http://www.zarlink.com
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 December 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 January 30, 2004 there were 127,276,474 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.................................................3
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.....................................3
Consolidated Balance Sheets......................................3
Consolidated Statements of Loss (Unaudited)......................4
Consolidated Statements of Cash Flows (Unaudited)................5
Notes to the Consolidated Financial Statements...................6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS............................................17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...........27
ITEM 4. CONTROLS AND PROCEDURES..............................................27
PART II - OTHER INFORMATION...................................................28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................28
Signatures....................................................................28
2
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Zarlink Semiconductor Inc.
CONSOLIDATED BALANCE SHEETS
(In millions of U.S. dollars, U.S. GAAP)
December 26, March 28,
2003 2003
------------ ---------
(Unaudited) (Note 1)
ASSETS
Current assets:
Cash and cash equivalents $ 18.6 $ 23.5
Short-term investments 59.7 89.5
Restricted cash 9.5 6.2
Trade accounts receivable, less allowance for
doubtful accounts of $0.5 (March 28, 2003 - $1.1) 29.4 20.3
Other receivables 2.9 4.2
Note receivable - net of deferred gain of $16.8
(March 28, 2003 - $15.8) 0.1 --
Inventories 23.6 24.0
Deferred income tax assets - net 1.2 1.0
Prepaid expenses and other 10.1 7.3
-------- --------
155.1 176.0
Fixed assets - net 43.3 56.4
Deferred income tax assets - net 11.7 10.4
Other assets 4.5 4.7
Note receivable - net of deferred gain of $16.8
(March 28, 2003 - $15.8) -- 0.1
-------- --------
$ 214.6 $ 247.6
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 18.0 $ 10.1
Employee-related accruals 11.6 15.5
Income and other taxes payable 14.0 13.0
Provisions for exit activities 3.9 4.2
Other accrued liabilities 10.8 12.6
Deferred credits 1.0 1.1
Current portion of long-term debt 0.2 0.6
-------- --------
59.5 57.1
Long-term debt 0.1 0.2
Pension liabilities 17.1 14.3
Deferred income tax liabilities - net 2.2 2.0
-------- --------
78.9 73.6
-------- --------
Redeemable preferred shares, unlimited shares
authorized; 1,377,400 shares issued and
outstanding (March 28, 2003 - 1,451,600) 17.6 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 2.2 2.1
Deficit (620.7) (582.8)
Accumulated other comprehensive loss (31.7) (32.5)
-------- --------
118.1 155.1
-------- --------
$ 214.6 $ 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 Nine Months Ended
---------------------- ----------------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
------ ------ ------ ------
Revenue $ 47.0 $ 46.8 $147.3 $141.0
Cost of revenue 26.0 25.6 81.3 77.0
------ ------ ------ ------
Gross margin 21.0 21.2 66.0 64.0
------ ------ ------ ------
Expenses:
Research and development 19.5 23.5 57.9 66.8
Selling and administrative 11.8 11.8 37.6 35.6
Asset impairment and other 1.7 -- 7.0 --
Stock compensation expense (recovery) 0.1 -- 0.1 (1.4)
------ ------ ------ ------
33.1 35.3 102.6 101.0
------ ------ ------ ------
Loss from operations (12.1) (14.1) (36.6) (37.0)
Other income (expense) - net (0.2) 1.0 (0.5) 4.5
Interest expense (0.3) (0.3) (0.6) (0.7)
------ ------ ------ ------
Loss before income taxes (12.6) (13.4) (37.7) (33.2)
Income tax (expense) recovery 1.4 (0.3) 1.4 (1.2)
------ ------ ------ ------
Net loss for the period $(11.2) $(13.7) $(36.3) $(34.4)
====== ====== ====== ======
Net loss attributable to common shareholders
after preferred share dividends $(11.8) $(14.2) $(37.9) $(35.9)
====== ====== ====== ======
Net loss per common share:
Basic and diluted $(0.09) $(0.11) $0.30) $(0.28)
====== ====== ====== ======
Weighted average number of common shares
outstanding (millions):
Basic and diluted 127.3 127.2 127.3 127.0
====== ====== ====== ======
(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 Nine Months Ended
---------------------- ----------------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
------ ------ ------ ------
CASH PROVIDED BY (USED IN)
Operating activities:
Net loss for the period $(11.2) $ (13.7) $ (36.3) $ (34.4)
Depreciation of fixed assets 2.8 3.1 9.7 9.6
Amortization of other assets 0.4 0.3 1.2 0.9
Other non cash changes in operating activities 2.3 (0.5) 9.3 (2.0)
Stock compensation expense (recovery) 0.1 -- 0.1 (1.4)
Deferred income taxes (0.4) 0.1 (1.2) 0.1
Decrease (increase) in working capital
Trade accounts and other receivables (2.8) 3.9 (8.4) 6.4
Inventories (1.8) 5.6 0.5 12.9
Prepaid expenses and other 0.2 1.6 (2.5) 3.6
Trade accounts payable and other accrued liabilities 2.8 (5.8) 2.7 (20.3)
Deferred credits 0.3 3.7 0.1 4.0
------ ------- ------- -------
Total (7.3) (1.7) (24.8) (20.6)
------ ------- ------- -------
Investing activities:
Purchased short-term investments (59.7) (103.1) (144.7) (252.7)
Matured short-term investments 35.2 62.3 174.5 228.3
Proceeds from disposal of fixed and other assets 0.2 -- 0.8 0.4
Expenditures for fixed and other assets (1.5) (1.4) (4.7) (5.7)
Increase in long-term investments -- -- -- (0.4)
Proceeds from sale of long-term investments 0.6 4.2 0.6 4.2
------ ------- ------- -------
Total (25.2) (38.0) 26.5 (25.9)
------ ------- ------- -------
Financing activities:
Repayment of capital lease liabilities (0.1) (0.4) (0.5) (1.8)
Payment of dividends on preferred shares (0.6) (0.5) (1.6) (1.5)
Issue of common shares -- -- -- 0.5
Repurchase of preferred shares (0.7) (0.9) (1.2) (1.3)
Increase in hypothecation of cash under letters
of credit (3.9) -- (3.3) --
------ ------- ------- -------
Total (5.3) (1.8) (6.6) (4.1)
------ ------- ------- -------
Effect of currency translation on cash and cash equivalents -- 1.4 -- 2.8
------ ------- ------- -------
Decrease in cash and cash equivalents (37.8) (40.1) (4.9) (47.8)
Cash and cash equivalents, beginning of period 56.4 67.9 23.5 75.6
------ ------- ------- -------
Cash and cash equivalents, end of period $ 18.6 $ 27.8 $ 18.6 $ 27.8
====== ======= ======= =======
(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 December 26, 2003,
and the results of operations and cash flows of the Company for the three
and nine month periods ended December 26, 2003 and December 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.
The balance sheet at March 28, 2003 has been derived from the audited
consolidated financial statements at that date but does not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. 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.
6
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
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.
In January 2003, the FASB issued Interpretation No. 46, ("FIN 46"),
"Consolidation of Variable Interest Entities". FIN 46 expands upon existing
guidance that addresses when a company should include in its financial
statements the assets, liabilities, and activities of another company. A
variable interest entity is any legal structure used for business purposes
that either (a) does not have equity investors or has equity investors that
lack characteristics of control; or (b) the equity investment at risk does
not provide sufficient financial resources for the entity to support its
activities. Under FIN 46, a variable interest entity must be consolidated
by a company if that company is expected to absorb a majority of the
entity's expected losses or to receive a majority of the entity's expected
residual returns. The consolidation requirements are currently applicable
to variable interests created after January 31, 2003. For variable interest
entities created before January 31, 2003, the consolidation requirements
are applicable for reporting periods ending after March 15, 2004. FIN 46
also requires certain disclosures about variable interest entities where
those entities are not required to be consolidated. The Company has not yet
evaluated the impact of this new pronouncement on its financial position or
results of operations.
In December 2003 the FASB published a revision to Statement of Financial
Accounting Standard No. 132 ("SFAS 132"), "Employers Disclosures about
Pensions and Other Postretirement Benefits". The revision requires
additional disclosure, including information describing the types of plan
assets, investment strategy, measurement date(s), plan obligations, cash
flows, and components of net periodic benefit cost recognized during
interim periods. Most of the guidance in the revision to SFAS 132 relating
to domestic plans is effective for year ends after December 15, 2003, and
the guidance relating to foreign plans is effective for year ends after
June 15, 2004. The requirements pertaining to interim periods are effective
for quarters beginning after December 15, 2003. The adoption of the
revision to SFAS 132 is not expected to have a material impact on the
Company's financial position or results of operations.
7
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 Nine Months Ended
---------------------- ----------------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
------ ------ ------ ------
Net loss, as reported $(11.2) $(13.7) $(36.3) $(34.4)
Adjustments:
Stock compensation expense (recovery) as 0.1 -- 0.1 (1.4)
reported
Pro forma stock compensation expense (3.4) (3.3) (9.6) (10.0)
------ ------ ------ ------
Pro forma net loss $(14.5) $(17.0) $(45.8) $(45.8)
------ ------ ------ ------
Net loss per common share, as reported
Basic and diluted $(0.09) $(0.11) $(0.30) $(0.28)
------ ------ ------ ------
Pro forma net loss per common share:
Basic and diluted $(0.12) $(0.14) $(0.37) $(0.37)
------ ------ ------ ------
Based upon the fair value method of accounting for stock compensation
expense, the pro forma net loss for the three and nine months ended
December 26, 2003, was increased by $3.3 and $9.5, respectively, as
compared to the net loss, as reported (three and nine months ended December
27, 2002, $3.3 and $11.4, respectively).
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 nine month fiscal periods
ended December 26, 2003 and December 27, 2002:
Three Months Ended Nine Months Ended
---------------------- ----------------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
------ ------ ------ ------
Weighted average fair value price of the
options granted during the quarter $ 1.50 $ 1.19 $ 1.74 $ 1.82
Risk free interest rate 3.26% 3.45% 3.15% 3.82%
Dividend yield Nil Nil Nil Nil
Volatility factor of the expected market
price of the Company's common stock 0.701 0.673 0.692 0.622
Weighted average expected life of the options 3.3 years 3.1 years 3.3 years 3.1 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.
8
5. Inventories
Dec. 26, March 28,
2003 2003
------- --------
Raw materials $ 2.4 $ 2.6
Work-in-process 17.0 18.3
Finished goods 4.2 3.1
------- -------
$ 23.6 $ 24.0
======= =======
6. Fixed assets
Dec. 26, March 28,
2003 2003
------- --------
Cost $ 164.3 $ 163.7
Accumulated depreciation 121.0 107.3
------- -------
$ 43.3 $ 56.4
======= =======
The Company recorded an impairment loss on fixed assets of $1.4 and $6.1,
respectively, during the three and nine months ended December 26, 2003, as
a result of a review of the ongoing usage of the Company's testing
equipment and enterprise resource planning system.
7. Other assets
Dec. 26, March 28,
2003 2003
------- --------
Patents, trademarks, and other intangible
assets:
Cost $ 10.8 $ 9.5
Accumulated amortization (6.3) (5.0)
------- -------
Patents, trademarks, and other intangible
assets - net 4.5 4.5
Other -- 0.2
------- -------
$ 4.5 $ 4.7
======= =======
The amortization of patents, trademarks and other intangible assets
amounted to $0.4 and $1.2, respectively, for the three and nine months
ended December 26, 2003 (three and nine months ended December 27, 2002 -
$0.3 and $0.9, respectively).
8. Note receivable
Dec. 26, March 28,
2003 2003
------- --------
Note receivable, non-interest bearing $16.9 $ 15.9
Less: Deferred gain (16.8) (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
9. Provisions for exit activities
Dec. 26, March 28,
2003 2003
------- --------
Restructuring provisions $ 3.3 $ 2.9
Provision for disposal of discontinued
operations -- 0.1
Provision for disposal of foundry businesses 0.6 1.2
------- -------
$ 3.9 $ 4.2
======= =======
During the second and third quarters of Fiscal 2004, the Company
implemented further cost reductions in efforts to outsource programs and
streamline operations. During the three months ended December 26, 2003, the
Company incurred workforce reduction costs of $2.9 ($6.3 year-to-date) as a
result of reducing the Company's employee base by approximately 100
employees, bringing the total employee reduction to approximately 220 for
the first nine months of Fiscal 2004. The reductions were performed
globally across all job categories and business units. During the third
quarter, severance costs of $1.4 ($2.4 year-to-date) 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 $1.1 ($2.9 year-to-date) were included in selling and
administration. The Company also recorded severance costs of $0.4 ($1.0
year-to-date) in cost of revenue, related to further cost reductions as it
finalizes its outsourcing programs and streamlines operations.
As a result of the workforce reduction program and streamlining of
operations, the Company recorded a charge of $nil during the third quarter
of Fiscal 2004 ($0.6 year-to-date), included in asset impairment and other,
related to excess space under lease contract in Canada.
Of the $2.9 of restructuring provision recorded in the third quarter of
Fiscal 2004, $1.8 related to the Network Communications segment, $1.0
related to the Consumer Communications segment, and $0.1 related to the
Ultra Low-Power Communications segment. The restructuring provision
recorded in the nine months ended December 26, 2003 included $4.4 related
to the Network Communications segment, $1.9 pertaining to the Consumer
Communications segment, and $0.6 in the Ultra Low-Power Communications
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, that will be paid over the lease term unless settled earlier.
The following table summarizes the continuity of these restructuring
provisions for the three and nine months ended December 26, 2003:
Lease
Workforce and 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
Restructuring activities during
the quarter 2.9 -- 2.9
Cash drawdowns during quarter (3.3) (0.1) (3.4)
------ ----- -----
Balance, Dec. 26, 2003 $ 1.0 $ 2.3 $ 3.3
====== ===== =====
10
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 December 26, 2003, was $35.5 (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 December 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 December 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 December 26,
2003, the taxation years 2000 to February 16, 2001 are subject to audit by
taxation authorities.
As at December 26, 2003, the Company has guaranteed a custom bond amounting
to $2.8 to a third party on behalf of a subsidiary.
Based upon the transition rules outlined in FASB Interpretation no. 45
("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for
Guarantees of Indebtedness of Others", 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 nine month
periods ended December 26, 2003:
Three Months Nine Months
Ended Ended
Dec. 26, 2003 Dec. 26, 2003
------------- -------------
Beginning balance $ 0.1 $ --
Accruals for new and pre-existing warranties -- 0.5
Reduction based on change in estimates -- (0.4)
------ ------
Ending balance $ 0.1 $ 0.1
====== ======
11
11. Commitments
The Company had letters of credit outstanding as at December 26, 2003 of
approximately $9.2 (December 27, 2002 - $6.0). Cash and cash equivalents of
$9.5 have been pledged as security against certain outstanding letters of
credit, which expire within 12 months, and are presented as restricted
cash.
During the third quarter of Fiscal 2004, the Company cancelled the
operating line component of its revolving global credit facility, as it was
not being utilized or required by the Company. This resulted in reducing
the total credit facility from $19.0 (Cdn $25.0) to a facility of $9.5 (Cdn
$12.5) available for letters of credit.
Prior to the third quarter of Fiscal 2004, the Company had not met a
quarterly financial covenant with respect to shareholder's equity under the
Company's credit facility, as a result of restructuring and impairment
losses recorded since the fourth quarter of Fiscal 2003. In previous
quarters the Company had obtained a waiver from the bank in respect of the
financial covenant. In addition to the reduction in the amount of the
credit facility, the financial covenant with respect to shareholder's
equity was also modified under the new agreement, such that no waiver was
required as at December 26, 2003.
12. Redeemable Preferred Shares
There were 64,300 preferred shares purchased during the nine months ended
December 26, 2003 for cash consideration of $1.2. As at December 26, 2003,
there were 12,900 repurchased preferred shares that had not been cancelled
by the end of the quarter.
During the third quarter of Fiscal 2004, the Company paid dividends on its
redeemable preferred shares of $0.6 and declared a quarterly dividend of
$0.38 (Cdn$0.50) per share, resulting in a cumulative dividend of $1.14
(Cdn$1.50) per share for the first nine 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:
Nine Months Ended
-----------------------------
December 26, December 27,
2003 2002
----------- -----------
Outstanding Options:
Balance, beginning of period 10,828,557 10,914,962
Granted 379,500 400,300
Exercised (10,617) (109,193)
Forfeited (1,396,565) (1,896,121)
----------- -----------
Balance, end of period 9,800,875 9,309,948
=========== ===========
As at December 26, 2003, there were 4,731,187 (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 $2.59 to $28.50 per share with
exercise periods extending to December 2009. The exercise price of stock
options was based on prices in Canadian dollars translated at the U.S.
dollar exchange rate on December 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.
12
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 Nine Months Ended
------------------- ---------------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
------ ------ ------ ------
Stock options 19,599 30,473 328,532 91,921
====== ====== ======= ======
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 Nine Months Ended
------------------- --------------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
------ ------ ------ ------
Number of outstanding
options 9,488,938 9,218,448 7,126,213 8,837,767
Average exercise price
per share $ 9.13 $ 8.92 $ 10.87 $ 9.21
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 Nine Months Ended
---------------------- ----------------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
------ ------ ------ ------
Net loss for the period $(11.2) $(13.7) $(36.3) $(34.4)
Other comprehensive income (loss):
Realized net derivative gains on cash flow
hedges (0.3) (0.9) (0.3) (2.3)
Unrealized net derivative gains (losses) on
cash flow hedges 0.7 (1.5) 1.1 (3.7)
Change in cumulative translation adjustment -- 2.8 -- 9.3
------ ------ ------ ------
Other comprehensive loss for the period $(10.8) $(13.3) $(35.5) $(31.1)
====== ====== ====== ======
The changes to accumulated other comprehensive loss for the nine months
ended December 26, 2003 were as follows:
Realized and
Unrealized
Cumulative Net Gain
Translation (Loss) on
Account Derivatives Total
------- ----------- -----
Balance, March 28, 2003 $(32.4) $(0.1) $(32.5)
Change during the three months ended June 27,
2003 -- 0.2 0.2
------ ----- ------
Balance, June 27, 2003 $(32.4) $ 0.1 $(32.3)
Change during the three months ended
September 26, 2003 -- 0.2 0.2
------ ----- ------
Balance, September 26, 2003 $(32.4) $ 0.3 $(32.1)
Change during the three months ended December
26, 2003 -- 0.4 0.4
------ ----- ------
Balance, December 26, 2003 $(32.4) $ 0.7 $(31.7)
====== ===== ======
13
The Company recorded a decrease in other comprehensive loss in the nine
months ended December 26, 2003 of $0.8 (December 27, 2002 - increase of
$6.0) 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 $0.7
of net derivative gain included in other comprehensive loss will be
reclassified into earnings within the next six months.
15. Other income (expense) (net)
Three Months Ended Nine Months Ended
---------------------- ----------------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
------ ------ ------ ------
Interest income $ 0.4 $ 0.7 $ 1.0 $2.6
Foreign exchange gain (loss) (1.2) (0.4) (2.1) 1.2
Gain on sale of long-term investments 0.6 0.7 0.6 0.7
----- ----- ----- ----
Other income (expense) (net) $(0.2) $ 1.0 $(0.5) $4.5
===== ===== ===== ====
On December 5, 2003, the Company sold its investment in a privately held
company for cash proceeds of $0.6. The carrying value had been written down
to $nil in Fiscal 2002 to reflect an impairment of the investment.
16. Income Taxes
An income tax recovery of $1.4 was recorded for the third quarter of Fiscal
2004 as a result of a recovery of domestic income taxes, compared with an
expense of $0.3 for the corresponding period in Fiscal 2003. During the
nine months ended December 26, the income tax recovery was $1.4, compared
with an expense of $1.2 for the first nine months of Fiscal 2003.
The Company is subject to income taxes in Canada, the United Kingdom, the
United States and numerous other foreign jurisdictions. The Company has
recorded a valuation allowance on its deferred tax assets, and recorded
only deferred tax assets that can be applied against income in taxable
jurisdictions or applied against deferred tax liabilities that will reverse
in the future. Significant judgment is required in determining the
provision for income taxes and the valuation allowance on deferred tax
assets. In establishing the appropriate valuation allowance for tax loss
carry-forwards and investment tax credits, it is necessary to consider all
available evidence, both positive and negative.
Management periodically reviews the Company's valuation allowance to
determine whether the overall tax estimates are reasonable. When management
performs its quarterly assessments of the valuation allowance, it may be
determined that an adjustment is required to the valuation allowance, which
may have a material impact on the Company's financial position and results
of operations.
17. 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 segment provides
Application-Specific Integrated Circuit ("ASIC") and Application-Specific
Standard Product ("ASSP") solutions for applications such as pacemakers,
hearing aids and portable instruments.
14
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, interest expense or income taxes to its
reportable segments. In addition, the Company does not use a measure of
segment assets to assess performance or allocate resources. As a result,
segmented asset information is not presented; however, depreciation of
fixed assets is allocated to the segments based on the estimated asset
usage. The accounting policies of the reportable segments are the same as
those of the Company as reflected in the consolidated financial statements.
Three Months Ended Dec. 26, 2003 Network Consumer Ultra Low-Power Unallocated
Communications Communications Communications Costs Total
-------------- -------------- -------------- ----------- -----
Total external sales revenue $ 24.6 $ 14.9 $ 7.5 $ -- $ 47.0
Depreciation of buildings and equipment 1.8 0.6 0.4 -- 2.8
Asset impairment and other 1.6 0.1 -- -- 1.7
Stock compensation expense -- -- -- 0.1 0.1
Segment's operating income (loss) (6.7) (5.4) 0.1 (0.1) (12.1)
Network Consumer Ultra Low-Power Unallocated
Three Months Ended Dec. 27, 2002 Communications Communications Communications Costs Total
-------------- -------------- -------------- ----------- -----
Total external sales revenue $ 27.8 $ 12.0 $ 7.0 $ -- $ 46.8
Depreciation of buildings and equipment 2.4 0.5 0.2 -- 3.1
Stock compensation expense -- -- -- -- --
Segment's operating loss (8.3) (4.6) (1.2) -- (14.1)
Nine Months Ended Dec. 26, 2003 Network Consumer Ultra Low-Power Unallocated
Communications Communications Communications Costs Total
-------------- -------------- -------------- ----------- -----
Total external sales revenue $ 78.9 $ 42.1 $ 26.3 $ -- $ 147.3
Depreciation of buildings and equipment 5.5 2.7 1.5 -- 9.7
Asset impairment and other 4.6 2.0 0.4 -- 7.0
Stock compensation expense -- -- -- 0.1 0.1
Segment's operating loss (20.6) (15.0) (0.9) (0.1) (36.6)
Network Consumer Ultra Low-Power Unallocated
Nine Months Ended Dec. 27, 2002 Communications Communications Communications Costs Total
-------------- -------------- -------------- ----------- -----
Total external sales revenue $ 85.6 $ 35.0 $ 20.4 $ -- $ 141.0
Depreciation of buildings and equipment 7.5 1.7 0.4 9.6
Stock compensation recovery -- -- -- (1.4) (1.4)
Segment's operating loss (20.1) (15.7) (2.6) 1.4 (37.0)
15
18. Supplementary cash flow information
The following table summarizes the Company's other non cash changes in
operating activities:
Three Months Ended Nine Months Ended
---------------------- ----------------------
Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
------ ------ ------ ------
Cash provided by (used in)
Loss (gain) on disposal of fixed assets $ -- $ (0.1) $ 0.1 $ (0.1)
Foreign exchange loss (gain) on short-term
investments -- 0.3 -- (1.2)
Gain on sale of long-term investment (0.6) (0.7) (0.6) (0.7)
Change in pension liabilities 1.2 -- 2.8 --
Impairment of fixed and other assets 1.7 -- 6.4 --
Provision for excess space under lease contract -- -- 0.6 --
------ ------ ------ ------
Other non cash changes in operating activities $ 2.3 $ (0.5) $ 9.3 $ (2.0)
====== ====== ====== ======
19. Comparative figures
Certain of the Fiscal 2003 comparative figures have been reclassified to
conform to the presentation adopted in Fiscal 2004.
16
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 nine months ended December
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; product mix; 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.
17
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED DECEMBER 26, 2003
Three Months Ended Nine Months Ended
Summary of Results from Operations ------------------------ ------------------------
(millions of U.S. dollars, except per share Dec. 26, Dec. 27, Dec. 26, Dec. 27,
amounts) 2003 2002 2003 2002
---- ---- ---- ----
Consolidated revenue $ 47.0 $ 46.8 $ 147.3 $ 141.0
Network Communications 24.6 27.8 78.9 85.6
Consumer Communications 14.9 12.0 42.1 35.0
Ultra Low-Power Communications 7.5 7.0 26.3 20.4
Operating income (loss) (12.1) (14.1) (36.6) (37.0)
Network Communications (6.7) (8.3) (20.6) (20.1)
Consumer Communications (5.4) (4.6) (15.0) (15.7)
Ultra Low-Power Communications 0.1 (1.2) (0.9) (2.6)
Unallocated recoveries (costs) (0.1) -- (0.1) 1.4
Net loss for the period (11.2) (13.7) (36.3) (34.4)
Net loss per common share - basic and diluted (0.09) (0.11) (0.30) (0.28)
Weighted average common shares outstanding - millions 127.3 127.2 127.3 127.0
Revenue in the third quarter of Fiscal 2004 was $47.0, in line with revenue of
$46.8 in the third quarter of Fiscal 2003. Revenue in the first nine months of
Fiscal 2004 was $147.3, an increase of 4% from the first nine 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. However, the Company experienced higher sequential bookings in the
third quarter of Fiscal 2004, and bookings remain in line with the levels
experienced during the same period in Fiscal 2003.
In the third quarter of Fiscal 2004, the Company recorded a net loss, after
preferred share dividends, of $11.8, or $0.09 per share. This compares to a net
loss, after preferred share dividends, of $14.2, or $0.11 per share, in the
third quarter of Fiscal 2003.
For the nine months ended December 26, 2003, the Company recorded a net loss,
after preferred share dividends, of $37.9, or $0.30 per share. This compares to
a net loss, after preferred share dividends, of $35.9, or $0.28 per share, for
the nine months ended December 27, 2002.
The Company implemented further cost reductions in the second and third quarters
of Fiscal 2004 in efforts to outsource programs and streamline operations.
During the third quarter, the Company incurred $2.9 ($6.3 year-to-date) of
expenses related to reducing its global workforce by approximately 100
employees, bringing the total workforce reduction for the nine months ended
December 26, 2003 to approximately 220 employees. Workforce reductions were
implemented across all regions and business units. The Company also recorded a
charge related to excess space under lease contract of $nil ($0.6 year-to-date)
as a result of restructuring activities implemented during the periods. In
addition, the Company recorded an impairment loss on fixed and other assets of
$1.7 ($6.4 year-to-date) 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.
18
Network Communications
Three Months Ended Nine Months Ended
-------------------- -------------------
Network Communications Dec. 26, Dec. 27, Dec. 26, Dec. 27,
(millions of U.S. dollars) 2003 2002 2003 2002
------- ------ ------- -------
Revenue: $ 24.6 $ 27.8 $ 78.9 $ 85.6
------- ------ ------- -------
As a % of total revenue 52% 59% 53% 61%
Operating loss $ (6.7) $ (8.3) $ (20.6) $ (20.1)
======= ====== ======= =======
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 third quarter of Fiscal 2004 totaled $24.6, down 12% from the
third quarter of Fiscal 2003. During the first nine months of Fiscal 2004
revenue decreased to $78.9, down 8% 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 sales volumes of the
Company's packet switching, packet processing, TDM switching, and specialty
products, partially offset by increased sales volumes of voice processing
products. The overall decline in revenue was predominantly due to lower revenue
from the North America region.
The segment's operating loss decreased to $6.7 in the third quarter of Fiscal
2004, down 19% from $8.3 in the third quarter of Fiscal 2003, due primarily to
the timing of severance costs incurred. Severance costs for the third quarter of
Fiscal 2004 were $1.8, as compared to $3.2 in the same period in Fiscal 2003.
Improvements also resulted from a stronger product mix in the current quarter
and lower R&D spending, primarily a result of the cancellation of development in
the VDSL (Very high rate Digital Subscriber Line) market which occurred in the
third quarter of Fiscal 2003. These savings were partially offset by asset
impairment charges of $1.6 in the third quarter of Fiscal 2004.
The segment's operating loss increased to $20.6 in the first nine months of
Fiscal 2004 from an operating loss of $20.1 in the first nine months of Fiscal
2003, due primarily to asset impairments and other costs incurred in the second
and third quarters of Fiscal 2004, partially offset by cost control initiatives
and lower R&D spending, in addition to improved margins on a stronger mix of
products sold, including margin improvements on the Company's voice processing
products. During the first nine months of Fiscal 2004, the Network
Communications segment incurred asset impairment and other costs of $4.6 and
approximately $1.4 of severance costs related to its direct R&D initiatives, as
it implemented cost control initiatives, as compared to approximately $3.2 in
severance over the same period in Fiscal 2003, when the Company ceased
development in the VDSL market.
Consumer Communications
Three Months Ended Nine Months Ended
------------------ ------------------
Consumer Communications Dec. 26, Dec. 27, Dec. 26, Dec. 27,
(millions of U.S. dollars) 2003 2002 2003 2002
------ ------ ------- -------
Revenue: $ 14.9 $ 12.0 $ 42.1 $ 35.0
------ ------ ------- -------
As a % of total revenue 32% 26% 29% 25%
Operating loss $ (5.4) $ (4.6) $ (15.0) $ (15.7)
====== ====== ======= =======
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 third quarter of Fiscal 2004 totaled $14.9, up 24% from the
third quarter of Fiscal 2003. During the first nine months of Fiscal 2004,
revenue increased 20% over the same period in Fiscal 2003 to $42.1, principally
as a result of increased shipments of the Company's tuners and demodulators.
19
The segment's operating loss during the third quarter of Fiscal 2004 increased
to $5.4, up 17% from the same period of Fiscal 2003. This was due primarily to
severance costs of $1.0 incurred during the quarter, partially offset by revenue
improvements.
The segment's operating loss decreased to $15.0 in the first nine months of
Fiscal 2004 from an operating loss of $15.7 in the same period of Fiscal 2003,
due principally to improved revenues. The increase was partially offset by asset
impairments of $0.1 and other cost control initiatives, including $1.9 in
severance costs during the period, as well as lower margins on tuners and
demodulators resulting from increasing price pressure on certain of the
Company's tuners.
Ultra Low-Power Communications
Three Months Ended Nine Months Ended
------------------ -----------------
Ultra Low-Power Communications Dec. 26, Dec. 27, Dec. 26, Dec. 27,
(millions of U.S. dollars) 2003 2002 2003 2002
----- ------ ------ ------
Revenue: $ 7.5 $ 7.0 $ 26.3 $ 20.4
----- ------ ------ ------
As a % of total revenue 16% 15% 18% 14%
Operating income (loss) $ 0.1 $ (1.2) $ (0.9) $ (2.6)
===== ====== ====== ======
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 third quarter of Fiscal 2004 totaled $7.5, up 7% from the third
quarter of Fiscal 2003, due mainly to increases in the sales volume of pacemaker
circuits and wireless products, partially offset by a decrease in the sales
volume of hearing aid components. During the first nine months of Fiscal 2004,
revenue increased 29% over the same period in Fiscal 2003 to $26.3, due mainly
to increases in the sale of hearing aid components. Revenue improvements were
also realized on the Company's pacemaker circuits and other wireless ASIC
products.
The segment had operating income of $0.1 in the third quarter of Fiscal 2004, as
compared to an operating loss of $1.2 in the same period of Fiscal 2003, due
principally to a more favorable product mix and increased margins, in addition
to savings resulting from cost control initiatives. The segment's operating loss
improved to $0.9 in the first nine months of Fiscal 2004 from an operating loss
of $2.6 in the same period of Fiscal 2003, as a result of increased revenues and
favorable product mix and increased margins on the company's wireless ASIC
products, in addition to savings resulting from cost control initiatives. These
favorable impacts were partially offset by $0.2 in severance costs, and asset
impairments and other costs of $0.4 recorded earlier in the second quarter of
Fiscal 2004.
GEOGRAPHIC REVENUE
Revenue, based on the geographic location of customers, was distributed as
follows:
Three Months Ended Nine Months Ended
------------------------------------ --------------------------------------
Dec. 26, % of Dec. 27, % of Dec. 26, % of Dec. 27, % of
(millions of U.S. dollars) 2003 Total 2002 Total 2003 Total 2002 Total
- -------------------------- ---- ----- ---- ----- ---- ----- ---- -----
Revenue:
Asia / Pacific $20.4 44% $17.6 37% $ 60.6 41% $ 52.3 37%
Europe 13.8 29% 15.4 33% 44.3 30% 46.4 33%
United States 10.0 21% 9.7 21% 32.9 23% 29.4 21%
Canada 2.5 5% 2.4 5% 6.4 4% 8.9 6%
Other Regions 0.3 1% 1.7 4% 3.1 2% 4.0 3%
----- --- ----- --- ------ --- ------ ---
Total $47.0 100% $46.8 100% $147.3 100% $141.0 100%
===== === ===== === ====== === ====== ===
Asia/Pacific
Asia/Pacific sales increased by 16% during the third quarter of Fiscal 2004
compared to the third quarter of Fiscal 2003, and continue to represent the
largest geographic segment of customer revenues. During the first nine months of
Fiscal 2004, sales increased by 16% compared to the same period in Fiscal 2003.
Increases were driven primarily from the Consumer Communications segment.
20
Europe
European sales decreased by 10% in the third quarter of Fiscal 2004 compared to
the third quarter of Fiscal 2003. For the first nine months of Fiscal 2004,
sales decreased by 5% compared to the first nine months of Fiscal 2003 due to
declines in the revenues from the Consumer Communications and Network
Communications segments, partially offset by improved revenues in the Ultra
Low-Power Communications segment.
United States
Sales to customers in the United States increased by 3% during the third quarter
of Fiscal 2004 compared to the third quarter of Fiscal 2003. For the first nine
months of Fiscal 2004, sales increased by 12% 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 third quarter of Fiscal 2004 were in line with the same
period in Fiscal 2003. During the first nine months of Fiscal 2004, sales to
Canadian customers decreased by 28% compared to the same period in Fiscal 2003
due to lower Network Communications segment sales.
GROSS MARGIN
Three Months Ended Nine Months Ended
------------------- --------------------
(millions of U.S. dollars) Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
-------- -------- -------- --------
Gross Margin $ 21.0 $ 21.2 $ 66.0 $ 64.0
As a percentage of revenue 45% 45% 45% 45%
Gross margin in the third quarter of Fiscal 2004 was unchanged from the same
period in Fiscal 2003. The Company increased sales of its tuners and
demodulators, and had a more favorable product mix in their voice processing,
other network, and consumer wireless product lines. These favorable impacts were
offset by lower than expected sales volumes in the Network Communications
segment, and increasing price pressure on the Company's tuners and demodulators.
In addition, gross margin included approximately $0.4 of severance costs related
to the restructuring activities implemented during the quarter.
Gross margin of 45% in the first nine months of Fiscal 2004 was unchanged from
the same period in Fiscal 2003. During the first nine months of Fiscal 2004, the
Company continued its effort to lower overall manufacturing costs, as it
incurred approximately $1.0 of severance costs during the period. The adverse
impact of the severance costs was offset by increased sales volumes and a more
favorable product mix in the Company's Network Communications and Consumer
Communications segments.
OPERATING EXPENSES
Research and Development ("R&D")
Three Months Ended Nine Months Ended
------------------- --------------------
(millions of U.S. dollars) Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
-------- -------- -------- --------
R&D Expenses $ 19.5 $ 23.5 $ 57.9 $ 66.8
As a percentage of revenue 41% 50% 39% 47%
R&D expenses decreased by 17%, or $4.0, in the third quarter of Fiscal 2004 from
the same period in Fiscal 2003. During the first nine months of Fiscal 2004, R&D
expenses decreased by 13%, or $8.9 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 and third quarters of Fiscal 2004. During
the three and nine month periods ended December 26, 2003, severance costs of
$1.4 and $2.4 respectively 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 in the remaining quarter of Fiscal 2004 as a result of optimizing
electronic design automation and cost control.
21
The Company continued its investment in research and development to develop and
launch new products, with 30 new products being released in the third quarter of
Fiscal 2004, bringing the year-to-date total to 52 new product launches. 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 Internet Protocol ("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, Asymmetric Digital Subscriber Line ("ADSL") drivers and High
Speed Amplifiers products for wired and wireless applications;
utilizing our analog/mixed-signal expertise; and
o Receivers and transmitters for single mode fiber ("SMF") targeting the
access network as well as industrial applications where customization
is required.
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 Global System for Mobile communication
("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 Nine Months Ended
------------------- --------------------
(millions of U.S. dollars) Dec. 26, Dec. 27, Dec. 26, Dec. 27,
2003 2002 2003 2002
-------- -------- -------- --------
S&A Expenses $ 11.8 $ 11.8 $ 37.6 $ 35.6
As a percentage of revenue 25% 25% 26% 25%
In the third quarter of Fiscal 2004, S&A expenses were unchanged from the third
quarter of Fiscal 2003, while S&A expenses increased by $2.0, or 6% during the
first nine months of Fiscal 2004. S&A expenses in the third quarter of Fiscal
2004 included approximately $1.1 ($2.9 year to date) of severance charges, which
were partially offset by savings realized
22
from cost reduction activities implemented earlier in the year. The Company
anticipates a reduction in S&A expenses during the remaining 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 and from stock options awarded to
former employees. In prior years, the Company also recorded stock compensation
expense arising from retention conditions associated with the stock awarded to
certain employees of Vertex Networks Incorporated, which was acquired in July
2000.
During the three and nine months ended December 26, 2003, the Company recorded
stock compensation expense of $0.1, representing amortization of the fair value
of stock options awarded to a former employee. During the three months ended
December 27, 2002, the Company recorded a stock compensation expense of $nil
(nine months ended December 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, foreign exchange gains
and losses, and gains on sales of investments.
Interest income was $0.4 for the three months ended December 26, 2003 as
compared to $0.7 in the same period of Fiscal 2003. During the first nine months
of Fiscal 2004, interest income was $1.0 as compared to $2.6 in the first nine
months of Fiscal 2003. The decreases were mainly due to reduced average cash
balances and lower interest rates in Fiscal 2004.
Foreign exchange losses in the third quarter of Fiscal 2004 amounted to $1.2 as
compared to $0.4 for the same period in Fiscal 2003. During the nine months
ended December 26, 2003, foreign exchange losses amounted to $2.1 as compared to
a gain of $1.2 for the nine months ended December 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 net 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.
On December 5, 2003, the Company sold its investment in a privately held company
for cash proceeds of $0.6. The investment had a carrying value of $nil resulting
from an impairment charge recorded in the fourth quarter of Fiscal 2002. This
resulted in a gain of $0.6 for the three and nine month periods ended December
26, 2003. In the third quarter of Fiscal 2003 the Company sold its investment in
DALSA Semiconductor Inc. ("DALSA") for cash proceeds of $4.2, resulting in a
gain of $0.7 during the three and nine month periods ended December 27, 2002.
INTEREST EXPENSE
Interest expense was $0.3 for the three months ended December 26, 2003, compared
with $0.3 for the third quarter of Fiscal 2003. During the first nine months of
Fiscal 2004, interest expense was $0.6, compared with $0.7 for the same period
of Fiscal 2003. The interest expense relates primarily to the Company's capital
leases.
INCOME TAXES
An income tax recovery of $1.4 was recorded for the third quarter of Fiscal
2004, as a result of a recovery of domestic income taxes, compared with an
expense of $0.3 for the corresponding period in Fiscal 2003. During the nine
months ended December 26, 2003, income tax recovery was $1.4, compared with an
expense of $1.2 for the first nine months of Fiscal 2003.
The Company is subject to income taxes in Canada, the United Kingdom, the United
States and numerous other foreign jurisdictions. The Company has recorded a
valuation allowance on its deferred tax assets, and recorded only deferred tax
assets that can be applied against income in taxable jurisdictions or applied
against deferred tax liabilities that will reverse in the future. The Company
has a valuation allowance on its deferred tax assets at December 26, 2003 of
$133.0, (March 28, 2003 - $106.0). The increase relates mainly to foreign
exchange, losses incurred in the Company's foreign jurisdictions and temporary
differences in the Company's foreign and domestic operations. Significant
judgment is required in determining the provision for income taxes and the
valuation allowance on deferred tax assets. In establishing
23
the appropriate valuation allowance for tax loss carry-forwards and investment
tax credits, it is necessary to consider all available evidence, both positive
and negative.
Management periodically reviews the Company's valuation allowance to determine
whether the overall tax estimates are reasonable. When management performs its
quarterly assessments of the valuation allowance, it may be determined that an
adjustment is required to the valuation allowance, which may have a material
impact on the Company's financial position and results of operations.
NET LOSS
The Company recorded a net loss, after preferred share dividends, of $11.8, or
$0.09 per share, in the third quarter of Fiscal 2004. This compares to a net
loss, after preferred share dividends, of $14.2, or $0.11 per share, in the same
period in Fiscal 2003. For the nine months ended December 26, 2003, the Company
recorded a net loss, after preferred share dividends, of $37.9, or $0.30 per
share, as compared to $35.9 or $0.28 per share in the first nine months of
Fiscal 2003.
The net loss for the three and nine month periods ended December 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 and
third quarters.
LIQUIDITY AND CAPITAL RESOURCES
At December 26, 2003, cash, cash equivalents, short-term investments and
restricted cash balances totaled $87.8, down from $119.2 at March 28, 2003. Cash
and cash equivalents at December 26, 2003, included in the amount above, totaled
$18.6 (March 28, 2003 - $23.5).
Cash used in operating activities was $24.8 for the nine months ended December
26, 2003. Cash used in operations before working capital changes amounted to
$17.2 during the first nine months of Fiscal 2004, as compared to $27.2 used in
the first nine months of Fiscal 2003. Cash used in operations included various
one-time costs, including severance payments of $3.3, associated with the
restructuring activities implemented during the second and third quarters. Since
March 28, 2003, the Company's working capital increased by $7.6, mainly as a
result of increases in accounts receivable of $8.4, and other prepaid expenses
totaling $2.5. 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
fourth 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 an increase in accounts payable and
other accrued liabilities totaling $2.7, and a reduction in inventories of $0.5
and deferred credits of $0.1 over the first nine months of the year. The
increase in accounts payable and other accrued liabilities resulted from the
timing of payments. 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 increased by $6.6 during the first nine months of Fiscal 2003, as a
result of reductions in inventories, prepaid expenses and deferred credits and
improved cash collections against trade receivables, partially offset by
decreases in accounts payable and accrued liabilities.
Cash provided from investing activities was $26.5 for the nine months ended
December 26, 2003, primarily from matured short-term investments totaling
$174.5, offset by purchases of short-term investments of $144.7. In addition,
proceeds of $0.6 were received upon sale of the Company's investment in a
privately held company. Cash balances were reduced by purchases of fixed and
other assets amounting to $4.7 during the first nine months of the year, offset
by proceeds from disposal of fixed assets of $0.8. 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 nine months of Fiscal 2004. Cash used in investing activities for the
first nine months of Fiscal 2003 was $25.9. Net purchases of short-term
investments in the amount of $24.4 and net expenditures for fixed and other
assets of $5.3 contributed to the net cash outflow, offset by a net reduction in
long-term investments of $3.8. The fixed asset additions were primarily related
to design tools and upgrades to information technology resources. The net
reduction in long-term investments resulted from cash proceeds of $4.2 received
upon the sale of the Company's minority investment in DALSA Semiconductor Inc.,
offset by a small investment earlier in the year.
Cash used in financing activities during the first nine months of Fiscal 2004
was $6.6. The use of cash was primarily the result of an increase of the
hypothecation of cash under letters of credit of $3.3, the repayment of $0.5 of
capital leases, the repurchase of $1.2 of the Company's redeemable preferred
shares, and the payment of $1.6 for dividends on the preferred shares. Cash used
in financing activities in the first nine months of Fiscal 2003 was $4.1. The
use of cash was primarily the result of the repayment of $1.8 of capital lease
liabilities, the repurchase of $1.3 of preferred shares, and the payment of $1.5
for dividends on the preferred shares, offset by $0.5 of new common shares
issued from exercised stock options.
24
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 $2.6 in the
fourth quarter of Fiscal 2004 after the final adjustments are calculated.
During the first nine months of Fiscal 2004, the Company declared and paid
dividends of $1.6 on its redeemable preferred shares based on a cumulative $1.14
(Cdn$1.50) per share dividend. In addition, the Company purchased 64,300
preferred shares under its purchase obligation during this period. As at
December 26, 2003, the Company has repurchased 12,900 preferred shares that had
not yet been cancelled by the transfer agent. In addition to cash, cash
equivalents, short-term investment and restricted cash balances of $87.8 as at
December 26, 2003, the Company had a credit facility of approximately $9.5
(Cdn$12.5), of which $9.2 in letters of credit were outstanding. Accordingly,
the Company had an unused facility totaling $0.3 available for letters of credit
as at December 26, 2003.
During the third quarter of Fiscal 2004, the Company cancelled the operating
line component of its revolving global credit facility, as it was not being
utilized or required by the Company. This resulted in reducing the total credit
facility from $19.0 (Cdn $25.0) to a facility of $9.5 (Cdn $12.5) available for
letters of credit.
Prior to the third quarter of Fiscal 2004, the Company had not met a quarterly
financial covenant with respect to shareholder's equity under the Company's
credit facility, as a result of restructuring and impairment losses recorded
since the fourth quarter of Fiscal 2003. In previous quarters the Company had
obtained a waiver from the bank in respect of the financial covenant. In
addition to the reduction in the amount of the credit facility, the financial
covenant with respect to shareholder's equity was also modified under the new
agreement, such that no waiver was required as at December 26, 2003.
Cash and cash equivalents totaling $9.5 were hypothecated under the credit
facility to cover outstanding letters of credit. The credit facility is subject
to periodic review, including the determination of certain financial covenants.
It is uncertain if the Company will be able to meet these financial covenants in
the future and, if not, to obtain a waiver from the bank, which may result in
the availability of the credit facility being reduced or restricted. Management
does not anticipate that this would have a material adverse effect on the
financial position of the Company. Management believes the Company is in a
position to meet all foreseeable business cash requirements and capital lease
and preferred share payments from its cash balances on hand, existing financing
facilities and cash flow from operations.
BACKLOG
As at
---------------------------------------------
Dec. 26, Sept. 26, June 27, Mar. 28,
(millions of U.S. dollars) 2003 2003 2003 2003
-------- --------- -------- --------
90 Day Backlog $ 32.4 $ 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 increased from the prior quarter due to increased bookings across the
Consumer and Network Communications segments. 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.
25
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 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.
In January 2003, the FASB issued Interpretation No. 46, ("FIN 46"),
"Consolidation of Variable Interest Entities". FIN 46 expands upon existing
guidance that addresses when a company should include in its financial
statements the assets, liabilities, and activities of another company. A
variable interest entity is any legal structure used for business purposes that
either (a) does not have equity investors or has equity investors that lack
characteristics of control; or (b) the equity investment at risk does not
provide sufficient financial resources for the entity to support its activities.
Under FIN 46, a variable interest entity must be consolidated by a company if
that company is expected to absorb a majority of the entity's expected losses or
to receive a majority of the entity's expected residual returns. The
consolidation requirements are currently applicable to variable interests
created after January 31, 2003. For variable interest entities created before
January 31, 2003, the consolidation requirements are applicable for reporting
periods ending after March 15, 2004. FIN 46 also requires certain disclosures
about variable interest entities where those entities are not required to be
consolidated. The Company has not yet evaluated the impact of this new
pronouncement on its financial position or results of operations.
In December 2003 the FASB published a revision to Statement of Financial
Accounting Standard No. 132 ("SFAS 132"), "Employers Disclosures about Pensions
and Other Postretirement Benefits". The revision requires additional disclosure,
including information describing the types of plan assets, investment strategy,
measurement date(s), plan obligations, cash flows, and components of net
periodic benefit cost recognized during interim periods. Most of the guidance in
the revision to SFAS 132 relating to domestic plans is effective for year ends
after December 15, 2003, and the guidance relating to
26
foreign plans is effective for year ends after June 15, 2004. The requirements
pertaining to interim periods are effective for quarters beginning after
December 15, 2003. The adoption of the revision to SFAS 132 is not expected to
have a material impact on the Company's financial position or results of
operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 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 December 26, 2003, there were unrealized gains of $0.7 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 December 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 December 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. 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 December 26, 2003. Based
upon that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer concluded that the 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 December 26, 2003 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
27
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
- --------------- --------------------------------------------------------
October 16, 2003 Press Release: "Financial Results for the Quarter Ended
September 26, 2003"
January 21, 2004 Press Release: "Financial Results for the Quarter Ended
December 26, 2003"
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant, Zarlink Semiconductor Inc., has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
Zarlink Semiconductor Inc.
(Registrant)
Name Title Date
- --------------------- ----------------------------------- ----------------
/s/ SCOTT MILLIGAN
- --------------------- Senior Vice President of Finance February 5, 2004
Scott Milligan and Chief Financial Officer
(Principal Financial and Accounting
Officer)
28
EXHIBIT INDEX
Exhibit
Number Description Page
- ---------- --------------------------------------------------------- ----
31.1 Certification Pursuant to 18 U.S.C. Section 1350, As 30
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 31
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 32
Sarbanes-Oxley Act of 2002, President and Chief Executive
Officer
32.2 Certification Pursuant to Section 906 of the 33
Sarbanes-Oxley Act of 2002, Senior Vice President of
Finance and Chief Financial Officer
99.1 Selected Consolidated Financial Statements in U.S. Dollars 34
and in accordance with Canadian Generally Accepted
Accounting Principles
99.2 Management's Discussion and Analysis of Financial 46
Condition and Results of Operations - Canadian Supplement
29