases were to take place on the open
market through the stock exchanges of New York and Toronto over a twelve-month
period beginning on June 10, 2002 and ending on June 9, 2003. No common shares
were repurchased under the program during the period from March 28, 2003 to June
9, 2003. The program expired on June 9, 2003, and was not renewed by the
Company.
In addition to cash, cash equivalents, short-term investment and restricted cash
balances of $107.7 as at June 27, 2003, the Company had a revolving global
credit facility of approximately $18.5 (Cdn$25.0), of which $6.2 in letters of
credit were outstanding. Accordingly, the Company had unused and available
demand bank lines of credit totaling $12.3 as at June 27, 2003. Cash and cash
equivalents totaling $6.2 were hypothecated under the credit facility to cover
outstanding letters of credit. As a result of the non-cash write-down of the
Mitel investment in the fourth quarter of Fiscal 2003, the Company did not meet
a quarterly financial covenant under the Company's credit facility. A waiver was
obtained from the bank in respect of the financial covenant. The credit facility
is subject to periodic review, including the determination of financial
covenants. It is uncertain if the Company will be able to meet these financial
covenants in the future and, if not, to obtain a waiver from the bank, which may
result in the availability of the credit facility being reduced or restricted.
Management does not anticipate that this would have a material adverse effect on
the financial position of the Company. Management believes the Company is in a
position to meet all foreseeable business cash requirements and capital lease
and preferred share payments from its cash balances on hand, existing financing
facilities and cash flow from operations.
OTHER
Critical Accounting Policies and Significant Estimates
The Company's consolidated financial statements are based on the selection and
application of significant accounting policies, which require management to make
significant estimates and assumptions. As a result of writing off the carrying
value of the Company's remaining investment in Mitel Networks Corporation in
Fiscal 2003, management believes the policy on investments in private companies
is no longer a critical accounting policy of the Company. Other than the policy
on investments in private companies, there is no change in the Company's
critical accounting policies included in Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations, of the Company's
Annual Report on Form 10-K for the year ended March 28, 2003.
Foreign Currency Translation
Prior to March 29, 2003, the financial statements of the foreign subsidiaries
were measured using the local currency as the functional currency. All balance
sheet amounts were translated using the exchange rates in effect at the
applicable period end, and income statement amounts were translated using the
weighted average exchange rates for the applicable period. Any gains and losses
resulting from the changes in exchange rates from year to year were reported as
a separate component of other comprehensive loss included in Shareholders'
Equity.
Effective March 29, 2003, the functional currency of Zarlink and its
subsidiaries is the U.S. dollar. Monetary assets and liabilities denominated in
currencies other than the U.S. dollar are remeasured at the closing period-end
rates of exchange. The gains or losses resulting from the remeasurement of these
amounts have been reflected in earnings in the respective periods. Non-monetary
items and any related amortization of such items are measured at the rates of
exchange in effect when the assets were acquired or obligations incurred. All
other income and expense items have been remeasured at the average rates
prevailing during the period. Gains (losses) relating to external foreign
exchange contracts are recognized in income as they mature, or to the extent
they are ineffective hedges.
Recently Issued Accounting Standards
On April 30, 2003, the FASB issued Statement of Financial Accounting Standard
No. 149 ("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities". The amendments set forth in SFAS 149 improve financial
reporting by requiring that contracts with comparable characteristics be
accounted for similarly. In particular, this
21
statement clarifies under what circumstances a contract with an initial net
investment meets the characteristic of a derivative as discussed in SFAS 133. In
addition, it clarifies when a derivative contains a financing component that
warrants special reporting in the statement of cash flows. SFAS 149 amends
certain other existing pronouncements. Those changes will result in more
consistent reporting of contracts that are derivatives in their entirety or that
contain embedded derivatives that warrant separate accounting. This Statement is
effective for contracts entered into or modified after June 30, 2003, except as
stated below, and for hedging relationships designated after June 30, 2003. The
guidance will be applied prospectively. The provisions of this Statement that
relate to Statement 133 Implementation Issues that have been effective for
fiscal quarters that began prior to June 15, 2003, will continue to be applied
in accordance with their respective effective dates. In addition, certain
provisions relating to forward purchases or sales of when-issued securities or
other securities that do not yet exist, should be applied to existing contracts
as well as new contracts entered into after June 30, 2003. The Company has not
yet evaluated the impact of this new pronouncement on its financial position,
results of operations or accounting for derivatives.
On May 15, 2003, the FASB issued Statement of Financial Accounting Standard No.
150 ("SFAS 150"), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity". The Statement improves the
accounting for certain financial instruments that, under previous guidance,
issuers could account for as equity. SFAS 150 requires that those instruments be
classified as liabilities in the statements of financial position, whereas
previously such instruments may have been classified as equity or as temporary
equity. In addition to its requirements for the classification and measurement
of financial instruments in its scope, SFAS 150 also requires disclosures about
alternative ways of settling the instruments and the capital structure of
entities, all of whose shares are mandatorily redeemable. Most of the guidance
in SFAS 150 is effective for all financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. The Company has not yet evaluated
the impact of this new pronouncement on its financial position.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Market Risk. Market risk represents the risk of loss that may impact Zarlink's
financial statements due to adverse changes in financial markets. Zarlink is
exposed to market risk from changes in interest rates and foreign exchange
rates. To manage these risks, Zarlink uses certain derivative financial
instruments, including interest rate swaps, forward contracts and other
derivative instruments from time to time, that have been authorized pursuant to
board-approved policies and procedures. Zarlink does not hold or issue financial
instruments for trading or speculative purposes.
Foreign Exchange Risk. The Company currently uses forward contracts, and to a
lesser extent foreign currency options, to reduce the exposure to foreign
exchange risk. The most significant foreign exchange exposures for the Company
relate to the Canadian dollar, the U.K. pound sterling, and the Swedish Krona.
At June 27, 2003, there were unrealized gains of $0.1 on the forward contracts
relating to Fiscal 2004. The unrealized gain is calculated as the difference
between the actual contract rates and the applicable current market rates that
would be used to terminate the forward contracts on June 27, 2003, if it became
necessary to unwind these contracts. Management believes that the established
hedges are effective against its known and anticipated cash flows, and that
potential future losses from these hedges being marked to market would be
largely offset by gains on the underlying hedged transactions.
Interest Rate Risk. The Company's primary exposure to interest rates is expected
to be in the rollover of its short-term investment portfolio. In accordance with
Company policy, cash equivalents and short-term investment balances are
primarily comprised of high-grade money market instruments with original
maturity dates of less than one year. The Company does not hedge the
re-investment risk on its short-term investments.
Management does not foresee any significant changes in the strategies used to
manage interest and foreign exchange rate risks in the near future.
As at June 27, 2003, there were no material changes in information about market
risks as disclosed in the Company's Annual Report on Form 10-K for the fiscal
year ended March 28, 2003.
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES
As of June 27, 2003, an evaluation was performed under the supervision and with
the participation of the management of the Company, including its Chief
Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness
of the design and operation of the Company's disclosure controls and procedures.
Based on that evaluation, the Company's management, including the CEO and CFO,
concluded that the Company's disclosure controls and procedures were effective
as of June 27, 2003. There have been no significant changes in the Company's
internal controls or in other factors that could significantly affect internal
controls subsequent to June 27, 2003.
22
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
99.1 Selected Consolidated Financial Statements in U.S. Dollars and in
accordance with Canadian Generally Accepted Accounting Principles
99.2 Management's Discussion and Analysis of Financial Condition and Results of
Operations - Canadian Supplement
99.3 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.4 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K
Date of Filing Description
- --------------------------------------------------------------------------------
June 25, 2003 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002,
President and Chief Executive Officer
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant To Section 906 of The Sarbanes-Oxley Act of 2002,
Senior Vice President of Finance and Chief Financial Officer
June 20, 2003 Press Release: "Notice of Annual General Meeting and Proxy
Circular dated May 30, 2003"
May 8, 2003 Press Release: "Financial Results for Quarter and Year Ended
March 28, 2003"
April 8, 2003 Press Release: "Zarlink To Write Down Its Investment in Mitel
Networks Corporation in the Fourth Quarter of Fiscal 2003"
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant, Zarlink Semiconductor Inc., has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
Zarlink Semiconductor Inc.
(Registrant)
Name Title Date
- --------------------- -------------------------------- --------------
/s/ SCOTT MILLIGAN
- ---------------------
Scott Milligan Senior Vice President of Finance August 5, 2003
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
23
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 (a) OF THE SARBANES-OXLEY ACT OF 2002
I, Patrick J. Brockett, President and Chief Executive Officer of Zarlink
Semiconductor Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Zarlink
Semiconductor Inc. (the "registrant");
2. Based on my knowledge, this quarterly report on Form 10-Q does not
contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this quarterly
report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: August 5, 2003
/s/ PATRICK J. BROCKETT
-----------------------------
Patrick J. Brockett
President and Chief Executive
Officer
24
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 (a) OF THE SARBANES-OXLEY ACT OF 2002
I, Scott Milligan, Senior Vice-President of Finance and Chief Financial Officer
of Zarlink Semiconductor Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Zarlink
Semiconductor Inc. (the "registrant");
2. Based on my knowledge, this quarterly report on Form 10-Q does not
contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this quarterly
report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: August 5, 2003
/s/ SCOTT MILLIGAN
--------------------------------
Scott Milligan
Senior Vice-President of Finance
and Chief Financial Officer
25
EXHIBIT INDEX
Exhibit
Number Description Page
- ------------ ----------------------------------------------------------------------- ------
99.1 Selected Consolidated Financial Statements in U.S. Dollars and in 27
accordance with Canadian Generally Accepted Accounting Principles
99.2 Management's Discussion and Analysis of Financial Condition and 37
Results of Operations - Canadian Supplement
99.3 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 39
99.4 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 40