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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 27, 2002
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 |_|
As at November 1, 2002, there were 127,191,316 shares of the Common Stock 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 (Unaudited)...................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...........................13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISKS..........................................................21
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES.............................22
PART II - OTHER INFORMATION.................................................22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...............................23
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 27, March 29,
2002 2002
------------ ---------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 67.9 $ 75.6
Short-term investments 64.8 78.8
Trade accounts receivable, less
allowance of $1.5
(March 29, 2002 - $1.3) 27.6 26.9
Other receivables 3.5 5.5
Inventories 27.9 32.6
Deferred income tax assets - net 2.3 4.1
Prepaid expenses and other 6.9 11.3
------ ------
200.9 234.8
Fixed assets (net) 60.5 60.3
Deferred income tax assets - net 11.1 11.0
Long-term investments 14.6 14.1
Other assets - net of deferred gain of
$15.2 (March 29, 2002 - $14.7) 3.7 3.0
------ ------
$290.8 $323.2
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 10.8 $ 14.6
Employee-related payables 12.1 12.8
Income and other taxes payable 8.7 5.9
Provisions for exit activities 14.3 19.8
Other accrued liabilities 14.5 18.9
Deferred revenue 2.5 2.0
Current portion of long-term debt 1.1 2.1
------ ------
64.0 76.1
Long-term debt 0.3 0.7
Pension liability 19.5 17.4
Deferred income tax liabilities - net 4.2 6.3
------ ------
88.0 100.5
------ ------
Redeemable preferred shares, unlimited shares
authorized; 1,526,000 shares issued
and outstanding (March 29, 2002 - 1,558,700) 20.2 20.6
------ ------
Shareholders' equity:
Common shares, unlimited shares authorized;
no par value; 127,191,316 shares
issued and outstanding
(March 29, 2002 - 127,082,123) 768.1 767.6
Additional paid-in capital 2.1 4.1
Deferred stock compensation -- (0.8)
Deficit (544.6) (522.9)
Accumulated other comprehensive loss (43.0) (45.9)
------ ------
182.6 202.1
------ ------
$290.8 $323.2
====== ======
(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. 27, Sept. 28, Sept. 27, Sept. 28,
2002 2001 2002 2001
--------- --------- --------- ---------
Revenue $ 46.2 $ 50.5 $ 94.2 $118.3
Cost of revenue 25.5 33.9 51.4 96.6
------ ------ ------ ------
Gross margin 20.7 16.6 42.8 21.7
------ ------ ------ ------
Expenses:
Research and development 23.2 19.5 43.9 43.0
Selling and administrative 11.3 12.8 23.1 25.9
Stock compensation expense (recovery) 0.2 2.4 (1.4) 6.3
Special charge -- -- -- 34.6
Amortization of acquired intangibles -- 0.8 -- 2.2
------ ------ ------ ------
34.7 35.5 65.6 112.0
------ ------ ------ ------
Loss from operations (14.0) (18.9) (22.8) (90.3)
Other income (expense) - net 3.0 (0.1) 3.5 7.8
Interest expense (0.3) (0.2) (0.4) (0.4)
------ ------ ------ ------
Loss before income taxes (11.3) (19.2) (19.7) (82.9)
Income tax (expense) recovery (0.6) (0.5) (0.9) 2.7
------ ------ ------ ------
Net loss for the period $(11.9) $(19.7) $(20.6) $(80.2)
====== ====== ====== ======
Net loss attributable to common shareholders
after preferred share dividends $(12.4) $(20.2) $(21.6) $(81.2)
====== ====== ====== ======
Net loss per common share:
Basic and diluted $(0.10) $(0.16) $(0.17) $(0.65)
====== ====== ====== ======
Weighted average number of common shares outstanding (millions):
Basic and diluted 127.2 125.6 126.9 125.4
====== ====== ====== ======
(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)
Six Months Ended
------------------------------
September 27, September 28,
2002 2001
------------- -------------
Cash flows from operating activities:
Net loss for the period $(20.6) $(80.2)
Depreciation and amortization 7.1 12.7
Stock compensation expense (recovery) (1.4) 6.3
Special charges, non-cash -- 1.1
Loss on disposal of fixed assets -- 0.4
Inventory write-down -- 29.1
Deferred income taxes -- (1.5)
Change in pension liability -- 0.3
Equity loss in investment -- 1.4
Decrease (increase) in working capital:
Trade accounts and other receivables 3.0 19.2
Inventories 7.1 3.4
Prepaid expenses and other 1.9 (5.3)
Trade accounts payable and other
accrued liabilities (14.8) (13.4)
Deferred revenue 0.3 0.1
------ ------
Cash used in operating activities (17.4) (26.4)
------ ------
Cash flows from investing activities:
Purchased short-term investments (146.5) --
Matured short-term investments 161.7 --
Proceeds from disposal
of fixed and other assets 0.4 0.2
Expenditures for fixed and
other assets (4.3) (22.9)
Increase in long-term investments (0.4) (2.0)
Proceeds from repayment of note
receivable -- 4.5
Proceeds from sale of discontinued
operations (net) -- 1.3
------ ------
Cash provided by (used in)
investing activities 10.9 (18.9)
------ ------
Cash flows from financing activities:
Repayment of long-term debt -- (0.8)
Repayment of capital lease
liabilities (1.4) (2.7)
Payment of dividends on preferred
shares (1.0) (1.0)
Issue of common shares 0.5 2.1
Repurchase of preferred shares (0.4) (0.4)
------ ------
Cash used in financing activities (2.3) (2.8)
------ ------
Effect of currency translation on
cash and cash equivalents 1.1 0.6
------ ------
Decrease in cash and cash equivalents (7.7) (47.5)
Cash and cash equivalents, beginning
of period 75.6 179.9
------ ------
Cash and cash equivalents, end of period $ 67.9 $132.4
====== ======
(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 27, 2002,
the results of operations for the three and six month periods ended
September 27, 2002 and September 28, 2001, and cash flows of the Company
for the six month periods ended September 27, 2002 and September 28, 2001,
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 29, 2002. 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 accounting policies
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 141 ("SFAS 141"), "Business
Combinations" and Statement of Financial Accounting Standard No. 142
("SFAS 142"), "Goodwill and Other Intangible Assets". In October 2001, the
FASB issued Statement of Financial Accounting Standard No. 144 ("SFAS
144"), "Accounting for the Impairment or Disposal of Long-Lived Assets".
a) SFAS 141 requires that business combinations be accounted for under
the purchase method of accounting and addresses the initial
recognition and measurement of assets acquired, including goodwill
and intangibles, and liabilities assumed in a business combination.
The Company adopted SFAS 141 on a prospective basis effective March
30, 2002, the beginning of Fiscal 2003. The adoption of SFAS 141 did
not have a material effect on the Company's financial statements,
but will impact the accounting treatment of future acquisitions.
b) SFAS 142 requires goodwill to be allocated to, and assessed as part
of, a reporting unit. Further, SFAS 142 specifies that goodwill will
no longer be amortized but instead will be subject to impairment
tests at least annually. The Company adopted SFAS 142 on a
prospective basis at the beginning of Fiscal 2003. As at the
beginning of Fiscal 2003, the Company did not have any goodwill or
intangible assets with indefinite lives recorded on the balance
sheet. Accordingly, no transition impairment charge is necessary to
be recognized under SFAS 142, nor was there a material impact on the
Company's financial statements on adoption of the new rules.
As there was no goodwill or indefinite lived intangibles on the
balance sheet at the beginning of Fiscal 2002, the comparative prior
period's financial results would not have been affected if SFAS 142
was adopted in Fiscal 2002.
c) SFAS 144 supersedes Statement of Financial Accounting Standard No.
121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" and the
accounting and reporting provisions of Accounting Principles Board
("APB") Opinion No. 30 for the disposal of a business segment. SFAS
144 establishes a single accounting model, based on the framework
established in SFAS 121, for long-lived assets to be disposed of by
sale. SFAS 144 broadens the presentation of discontinued operations
to include disposals of a component of an entity and provides
additional implementation guidance with respect to the
classification of assets as held-for-sale and the calculation of an
impairment loss. The
6
Company adopted SFAS 144 at the beginning of Fiscal 2003. The
adoption of SFAS 144 did not have a material impact on the Company's
financial statements.
3. Recently issued accounting standards
In July 2002, the FASB issued Statement No. 146 ("SFAS 146"), "Accounting
for Costs Associated with Exit or Disposal Activities", which addresses
financial accounting and reporting for costs associated with exit or
disposal activities and nullifies EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to
Exit an Activity (including Certain Costs Incurred in a Restructuring)."
SFAS 146 requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred. Under
Issue 94-3, a liability for an exit cost was recognized at the date of an
entity's commitment to an exit plan. SFAS 146 concludes that an entity's
commitment to a plan, by itself, does not create a present obligation to
others that meets the definition of a liability. Therefore, SFAS 146
eliminates the definition and requirements for recognition of exit costs
in Issue 94-3. SFAS 146 also establishes that fair value is the objective
for initial measurement of the liability. SFAS 146 will be effective for
exit or disposal activities initiated after December 31, 2002 and had no
impact on the Company's financial statements, but will impact the
accounting treatment of future exit or disposal activities should they
occur.
4. Inventories
September 27, March 29,
2002 2002
------------- ---------
Raw materials $ 2.7 $ 2.4
Work-in-process 19.0 20.8
Finished goods 6.2 9.4
------ ------
$ 27.9 $ 32.6
====== ======
5. Fixed assets
September 27, March 29,
2002 2002
------------- ---------
Cost $161.5 $153.1
Accumulated depreciation (101.0) (92.8)
------ ------
$ 60.5 $ 60.3
====== ======
The comparative gross amounts of cost and accumulated depreciation have
each been adjusted by $57.9 to properly reflect the disposition of certain
fixed assets. There was no impact to the previously reported net fixed
assets.
6. Long-term investments
As at September 27, 2002, the Company had investments in private companies
with a carrying value of $14.6 (March 29, 2002 - $14.1). On October 3,
2002, the Company sold its investment in DALSA Semiconductor Inc.
("DALSA") for cash proceeds of $4.1. As a result of the sale, the Company
will record a gain of $0.7 in the third quarter of Fiscal 2003 (see Note
14). Following the sale, the carrying value of the Company's remaining
long-term investments approximated $11.2, of which $10.8 represented the
Company's nine percent interest in Mitel Networks Corporation.
Management periodically reviews the Company's investments to determine if
there has been other than a temporary decline in the market value of these
investments below the carrying value. When management performs future
assessments of its investments in the coming quarters, a decline in the
value of these companies may require the Company to recognize impairment
on the remaining value of its investments which could be material.
7. Provisions for exit activities
September 27, March 29,
2002 2002
------------- ---------
Restructuring provisions $ 5.5 $ 7.9
Provision for disposal of discontinued operations 3.9 5.8
Provision for disposal of foundry businesses 4.9 6.1
----- -----
$14.3 $19.8
===== =====
7
8. Redeemable preferred shares
There were 27,700 preferred shares purchased during the six months ended
September 27, 2002 for cash consideration of $0.4. The transfer agent
cancelled 32,700 shares in the first half of Fiscal 2003, of which 5,000
shares were repurchased in the fourth quarter of Fiscal 2002. As at
September 27, 2002, all repurchased preferred shares were cancelled.
During the second quarter, the dividend declared and paid on the
redeemable preferred shares was $0.32 (Cdn $0.50) per share, resulting in
a cumulative dividend of $0.64 (Cdn$1.00) per share for the first half of
Fiscal 2003.
9. 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. All
repurchased shares will be cancelled. During the six months ended
September 27, 2002, no shares were repurchased under the normal
course issuer bid program.
c) A summary of the Company's stock option activity is as follows:
Six Months Ended
----------------------------------
September 27, September 28,
2002 2001
------------- -------------
Outstanding Options:
Balance, beginning of period 10,914,962 9,464,693
Granted 357,300 1,586,500
Exercised (109,193) (435,689)
Forfeited (1,476,966) (902,069)
---------- ---------
Balance, end of period 9,686,103 9,713,435
========== =========
On August 14, 2002, 1,136,778 unexercised stock options held by
former employees of the discontinued Systems business expired in
accordance with the terms of the sales agreement. The options were
returned to the pool of options available for grant. Available for
grant at September 27, 2002 were 4,930,576 (March 29, 2002 -
3,810,910) common shares. The exercise price on outstanding stock
options ranges from $1.77 to $24.95 per share with exercise periods
extending to September 2008. The exercise price of stock options was
based on prices in Canadian dollars translated at the U.S. dollar
exchange rate on September 27, 2002.
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.
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. 27, Sept. 28, Sept. 27, Sept. 28,
2002 2001 2002 2001
--------- --------- --------- ---------
Stock options 41,054 1,426,875 208,942 1,366,492
Restricted shares -- 771,120 -- 771,120
------ -------- ------- ---------
Total 41,054 2,197,995 208,942 2,137,612
====== ========= ======= =========
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:
8
Three Months Ended Six Months Ended
--------------------- ---------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
2002 2001 2002 2001
--------- --------- --------- ---------
Number of outstanding
options 9,420,728 5,306,179 8,219,274 5,714,179
Average exercise price
per share $ 9.03 $ 10.47 $ 9.65 $ 10.35
Pro Forma financial information 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 27, 2002 and
September 28, 2001:
Three Months Ended Six Months Ended
---------------------- ---------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
2002 2001 2002 2001
--------- --------- --------- ---------
Pro Forma net loss attributable to
common shareholders
after preferred dividends $ (15.8) $ (27.7) $ (28.3) $ (91.7)
Pro Forma net loss per common share:
Basic and diluted $ (0.12) $ (0.22) $ (0.22) $ (0.73)
Weighted average fair value price
of the options $ 3.37 $ 3.60 $ 3.37 $ 3.60
Risk free interest rate 3.69% 4.44% 3.69% 4.44%
Dividend yield Nil Nil Nil Nil
Volatility factor of the
expected market price of
the Company's common stock 0.628 0.574 0.628 0.574
Weighted-average expected
life of the options 3.0 years 4.0 years 3.0 years 4.0 years
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.
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.
10. Accumulated other comprehensive loss
The components of other comprehensive loss were as follows:
Three Months Ended Six Months Ended
---------------------- ---------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
2002 2001 2002 2001
--------- --------- --------- ---------
Net loss for the period $(11.9) $(19.7) $(20.6) $(80.2)
Other comprehensive income (loss):
Unrealized net derivative gains
(losses) on cash flow hedges (3.2) 0.6 (3.6) (0.6)
Change in cumulative translation
adjustment (5.8) (0.3) 6.5 3.1
------ ------ ------ ------
Other comprehensive loss for
the period $(20.9) $(19.4) $(17.7) $(77.7)
====== ====== ====== ======
9
The changes to accumulated other comprehensive loss for the six months
ended September 27, 2002 were as follows:
Cumulative Minimum Unrealized Net
Translation Pension Loss on
Account Liability Derivatives Total
----------- --------- -------------- --------
Balance, March 29, 2002 $(43.0) $(2.5) $(0.4) $(45.9)
Change during the three months ended
June 28, 2002 12.3 -- (0.4) 11.9
------ ----- ----- ------
Balance, June 28, 2002 $(30.7) $(2.5) $(0.8) $(34.0)
Change during the three months
ended September 27, 2002 (5.8) -- (3.2) (9.0)
------ ----- ----- ------
Balance, September 27, 2002 $(36.5) $(2.5) $(4.0) $(43.0)
====== ===== ===== ======
The Company recorded an increase in other comprehensive loss in the six
months ended September 27, 2002 of $3.6 (six months ended September 28,
2001 - $0.6) 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 $4.0 of net derivative loss included in other comprehensive
loss will be reclassified into earnings within the next 12 months.
11. Inventory write-down and special charge
First Quarter of Fiscal 2002
In the first quarter of Fiscal 2002, the Company reviewed its inventory
requirements for the succeeding 12 months in light of the semiconductor
industry-wide slowdown and higher channel inventories. As a result of this
review, the Company recorded an excess inventory charge to cost of sales
amounting to $29.1 for inventories estimated to be beyond its needs for
the following 12 months.
In the first quarter of Fiscal 2002 and in response to the industry
downturn, the Company implemented a cost-containment plan in order to
preserve cash resources. The cost-containment plan included a workforce
reduction of the Company's total employee base by 439 employees, globally
across all job categories, which was completed by the end of Fiscal 2002.
The total cost of the first quarter Fiscal 2002 workforce reduction
program was estimated to be $26.7.
As a result of the workforce reduction program and consolidating design
activity, the Company took steps to provide for excess leased facilities
in Canada, the United States, the United Kingdom, and the Far East. The
cost of the lease and contract settlements amounted to $7.9 in the first
quarter of Fiscal 2002.
The total of these pre-tax special charges amounted to $34.6 in the first
quarter of Fiscal 2002. In the fourth quarter of Fiscal 2002, $3.1 of the
first quarter special charge was reversed due to savings on the workforce
reduction program and to the subsequent sub-letting of vacant space in
Irvine, California.
The following summarizes the activity related to the March 29, 2002
restructuring liability during the first half of Fiscal 2003:
Workforce Excess Lease
Reduction Costs Total
--------- ------------ -------
Provision balance as at
March 29, 2002 $ 2.9 $ 5.0 $ 7.9
Cash draw-downs during
Q1 2003 (0.5) (0.3) (0.8)
Cash draw-downs during
Q2 2003 (0.4) (0.7) (1.1)
Non-cash draw-downs during
Q2 2003 -- (0.5) (0.5)
----- ----- -----
Provision balance as at
September 27, 2002 $ 2.0 $ 3.5 $ 5.5
===== ===== =====
All of the liability relating to the workforce reduction is in respect of
the fourth quarter Fiscal 2002 restructuring program.
10
12. Other income (expense) (net)
Three Months Ended Six Months Ended
---------------------- ---------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
2002 2001 2002 2001
--------- --------- --------- ---------
Interest income $1.0 $ 1.5 $1.9 $ 3.6
Foreign exchange gain (loss) 2.0 (0.7) 1.6 5.6
Equity loss in Optenia, Inc. -- (0.9) -- (1.4)
---- ----- ---- -----
Other income (expense) (net) $3.0 $(0.1) $3.5 $ 7.8
==== ===== ==== =====
13. Information on business segments
The Company's reportable business segments are comprised of the
Communications and Medical groups. Reportable segments are business units
that offer different products and services, sell to different customers,
use different production and distribution processes, and are managed
separately because of these differences.
The Communications business specializes in broadband connectivity
solutions over wired, wireless and optical media. The Communications
business includes network access products that provide connectivity to the
enterprise and metro segments such as feeder, aggregation and transmission
applications and those that address the multi-protocol physical and
network layers. In addition, the Communications business includes user
access products that allow users to connect to the network. These products
include wireless and infotainment applications. Network access products
accounted for $29.4 and $57.8 in revenue in the three and six months ended
September 27, 2002, respectively (three and six months ended September 28,
2001 - $26.6 and $62.4, respectively). User access products accounted for
$10.4 and $23.0 in revenue in the three and six months ended September 27,
2002, respectively (three and six months ended September 28, 2001 - $16.4
and $39.1, respectively).
The Medical business provides ultra low power 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,
which excludes any intersegment sales of products and services. 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; however, depreciation of fixed assets is allocated to the
segments based on the asset usage. The accounting policies of the
reportable segments are the same as those of the Company as reflected in
the consolidated financial statements.
Unallocated
Three Months Ended Sept. 27, 2002 Communications Medical Costs Total
-------------- ------- ----------- ------
Revenue $ 39.8 $ 6.4 $ -- $ 46.2
Depreciation of fixed assets 3.2 -- -- 3.2
Stock compensation expense -- -- 0.2 0.2
Segment's operating loss (12.5) (1.3) (0.2) (14.0)
Unallocated
Three Months Ended Sept. 28, 2001 Communications Medical Costs Total
-------------- ------- ----------- ------
Revenue $ 43.0 $7.5 $ -- $ 50.5
Depreciation of fixed assets 4.4 -- -- 4.4
Amortization of acquired intangibles 0.8 -- -- 0.8
Stock compensation expense -- -- 2.4 2.4
Segment's operating income (loss) (19.1) 2.6 (2.4) (18.9)
11
Unallocated
Six Months Ended Sept. 27, 2002 Communications Medical Costs Total
-------------- ------- ----------- ------
Revenue $ 80.8 $13.4 $ -- $ 94.2
Depreciation of fixed assets 6.4 0.1 -- 6.5
Stock compensation recovery -- -- (1.4) (1.4)
Segment's operating loss (22.8) (1.4) 1.4 (22.8)
Unallocated
Six Months Ended Sept. 28, 2001 Communications Medical Costs Total
-------------- ------- ----------- ------
Revenue $101.5 $16.8 $ -- $118.3
Depreciation of fixed assets 10.4 0.1 -- 10.5
Amortization of acquired intangibles 2.2 -- -- 2.2
Stock compensation expense -- -- 6.3 6.3
Special charge -- -- 34.6 34.6
Segment's operating income (loss) (54.4) 5.0 (40.9) (90.3)
14. Subsequent events
(a) On October 3, 2002, the Company sold its entire 19.9 percent
interest in DALSA Semiconductor Inc. to DALSA for cash proceeds of
$4.1 (Cdn$6.5). The Company will record a gain of approximately $0.7
in the third quarter of Fiscal 2003.
(b) On October 17, 2002, the Company announced that it is withdrawing
from the VDSL (Very high rate Digital Subscriber Line) market in
order to concentrate its R&D resources on higher and more immediate
growth opportunities. The company is ceasing all VDSL product
development, resulting in certain layoffs in its Network Access
group, based in Ottawa. Costs related to these and other layoffs
approximate $3.6? and will be expensed and paid in the third quarter
of Fiscal 2003. The company does not expect this action to impact
revenues.
15. Comparative figures
Certain of the Fiscal 2002 comparative figures have been reclassified to
conform to the presentation adopted in Fiscal 2003.
12
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
Zarlink is a global provider of microelectronics for voice, data and video
networks and for medical applications. Zarlink's semiconductor Communications
business specializes in broadband connectivity solutions over wired, wireless
and optical media. Zarlink's semiconductor Medical business provides
applications specific integrated circuit solutions (ASIC) for applications such
as pacemakers, hearing aids and portable instruments. At September 27, 2002, the
Company employed approximately 1,440 people worldwide, including approximately
500 designers.
The following discussion and analysis explains trends in Zarlink's financial
condition and results of operations for the three and six months ended September
27, 2002, respectively, 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 29, 2002.
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; 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 29, 2002.
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 29, 2002, 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.
13
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED SEPTEMBER 27, 2002
Summary of Results from Operations Three Months Ended Six Months Ended
--------------------- ---------------------
(millions of U.S. dollars, Sept. 27, Sept. 28, Sept. 27, Sept. 28,
except per share amounts) 2002 2001 2002 2001
--------- --------- --------- ---------
Consolidated revenue $ 46.2 $ 50.5 $ 94.2 $118.3
Communications segment revenue 39.8 43.0 80.8 101.5
Medical segment revenue 6.4 7.5 13.4 16.8
Operating loss (14.0) (18.9) (22.8) (90.3)
Communications segment operating loss (12.5) (19.1) (22.8) (54.4)
Medical segment operating income (loss) (1.3) 2.6 (1.4) 5.0
Unallocated recoveries (costs) (0.2) (2.4) 1.4 (40.9)
Net loss for the period (12.4) (20.2) (21.6) (81.2)
Net loss per common share - basic and diluted (0.10) (0.16) (0.17) (0.65)
Weighted average common shares outstanding - millions 127.2 125.6 126.9 125.4
Revenue in the second quarter of Fiscal 2003 was $46.2, a decrease of 9%, or
$4.3, from the second quarter of Fiscal 2002. Revenue in the first half of
Fiscal 2003 was $94.2, a decrease of 20%, or $24.1, from the first half of
Fiscal 2002. Semiconductor sales volumes continue to be affected by the
prolonged downturn impacting the entire semiconductor industry. Higher channel
inventory levels and lower end-customer demand continue to keep sales levels
suppressed.
In the second quarter of Fiscal 2003, the Company recorded a net loss of $12.4,
or $0.10 per share, including stock compensation expense of $0.2. This compares
to a net loss of $20.2, or $0.16 per share, in the second quarter of Fiscal
2002, after amortization of acquired intangibles of $0.8 and stock compensation
expense of $2.4.
During the second quarter of Fiscal 2003, the Company reduced its workforce by
73 employees and incurred severance costs of $1.3, undertaken in a continuing
effort to streamline operations. Of this charge, $0.6 was included in cost of
revenue, negatively impacting gross margins by one percentage point during the
second quarter and first half of Fiscal 2003. The remainder of the charge
increased research and development expense and sales and administration expense
by $0.3 and $0.4, respectively.
For the six months ended September 27, 2002, the Company recorded a net loss of
$21.6, or $0.17 per share, including a stock compensation recovery of $1.4. This
compares to a net loss of $81.2, or $0.65 per share, for the six months ended
September 28, 2001, after a special inventory write-down of $29.1, special
charges of $34.6 related to workforce restructuring, amortization of acquired
intangibles of $2.2, and stock compensation expense of $6.3.
Zarlink's operations are comprised of two reportable business segments -
Communications and Medical. Zarlink targets the communications industry with
offerings that specialize in broadband connectivity solutions over wired,
wireless and optical media. Zarlink's Medical business 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.
Communications
Six Months Ended
----------------------------------------
Sept. 27, % of Sept. 28, % of
(millions of U.S. dollars) 2002 Total 2001 Total
--------- ----- --------- -----
Revenue:
Network Access $ 57.8 72% $ 62.4 61%
User Access 23.0 28% 39.1 39%
------ --- ------ ---
Total Communications $ 80.8 100% $101.5 100%
====== === ====== ===
As a % of total revenue 86% 86%
Communications operating loss $(22.8) $(54.4)
====== ======
Network access and user access products represent the two major growth
categories in the Company's Communications business segment. Network access
products include products that provide connectivity to the enterprise and metro
14
segments such as feeder, aggregation and transmission applications and products
that address the multi-protocol physical and network layers. In simple terms,
network access semiconductor products connect network equipment together. User
access products 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).
Revenue for the first half of Fiscal 2003 totaled $80.8, down 20% from $101.5
for the same period in Fiscal 2002. Revenue was adversely affected by customer
and channel inventory adjustments in the Company's network access and user
access business, a trend that began during the second half of Fiscal 2001 and is
continuing into Fiscal 2003. Revenue also decreased in Fiscal 2003 due to the
loss of foundry revenue resulting from the disposal of two complementary metal
oxide semiconductor ("CMOS") fabrication facilities in the fourth quarter of
Fiscal 2002.
With customers currently placing orders to meet their short-term needs, the
"turns" business (customers placing orders for shipment in the same fiscal
quarter) has been steadily increasing since the second quarter of Fiscal 2002 to
represent approximately 40% of the orders shipped in the three months ended
September 27, 2002.
The segment's operating loss declined to $22.8 in the first half of Fiscal 2003
from an operating loss of $54.4 in the first half of Fiscal 2002. The Fiscal
2002 operating loss included an inventory write-down of $29.1 in the first
quarter of that year. The balance of the improvement is due to the effects of
cost reduction programs implemented since the first quarter of Fiscal 2002.
Medical
Six Months Ended
---------------------------------------
Sept. 27, % of Sept. 28, % of
(millions of U.S. dollars) 2002 Total 2001 Total
--------- ----- --------- -----
Revenue:
Medical $13.4 100% $16.8 100%
===== === ===== ===
As a % of total revenue 14% 14%
Medical operating income (loss) $(1.4) $ 5.0
===== =====
Zarlink's Medical business provides ultra low power ASIC solutions for
applications such as pacemakers, hearing aids and portable instruments.
Revenue decreased in the first six months of Fiscal 2003 to $13.4 from $16.8 in
the first six months of Fiscal 2002 due to higher customer inventories and
reduced demand by customers in the analog audiologic business.
The "turns" business has also increased within the Medical Segment, to represent
approximately 20% of the orders shipped in the three months ended September 27,
2002.
The segment's operating results declined from the same period last year as a
result of lower revenues combined with reduced margins on the medical segment
products.
GEOGRAPHIC REVENUE
Revenue, based on the geographic location of customers, was distributed as
follows:
Six Months Ended
------------------------------------------
Sept. 27, % of Sept. 28, % of
(millions of U.S. dollars) 2002 Total 2001 Total
--------- ----- --------- -----
Revenue:
Asia / Pacific $34.7 37% $ 27.2 23%
Europe 31.0 33% 41.9 36%
United States 19.7 21% 37.7 32%
Canada 6.5 7% 8.6 7%
Other Regions 2.3 2% 2.9 2%
----- --- ------ ---
Total $94.2 100% $118.3 100%
===== === ====== ===
For the six months ended September 27, 2002, the net movement in exchange rates
from the corresponding period in Fiscal 2002 favorably impacted total revenue by
2% ($2.3). The favorable foreign exchange impact in the first six months
15
of Fiscal 2003 was primarily a result of increases in the U.K. pound sterling
and Swedish Krona against the U.S. dollar exchange rate.
Asia/Pacific
Asia/Pacific sales increased by 28% in the first six months of Fiscal 2003
compared to the first six months of Fiscal 2002, due to higher communications
product sales in both of the network and user access product categories,
partially offset by reduced medical sales. The increase partly reflects the
movement of certain customers' manufacturing operations from other parts of the
world to the Asia/Pacific region.
Europe
European sales decreased by 26% in the first six months of Fiscal 2003 compared
to the first six months of Fiscal 2002 due to lower communications segment sales
of both network access and user access products.
United States
Sales into the United States decreased by 48% during the first half of Fiscal
2002 compared to the first half of Fiscal 2003. The decrease was due primarily
to lower medical and user access product sales.
Canada
Canadian sales decreased by 24% in the first half of Fiscal 2003 over the same
period in Fiscal 2002 due to lower communications segment sales.
GROSS MARGIN
Three Months Ended Six Months Ended
-------------------- --------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
(millions of U.S. dollars) 2002 2001 2002 2001
--------- --------- --------- ---------
Gross Margin $20.7 $16.6 $42.8 $21.7
As a percentage of revenue 45% 33% 45% 18%
As a percentage of revenue,
excluding excess Q1
Fiscal 2002 inventory
charge of $29.1 45% 33% 45% 43%
Gross margin improved by 12 percentage points in the second quarter of Fiscal
2003 compared to the same period in Fiscal 2002. Although still being impacted
by lower sales volumes, a favorable product mix in the communications segment
has benefited the margin percentages in the quarter relative to last year.
Compared to the first quarter of Fiscal 2003, gross margin decreased by one
percentage point.
Gross margin improved by two percentage points in the first six months of Fiscal
2003 compared to the same period in Fiscal 2002, excluding the excess inventory
charge recorded in the first quarter of Fiscal 2002. The improved product mix in
the second quarter of Fiscal 2003 has improved the year-to-date margin
percentages, as compared to the same period last year. However, gross margin
continues to be impacted by low sales volumes.
Fiscal 2002 Inventory Charge
During the first quarter ended June 29, 2001, the Company reviewed its inventory
requirements for the following 12 months in light of the semiconductor
industry-wide slowdown and higher channel inventories. As a result of this
review, the Company recorded an excess inventory charge to cost of sales in the
first quarter of Fiscal 2002 amounting to $29.1 for inventories estimated to be
beyond its needs for the following 12 months. Excluding the effect of the excess
inventory charge of $29.1, the Company's gross margin as a percent of revenue
was 43% for the six months ended September 28, 2001.
16
OPERATING EXPENSES
Research and Development ("R&D")
Three Months Ended Six Months Ended
-------------------- --------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
(millions of U.S. dollars) 2002 2001 2002 2001
--------- --------- --------- ---------
R&D Expenses $23.2 $19.5 $43.9 $43.0
As a percentage of revenue 50% 39% 47% 36%
R&D expenses increased by 19%, or $3.7, in the second quarter of Fiscal 2003
from the same period a year ago, primarily due to new product development and
increased headcount in certain R&D projects to accelerate time to market
initiatives. During the first six months of Fiscal 2003, R&D expenses increased
by 2%, or $0.9, compared to the same period in Fiscal 2002.
During the second quarter of Fiscal 2003, the Company released 24 new products,
putting the total for the first six months of Fiscal 2003 at 28 new product
releases. New communications circuits released during Fiscal 2003 target high
performance in network access processing and data switching, and also include
industry leading tuner chips for cable set top boxes. The Company's medical
segment has also released various pacemaker protection circuits during the first
half of 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 2003 as a
result of this exercise. The Company announced on October 17, 2002, that it was
withdrawing from the VDSL (Very high rate Digital Subscriber Line) market in
order to concentrate its R&D resources on higher and more immediate growth
opportunities. Management decided to cease its VDSL product development, within
it communications segment, due to revised expectations of unacceptably long
time-to-revenue and volume deployment.
In the Network Access product line, R&D activities focused on the following
areas:
o Building network timing and synchronization products for high speed
applications;
o Delivering multi-channel carrier-class convergence solutions,
including time division multiplex ("TDM") switching, asynchronous
transfer mode ("ATM") convergence, or internet protocol ("IP")
switching;
o Providing high quality voice in packet switching applications to
metro and enterprise markets; and
o Very Short Reach ("VSR") parallel optical solutions targeted at
terabit speeds and higher.
In the User Access product line, R&D activities focused on the following areas:
o Providing a multi-mode cell phone radio transceiver chip, compliant
with 2/2.5G standards for Time Division Multiple Access
("TDMA")/Global System for Mobile communications ("GSM")/Enhanced
Data rates for GSM Evolution ("EDGE")/General Packet Radio Service
("GPRS")/Advanced Mobile Phone Service/System ("AMPS"), and
developing a 2-chip radio solution for 3rd generation GSM/Wideband
Code Division Multiple Access ("WCDMA") cell phones.
o Providing Tuner, demodulator and peripheral chips for Satellite,
Cable and Terrestrial Digital Set Top boxes, integrated Digital TV's
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 Medical business segment, R&D activities focused on semiconductor
solutions and technologies for a variety of in-vivo and audiological
applications, including:
o Implantable pacemakers and defibrillators for cardiac rhythm
control, hearing aids, cochlea implants (auditory nerve stimulators)
for restoring hearing in the profoundly deaf, and medical
instruments for a variety of diagnostic and therapeutic
applications;
o Ultra low power radio frequency ("RF") communication with medical
devices that have increasing diagnostic capability;
o Ultra low power audio processing and digital signal processing
("DSP") to support digital hearing aids providing improved sound
quality that can be better matched to the patient's hearing loss;
and
o Application-specific standard products ("ASSPs") as opposed to
ASICs.
17
Selling and Administrative ("S&A")
Three Months Ended Six Months Ended
-------------------- --------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
(millions of U.S. dollars) 2002 2001 2002 2001
--------- --------- --------- ---------
S&A Expenses $11.3 $12.8 $23.1 $25.9
As a percentage of revenue 24% 25% 25% 22%
S&A expenses decreased in the second quarter of Fiscal 2003 by $1.5, or 12%
compared to the second quarter of Fiscal 2002. During the six months ended
September 27, 2002, S&A expenses decreased by $2.8, or 11%, as compared to the
first half of Fiscal 2002, principally as a result of cost reductions
implemented in Fiscal 2002 in response to the industry downturn. Management
expects that S&A expenses will continue to show moderate cost savings throughout
Fiscal 2003 in absolute dollar amounts.
Stock Compensation
The Company records stock compensation expense or recovery arising from
retention conditions associated with the stock awarded to certain employees of
Vertex Networks, Incorporated ("Vertex") which was acquired in July 2000, and
from certain stock options subjected to option exchange programs.
During the three months ended September 27, 2002, the Company recorded stock
compensation expense of $0.2, related to the vesting of restricted stock awarded
to certain employees of Vertex (September 28, 2001 - $2.4, related to the
vesting of restricted stock and the amortization of intrinsic value of
unexercised stock options modified by the option exchange programs).
For the six months ended September 28, 2002, the Company recorded a net stock
compensation recovery of $1.4, as compared to a stock compensation expense of
$6.3 for the six months ended September 28, 2001. The compensation recovery in
the first six months of Fiscal 2003 is a result of the decrease in market price
of the underlying common stock in Fiscal 2003. The reduced market price resulted
in a reduction of the intrinsic value being amortized over the term of the stock
option and a recovery of previously recorded stock compensation expense on
outstanding unvested options.
Special Charge Recorded in the First Quarter of Fiscal 2002
In the first quarter of Fiscal 2002 and in response to the industry downturn,
the Company implemented a cost-containment plan in order to preserve cash
resources. The cost-containment plan included a workforce reduction of the
Company's total employee base by 439 employees, globally across all job
categories, which was completed by the end of Fiscal 2002. The total cost of the
first quarter Fiscal 2002 workforce reduction program was estimated to be $26.7.
As a result of the workforce reduction program and consolidating design
activity, the Company took steps to provide for excess leased facilities in
Canada, the United States, the United Kingdom, and the Far East. The estimated
cost of the lease and contract settlements amounted to $7.9 in the first quarter
of Fiscal 2002.
The total of these pre-tax special charges amounted to $34.6 in the first
quarter of Fiscal 2002. In the fourth quarter of Fiscal 2002, $3.1 of the first
quarter special charge was reversed due to savings of $2.3 on the workforce
reduction program and $0.8 related to the subsequent sub-letting of vacant space
in Irvine, California.
Amortization of Acquired Intangibles
Amortization of acquired intangibles decreased in the three and six months ended
September 27, 2002 to nil in each period from $0.8 and $2.2 in the second
quarter and first half of Fiscal 2002, respectively. The remaining acquired
intangibles, including goodwill, resulting from the acquisition of Vertex on
July 28, 2000 were expensed in the third quarter of Fiscal 2002 to reduce the
carrying value to nil. With the adoption of SFAS 142 in Fiscal 2003, intangible
assets with indefinite lives will no longer be amortized, but will be subject to
periodic impairment tests.
OTHER INCOME (EXPENSE)
Other income (expense) was comprised of interest income, foreign exchange gains
or losses, and, in Fiscal 2002, equity losses from the investment in Optenia,
Inc.
18
Interest income was $1.0 for the three months ended September 27, 2002 as
compared to $1.5 in the same period of Fiscal 2002. The decrease from the second
quarter of Fiscal 2002 was mainly due to lower interest rates and reduced cash
balances. During the first six months of Fiscal 2003, interest income was $1.9
as compared to $3.6 in the first six months of Fiscal 2002. The decrease from
the first six months of Fiscal 2002 was also due to the reduced cash balances
and lower interest rates.
Foreign exchange gains in the second quarter of Fiscal 2003 amounted to $2.0 as
compared to a loss of $0.7 for the same period in Fiscal 2002. During the six
months ended September 27, 2002, foreign exchange gains amounted to $1.6 as
compared to a gain of $5.6 for the six months ended September 28, 2001. Gains
(losses) relating to external foreign exchange contracts are recognized in
income as they mature. Gains (losses) are also realized on short-term
investments according to month-end market rates.
There were no further equity losses recorded during the three and six months
ended September 27, 2002, as the investment in Optenia, Inc. was written off to
nil in the fourth quarter of Fiscal 2002 following its bankruptcy. Equity losses
of $0.9 on the investment in Optenia, Inc. were recognized in the second quarter
of Fiscal 2002. During the first half of Fiscal 2002, equity losses on the
investment in Optenia, Inc. amounted to $1.4.
INTEREST EXPENSE
Interest expense was $0.3 for the three months ended September 27, 2002,
compared with $0.2 for the second quarter of Fiscal 2002. During the first half
of Fiscal 2003, interest expense of $0.4 was recognized, unchanged from the
first six months of Fiscal 2002. The interest expense relates principally to
capital leases.
INCOME TAXES
Income tax expense for the second quarter of Fiscal 2003 was $0.6, comprised of
domestic income and capital taxes, compared with an expense of $0.5 for the
corresponding period in Fiscal 2002.
Income tax expense for the first six months of Fiscal 2003 was $0.9, comprised
of domestic income and capital taxes, compared with a recovery of $2.7 for the
corresponding period in Fiscal 2002. The income tax recovery in the first six
months of Fiscal 2002 was due principally to tax allowances on the special
inventory charge recorded at June 29, 2001.
The Company has a valuation allowance at September 27, 2002 of $98.2 (March 29,
2002 - $75.8). The increase relates mainly to losses incurred in the Company's
foreign jurisdictions and temporary differences in the Company's domestic
operations. Management has determined that sufficient uncertainties exist
regarding the realization of certain of its deferred tax assets.
BACKLOG
As at
--------------------------------------------------
(millions of U.S. dollars) Sept. 27, 2002 June 28, 2002 March 29, 2002
-------------- ------------- --------------
90 Day Backlog $31.5 $28.0 $33.5
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.
The backlog decrease from last year has been attributable to 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 of $12.4, or $0.10 per share, in the second
quarter of Fiscal 2003. This compares to a net loss of $20.2, or $0.16 per
share, in the same period in Fiscal 2002. For the six months ended September 27,
2002, the Company recorded a net loss of $21.6, or $0.17 per share, as compared
to a net loss of $81.2, or $0.65 per share, in the first six months of Fiscal
2002.
The net losses for the three and six months ended September 27, 2002, were
primarily a result of lower revenues across the communications and medical
segments. The net loss in the quarter also included a stock compensation expense
of $0.2, while the year-to-date net loss included a stock compensation recovery
of $1.4.
19
The comparative net loss for the six months ended September 28, 2001 included a
charge to cost of revenue for excess inventory of $29.1 and special
restructuring charges of $34.6. The loss also included stock compensation
expense of $6.3 and amortization of intangibles of $2.2.
LIQUIDITY AND CAPITAL RESOURCES
At September 27, 2002, cash, cash equivalents and short-term investment balances
totaled $132.7, down from $154.4 at March 29, 2002. Cash and cash equivalents at
September 27, 2002, included in the amount above, amounted to $67.9 (March 29,
2002 - $75.6).
Cash flow used in operations before working capital changes amounted to $14.9
during the first six months of Fiscal 2003 as compared to $30.4 used in the
first six months of Fiscal 2002 when the Company began to carry out significant
restructuring activities. Since March 29, 2002, the Company's working capital,
as reflected in the consolidated statements of cash flows, decreased by $2.5,
mainly as a result of inventory reductions, principally in finished goods,
amounting to $7.1 and lower receivables by $3.0. This was offset by the
reduction of trade accounts payable and other accrued liabilities in the amount
of $14.8. Management expects to further draw down inventory levels in Fiscal
2003 by reducing cycle times and managing inventories on a build-to-order basis.
Cash flows provided by investing activities were $10.9 for the six months ended
September 27, 2002, primarily from matured short-term investments of $161.7, net
of purchased short-term investments of $146.5, offset by $4.3 of fixed asset
purchases. The fixed asset additions were primarily related to design tools and
continuing improvements to information technology resources. Management expects
capital spending in the second half of Fiscal 2003 to remain relatively flat, as
compared to the second quarter of this year. Cash flows used in investing
activities were $18.9 for the six months ended September 28, 2001, primarily
from $22.9 of fixed asset additions, offset by proceeds from the repayment of a
note receivable in the amount of $4.5. Additions to fixed assets during the
first six months of Fiscal 2002 mainly consisted of construction of the
Company's new headquarters in Ottawa, Canada. The building was subsequently sold
in the fourth quarter of Fiscal 2002.
Cash flows used in financing activities during the first six months of Fiscal
2003 were $2.3. The use of cash was primarily the result of the repayment of
$1.4 of capital leases, 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. The cash flows used in
financing activities in the first six months of Fiscal 2002 were $2.8. The use
of cash was primarily the result of the repayment of $3.5 of long-term debt and
capital leases, the repurchase of $0.4 of preferred shares, and the payment of
$1.0 for dividends on the preferred shares, offset by $2.1 of new common shares
issued from exercised stock options.
During Fiscal 2002, the Company took steps to wind up the defined benefit
pension plan in the United Kingdom and replaced it with a defined contribution
plan. The cost to settle the pension plan is expected to be approximately $6.0.
The Company expects to make this payment in the fourth quarter of Fiscal 2003
after the appropriate approvals are received and the plan is ultimately settled.
During the first six months of Fiscal 2003, the Company declared and paid
dividends amounting to $1.0 on its redeemable preferred shares based on a $0.32
(Cdn$0.50) per share dividend. In addition, the Company purchased 27,700
preferred shares under its purchase obligation during the six months ended
September 27, 2002. All of the repurchased preferred shares were cancelled as at
September 27, 2002. The cost to repurchase the preferred shares amounted to $0.4
in the first half of Fiscal 2003.
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 will 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, or on such earlier
date as the Company may complete its purchases pursuant to the notice of
intention to make a normal course issuer bid filed with The Toronto Stock
Exchange. The Company, which intends to cancel the repurchased shares, believes
that at present no director, senior officer or insider of the Company intends to
sell any common shares under this program. No common shares were repurchased
under the program during the period from March 30, 2002 to June 8, 2002, nor
under the renewed program for the period ended September 27, 2002.
In addition to cash, cash equivalents and short-term investment balances of
$132.7 as at September 27, 2002, the Company had a revolving global credit
facility of approximately $15.8 (Cdn$25.0), of which $3.1 in letters of credit
were outstanding. Accordingly, the Company had unused and available demand bank
lines of credit amounting to $12.7 as at September 27, 2002. Management believes
the Company is in a position to meet all foreseeable business cash
20
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. 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 29, 2002.
As at September 27, 2002, the Company had investments in private companies with
a carrying value of $14.6 (March 29, 2002 - $14.1). Management periodically
reviews these investments to determine if there has been other than a temporary
decline in the market value of these investments below the carrying value. When
management performs future assessments of these investments in the coming
quarters, a decline in the value of these companies may require the Company to
recognize impairment on the remaining value of its investments which could be
material.
Foreign Currency Translation
Management periodically evaluates the financial and operational independence of
its foreign operations. Should a foreign subsidiary's local currency cease to be
its functional currency, then translation gains or losses on consolidating the
foreign subsidiary's financial statements subsequent to the change in functional
currency would be charged to operating income instead of a separate component of
accumulated other comprehensive income.
Recently issued accounting standards
In July 2002, the Financial Accounting Standards Board ("FASB") issued Statement
No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities", which addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies EITF Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)."
Statement 146 requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred. Under Issue
94-3, a liability for an exit cost was recognized at the date of an entity's
commitment to an exit plan. Statement 146 concludes that an entity's commitment
to a plan, by itself, does not create a present obligation to others that meets
the definition of a liability. Therefore, SFAS 146 eliminates the definition and
requirements for recognition of exit costs in Issue 94-3. SFAS 146 also
establishes that fair value is the objective for initial measurement of the
liability. SFAS 146 will be effective for exit or disposal activities initiated
after December 31, 2002 and had no impact on the Company's financial statements,
but will impact the accounting treatment of future exit or disposal activities
should they occur.
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 U.S. dollar and the U.K. pound sterling. At September 27, 2002,
there were unrealized losses of $0.1 on the forward contracts relating to Fiscal
2003. The unrealized loss 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 27, 2002, 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.
21
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 27, 2002, 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 29, 2002.
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES
As of October 25, 2002, an evaluation was performed under the supervision and
with the participation of the management of Zarlink Semiconductor ("Zarlink" or
"the Company"), including the 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 September 27, 2002. There have been
no significant changes in the Company's internal controls or in other factors
that could significantly affect internal controls subsequent to September 27,
2002.
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders was held on July 31, 2002 at the Chateau
Laurier Hotel, Ottawa, Canada. At the Annual Meeting, the following matters were
presented to shareholders for approval:
Motion 1: In respect of the election of directors;
Motion 2: In respect of the appointment of Ernst & Young, LLP as auditors;
Motion 3: Approval of the amendments to By-law No. 16 of the Company relating
to Canadian residency requirements of members of the Board of
Directors and committees thereof.
Motion 4: Approval of all other amendments By-law No. 16.
The results of matters submitted to a vote of shareholders were as follows:
Motion 1: Shares
For 85,679,313
Withheld 429,542
Motion 2: Shares
For 83,114,913
Withheld 2,993,942
Motion 3: Shares
For 85,668,392
Against 440,463
Motion 4: Shares
For 82,067,644
Against 4,041,211
The following nine directors were re-elected at the 2002 Annual Meeting: Mr.
Andre Borrel, Mr. Patrick J. Brockett, Mr. Jean-Jacques Carrier, Mr. Hubert T.
Lacroix, Mr. Kirk K. Mandy, Mr. Donald G. McIntyre, Mr. Kent H.E. Plumley, Dr.
Henry Simon, and Dr. Semir D. Sirazi.
22
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
b) Reports on Form 8-K
There were no reports on Form 8-K filed during the three months ended September
27, 2002.
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/ Jean-Jacques Carrier Director, Senior Vice November 6, 2002
- ------------------------ President of Finance 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: November 6, 2002
----------------
/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, Jean-Jacques Carrier, 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: November 6, 2002
----------------
/s/ Jean-Jacques Carrier
---------------------------------
Jean-Jacques Carrier
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. 27
Dollars and in accordance with Canadian Generally
Accepted Accounting Principles
99.2 Management's Discussion and Analysis of Financial 36
Condition and Results of Operations - Canadian
Supplement
26