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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 September 26, 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 October 17, 2003 there were 127,275,933 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...........................................15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS..........24
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES...................................24
PART II - OTHER INFORMATION...................................................25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................25
Signatures....................................................................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)
September 26, March 28,
2003 2003
------------- ---------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 56.4 $ 23.5
Short-term investments 35.2 89.5
Restricted cash 5.6 6.2
Trade accounts receivable, less
allowance for doubtful accounts of
$0.7 (March 28, 2003 - $1.1) 27.0 20.3
Other receivables 2.7 4.2
Note receivable - net of deferred gain of
$16.4 (March 28, 2003 - $15.8) 0.1 --
Inventories 21.8 24.0
Deferred income tax assets - net 1.4 1.0
Prepaid expenses and other 10.4 7.3
------ ------
160.6 176.0
Fixed assets - net 46.6 56.4
Deferred income tax assets - net 11.3 10.4
Other assets 4.6 4.7
Note receivable - net of deferred gain of
$16.4 (March 28, 2003 - $15.8) -- 0.1
------ ------
$223.1 $247.6
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 15.3 $ 10.1
Employee-related accruals 10.2 15.5
Income and other taxes payable 15.0 13.0
Provisions for exit activities 4.5 4.2
Other accrued liabilities 10.7 12.6
Deferred credits 0.8 1.1
Current portion of long-term debt 0.3 0.6
------ ------
56.8 57.1
Long-term debt 0.1 0.2
Pension liabilities 15.9 14.3
Deferred income tax liabilities - net 2.5 2.0
------ ------
75.3 73.6
------ ------
Redeemable preferred shares, unlimited
shares authorized; 1,419,800 shares
issued and outstanding (March 28, 2003 -
1,451,600) 18.4 18.9
------ ------
Commitments (Note 11)
Shareholders' equity:
Common shares, unlimited shares authorized;
no par value; 127,275,933 shares
issued and outstanding (March 28, 2003 -
127,265,316) 768.3 768.3
Additional paid-in capital 2.1 2.1
Deficit (608.9) (582.8)
Accumulated other comprehensive loss (32.1) (32.5)
------ ------
129.4 155.1
------ ------
$223.1 $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 Six Months Ended
--------------------------- --------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
--------- --------- --------- ---------
Revenue $ 46.6 $ 46.2 $ 100.3 $ 94.2
Cost of revenue 27.2 25.5 55.3 51.4
------- ------- ------- -------
Gross margin 19.4 20.7 45.0 42.8
------- ------- ------- -------
Expenses:
Research and development 19.2 22.9 38.4 43.3
Selling and administrative 14.2 11.6 25.8 23.7
Asset impairment and other 5.3 -- 5.3 --
Stock compensation expense (recovery) -- 0.2 -- (1.4)
------- ------- ------- -------
38.7 34.7 69.5 65.6
------- ------- ------- -------
Loss from operations (19.3) (14.0) (24.5) (22.8)
Other income (expense) - net 0.4 3.0 (0.3) 3.5
Interest expense (0.3) (0.3) (0.3) (0.4)
------- ------- ------- -------
Loss before income taxes (19.2) (11.3) (25.1) (19.7)
Income tax (expense) recovery 0.3 (0.6) -- (0.9)
------- ------- ------- -------
Net loss for the period $ (18.9) $ (11.9) $ (25.1) $ (20.6)
======= ======= ======= =======
Net loss attributable to common shareholders
after preferred share dividends $ (19.4) $ (12.4) $ (26.1) $ (21.6)
======= ======= ======= =======
Net loss per common share:
Basic and diluted $ (0.15) $ (0.10) $ (0.20) $ (0.17)
======= ======= ======= =======
Weighted average number of common
shares outstanding (millions):
Basic and diluted 127.3 127.2 127.3 126.9
======= ======= ======= =======
(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 Six Months Ended
--------------------------- --------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
--------- --------- --------- ---------
CASH PROVIDED BY (USED IN)
Operating activities:
Net loss for the period $ (18.9) $ (11.9) $ (25.1) $ (20.6)
Depreciation of fixed assets 3.3 3.4 6.9 6.5
Amortization of other assets 0.5 0.3 0.8 0.6
Other non cash changes in operating activities 5.9 (1.8) 7.0 (1.5)
Stock compensation expense (recovery) -- 0.2 -- (1.4)
Deferred income taxes (0.9) -- (0.8) --
Decrease (increase) in working capital
Trade accounts and other receivables 1.8 0.4 (5.6) 2.5
Inventories 1.5 4.6 2.3 7.3
Prepaid expenses and other 0.3 -- (2.7) 1.9
Trade accounts payable and other accrued liabilities (1.4) (9.8) (0.1) (14.5)
Deferred credits -- 0.4 (0.2) 0.3
------- ------- ------- -------
Total (7.9) (14.2) (17.5) (18.9)
------- ------- ------- -------
Investing activities:
Purchased short-term investments (22.7) (63.6) (85.0) (149.6)
Matured short-term investments 49.8 119.5 139.3 166.0
Proceeds from disposal of fixed and other assets 0.2 0.4 0.6 0.4
Expenditures for fixed and other assets (2.0) (1.6) (3.2) (4.3)
Increase in long-term investments -- -- -- (0.4)
------- ------- ------- -------
Total 25.3 54.7 51.7 12.1
------- ------- ------- -------
Financing activities:
Repayment of capital lease liabilities (0.2) (0.8) (0.4) (1.4)
Payment of dividends on preferred shares (0.5) (0.5) (1.0) (1.0)
Issue of common shares -- -- -- 0.5
Repurchase of preferred shares (0.1) (0.2) (0.5) (0.4)
Reduction in hypothecation of cash
under letters of credit 0.6 -- 0.6 --
------- ------- ------- -------
Total (0.2) (1.5) (1.3) (2.3)
------- ------- ------- -------
Effect of currency translation on cash
and cash equivalents
-- (2.0) -- 1.4
------- ------- ------- -------
Increase (decrease) in cash and cash equivalents 17.2 37.0 32.9 (7.7)
Cash and cash equivalents, beginning of period 39.2 30.9 23.5 75.6
------- ------- ------- -------
Cash and cash equivalents, end of period $ 56.4 $ 67.9 $ 56.4 $ 67.9
======= ======= ======= =======
(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 September 26, 2003,
and the results of operations and cash flows of the Company for the three
and six month periods ended September 26, 2003 and September 27, 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 is effective for contracts entered into or
modified after June 30, 2003, except as stated below, and for hedging
6
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 adoption of SFAS 149 did not have a material impact on the
Company's financial statements.
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 clarifies 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
adoption of SFAS 150 did not have a material impact on the Company's
financial statements.
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 Six Months Ended
--------------------------- --------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
--------- --------- --------- ---------
Net loss, as reported $ (18.9) $ (11.9) $ (25.1) $ (20.6)
Adjustments:
Stock compensation expense (recovery) as -- 0.2 -- (1.4)
reported
Pro forma stock compensation expense (3.1) (3.4) (6.2) (6.7)
------- ------- ------- -------
Pro forma net loss $ (22.0) $ (15.1) $ (31.3) $ (28.7)
------- ------- ------- -------
Net loss per common share, as reported
Basic and diluted $ (0.15) $ (0.10) $ (0.20) $ (0.17)
------- ------- ------- -------
Pro forma net loss per common share:
Basic and diluted $ (0.17) $ (0.12) $ (0.25) $ (0.23)
------- ------- ------- -------
Based upon the fair value method of accounting for stock compensation
expense, the pro forma net loss for the three and six months ended
September 26, 2003, was increased by $3.1 and $6.2, respectively, as
compared to the net loss, as reported (three and six months ended
September 27, 2002, $3.2 and $8.1, respectively).
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 and six month fiscal periods
ended September 26, 2003 and September 27, 2002:
Three Months Ended Six Months Ended
--------------------------- --------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
--------- --------- --------- ---------
Weighted average fair value price of the options
granted during the quarter $ 2.39 $ 1.56 $ 2.31 $ 1.73
Risk free interest rate 3.01% 3.69% 3.10% 4.19%
Dividend yield Nil Nil Nil Nil
Volatility factor of the expected market
price of the Company's common stock 0.692 0.628 0.687 0.595
Weighted-average expected life of the options 3.4 years 3.0 years 3.4 years 3.3 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
Sept. 26, March 28,
2003 2003
--------- ---------
Raw materials $ 2.3 $ 2.6
Work-in-process 16.0 18.3
Finished goods 3.5 3.1
----- -----
$21.8 $24.0
===== =====
6. Fixed assets
Sept. 26, March 28,
2003 2003
--------- ---------
Cost $163.5 $163.7
Accumulated depreciation 116.9 107.3
------ ------
$ 46.6 $ 56.4
====== ======
The Company recorded an impairment loss on fixed assets of $4.7 during the
second quarter of Fiscal 2004 as a result of a review of the ongoing usage
of the Company's testing equipment and enterprise resource planning
system.
7. Other assets
Sept. 26, March 28,
2003 2003
--------- ---------
Patents, trademarks, and other
intangible assets:
Cost $10.5 $ 9.5
Accumulated amortization (5.9) (5.0)
----- -----
Patents, trademarks, and other
intangible assets - net 4.6 4.5
Other -- 0.2
----- -----
$ 4.6 $ 4.7
===== =====
The amortization of patents, trademarks and other intangible assets
amounted to $0.5 and $0.8, respectively, for the three and six months
ended September 26, 2003 (three and six months ended September 27, 2002 -
$0.3 and $0.6, respectively).
8
8. Note Receivable
Sept. 26, March 28,
2003 2003
--------- ---------
Note receivable, non-interest bearing $16.5 $15.9
Less: Deferred gain (16.4) (15.8)
----- -----
0.1 0.1
Less: current portion (0.1) --
----- -----
$ -- $ 0.1
===== =====
Based upon the terms of the Plymouth Foundry sale agreement with X-FAB
Semiconductor Foundries AG, the first payment of $10.0 against the
discounted note receivable is due in June 2004 with the final payment of
$8.0 due in March 2005.
9. Provisions for exit activities
Sept. 26, March 28,
2003 2003
--------- ---------
Restructuring provisions $ 3.8 $ 2.9
Provision for disposal of
discontinued operations -- 0.1
Provision for disposal of
foundry businesses 0.7 1.2
----- -----
$ 4.5 $ 4.2
===== =====
During the second quarter of Fiscal 2004, the Company implemented further
cost reductions in efforts to outsource programs and streamline
operations. The Company incurred workforce reduction costs of $3.4 as a
result of reducing the Company's employee base by approximately 120
employees, globally across all job categories and business units. In
particular, severance costs of $1.0 were included in research and
development, related to a reduction in R&D engineers, and as a result of a
further reduction in the selling and administrative workforce, severance
costs of $1.8 were included in selling and administration in the quarter.
The Company also recorded severance costs of $0.6 in cost of revenue,
related to further cost reductions as it finalizes its outsourcing
programs and streamline operations.
As a result of the workforce reduction program and streamlining of
operations, the Company recorded a charge of $0.6, included in asset
impairment and other, related to excess space under lease contract in
Canada.
Of the $4.0 of restructuring provision recorded in the second quarter of
Fiscal 2004, $2.6 related to the Network Communication segment, $0.9
related to the Consumer Communications segment, and $0.5 related to the
Ultra Low-Power segment.
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 and six months ended September 26, 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
Restructuring activities
during the quarter 3.4 0.6 4.0
Cash drawdowns during quarter (2.2) (0.6) (2.8)
---- ---- ----
Balance, Sept. 26, 2003 $1.4 $2.4 $3.8
==== ==== ====
9
10. 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 September 26, 2003, was $33.2 (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 September 26, 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
September 26, 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 September 26,
2003, the taxation years 2000 to February 16, 2001 are subject to audit by
taxation authorities.
As at September 26, 2003, the Company has guaranteed a custom bond
amounting to $2.7 to a third party on behalf of a subsidiary.
Based upon the transition rules outlined in FIN 45, no amounts have been
recorded by the Company related to the above-mentioned items.
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 three and six month
periods ended September 26, 2003:
Three Months Six Months
Ended Ended
Sept. 26, 2003 Sept. 26, 2003
-------------- --------------
Beginning balance $ 0.5 $ --
Accruals for new and pre-existing
warranties -- 0.5
Reduction based on change in
estimates (0.4) (0.4)
----- -----
Ending balance $ 0.1 $ 0.1
===== =====
10
11. Commitments
The Company had letters of credit outstanding as at September 26, 2003 of
approximately $5.6 (September 27, 2002 - $3.1). Cash and cash equivalents
of $5.6 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 restructuring and impairment losses recorded in the
second quarter of Fiscal 2004, the Company did not meet a quarterly
financial covenant with respect to shareholder's equity under the
Company's credit facility. A waiver was obtained from the bank in respect
of the financial covenant, and subsequent to the quarter ended September
26, 2003, the Company has cancelled the operating line component of the
revolving global credit facility. As a result of this change the Company
will operate with a credit facility of approximately $9.2 (Cdn$12.5),
available for letters of credit. The financial covenant with respect to
shareholder's equity has also been modified under the new agreement.
12. Redeemable Preferred Shares
There were 27,800 preferred shares purchased during the six months ended
September 26, 2003 for cash consideration of $0.5. As at September 26,
2003, there were 5,900 repurchased preferred shares that had not been
cancelled by the end of the quarter.
During the second 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, resulting in a cumulative dividend of $0.74
(Cdn$1.00) per share for the first six months of Fiscal 2004.
13. 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:
Six Months Ended
-----------------------------------
September 26, September 27,
2003 2002
------------- -------------
Outstanding Options:
Balance, beginning of period 10,828,557 10,914,962
Granted 109,500 357,300
Exercised (10,617) (109,193)
Forfeited (997,883) (1,476,966)
---------- ----------
Balance, end of period 9,929,557 9,686,103
========== ==========
As at September 26, 2003, there were 4,602,505 (March 28, 2003 -
3,714,122) options available for grant under the stock option plan
approved by the Company's shareholders on December 7, 2001. The exercise
price of outstanding stock options ranges from $2.51 to $ 27.57 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 September 26, 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.
11
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 Six Months Ended
--------------------------- ---------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
--------- --------- --------- ---------
Stock options 537,993 41,054 573,690 208,942
======= ====== ======= =======
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 Six Months Ended
--------------------------- ---------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
--------- --------- --------- ---------
Number of outstanding options 7,451,043 9,420,728 7,401,043 8,219,274
Average exercise price per share $ 10.56 $ 9.03 $ 10.59 $ 9.65
The average exercise price of stock options was based on prices in
Canadian dollars translated at the U.S. dollar exchange rate on the
applicable period end date.
14. Accumulated other comprehensive income (loss)
The components of other comprehensive income (loss) were as follows:
Three Months Ended Six Months Ended
--------------------------- ---------------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
--------- --------- --------- ---------
Net loss for the period $ (18.9) $ (11.9) $ (25.1) $ (20.6)
Other comprehensive income (loss):
Realized net derivative (gains) losses on cash
flow hedges (0.1) (1.5) -- (1.4)
Unrealized net derivative gains (losses) on
cash flow hedges 0.3 (1.7) 0.4 (2.2)
Change in cumulative translation adjustment -- (5.8) -- 6.5
------- ------- ------- -------
Other comprehensive loss for the period $ (18.7) $ (20.9) $ (24.7) $ (17.7)
======= ======= ======= =======
The changes to accumulated other comprehensive loss for the six months
ended September 26, 2003 were as follows:
Realized and
Cumulative Unrealized Net
Translation Gain (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)
Change during the three months
ended September 26, 2003 -- 0.2 0.2
------ ----- ------
Balance, September 26, 2003 $(32.4) $ 0.3 $(32.1)
====== ===== ======
The Company recorded a decrease in other comprehensive loss in the six
months ended September 26, 2003 (September 27, 2002 - $3.6) of $0.4 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. The Company estimates that $0.3 of
net derivative gain included in other comprehensive loss will be
reclassified into earnings within the next four months.
12
15. Other income (expense) (net)
Three Months Ended Six Months Ended
-------------------------------- -------------------------------
Sept. 26, 2003 Sept. 27, 2002 Sept. 26, 2003 Sept. 27, 2002
-------------------------------- -------------------------------
Interest income $0.3 $1.0 $0.6 $1.9
Foreign exchange gain (loss) 0.1 2.0 (0.9) 1.6
--------------------------------- -------------------------------
Other income (expense) (net) $0.4 $3.0 $(0.3) $3.5
================================= ===============================
16. 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 sectors 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.
Network Consumer Ultra Low-Power Unallocated
Three Months Ended Sept. 26, 2003 Communications Communications Communications Costs Total
-------------- -------------- --------------- ----------- --------
Total external sales revenue $ 25.0 $ 13.8 $ 7.8 $ -- $ 46.6
Amortization of buildings and equipment 1.9 1.0 0.4 -- 3.3
Asset impairment and other 3.0 1.9 0.4 -- 5.3
Segment's operating loss (11.5) (5.8) (2.0) -- (19.3)
Network Consumer Ultra Low-Power Unallocated
Three Months Ended Sept. 27, 2002 Communications Communications Communications Costs Total
-------------- -------------- --------------- ----------- --------
Total external sales revenue $ 29.4 $ 10.4 $ 6.4 $ -- $ 46.2
Amortization of buildings and equipment 2.6 0.6 0.1 -- 3.3
Stock compensation expense -- -- -- 0.2 0.2
Segment's operating loss (6.5) (6.0) (1.3) (0.2) (14.0)
13
Network Consumer Ultra Low-Power Unallocated
Six Months Ended Sept. 26, 2003 Communications Communications Communications Costs Total
-------------- -------------- --------------- ----------- ---------
Total external sales revenue $ 54.3 $ 27.2 $ 18.8 $ -- $ 100.3
Amortization of buildings and equipment 3.7 2.1 1.1 -- 6.9
Asset impairment and other 3.0 1.9 0.4 -- 5.3
Segment's operating loss (13.9) (9.6) (1.0) -- (24.5)
Network Consumer Ultra Low-Power Unallocated
Six Months Ended Sept. 27, 2002 Communications Communications Communications Costs Total
-------------- -------------- --------------- ----------- ---------
Total external sales revenue $ 57.8 $ 23.0 $ 13.4 $ -- $ 94.2
Amortization of buildings and equipment 5.1 1.2 0.2 6.5
Stock compensation recovery -- -- -- (1.4) (1.4)
Segment's operating loss (11.8) (11.1) (1.3) 1.4 (22.8)
17. Supplementary cash flow information
The following table summarizes the Company's other non-cash changes in
operating activities:
Three Months Ended Six Months Ended
-------------------------------- -------------------------------
Sept. 26, 2003 Sept. 27, 2002 Sept. 26, 2003 Sept. 27, 2002
-------------------------------- -------------------------------
Cash provided by (used in)
Loss on disposal of fixed assets $ 0.1 $ -- $ 0.1 $ --
Foreign exchange gain on short-term investments -- (1.8) -- (1.5)
Change in pension liabilities 0.5 -- 1.6 --
Impairment of fixed assets 4.7 -- 4.7 --
Provision for excess space under lease contract 0.6 -- 0.6 --
---------------------------------------------------------------------
Other non-cash changes in operating activities $ 5.9 $ (1.8) $ 7.0 $ (1.5)
=====================================================================
18. Subsequent event
On October 16, 2003, the Company announced reduced spending primarily in
its Network Communications segment. The Company expects to record
additional charges of approximately $4.5 in the third quarter of Fiscal
2004, related to reducing its global workforce by approximately 5%.
19. Comparative figures
Certain of the Fiscal 2003 comparative figures have been reclassified to
conform to the presentation adopted in Fiscal 2004.
14
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 and six months ended September
26, 2003, compared with the corresponding periods 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.
15
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED SEPTEMBER 26, 2003
Summary of Results from Operations Three Months Ended Six Months Ended
----------------------- ----------------------
Sept. 26, Sept. 27, Sept. 26, Sept. 27,
(millions of U.S. dollars, except per share amounts) 2003 2002 2003 2002
--------- --------- --------- ---------
Consolidated revenue $ 46.6 $ 46.2 $ 100.3 $ 94.2
Network Communications segment revenue 25.0 29.4 54.3 57.8
Consumer Communications segment revenue 13.8 10.4 27.2 23.0
Ultra Low-Power Communications segment revenue 7.8 6.4 18.8 13.4
Operating loss (19.3) (14.0) (24.5) (22.8)
Network Communications segment operating loss (11.5) (6.5) (13.9) (11.8)
Consumer Communications segment operating loss (5.8) (6.0) (9.6) (11.1)
Ultra Low-Power Communications segment operating loss (2.0) (1.3) (1.0) (1.3)
Unallocated recoveries (costs) -- (0.2) -- 1.4
Net loss for the period (18.9) (11.9) (25.1) (20.6)
Net loss per common share - basic and diluted (0.15) (0.10) (0.20) (0.17)
Weighted average common shares outstanding - millions 127.3 127.2 127.3 126.9
Revenue in the second quarter of Fiscal 2004 was $46.6, an increase of 1% from
the second quarter of Fiscal 2003. Revenue in the first six months of Fiscal
2004 was $100.3, an increase of 6% from the first six months 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 second quarter of Fiscal
2004, in excess of that expected with normal seasonal trends for lower shipments
through the summer months. Booking levels improved late in the second quarter,
and remain above those levels experienced during the same period in Fiscal 2003.
In the second quarter of Fiscal 2004, the Company recorded a net loss, after
preferred share dividends, of $19.4, or $0.15 per share. This compares to a net
loss, after preferred share dividends, of $12.4, or $0.10 per share, in the
second quarter of Fiscal 2003.
For the six months ended September 26, 2003, the Company recorded a net loss,
after preferred share dividends, of $26.1, or $0.20 per share. This compares to
a net loss, after preferred share dividends, of $21.6, or $0.17 per share, for
the six months ended September 27, 2002.
The Company implemented further cost reductions in the second quarter of Fiscal
2004 in efforts to outsource programs and streamline operations. During the
quarter, the Company incurred $3.4 of expenses related to reducing its global
workforce by approximately 120 employees across all regions and business units.
The Company also recorded a charge related to excess space under lease contract
of $0.6 as a result of restructuring activities implemented during the quarter.
In addition, the Company recorded an impairment loss on fixed assets of $4.7 as
a result of a review of the ongoing usage of certain assets of the Company.
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.
16
Network Communications
Three Months Ended Six Months Ended
Network Communications Sept. 26, Sept. 27, Sept. 26, Sept. 27,
(millions of U.S. dollars) 2003 2002 2003 2002
--------- --------- --------- ----------
Revenue:
$ 25.0 $ 29.4 $ 54.3 $ 57.8
======= ======= ======= =======
As a % of total revenue 54% 64% 54% 61%
Operating loss $ (11.5) $ (6.5) $ (13.9) $ (11.8)
======= ======= ======= =======
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.
Revenue for the second quarter of Fiscal 2004 totaled $25.0, down 15% from the
second quarter of Fiscal 2003. During the first six months of Fiscal 2004
revenue decreased to $54.3, down 6% from the same period in Fiscal 2003. Reduced
capital spending in the market continues to impact demand by networking
companies. Revenue declines were a result of decreased revenue from the
Company's packet switching, packet processing, and specialty products,
predominately in the Asia Pacific region.
The segment's operating loss declined to $13.9 in the first six months of Fiscal
2004 from an operating loss of $11.8 in the first six months of Fiscal 2003, due
primarily to asset impairments and other costs incurred in the second quarter of
Fiscal 2004, partially offset by cost control initiatives and improved margins
on a stronger mix of products sold. During the first half of Fiscal 2004, the
Network Communications segment has incurred asset impairment and other costs of
$3.0 and approximately $0.6 of severance costs related to its direct R&D
initiatives, as it implemented cost control initiatives.
Consumer Communications
Three Months Ended Six Months Ended
Consumer Communications Sept. 26, Sept. 27, Sept. 26, Sept. 27,
(millions of U.S. dollars) 2003 2002 2003 2002
--------- --------- --------- ---------
Revenue:
$ 13.8 $ 10.4 $ 27.2 $ 23.0
======= ======= ======= =======
As a % of total revenue 29% 22% 27% 25%
Operating loss $ (5.8) $ (6.0) $ (9.6) $ (11.1)
======= ======= ======= =======
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 second quarter of Fiscal 2004 totaled $13.8, up 33% from the
second quarter of Fiscal 2003. During the first six months of Fiscal 2004,
revenue increased 18% over the same period in Fiscal 2003, to $27.2, principally
as a result of improved shipments of the Company's tuners and demodulators.
The segment's operating loss decreased to $9.6, in the first six months of
Fiscal 2004 from an operating loss of $11.1 in the same period of Fiscal 2003,
due principally to improved revenues, partially offset by asset impairment and
other costs of $1.9 and cost control initiatives, where it incurred
approximately $0.2 in R&D specific severance costs during the period.
17
Ultra Low-Power Communications
Three Months Ended Six Months Ended
Ultra Low-Power Communications Sept. 26, Sept. 27, Sept. 26, Sept. 27,
(millions of U.S. dollars) 2003 2002 2003 2002
--------- --------- --------- ---------
Revenue:
$ 7.8 $ 6.4 $ 18.8 $ 13.4
======= ======= ======= =======
As a % of total revenue 17% 14% 19% 14%
Operating loss $ (2.0) $ (1.3) $ (1.0) $ (1.3)
======= ======= ======= =======
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 second quarter of Fiscal 2004 totaled $7.8, up 22% from the
second quarter of Fiscal 2003. During the first six months of Fiscal 2004,
revenue increased 40% over the same period in Fiscal 2003, to $18.8, due mainly
to increases in the sale of hearing aid components. Revenue improvements were
also realized on the Company's pacemaker circuits.
The segment's operating loss improved to $1.0, in the first six months of Fiscal
2004 from an operating loss of $1.3 in the same period of Fiscal 2003, due
principally to a more favorable product mix and cost control initiatives,
inclusive of approximately $0.2 in severance costs during the period related to
its R&D spending, but partially offset by asset impairments and other costs of
$0.4 recorded during the second quarter of Fiscal 2004.
GEOGRAPHIC REVENUE
Revenue, based on the geographic location of customers, was distributed as
follows:
Three Months Ended Six Months Ended
------------------------------------------- ------------------------------------------
Sept. 26, % of Sept. 27, % of Sept. 26, % of Sept. 27, % of
(millions of U.S. dollars) 2003 Total 2002 Total 2003 Total 2002 Total
--------- ----- --------- ----- --------- ----- --------- -----
Revenue:
Asia / Pacific $ 17.7 38% $ 18.0 39% $ 40.2 40% $ 34.7 37%
Europe 13.7 29% 14.7 32% 30.5 30% 31.0 33%
United States 10.6 23% 9.9 21% 22.9 23% 19.7 21%
Canada 2.3 5% 2.3 5% 3.9 4% 6.5 7%
Other Regions 2.3 5% 1.3 3% 2.8 3% 2.3 2%
------ ---- ------ ---- ------ ---- ------ ----
Total $ 46.6 100% $ 46.2 100% $100.3 100% $ 94.2 100%
====== ==== ====== ==== ====== ==== ====== ====
Asia/Pacific
Asia/Pacific sales decreased by 2% during the second quarter of Fiscal 2004
compared to the second quarter of Fiscal 2003, but continue to represent the
largest geographic segment of customer revenues. The decline in regional sales
was primarily within the Network Communications segment during the quarter.
During the first six months of Fiscal 2004, sales increased by 16% compared to
the same period in Fiscal 2003. Increases were driven primarily from the
Consumer Communication segment, with moderate improvements from the Ultra
Low-Power Communications segment.
18
Europe
European sales decreased by 7% in the second quarter of Fiscal 2004 compared to
the second quarter of Fiscal 2003. For the first six months of Fiscal 2004,
sales decreased by 2% compared to the first six months of Fiscal 2003 due to
declines in the revenues from the Consumer Communications segments offset by
improved revenues in the Network and Ultra Low-Power Communications segments.
United States
Sales to customers in the United States increased by 7% during the second
quarter of Fiscal 2004 compared to the second quarter of Fiscal 2003. For the
first six months of Fiscal 2004, sales increased by 16% compared to the same
period in Fiscal 2003. The increase was due primarily to improved Ultra
Low-Power and Consumer Communications product sales.
Canada
Canadian sales in the second quarter of Fiscal 2004 were in line with the same
period in Fiscal 2003. During the first six months of Fiscal 2004, sales to
Canadian customers decreased by 40% compared to the same period in Fiscal 2003
due to lower Network Communications segment sales.
GROSS MARGIN
Three Months Ended Six Months Ended
-------------------- ---------------------
(millions of U.S. dollars) Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
--------- --------- --------- ---------
Gross Margin $19.4 $20.7 $45.0 $42.8
As a percentage of revenue 42% 45% 45% 45%
Gross margin decreased by three percentage points in the second quarter of
Fiscal 2004 compared to the same period in Fiscal 2003. The decrease in margin
was a result of lower than expected sales volumes and increasing price pressure
on products in the Consumer Communication segment. Also included in the gross
margin during the quarter was approximately $0.6 of severance costs related to
the restructuring activities implemented this period.
Gross margin of 45% in the first six months of Fiscal 2004 was consistent with
the same period in Fiscal 2003. During the first half of Fiscal 2004, the
Company continued its effort to lower overall manufacturing costs, as it
incurred approximately $0.7 of severance costs during the period.
OPERATING EXPENSES
Research and Development ("R&D")
Three Months Ended Six Months Ended
-------------------- ---------------------
(millions of U.S. dollars) Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
--------- --------- --------- ---------
R&D Expenses $19.2 $22.9 $38.4 $43.3
As a percentage of revenue 41% 50% 38% 46%
R&D expenses decreased by 16%, or $3.7, in the second quarter of Fiscal 2004
from the same period in Fiscal 2003. During the first six months of Fiscal 2004,
R&D expenses decreased by 11%, or $4.9 compared to the same period in Fiscal
2003, primarily due to the timing of certain material spending and cost
reduction initiatives implemented in the second quarter of Fiscal 2004. During
the three and six month periods ended September 26, 2003, severance costs of
$1.0 were incurred. 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 second quarter
of Fiscal 2004, bringing the year to date total to 22 new product launches.
19
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.
In the Network Communications product line, R&D activities focused on the
following areas:
o Time Division Multiplex ("TDM") Switching - Solutions to set new
industry standards for channel density, levels of integration,
feature sets and power density for enterprise, edge and metro
segments;
o Network Timing and Synchronization - Digital and Analog Phase Lock
Loops ("PLL") solutions for T1/E1 to SONET/SDH equipment requiring
accurate and standards driven timing and synchronization;
o Voice Processing Solutions - Low, medium and high-density voice echo
cancellation solutions meeting G.168 standards for wireless, wired
and enterprise segments;
o TDM to IP Processing Solutions - Meeting network convergence with
TDM to IP processing solutions for applications requiring Circuit
Switched Traffic over Packet Domains;
o Ethernet Switching - Fast Ethernet (FE) to Gigabit Ethernet ("GbE")
switching for communication backplanes and linecards;
o Analog and Mixed Signal Solutions - Timing, Synthesizers, Interface
drivers, ADSL drivers and High Speed Amplifiers products for wired
and wireless applications; utilizing our analog/mixed-signal
expertise; 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;
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 Six Months Ended
-------------------- ---------------------
(millions of U.S. dollars) Sept. 26, Sept. 27, Sept. 26, Sept. 27,
2003 2002 2003 2002
--------- --------- --------- ---------
S&A Expenses $14.2 $11.6 $25.8 $23.7
As a percentage of revenue 30% 25% 26% 25%
In the second quarter of Fiscal 2004, S&A expenses increased by $2.6, or 22%
compared to the second quarter of Fiscal 2003, principally as a result of cost
reduction activities implemented during the quarter. S&A expenses in the second
quarter of Fiscal 2004 included approximately $1.8 of severance charges. The
Company anticipates a reduction in S&A expenses during the third quarter of
Fiscal 2004, as a result of these cost reduction activities.
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
20
associated with the stock awarded to certain employees of Vertex Networks,
Incorporated, which was acquired in July 2000.
During the three and six months ended September 26, 2003, there was no stock
compensation recorded, as the intrinsic value of options under the exchange
program was nil. During the three months ended September 27, 2002, the Company
recorded a stock compensation expense of $0.2 (six months ended September 27,
2002 - recovery of $1.4) 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 related to the formerly restricted shares.
OTHER INCOME (EXPENSE)
Other income (expense) was comprised of interest income and foreign exchange
gains and losses.
Interest income was $0.3 for the three months ended September 26, 2003 as
compared to $1.0 in the same period of Fiscal 2003. During the first six months
of Fiscal 2004, interest income was $0.6 as compared to $1.9 in the first six
months of Fiscal 2003. The decreases were mainly due to reduced average cash
balances and lower interest rates in Fiscal 2004.
Foreign exchange gains in the second quarter of Fiscal 2004 amounted to $0.1 as
compared to gains of $2.0 for the same period in Fiscal 2003. During the six
months ended September 26, 2003, foreign exchange losses amounted to $0.9 as
compared to a gain of $1.6 for the six months ended September 27, 2002. 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 foreign exchange gains
were related to gains realized on short-term investments held in currencies
other than the functional currency of the parent company, and according to
month-end foreign exchange rates.
INTEREST EXPENSE
Interest expense was $0.3 for the three months ended September 26, 2003,
compared with $0.3 for the second quarter of Fiscal 2003. During the first half
of Fiscal 2004, interest expense was $0.3, compared with $0.4 for the first six
months of Fiscal 2003. The interest expense relates primarily to the Company's
capital leases.
INCOME TAXES
An income tax recovery of $0.3 was recorded for the second quarter of Fiscal
2004, as a result of a recovery of domestic income taxes, partially offset by
capital taxes, compared with an expense of $0.6 for the corresponding period in
Fiscal 2003. During the six months ended September 26, 2003, income tax expense
was nil, compared with an expense of $0.9 for the first six months of Fiscal
2003.
The Company has a valuation allowance against its deferred tax assets at
September 26, 2003 of $127.6, (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.
NET LOSS
The Company recorded a net loss, after preferred share dividends, of $19.4, or
$0.15 per share, in the second quarter of Fiscal 2004. This compares to a net
loss, after preferred share dividends, of $12.4, or $0.10 per share, in the same
period in Fiscal 2003. For the six months ended September 26, 2003, the Company
recorded a net loss, after preferred share dividends, of $26.1, or $0.20 per
share, as compared to $21.6 or $0.17 per share in the first six months of Fiscal
2003.
The net loss for the three and six month periods ended September 26, 2003, were
primarily a result of low revenues, caused by the continued downturn in the
semiconductor industry, combined with severance and asset impairment charges
incurred upon implementation of cost cutting initiatives during the second
quarter.
LIQUIDITY AND CAPITAL RESOURCES
At September 26, 2003, cash, cash equivalents, short-term investments and
restricted cash balances totaled $97.2, down from $119.2 at March 28, 2003. Cash
and cash equivalents at September 26, 2003, included in the amount above,
totaled $56.4 (March 28, 2003 - $23.5).
21
Cash used in operations before working capital changes amounted to $11.2 during
the first six months of Fiscal 2004, as compared to $16.4 used in the first six
months of Fiscal 2003. Cash used in operations included various one-time costs,
including severance payments, associated with the restructuring activities
implemented during the quarter. Since March 28, 2003, the Company's working
capital increased by $6.3, mainly as a result of increases in accounts
receivable of $5.6, other prepaid expenses totaling $2.7, a reduction in
accounts payable and other accrued liabilities totaling $0.1 and 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 third quarter of Fiscal 2004. The increase in other prepaid expenses was due
to scheduled payments for insurance and other annual payments. These increases
in working capital were partially offset by a reduction in inventories of $2.3
over the first half of the year. 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 $2.5 during the first six 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 $51.7 for the six months ended
September 26, 2003, primarily from matured short-term investments totaling
$139.3, offset by purchases of short-term investments of $85.0. Cash balances
were reduced by purchases of fixed and other assets amounting to $3.2 during the
first six months of the year, offset by proceeds from disposal of fixed assets
of $0.6. 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 six months of Fiscal 2004.
Cash provided by investing activities for the first six months of Fiscal 2003
was $12.1. Net proceeds from the sale of short-term investments in the amount of
$16.4 contributed to the net cash inflow, offset by net purchases of fixed and
other assets of $4.3. The fixed asset additions were primarily related to design
tools and continuing improvements to information technology resources.
Cash used in financing activities during the first six months of Fiscal 2004 was
$1.3. The use of cash was primarily the result of repayment of $0.4 of capital
leases, the repurchase of $0.5 of the Company's redeemable preferred shares, and
the payment of $1.0 for dividends on the preferred shares. These cash outflows
were partially offset by a reduction of the hypothecation of cash under letters
of credit. Cash used in financing activities in the first six months of Fiscal
2003 was $2.3. The use of cash was primarily the result of the repayment of $1.4
of capital lease liabilities, the repurchase of $0.4 of preferred shares, and
the payment of $1.0 for dividends on the preferred shares, offset by $0.5 of new
common shares issued from exercised stock options.
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 six months of Fiscal 2004, the Company declared and paid
dividends of $1.0 on its redeemable preferred shares based on a cumulative $0.74
(Cdn$1.00) per share dividend. In addition, the Company purchased 27,800
preferred shares under its purchase obligation during this period. As at
September 26, 2003, the Company has repurchased 5,900 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 $97.2 as at September 26, 2003, the Company had a revolving global
credit facility of approximately $18.5 (Cdn$25.0), of which $5.6 in letters of
credit were outstanding. Accordingly, the Company had unused and available
demand bank lines of credit totaling $12.9 as at September 26, 2003. Cash and
cash equivalents totaling $5.6 were hypothecated under the credit facility to
cover outstanding letters of credit. As a result of the restructuring and
impairment losses recorded in the second quarter of Fiscal 2004, the Company did
not meet a quarterly financial covenant with respect to shareholder's equity
under the Company's credit facility. A waiver was obtained from the bank in
respect of the financial covenant, and subsequent to the quarter ended September
26, 2003, the Company has cancelled the operating line component of the
revolving global credit facility. As a result of this change the Company will
operate with a credit facility of approximately $9.2 (Cdn$12.5), available for
letters of credit. The financial covenant with respect to shareholder's equity
has also been modified under the new agreement. 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
22
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.
BACKLOG
As at
-------------------------------------------------
(millions of U.S. dollars) Sept. 26, 2003 June 27, 2003 March 28, 2003
-------------- ------------- --------------
90 Day Backlog $ 27.5 $ 31.5 $ 36.9
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.
Backlog decreased from the prior quarter due to reduced bookings across the
Consumer and Ultra Low-Power segments, partially offset by a sequential
improvement in bookings in the Network Communications segment. Bookings continue
to be affected by the continued downturn in the communications semiconductor
industry, described elsewhere in this Management's Discussion and Analysis.
The comparative backlog amounts have been adjusted to reflect the Company's
revised methodology of applying distributor stock rotations and allowances
against distributor orders at the time of booking. The revised methodology
better matches order backlog with the net sales recorded at the time of
shipment.
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 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
23
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 adoption of SFAS 149 did not
have a material impact on the Company's financial statements.
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 clarifies 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 adoption of SFAS 150 did not
have a material impact on the Company's financial statements.
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 September 26, 2003, there were unrealized gains of $0.3 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 September 26,
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 September 26, 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
The Company's management carried out an evaluation, with the participation of
its Chief Executive Officer and Chief Financial Officer, of the effectiveness of
the Company's disclosure controls and procedures as of September 26, 2003. Based
upon that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer concluded that Company's disclosure controls and procedures were
effective to ensure that information required to be disclosed by the Company in
reports that it files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported, within the time periods specified
in the rules and forms of the Securities and Exchange Commission.
There has not been any change in the Company's internal controls over financial
reporting in connection with the evaluation required by Rule 13a-15(d) under the
Exchange Act that occurred during the quarter ended September 26, 2003 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
24
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
31.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To
Section 302(a) of The Sarbanes-Oxley Act of 2002, President and Chief
Executive Officer
31.2 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant To
Section 302(a) of The Sarbanes-Oxley Act of 2002, Senior Vice President of
Finance and Chief Financial Officer
32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
President and Chief Executive Officer
32.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
Senior Vice President of Finance and Chief Financial Officer
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
b) Reports on Form 8-K
Date of Filing Description
- --------------------------------------------------------------------------------
July 16, 2003 Press Release: "Financial Results for the Quarter Ended
June 27, 2003"
September 23, 2003 Press Release: "Zarlink Revises Guidance for Second
Quarter Fiscal 2004"
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 October 24, 2003
Finance and Chief
Financial Officer
(Principal Financial
and Accounting
Officer)
25
EXHIBIT INDEX
Exhibit
Number Description Page
- ------- ---------------------------------------------------- -------------
31.1 Certification Pursuant to 18 U.S.C. Section 1350, As 27
Adopted Pursuant To Section 302(a) of The
Sarbanes-Oxley Act of 2002, President and Chief
Executive Officer
31.2 Certification Pursuant to 18 U.S.C. Section 1350, As 28
Adopted Pursuant To Section 302(a) of The
Sarbanes-Oxley Act of 2002, Senior Vice President of
Finance and Chief Financial Officer
32.1 Certification Pursuant to Section 906 of the 29
Sarbanes-Oxley Act of 2002, President and Chief
Executive Officer
32.2 Certification Pursuant to Section 906 of the 30
Sarbanes-Oxley Act of 2002, Senior Vice President
of Finance and Chief Financial Officer
99.1 Selected Consolidated Financial Statements in U.S. 31
Dollars and in accordance with Canadian Generally
Accepted Accounting Principles
99.2 Management's Discussion and Analysis of 42
Financial Condition and Results of Operations -
Canadian Supplement
26