-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CaCN7JUxzMA91opzEhelGOoc7kds/McBuXLb/2pq+pLWLeUXfXBg6/PSyaHGRORM 1s7SIFxE/4FUIvH45+9ToA== 0000891092-08-002954.txt : 20080605 0000891092-08-002954.hdr.sgml : 20080605 20080604210056 ACCESSION NUMBER: 0000891092-08-002954 CONFORMED SUBMISSION TYPE: 20-F PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20080328 FILED AS OF DATE: 20080605 DATE AS OF CHANGE: 20080604 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ZARLINK SEMICONDUCTOR INC CENTRAL INDEX KEY: 0000352435 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 000000000 FISCAL YEAR END: 0326 FILING VALUES: FORM TYPE: 20-F SEC ACT: 1934 Act SEC FILE NUMBER: 001-08139 FILM NUMBER: 08881802 BUSINESS ADDRESS: STREET 1: 400 MARCH ROAD STREET 2: OTTAWA CITY: ONTARIO CANADA STATE: A6 ZIP: K2K 3H4 BUSINESS PHONE: 6135920200 MAIL ADDRESS: STREET 1: 400 MARCH ROAD STREET 2: OTTAWA CITY: ONTARIO CANADA STATE: A6 ZIP: K2K 3H4 FORMER COMPANY: FORMER CONFORMED NAME: MITEL CORP DATE OF NAME CHANGE: 19960116 20-F 1 e31856_20f.txt FORM 20-F\ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 20-F |_| REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 OR |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal year ended March 28, 2008 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR |_| SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-8139 ------ ZARLINK SEMICONDUCTOR INC. (Exact name of registrant as specified in its charter) Canada ------------------------------------------------ (Jurisdiction of incorporation or organization) 400 March Road, Ottawa, Ontario, Canada, K2K 3H4 ------------------------------------------------ (Address of principal executive offices) Securities registered or to be registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- Common shares, no par value New York Stock Exchange The Toronto Stock Exchange Securities registered or to be registered pursuant to Section 12(g) of the Act. None Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act. Title of each class ------------------- 6.0% Convertible Unsecured Subordinated Debentures Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report. 127,345,682 common shares were outstanding as of March 28, 2008 1,148,000 preferred shares were outstanding as of March 28, 2008 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes |_| No |X| If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes |_| No |X| 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer |_| Accelerated filer |X| Non-accelerated filer |_| Indicate by check mark which financial statement item the registrant has elected to follow. Item 17 |_| Item 18 |X| If this report is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| -2- Table of Contents Page No. -------- PART I .................................................................... 1 Item 1 Identity of Directors, Senior Management and Advisers ........... 1 Item 2 Offer Statistics and Expected Timetable ......................... 1 Item 3 Key Information ................................................. 1 A. Selected Financial Data .......................................... 1 B. Capitalization and Indebtedness .................................. 2 C. Reasons for the Offer and Use of Proceeds ........................ 2 D. Risk Factors ..................................................... 2 Item 4 Information on the Company ...................................... 7 A. History and Development of the Company ........................... 7 B. Business Overview ................................................ 8 Business Strategy ................................................ 8 Industry ......................................................... 9 Products and Customers ........................................... 10 Sales, Marketing and Distribution ................................ 13 Competition ...................................................... 14 Manufacturing .................................................... 14 Proprietary Rights ............................................... 14 Seasonality ...................................................... 15 Government Regulations ........................................... 15 C. Organizational structure ........................................ 15 D. Property, Plants and Equipment .................................. 15 Item 4A Unresolved Staff Comments ...................................... 16 Item 5 Operating and Financial Review and Prospects .................... 16 Critical Accounting Estimates .................................... 16 Foreign Currency Translation ..................................... 19 Recently Issued Accounting Pronouncements ........................ 19 A. Operating Results ................................................ 20 Business Overview ................................................ 21 Geographic Revenue ............................................... 22 Gross Margin ..................................................... 24 Research and Development (R&D) ................................... 24 Selling and Administrative (S&A) ................................. 25 Stock Compensation Expense ....................................... 25 Contract Impairment and Other .................................... 26 Asset Impairment ................................................. 27 Acquisition of Business and Intangible Assets .................... 27 Sale of Businesses ............................................... 29 Other Non Operating Income and Expense ........................... 30 Income Taxes ..................................................... 31 Discontinued Operations .......................................... 32 Net Income (Loss) ................................................ 33 Common Shares Outstanding ........................................ 33 B. Liquidity and Capital Resources .................................. 33 i C. Research and Development, Patents, and Licenses, etc ............. 35 D. Trend Information ................................................ 36 E. Off-balance Sheet Arrangements ................................... 36 F. Tabular Disclosure of Contractual Obligations .................... 37 G. Safe Harbor ...................................................... 37 Item 6 Directors, Senior Management and Employees ...................... 38 A. Directors and Senior Management .................................. 38 B. Compensation ..................................................... 40 C. Board practices .................................................. 41 D. Employees ........................................................ 41 E. Share Ownership .................................................. 42 Item 7 Major Shareholders and Related Party Transactions ............... 43 A. Major Shareholders ............................................... 43 B. Related Party Transactions ....................................... 44 C. Interests of Experts and Counsel ................................. 44 Item 8 Financial Information ........................................... 44 A. Consolidated Statements and Other Financial Information .......... 44 B. Significant Changes .............................................. 44 Item 9 The Offer and Listing ........................................... 44 A. Offer and Listing Details ........................................ 44 B. Plan of Distribution ............................................. 46 C. Markets .......................................................... 46 D. Selling Shareholders ............................................. 46 E. Dilution ......................................................... 46 F. Expenses of the Issue ............................................ 46 Item 10 Additional Information ......................................... 46 A. Share Capital .................................................... 46 B. Memorandum and Articles of Association ........................... 46 C. Material Contracts ............................................... 46 D. Exchange Controls ................................................ 47 E. Taxation ......................................................... 47 F. Dividends and Paying Agents ...................................... 50 G. Statements by Experts ............................................ 50 H. Documents on Display ............................................. 50 I. Subsidiary Information ........................................... 51 Item 11 Quantitative and Qualitative Disclosures About Market Risk ..... 51 Item 12 Description of Securities Other than Equity Securities ......... 52 PART II ................................................................... 52 Item 13 Defaults, Dividend Arrearages and Delinquencies ................ 52 Item 14 Material Modifications to the Rights of Security Holders and Use of Proceeds ................................... 52 Item 15 Controls and Procedures ........................................ 52 Item 16A Audit Committee Financial Expert .............................. 53 ii Item 16B Code of Ethics ................................................ 53 Item 16C Principal Accountant Fees and Services ........................ 53 Item 16D Exemptions from the Listing Standards for Audit Committees .... 53 Item 16E Purchases of Equity Securities by the Issuer and Affiliated Purchasers ....................................... 53 PART III .................................................................. 54 Item 17 Financial Statements ........................................... 54 Item 18 Financial Statements ........................................... 54 Item 19 Exhibits ....................................................... 92 "Zarlink" and the "Company" refer to Zarlink Semiconductor Inc. and its consolidated subsidiaries, unless otherwise indicated. Zarlink reports its financial accounts in U.S. dollars. All financial information and references to "$" and "dollars", other than dollars per share are expressed in millions of U.S. dollars unless otherwise stated. iii PART I Item 1 Identity of Directors, Senior Management and Advisers Not applicable Item 2 Offer Statistics and Expected Timetable Not applicable Item 3 Key Information A. Selected Financial Data The following tables are derived from our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP") and the requirements of the U.S. Securities and Exchange Commission ("SEC"). Fiscal Year Ended (at the end of Fiscal year for balance sheet data) (In millions of U.S. dollars, except gross margin percentage and per share amounts)
--------------------------------------------------------- 2008 2007 2006 2005 2004 --------------------------------------------------------- Income Statement Data: Revenue $ 183.6 $ 142.6 $ 144.9 $ 160.8 $ 170.7 Gross margin percentage 45% 52% 50% 47% 50% Research and development expense 47.7 32.7 37.5 52.7 62.2 Income (loss) from continuing operations (48.4) 15.8 2.0 (13.1) (23.5) Income (loss) from discontinued operations -- -- 46.8 (7.7) (15.1) Net income (loss) (48.4) 15.8 48.8 (20.8) (38.6) Income (loss) per common share from continuing operations Basic and diluted (0.41) 0.11 (0.01) (0.12) (0.20) Net income (loss) per common share Basic and diluted (0.41) 0.11 0.36 (0.18) (0.32) Balance Sheet Data: Working capital $ 94.5 $ 152.3 $ 139.4 $ 86.7 $ 96.3 Total assets 263.9 211.0 204.5 171.3 197.4 Long-term debt - Convertible debentures 77.4 -- -- 0.1 0.1 Redeemable preferred shares 14.7 16.1 16.2 17.2 17.6 Shareholders' equity Common shares 768.5 768.5 768.5 768.4 768.4 Additional paid in capital 5.1 4.3 3.0 2.2 2.3 Deficit (638.4) (587.6) (601.2) (646.5) (623.5) Accumulated other comprehensive loss (35.8) (34.3) (34.7) (33.1) (32.6) Dividends Declared per Preferred Share In U.S. Dollars $ 1.95 $ 1.76 $ 1.67 $ 1.59 $ 1.47 In Canadian Dollars 2.00 2.00 2.00 2.00 2.00
Discontinued operations in Fiscal 2004 to Fiscal 2006 relate to the sale of our RF Front-End Consumer business which is discussed further in Note 24 to the consolidated financial statements included elsewhere in this Form 20-F. 1 Selected Quarterly Financial Data (Unaudited, in millions of U.S. dollars, except gross margin percentage and per share amounts) First Second Third Fourth Full FISCAL 2008 Quarter Quarter Quarter Quarter Year ---------------------------------------------------- Revenue $ 30.6 $ 49.6 $ 48.6 $ 54.8 $ 183.6 Gross margin 13.2 22.6 22.8 24.5 83.1 Gross margin percentage 43% 46% 47% 44% 45% Net income (loss) (5.0) (15.9) (8.4) (19.1) (48.4) Net income (loss) per common share - basic and diluted (0.05) (0.13) (0.07) (0.16) (0.41) First Second Third Fourth Full FISCAL 2007 Quarter Quarter Quarter Quarter Year ---------------------------------------------------- Revenue $ 38.4 $ 38.1 $ 34.1 $ 32.0 $ 142.6 Gross margin 22.3 20.3 17.1 14.7 74.4 Gross margin percentage 58% 53% 50% 46% 52% Net income (loss) 4.2 6.9 5.6 (0.9) 15.8 Net income (loss) per common share - basic and diluted 0.03 0.05 0.04 (0.01) 0.11 B. Capitalization and Indebtedness Not applicable C. Reasons for the Offer and Use of Proceeds Not applicable D. Risk Factors Before deciding to purchase, hold, or sell our common shares, you should carefully consider the risks described below, in addition to the other cautionary statements described elsewhere and the other information contained in this report and in our other filings with the SEC. Additional risks and uncertainties not presently known to us or that we consider to be immaterial may also affect our results of operations. If any of these events or uncertainties occurs, our business, financial condition, and results of operations could be harmed. In that event, the market price for our common shares could decline, and you may lose all or part of your investment. In order to be successful, we are dependent on the development of new products, and our ability to introduce these products to the market in a cost-effective and timely manner. Our industry is characterized by the following: o Rapidly changing technology; o Product complexity; o Competition; and o Frequent new product introductions. We make investments in research and development in an effort to design new products and remain competitive in our markets. For example, in Fiscal 2008, our research and development efforts focused primarily on ultra low-power system-on-chip solutions for medical telemetry, active optical cables for data center interconnect, voice interface products, and network synchronization and timing over packet solutions. We cannot be certain that we will be successful in developing these new products. Furthermore, the development of our products is highly complex, and we may experience delays in completing our development initiatives. 2 In addition, even if we are successful in developing new products, we cannot be certain that these products will reach market acceptance. Our products are generally incorporated into our customers' products at the design stage. However, our design wins may not materialize into revenue for us, as customer projects may be cancelled, or their end market demand may decrease. We also cannot be certain that we will be able to provide the most cost-effective solutions for our customers. For example, during Fiscal 2007, we deemphasized our focus on the sale of electronic shelf labels, as we were unable to generate sufficiently high margins from the sale of these products due to the strong competition in this market. Our products generally take a minimum of two years from the initial product design to revenue generation. The market demand may change between the time of initial product design and volume sales, which could render our products obsolete and adversely affect our business and financial condition. Our business could be disrupted if we are unable to successfully integrate any businesses, technologies, product lines or services that we acquire in the future. The markets in which we compete are characterized by an increasing level of consolidation by companies within our industry. Within these markets, there has been a consolidation of smaller to similar sized companies in an effort to achieve scale, leadership and depth. During Fiscal 2008 and 2007, we acquired 100% of the capital stock of Legerity Holdings Inc. ("Legerity") and the assets and liabilities of the optical business of Primarion. We may make other strategic acquisitions and investments or enter into joint ventures or strategic alliances with other companies in the future. Such transactions entail many risks, including the following: o Inability to successfully integrate the acquired companies' personnel and businesses; o Inability to realize anticipated synergies, economies of scale or other value associated with the transactions; o Diversion of management's attention and disruption of our ongoing business; o Inability to retain key technical and managerial personnel; o Inability to establish and maintain uniform standards controls, procedures and policies; o Assumption of unknown liabilities or other unanticipated events or circumstances; and o Strained relationships with employees and customers as a result of the integration of new personnel. In addition, future acquisitions or investments may require us to issue additional equity or debt securities or obtain loans. Failure to avoid these or other risks associated with such acquisitions or investments could have a material adverse effect on our business, financial condition and results of operations. A change in product mix between new products and legacy products could adversely impact our results of operations. Our revenue is comprised of a mix of new products in growth markets, and legacy telecom products within our core business. We depend partly on revenue generation from our legacy products in order to fund development of our new products. We cannot be certain that we will successfully be able to extend the life of our legacy products, and these products may become obsolete. Furthermore, we expect the average selling prices of our products to decline as they mature, which could result in decreased revenues and margins from these products. In addition, we cannot be certain that our revenues from our new products will increase sufficiently to compensate for the revenue decline from legacy products as they reach their end of life stage. If we are unable to sell high volumes of our new products, this may result in decreased revenues and margins, which could adversely affect our business, cash flows, financial condition, and results of operations. We have limited visibility of demand in our end markets, and our customers may cancel and/or defer orders on short notice, which could adversely impact our operating results. We typically sell our products pursuant to purchase orders, which can be either cancelled or deferred on short notice without our customers incurring significant penalties, as is common in our industry. Generally, we do not have long-term supply arrangements with our customers. We have difficulty predicting demand because our customers are faced with volatile demand patterns among their customers. In addition, the increasing consolidation within our end markets has created uncertainty. We also depend heavily on our turns business, or orders placed and shipped within the same quarter. 3 In the past, our customers have cancelled and deferred purchase orders as a result of maintaining excess inventories of our products. We build products based on forecasted customer demand. Our limited visibility of demand in our end markets could result in our holding excess inventory, and could reduce profit margins and increase product obsolescence if we overestimate demand for our products. Conversely, if we underestimate demand for our products and are unable to meet customer expectations, we may lose market share and damage relationships with our customers. Both of these outcomes could negatively impact our cash flows from operations and could have an adverse impact on our business, financial condition, and results of operations. We have experienced operating losses in Fiscal 2008, as well as in several prior Fiscal years, and may not be able to return to profitability. The semiconductor industry is highly cyclical. We have seen periods of significant upturns and downturns. We have experienced net losses in Fiscal 2008, as well as in several prior Fiscal years during periods of industry downturns. These losses have contributed to negative operating cash flows in these years. If we incur losses in future periods, we may be required to implement additional restructuring activities, which may require that we exit certain markets in order to focus on markets we believe are more profitable or favorable from a financial standpoint. Our failure to return to profitability and positive operating cash flows, and future restructuring activities, could have a material adverse effect on our financial condition and results of operations. We compete with other companies to attract and retain key personnel. The loss of, or inability to attract, key personnel could have a material adverse effect on our business, financial condition or results of operations. Our future success depends, to a significant extent, on the continued service of our key technical, sales and management personnel, and on our ability to continue to attract and retain qualified employees. We depend particularly on highly skilled design, process and test engineers involved in the development of mixed signal products and processes, and on personnel in sales functions. If we were unable to attract and retain these employees, this could delay the development of new products, and could also harm our ability to sell our existing products. The competition for these employees is intense, and these employees would be very difficult to replace. Our failure to attract, retain and motivate qualified personnel could have a material adverse effect on our business, financial condition and results of operations. We have employment agreements with all of our executive officers. There are risks inherent in our international operations, which may have a material adverse effect on our business, financial condition and results of operations. Approximately 75% of our sales in Fiscal 2008 were derived from sales in markets outside North America. We expect sales from foreign markets to continue to represent a significant portion of total sales in the foreseeable future. We operate two manufacturing facilities as well as sales and technical support service centers in Europe and Asia. Certain risks are inherent in our international operations, including the following: o Political and economic instability; o Unexpected changes in regulatory requirements; o The burden of compliance with foreign laws; o Import and export restrictions; o Difficulties in staffing and managing operations; o Fluctuations in exchange rates against the U.S. Dollar; o Difficulties in collecting receivables; and o Potentially adverse tax consequences. For example, some of the costs in our foreign operations, principally payroll costs, are denominated in currencies other than the U.S. dollar functional currency. These expenses are predominantly denominated in British pounds, Swedish kronor, and Canadian dollars. Our results of operations are subject to the effects of exchange rate fluctuations of these currencies relative to the U.S. dollar. We use financial instruments, principally foreign exchange option and forward contracts, to help manage foreign currency exposure. These contracts reduce, but do not eliminate, the effect of foreign currency exchange rate fluctuations. 4 The above factors could have a material adverse effect on our business, financial condition and results of operations. Failure to protect our intellectual property or infringing on patents and proprietary rights of third parties could have a material adverse effect on our business, financial condition and results of operations. Our success and future revenue growth depends, in part, on our ability to protect our intellectual property. We rely primarily on patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods to protect our proprietary technologies and processes. We have been issued many patents, principally in the United States and the United Kingdom. We have also filed many patent applications, principally in the United States and the United Kingdom. However, these patents may not adequately protect us or provide us with a competitive advantage. If our patents fail to protect our technology, our competitors may benefit by offering similar products to customers. In addition, certain foreign countries have limited or no copyright, trademark and trade secret protection. Although we have taken steps to protect our intellectual property, we cannot guarantee that we will be successful in doing so. Failure to protect our intellectual property could have a material adverse effect on our business, financial condition and results of operations. We have been in the past and may in the future be notified of claims that our products infringe the patent or other proprietary rights of third parties, and claims may be raised against us. If we are unsuccessful in defending against such claims, we could be prevented from making, using or selling certain of our products, and we may be subject to damage assessments. All of these factors could have a material adverse effect on our business, financial condition and results of operations. Our stock price is subject to volatility, and significant fluctuations may adversely impact the market price of our common shares. The market price of our common shares has fluctuated in prior periods, and future market prices could be subject to significant fluctuations due to the following factors: o General economic and market conditions in response to variances in anticipated and actual operating results of us or our competitors; o Variations in our quarterly operating results; o Announcements of new product introductions by us or our competitors; o Conditions in the semiconductor market; and o Mergers and acquisitions. These and other factors may adversely impact the market price of our common shares. On December 18, 2007 we were notified by NYSE Regulation, Inc. that we were not in compliance with one of the New York Stock Exchange ("NYSE") continued listing requirements, due to the fact that the average closing price of our common shares was less than US$1.00 over a consecutive 30-day trading period. We will attempt to remediate this deficiency during the six-month cure period; however if at the end of the six-month cure period, both a US$1.00 share price and a US$1.00 average share price over the preceding 30 trading days are not attained, the NYSE could commence suspension and delisting procedures. A delisting could have a material adverse effect on our business, financial condition and results of operations. A delisting may impact our ability to raise additional financing and our position within our market space may be negatively impacted. Having an average closing share price of less than US$1.00 will have no impact on our Toronto Stock Exchange ("TSX") listing. Our operating results may vary significantly due to impairment of goodwill and other intangible assets incurred in the course of acquisitions, as well as to impairment of tangible assets due to changes in the business environment. Our operating results may vary significantly due to impairment of goodwill and intangible assets booked in connection with acquisitions and the purchase of technologies and licenses from third parties. As of March 28, 2008, the value on our consolidated balance sheet for goodwill was $46.9 and for intellectual property was $56.5, net of amortization. Because the market for our products is characterized by rapidly changing technologies, and because of significant changes in the semiconductor industry, our future cash flows may not support the value of goodwill and other intangibles recorded in our consolidated balance sheet. We are required to test goodwill 5 annually and to assess the carrying values of intangible and tangible assets when impairment indicators exist. As a result of such tests, we could be required to record impairment charges in our statement of income if the carrying value in our consolidated balance sheet is in excess of the fair value. The amount of any potential impairment is not predictable as it depends on our estimates of projected market trends, results of operations and cash flows. In addition, the introduction of new accounting standards can lead to a different assessment of goodwill carrying value, which could lead to a potential impairment of the goodwill amount. Any potential impairment, if required, could have a material adverse impact on our results of operations. We have a substantial amount of indebtedness that could adversely affect our financial position and prevent us from implementing future strategies. In connection with our acquisition of Legerity, we incurred Long-term debt of $77.4 ($78.8 million Cdn) as at March 28, 2008. The issuance of this indebtedness may: o Limit our ability to borrow additional funds for working capital, capital expenditures and future acquisitions; o Require us to use a substantial portion of our cash flow from operations to make debt service payments; o Place us at a competitive disadvantage compared to our less leveraged competitors; and o Increase our vulnerability to the impact of adverse economic and industry conditions, most significantly changes in foreign exchange rates as this debt is denominated in Canadian dollars, while our functional currency is the U.S. Dollar. We depend on third-party subcontractors to assemble, obtain packaging materials for, and test many of our products. If we lose the services of any of our subcontractors or if these subcontractors are unable to obtain sufficient packaging materials, shipments of our products may be disrupted, and we may be subject to warranty claims, which could harm our customer relationships and adversely affect our results of operations. Several third-party subcontractors located in Asia assemble, obtain packaging materials for, and test some of our products. Because we rely on third-party subcontractors to perform these functions, we cannot directly control our product delivery schedules and quality assurance. This lack of control has resulted, and could in the future result, in product shortages or quality assurance problems. This could delay shipments of our products or increase our manufacturing, assembly or testing costs. If our third-party subcontractors are unable to obtain sufficient packaging materials for our products in a timely manner, we may experience a significant product shortage or delay in product shipments, which could seriously harm our customer relationships and sales. In addition, quality assurance problems by our third-party subcontractors could result in defective products being shipped to our customers. The cost of product replacements or returns and other warranty related matters could materially adversely affect us. Some of our subcontractors are located in regions with a higher risk of being subject to earthquakes, floods and other natural disasters. During Fiscal 2008, a flood occurred at our Swindon foundry, which is now owned by MHS Electronics UK Ltd. ("MHS"), but continues to be a supplier to Zarlink. The flood resulted in the complete shut down of the facility and affected our supply of finished product. The occurrence of additional floods or other natural disasters could result in the disruption of our assembly and test capacity. If any of our subcontractors experience capacity constraints or financial difficulties, suffer any damage to their facilities, experience power outages or any other disruption of assembly or testing capacity, we may not be able to obtain alternative assembly and testing services in a timely manner. This could result in significant delays in product shipments if we are required to find alternative assemblers or testers for our components. Any problems that we may encounter with the delivery, quality or cost of our products could damage our customer relationships and materially and adversely affect our business, financial conditions and results of operations. We depend on eight independent foundries to manufacture most of our products, and elimination or disruption of these arrangements could adversely affect the timing of product shipments. In Fiscal 2008, approximately 95% of our products were sourced from eight independent foundries that supply the necessary wafers and process technologies. These independent foundries now include the analog foundry in Swindon UK, which we sold to MHS in Fiscal 2008. We have wafer supply agreements with six of these foundries, which expire between Fiscal 2009 and 2011. These suppliers are obligated to provide certain quantities of wafers per year under these agreements. These agreements are typically renewed prior to their expiry dates, or automatically renew for a specified period under the existing terms and conditions unless either party provides notification of non-renewal to the other party. These independent foundries also manufacture products for other companies. In the past, availability of foundry capacity has been reduced due to strong demand. As a result, 6 we may not have access to adequate capacity or certain process technologies as capacity and technologies may be allocated to other customers. In addition, a manufacturing disruption experienced by one or more of our outside foundries or a disruption of our relationship with an outside foundry, including discontinuance of our products by that foundry, would negatively impact the production of our products. As a result of the European Union directive Restriction of Hazardous Substances ("RoHS"), certain specific hazardous materials were eliminated from our production. We now have the capability to be compliant with the RoHS directive, however some of our customers have exemptions to the directive and our foundry suppliers may experience supply delays or shortages where they are maintaining the capability to produce the original products. If our foundry suppliers were unable or unwilling to manufacture our products in the volumes that we require, then we would need to identify and qualify acceptable additional or alternative foundries. This qualification process could take six months or longer, and such a change may require approval from certain customers. We may not find sufficient capacity quickly enough, if ever, to satisfy production requirements and we may be unable to meet customer demand for our products. This could cause customers to cancel or fail to place new orders, which could have a material adverse effect on our business, financial condition and results of operations. We are subject to environmental regulations, which impose restrictions surrounding the use, disposal and storage of hazardous substances. Our failure to comply with present or future environmental regulations could result in future liabilities and could have a material adverse effect on our business, financial condition and results of operations. We have manufacturing facilities located in the United Kingdom and Sweden, and are subject to a variety of laws, rules and regulations related to the discharge or disposal of toxic, volatile or other hazardous chemicals used in our manufacturing process. We believe that we have complied with these laws, rules, and regulations in all material respects, and to date have not been required to take any action to correct any noncompliance. However, if we fail to comply with present or future regulations, we could be subject to fines, or production being suspended or facilities closed. Such regulations could require that we acquire significant equipment or incur substantial other expenses to comply with environmental regulations. If we fail to control the use, disposal, storage of, or adequately restrict the discharge of, hazardous substances, we could be subject to future liabilities. This could have a material adverse effect on our business, financial condition and results of operations. Item 4 Information on the Company A. History and Development of the Company Our legal and commercial name is Zarlink Semiconductor Inc. Zarlink was incorporated in Canada in 1971 and continued under the Canada Business Corporations Act in 1976. The registered office and the executive offices are located at 400 March Road, Ottawa, Ontario, Canada K2K 3H4. The main telephone number is (613) 592-0200. Our common shares are listed under the symbol "ZL" on the New York Stock Exchange and the Toronto Stock Exchange. Our website address is www.zarlink.com. On February 29, 2008, Zarlink sold its analog foundry in Swindon, UK to MHS a subsidiary of MHS Industries Group for one British pound. In addition, Zarlink paid MHS (euro)2 million to support restructuring initiatives. On August 3, 2007, Zarlink acquired 100% of the capital stock of Legerity for $137.3 in cash, including $2.8 of direct transaction costs. On May 19, 2006, Zarlink purchased the optical in/out ("I/O") business of Primarion, Inc. for $7.1 in cash. The purchase included Primarion's optical I/O assets and intellectual property. On October 25, 2006, Zarlink sold the assets of its packet switching product line to Conexant Systems Inc. for cash and other consideration, including a cash payment at closing of $5.0 and additional amounts based on revenue performance of the product line over the next two years. On November 15, 2005, Zarlink sold the assets of its RF Front-End Consumer Business to Intel Corporation, through its wholly-owned subsidiary Intel Corporation (UK) Limited ("Intel"). This transaction was treated as a discontinued operation during Fiscal 2006. 7 B. Business Overview Zarlink designs and manufactures semiconductors for the communications and healthcare industries. For more than 30 years, Zarlink has delivered Integrated Circuits ("ICs") that enhance the capabilities of equipment used in voice, enterprise, broadband and wireless communications networks. ICs are silicon chips, known as semiconductors, etched with interconnected electronic components that process information. Our success depends primarily on our ability to design high-value ICs that solve complex problems for customers. Zarlink is focused on opportunities in the telecommunication, medical telemetry and optical interconnect markets. Each of these markets is experiencing technological change, and we believe that delivering high value solutions that solve key problems for our customers will provide revenue growth opportunities. The principal customers for Zarlink's products are network equipment manufacturers, medical device manufacturers, network operators and system integrators. Carriers and service providers, including cable companies and telephone operators, are investing in new network equipment, or retrofitting their existing infrastructure, to enable "triple play" voice, television and Internet services over a single packet-based network. Zarlink's timing and synchronization products deliver performance that allows network equipment to handle a complex mix of voice, data and video traffic and seamlessly deliver services to users. Through the acquisition of Legerity, we have added interface products required for reliable, high-quality voice service to cable and digital subscriber line ("DSL") networks. Telecom networking and optoelectronics products help customers navigate the complexity of converging networks. For hands-free communication systems, including car kits, speakerphones and home automation applications, Zarlink's voice processing products ensure high-quality voice by providing advanced acoustic echo cancellation and noise reduction techniques. Building on our experience in customized ICs, digital signal processors ("DSPs") and radio frequency ("RF") chips for cardiac pacemakers and hearing aids, Zarlink is developing innovative ultra low-power RF platforms driving a range of advanced wireless healthcare products. System-on-chip solutions deliver data rates and critical low power performance required to connect implanted medical devices, including pacemakers, implanted cardioverter defibrillators ("ICDs") and drug pumps, and monitoring and programming equipment. Zarlink's Optical Communications interconnect technologies extend the reach and improve the performance in data centers and video surveillance systems. Data centers have to expand quickly as more data is being accessed, received and stored. However, the weight, inflexibility and limited reach of traditional copper cables used to interconnect data center equipment is a significant barrier to expansion. Zarlink's ZLynx active optical cables are a plug-and-play solution that operates seamlessly with installed data center equipment, while delivering significant weight, reach and flexibility advantages to speed installation and expansion. Our video surveillance copper-to-fiber converter modules reduce installation and expansion costs and improve the performance of new and existing video surveillance systems. Business Strategy Zarlink's strategy is to exploit the following major industry developments: o Extended transition to "pure IP" -based packet networks; o Growing deployment of voice-over-Internet and voice-over-cable services; o The need to effectively manage converging time-sensitive voice and multimedia traffic on packet-based networks, while meeting rigorous performance standards to ensure Quality of Service ("QoS"); o Increasing demand for optical interconnect technologies in data centers and high-performance computer clusters; and video surveillance systems; and o Increasing use of short-range, low-power wireless communications in advanced healthcare applications. The key elements of Zarlink's business strategy are: o Seek niche market opportunities that value proprietary mixed-signal products and deliver these products at the highest integration point possible; 8 o Develop timing and voice enhancement products with a long lifespan that handle a complex mix of time-sensitive voice, data, video and legacy services that enable the transition from circuit-switched to packet IP networks; o Develop interface products required to add reliable, high-quality voice service to cable and broadband networks; o Offer standard and custom ultra low-power wireless technologies for intelligent medical devices; and o Develop optical interconnect products meeting new reach, weight and flexibility demands. We believe that Zarlink is well positioned to implement its business strategy because of our ability to design high-value ICs and integrated solutions. For the telecommunications market, we design ICs that groom, condition and manage voice and data traffic in the access and edge portions of the network, as well as optoelectronic devices for meeting high-performance requirements. Our ultra low-power expertise will enable us to design ICs and integrated system-on-chip solutions for next-generation medical devices and therapies incorporating short-range wireless functionality. See also Item 4B of this Form 20-F. Industry The global communications industry is characterized by rapid structural change, and economic growth caused by technological innovation, economic factors, and changes in government policies that encourage competition and choice. The communications industry is driven by service provider demand for more effective, more intelligent and, and lower cost networking equipment. The industry is further driven by consumer/enterprise adoption of new communications tools and an increasing requirement for real-time access to information. Customer demand is for real-time access to information, and the need for lower-cost and more effective networking equipment. These factors, in turn, are driving networking convergence, the growth in new mobile communication devices and services, and high-bandwidth access technologies. Evidence of these changes includes the impact of the Internet, telecom deregulation, optical networking technology, network convergence, broadband connectivity, home entertainment, wireless and mobile communications, and demand by enterprises for cost-effective, multi-functional networks and applications. We believe that the long-term opportunities for communications semiconductors are significant. There is a fundamental change occurring within today's telecommunication network, as cable companies and telephone operators invest in new equipment, or retrofit their existing infrastructure, to deliver "triple play" voice, video and data services over a converged network. We believe that the most important trend in the network communications industry is the gradual convergence of traditional circuit-switched to emerging packet networks, and requirements for new high-performance equipment to better manage and deliver a wider range of services over a single network. Traditional telephone networks, which still comprise the bulk of the existing telecommunications infrastructure, are based on circuit-switched technology. To achieve cost savings, improve network efficiency, and introduce new revenue-generating services, network operators are gradually building out lower-cost packet-switched networks that carry all types of traffic. The industry is currently in the early deployment stages of this transition, during which both types of networks must co-exist and be interconnected. This requires technologies that can groom and manage traffic across legacy and next-generation network equipment. In addition, packet-switched networks were not originally designed to carry time-sensitive information, including voice services. Cable operators and telephone companies are seeking new ways to more efficiently deliver services to their customers. In particular, both require interface products that enable high-quality, high-reliability voice service over cable and high-speed Internet networks. This transition presents exciting opportunities for Zarlink. Our experience in voice and other time sensitive traffic, network timing, and international standards ensures that customers can use our ICs in the converged network environment. We believe that the convergence to packet-based networks, the deployment of triple play services and the evolution of new services are long-term demand drivers that present exciting opportunities for Zarlink. Our experience in voice and other time-sensitive traffic, network timing, and international standards positions us so that customers can use our ICs in the converged network environment. We anticipate significant growth in wired, wireless and optical infrastructure in the enterprise and access portions of the network. New services will be provided over existing infrastructure and content-rich applications will drive the need for more bandwidth and the technologies that provide it. 9 Medical device manufacturers are increasingly integrating wireless capabilities to enable new applications and therapies in an effort to improve patient quality-of-life and lower healthcare costs. An aging, but increasingly mobile and independent population is driving demand for new home-based health monitoring equipment and devices that can alleviate chronic pain or lessen the debilitating effects of some diseases. Wireless technologies can also be used to reduce doctor visits, shorten surgery times and in some cases replace surgical procedures. Zarlink' experience in low power radio frequency ("RF") technologies, coupled with our understanding of the unique quality and regulatory process demands for the medical device industry, uniquely positions us in the emerging medical wireless market. The optical market is being driven in part by demand for new fiber-based interconnect technologies that extend reach and performance, reduce weight and improve flexibility versus existing solutions. In data centers and computer clusters, the bulk, inflexibility, weight and limited reach of multi-strand copper cable assemblies is an increasing barrier to installation, maintenance and expansion. Video surveillance network operators are moving towards new solutions that will speed installation and expansion; improve performance and scalability to support the evolution to more efficient, cost-effective and secure IP-based systems. Zarlink's 30-plus years of expertise is delivering optical solutions that meet strict quality demands for telecom, military and industrial applications and is supporting the development of new products that meet critical performance requirements for interconnect applications. Products and Customers Zarlink's ICs are microelectronic components that offer high levels of feature integration, low-power consumption, and the reduced physical space required for the design of advanced systems. These ICs provide features and control functions for a wide variety of electronic products and systems. Our semiconductor products are primarily non-commodity, specialized products that are proprietary in design and used by multiple customers. Zarlink's products are primarily Application Specific Standard Products ("ASSPs"), which are proprietary products designed to meet the specific requirements of a class of customers. These products are typically based on an original design, sell primarily on function and performance, and remain as a key component in the end product for the duration of its life cycle. Accordingly, once designed into a customer's product, our ICs become an integral part of that product and are difficult to replace, since replacement requires some degree of system redesign. We have a diverse and established base of over 400 customers in a wide spectrum of end-markets, including manufacturers in the telecommunications, data communications, and healthcare sectors. Zarlink generates revenues through both direct sales and sales through distributors. In Fiscal 2008, Zarlink had revenues from an independent distributor (Avnet Electronics Marketing group), which exceeded 10% of total sales. Worldwide sales to this distributor in Fiscal 2008 amounted to $38.4, representing 21% of sales (Fiscal 2007 - $48.4, or 34%; Fiscal 2006 - $43.7, or 30% of sales). Timing and Synchronization Zarlink's timing and synchronization products ensure accurate performance, quality and service reliability in all types of networks. To achieve reliable and error-free voice and data connections, customers use our timing devices in a wide range of networking equipment, from high-capacity routers, switches and digital subscriber line access managers ("DSLAMs") to media gateways and private branch exchanges ("PBXs"). In a typical system, Zarlink devices synchronize the overall system to the demanding standards required by modern networks and generate high performance clocks for individual ports or line cards inside the system. Our products consist of a broad portfolio of Synchronous Ethernet products supporting service deployment over packet-based networks, digital phase locked-loop ("PLL") devices for T1/E1 equipment, analog PLLs for Synchronous Optical Network/Synchronous Digital Hierarchy ("SONET/SDH") applications and Circuit Emulation Services-over-Packet ("CESoP") processors capable of transparently "tunneling" circuit-based TDM traffic with carrier-grade quality over many types of packet network. Voice Telephony As a result of Zarlink's purchase of Legerity during Fiscal 2008, we believe that Zarlink is in a strong position in the market for voice telephony products. Over the course of 27 years, Zarlink voice products have been a strong solution in the analog voice market, shipping over 450 million lines of DSP-based analog mixed signal products 10 and nearly 320 million SLIC lines. As a developer of silicon architecture for high quality voice telephone, our products utilize proprietary high voltage processes to communicate with and power analog telephone circuits for both voice and data applications. Our products are used in Central Office, multi-service access nodes ("MSAN"), and residential gateway platforms sold by the providers in the industry. The industry is undergoing a revolution whereby voice circuits, also known as the local loops, are being shortened in length to enable faster, more feature rich service offerings, and lower cost transport using Voice over IP protocols. In practical terms, the deployment of these new networks means that central office ports are being replaced by new equipment closer to the subscriber. Zarlink voice circuits play a critical role by offering carrier class performance and unique features that ease customer care at points well suited to the emerging access network. Zarlink offers companion devices that drive high-speed data services. The wireline telephony market is undergoing rapid; and significant change as service providers, including both established and new carriers, seek to enable a proliferation of voice, data and video based services. In addition, carriers are looking to new technologies that offer a lower cost of ownership and greater flexibility. Despite the widespread adoption of wireless telephony, wireline teledensity worldwide has continued to grow. Carriers are responding to market demands for voice services differently. As a result, demand continues to grow for voice line circuits in order to facilitate the new network architectures that are being deployed. Telecom and Voice Networking Zarlink's line of IP, TDM and telephony-based telecom networking ICs, including ATM SARs and PHYs, T1/E1 line interfaces, circuit-switching devices and range of voice interface products, enable efficient services over converging circuit and packet infrastructures. For example, Zarlink's comprehensive portfolio of low-, mid-, and high-density switching platforms boost the capabilities and simplify the design of wired and wireless networking equipment that must seamlessly transfer voice, data and multimedia services between circuit-switched and packet-based networks. Zarlink offers a wide range of devices used in telephones and telephone networking equipment, including: single- and multi-port, feature-rich T1/E1/J1 transceiver/framer products, silicon and hybrid subscriber line integrated circuits ("SLICs"), digital subscriber interfaces, data access arrangements ("DAAs"), dual tone multifrequency ("DTMF") receivers and transceivers, central office interface circuits ("COICs"), calling number identification circuits ("CNICs"), coder/decoder ICs ("CODECs"), and integrated digital phone ICs. Zarlink's voice processing technology delivers superior sound quality in IP phones, media gateways and fast-growing hands-free communication applications, including car kits, speakerphones, and intercom and home automation systems. Our voice processing products leverage over 30 years of expertise in telephony, digital signal processing and voice processing for telecommunication applications. Integrating advanced acoustic echo cancellation, noise reduction techniques, application-specific firmware and supported by a range of design tools, our voice processing solutions maximize voice sound quality while reducing system complexity and cost. Optical Communications For over 30 years, Zarlink has delivered optical solutions that meet strict quality and performance requirements for telecom, military, industrial and security applications. Our market-proven expertise is now helping drive a range of new optical interconnect products which are reliable, flexible and have bandwidth density. Our ZLynx active optical cables for data center and computer cluster interconnect deliver significant weight, flexibility and reach advantages while reducing installation time and layout concerns. Zarlink's parallel optical module and transceiver solutions combine ultra-high capacity channel transfer into one integrated module, providing equipment manufacturers with board space and power savings. Zarlink's homegrown multi-channel physical medium dependent integrated circuits and state-of-the-art array photonics technology is at the core of our parallel interconnect product portfolio. Zarlink's low-power, ultra-compact Video IP Surveillance ("VIPS") modules bring optical interconnect capabilities to video surveillance systems to help simplify installation and expansion while improving performance. 11 Zarlink's optical solutions are supported by specialized in-house processing capabilities ranging from wafer growth to test and assembly, at our manufacturing facility in Sweden. This enables us to have guaranteed standards-based and customized performance. Medical ASICs We have over 30 years of experience in the design of ICs used in medical products. Zarlink is a major supplier of mixed-signal complementary metal-oxide semiconductor ("CMOS") Application Specific Integrated Circuits ("ASICs") and Application Specific Standard Products ("ASSPs") for cardiac pacemakers, implantable defibrillators, swallowable camera capsules and hearing aids. Our expertise in designing ultra low-power and highly reliable ICs enables us to fabricate chips and modules that meet the rigorous performance and quality standards set by healthcare equipment makers. Medical Telemetry New medical applications and therapies integrating wireless technology are driving demand for ultra low-power mixed-signal analog and short-range wireless communications chips and modules. For example, Given Imaging's swallowable camera capsule relies on Zarlink's ultra low-power RF transmitter chip to relay real-time, full color images of the gastrointestinal tract. Our award-winning Medical Implant Communication Service (MICS) technology platform wirelessly links implanted medical devices, including pacemakers, defibrillators, neurostimulators, drug pumps and physiological monitors with remote monitoring and programming equipment. Using Zarlink's MICS technology, medical device manufacturers can design in-body communication systems that will improve patient care, lower healthcare costs, and support new monitoring, diagnostic and therapeutic applications. A key element of our strategy is to develop high performance, highly integrated chips and modules that combine low-power and short-range wireless capabilities for applications where extended battery life is a valued requirement. Foundry Manufacturing and Support Services During most of Fiscal 2008, Zarlink offered manufacturing and support services including product design, process design and support, wafer manufacture, die probe, die assembly, packaged part testing, and failure analysis. This line of business was included in the results from operations for eleven months of Fiscal 2008 until it was sold to MHS on February 29, 2008. Zarlink's wafer manufacture capability had been developed into a silicon wafer business referred to as the Swindon foundry. The Swindon foundry supported fabless semiconductor companies as well as original equipment manufacturers ("OEMs") and independent device manufacturers ("IDMs"). The Swindon foundry specialized in high performance analog technologies using the 150mm wafer line in Swindon, U.K. Our customers, including some of the top ten IDMs in the world, used the available technologies to manufacture high-performance radio frequency, line driver and power management semiconductor products. The technologies available included bipolar, complementary bipolar, bipolar CMOS ("BiCMOS"), CMOS, lateral double diffused metal oxide semiconductor ("LDMOS") and silicon-on-insulator ("SOI") process capabilities. The products manufactured at the Swindon foundry are used in a wide range of industrial and consumer products including automotive, telecommunication equipment and systems, consumer products and medical, including implantable products. The facility in Swindon operates under a number of quality and environmental standards including TS16949, ISO9001 and ISO14001, and is an approved site for the manufacture of medical implantable products. 12 Business Segments and Principal Markets The product lines within our operating segments contain similar products, production processes, and types of customers, distribution methods, and economic characteristics. As such, we have one reportable segment. Our revenue based on the geographic location of customers was distributed as follows: % of % of % of (In millions of U.S. dollars) 2008 Total 2007 Total 2006 Total --------------------------------------------------- Europe $ 53.4 29% $ 56.0 40% $ 53.3 37% Asia Pacific 84.9 46 40.5 28 46.2 32 United States 40.7 22 38.8 27 36.1 25 Canada 2.4 2 5.5 4 7.3 5 Other Regions 2.2 1 1.8 1 2.0 1 ------ --- ------ --- ------ --- Total $183.6 100% $142.6 100% $144.9 100% ====== === ====== === ====== === Sales, Marketing and Distribution The principal customers for Zarlink's semiconductors are telecommunications and healthcare equipment manufacturers. Our products are also marketed to network operators and installers. We sell through both direct and indirect channels of distribution. Factors affecting the choice of channel include, among others, customer preference, end-customer type, the stage of product introduction, geographic presence and location of markets, and volume levels. Our products are sold in over 40 countries through local Zarlink sales offices and our distributor network. Our strategic account program focuses on the development of business with the key customers in all the market segments we serve. We believe that long-term revenue growth will be supported by various factors that drive demand for communications equipment and infrastructure [See also "Business - Overview" and "- Industry"]. The requirement for basic telephone service in emerging countries is also a strong driver for both wireless and wired communications, which supports demand for our telephony ICs. An important element of Zarlink's ability to compete is the expertise of our applications groups, which are located in the United Kingdom, the United States, Canada, Singapore, and other locations in Asia and Europe, to serve customers in regional markets. The applications groups assist equipment manufacturers in designing their products using our components. Because of this approach, we have a strong record of understanding our customers and their applications and providing complete solutions. This is a critical element in obtaining design wins. The design-win cycle starts when Zarlink and/or a member of our distributor network identifies a need for one of our standard communications products in a customer's equipment design. Once a Zarlink product is selected for a design, we are generally assured of supplying it until the design is no longer manufactured. Europe Historically, sales in Europe have been made primarily through our direct sales channel, particularly in the medical ASIC and wireless markets. Distributors play an important role in the European region, accounting for approximately 31% of sales in this area in Fiscal 2008. We maintain technically qualified sales teams across the entire region and support them with a team of applications engineers. Asia/Pacific In the Asia/Pacific area, China, Korea, Japan, Taiwan and Malaysia represent the largest markets by country. We also sell ICs in Australia, Hong Kong, Thailand, New Zealand, Singapore, the Philippines, India and the Middle East. Zarlink's regional headquarters for Asia/Pacific is in Singapore, and we also have offices in Japan, Taiwan, Korea and China. In Fiscal 2008, approximately 43% of sales in these areas were achieved through distributors. An important function of the sales offices is to link customers with our applications support groups. The sales offices manage key customer and distributor relationships and opportunities, and ensure the most effective use of applications resources. 13 Americas We use a combination of direct sales teams and manufacturer's representatives to reach a broad spectrum of customers in the United States and Canada. We also depend on distributors for fulfillment requirements and demand creation in several geographical territories in the Americas Region. The direct sales force includes major account teams that target specific large customers for standard product designs. Competition Competition in the semiconductor market is intense, from both established companies and new entrants. Rapid technological change, ever-increasing functionality due to integration, a focus on price and performance, and evolving standards characterize the markets for Zarlink's products. Competition is based principally on design and system expertise, customer relationships, service and support. With our focus on proprietary designs and intellectual property, and our sales and application support network, we believe that our company is structured to compete effectively. Our main global competitors for network communications products include PMC-Sierra, Inc., Agere Systems, Inc., Infineon Technologies AG, Integrated Device Technology, Inc., Silicon Laboratories, Inc., and Semtech Corporation. We believe that Zarlink competes favorably based on our extensive intellectual property rights for proprietary designs, and our proven ability to meet regulatory and industry standards. In the medical IC market, Zarlink competes mainly with American Microsystems, Inc. and Microsemi Inc., in addition to system OEMs with in-house design capability, and smaller ASIC design houses. Zarlink sells to most of the healthcare OEMs worldwide. We believe that Zarlink has a competitive advantage based on our world-class low-power design skills, application knowledge, and intellectual property, in conjunction with our comprehensive and certified quality system and long experience with key customers in the highly regulated healthcare device industry. Manufacturing Our products share a common production process, however the selection of manufacturing sites or suppliers is dependent on the type of semiconductor to be manufactured and the required process and technology. All of our products are sourced from eight independent foundries that supply the necessary wafers and process technologies. Of these independent foundries, we have wafer supply agreements with six of them, which expire at various times from Fiscal 2009 to 2011. These agreements are typically renewed prior to their expiry dates, or automatically renew for a specified period under the existing terms and conditions unless either party provides notification of changes to the other party. Our remaining products are manufactured at our own facilities. IC probe and finished goods testing is done at our facilities in Ottawa, Canada and in Swindon and Plymouth in the United Kingdom. In Fiscal 2008, we began to outsource a portion of the IC probe and finished goods testing to third party providers and we plan to fully outsource these activities by the end of Fiscal 2009. Optoelectronic components and modules are produced at our Jarfalla, Sweden facility using gallium arsenide and indium phosphide processes. Our semiconductor and optoelectronic manufacturing facilities and quality management systems are certified to the strict standards established by the International Organization for Standardization. In addition, our processes must comply with the European Union directive Restriction of Hazardous Substances ("RoHS"), which defines the specific hazardous materials that were required to be eliminated by July 2006. We produce Pb-free IC devices and believe that we have the capability to be compliant with the RoHS directive. Some of our customers have exemptions to the directive, and as such we have maintained our capability to produce original products for these customers. Proprietary Rights We own many patents and have made numerous applications for patents relating to communications and semiconductor and optoelectronic technologies. We believe that the ownership of patents is an important factor in exploiting associated inventions and provides protection for our patentable technology in the areas referred to above. 14 The "ZARLINK" trademark and the Zarlink corporate logo are registered in Canada and pending registration in the United States, and have been registered in certain other countries where we conduct business. The "LEGERITY" trademark and the Legerity corporate logo are registered in the United States. Most of our other trademarks are registered or applications for registration have been filed in various countries where management has determined such registration to be advisable. We believe that our trademarks are valuable and generally support applications for registration of marks in countries where the assessment of potential business related to the sale of products or services associated with such marks justifies such action. We also own other intellectual property rights for which registration has not been pursued. In addition to applying for statutory protection for certain intellectual property rights, we take various measures to protect such rights, including maintaining internal security programs and requiring certain nondisclosure and other provisions in contracts. As is the case with many companies doing business in the telecommunications industry, from time to time we obtain licenses from third parties relating to technology for our products and processes. We do not consider any of our current licenses to be material to our business, financial condition or results of operations. Seasonality We experience seasonal fluctuations in revenue in certain regions. For example, second quarter sales in Europe are generally slower due to mandatory vacation periods in the summer, while our sales in the Asia Pacific region tend to be slower in our fourth quarter around the Chinese New Year season. Given the diversity of our revenue base, we do not believe that seasonality has a material impact on our business, financial condition, or results of operations. Given our limited visibility of demand in technology end markets, it is difficult to predict the extent to which seasonality will impact us in the future. Government Regulations The research and development, manufacture and marketing of our products are subject to regulation by U.S., Canadian and foreign governmental authorities and agencies. Such agencies regulate the testing, manufacturing, safety and promotion of our products. These regulations may materially impact our business, financial condition or results of operations. C. Organizational Structure The following subsidiaries are 100% owned, directly or indirectly, by Zarlink Semiconductor Inc. Name Country of Incorporation or Residence - ----------------------------------------- ------------------------------------- Zarlink Semiconductor (U.S.) Inc. U.S.A. Zarlink Semiconductor V.N. Inc. U.S.A. Legerity International, Inc. U.S.A Zarlink Semiconductor Limited United Kingdom Zarlink Semiconductor Holdings Ltd. United Kingdom Zarlink Semiconductor AB Sweden Zarlink Semiconductor S.A.R.L. France Zarlink Semiconductor GmbH Germany Zarlink Semiconductor XIC B.V. Netherlands Zarlink Semiconductor (Asia) Pte. Ltd. Singapore Zarlink Srl Italy Legerity BVBA Belgium Plessey Italy Srl Italy Legerity Japan KK Japan D. Property, Plants and Equipment We own one facility in Swindon, United Kingdom totaling approximately 33,000 sf which relates to a building that is no longer in use and is currently held for sale, as discussed in Note 7 of Item 18 to this Form 20-F. We occupy 15 approximately 27,000 sf of leased space in Swindon, United Kingdom that is used for test, assembly and administration. We also own a 333,000 sf facility in Jarfalla, Sweden, that is used for semiconductor manufacturing, R&D and administration, of which 30,000 sf is leased to tenants. We occupy 210,000 sf of leased space in Ottawa, Canada. Our Ottawa leased space consists of two interconnected buildings used for design, sales, administration, and integrated circuit design and testing. Approximately 86,000 sf of the space is sub-let to nine tenants with sub-lease periods expiring from Fiscal 2009 to 2012. We occupy 55,800 sf of leased space in Portskewett, Wales, United Kingdom that is used for hybrid modules, manufacturing and administration. We also lease and operate 14 regional facilities, totaling 206,000 sf, primarily dedicated to design and sales. A geographical breakdown of these facilities is as follows: four locations in the United States totaling 114,000 sf; three locations in the United Kingdom totaling 81,000 sf, of which 22,000 sf is sub-leased; four locations in Europe totaling 4,000 sf (France, Italy, Germany and the Netherlands); and five locations in the Asia/Pacific region totaling 7,000 sf. We believe that our facilities are adequate for our business needs for the foreseeable future. Item 4A Unresolved Staff Comments None Item 5 Operating and Financial Review and Prospects Critical Accounting Estimates Our consolidated financial statements are based on the selection and application of accounting policies, some of which require us to make estimates and assumptions. We believe that the following are some of the more critical judgment areas in the application of accounting policies that currently affect our financial condition and results of operations. We have discussed the application of these critical accounting estimates with the Audit Committee of our Board of Directors and with the full Board of Directors. This review is conducted annually. Revenue Recognition We recognize revenue from the sale of semiconductor products, which are primarily non-commodity, specialized products that are proprietary in design and used by multiple customers. Customer acceptance provisions for performance requirements are generally based on seller-specified criteria, and are demonstrated prior to shipment. We generate revenue through both direct sales and sales to distributors, of which distributor sales accounted for approximately 41%, 49% and 48% of our sales in Fiscal 2008, 2007, and 2006, respectively. In accordance with Securities Exchange Commission Staff Accounting Bulletin ("SAB") No. 104, Revenue Recognition, we recognize product revenue through direct sales and sales to distributors when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) transfer of title has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of the resulting receivable is reasonably assured. In addition, we have agreements with distributors that cover three sales programs, specifically ship and debit claims, which relate to pricing adjustments based upon distributor resale, stock rotation claims, which relate to certain stock return rights earned against sales, and sales rebates, which relates to refunds on certain products purchased. We accrue for these programs as a reduction of revenue at the time of shipment. In estimating our sales provisions, we examine historical sales returns as a percentage of distributor revenue for the preceding two Fiscal years, considering trends particularly in recent months. We also consider other known factors, including estimated inventory held by our distributors, in estimating our sales provisions. We recognize revenue at the time 16 of shipment in accordance with Statement of Financial Accounting Standards 48 ("SFAS 48"), Revenue Recognition When Right of Return Exists, because of the following: i) The price to the buyer is substantially fixed or determinable at the date of sale; ii) The distributor is obligated to pay us, and the obligation is not contingent on resale of the product; iii) The distributor's obligation to us would not be changed in the event of theft or physical destruction or damage of the product; iv) The distributor has economic substance apart from that provided by us; v) We do not have significant obligations for future performance to directly bring about resale of the product by the distributor; and vi) The amount of future returns can be reasonably estimated. We record all revenue net of all sales and related taxes, in accordance with Emerging Issues Task Force Issue No. 06-03 ("EITF 06-03"), How Taxes Collected from Customers and Remitted to Governmental Authorities should be Presented in the Income Statement. As at March 28, 2008, our sales provisions were $2.9 (2007 - $3.2). In estimating our sales provisions, we are required to estimate future sales returns. If actual sales returns or pricing adjustments exceed our estimates, we could be required to record additional reductions to revenue. Business Combinations Business Combinations - We account for acquisitions of companies in accordance with Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations. We allocate the purchase price to tangible assets, intangible assets, and liabilities based on fair values with the excess of purchase price amount being allocated to goodwill. Our acquisition of Legerity has resulted in the recognition of significant amounts of goodwill and acquired intangible assets. In order to allocate a purchase price to these intangible assets and goodwill, we make estimates and judgments based on assumptions about the future income producing capabilities of these assets and related future expected cash flows. We also make estimates about the useful life of the acquired intangible assets. Should different conditions prevail, we could incur write-downs of goodwill, write-downs of intangible assets, or changes in the estimation of useful life of those intangible assets. Additionally, we may have to make adjustments to the valuation allowance on deferred tax assets related to loss carry forwards acquired through acquisitions and the restructuring accruals related to acquisitions. These adjustments would not affect our result of operations. Instead, these adjustments would be applied to goodwill. Inventory Inventories are valued at the lower of an adjusted standard basis, which approximates average cost, or net realizable value for work-in-process and finished goods. Raw material inventories are valued at the lower of an adjusted standard basis, which approximates average cost, or current replacement cost. The cost of inventories includes material, labor and manufacturing overhead. We periodically compare our inventory levels to an estimated twelve-month demand, on a part-by-part basis. Inventory on hand in excess of our estimated twelve-month demand is further evaluated against other considerations to determine any required charge for obsolescence. The other factors we consider include forecasted demand in relation to inventory on hand, the competition facing our products, market conditions, and our product life cycles. If estimated demand is greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to write down additional inventory, which would negatively impact gross margin. If we sell inventory that has been written off in prior periods, we will record revenue without an offsetting charge to cost of revenue, which would favorably impact our gross margin. Restructuring We have undertaken, and may in the future undertake, restructuring initiatives that have required the development of formalized plans for exiting certain activities. All restructuring charges have been accounted for in accordance with Emerging Issues Task Force Issue No. 94-3 ("EITF 94-3"), Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring), and SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, depending on the time of the restructuring activity. These activities require estimation of the cost and timing of expenses for severance, idle facility, and other restructuring costs. In estimating severance costs, we are required to estimate the timing and 17 amount of future payments. In estimating idle facility costs, we are required to estimate future lease operating costs, the amount of sublease revenue that we expect to receive, and the expected discount rate. Idle facility costs are recorded as a component of provisions for exit activities. At the end of each reporting period, we evaluate the balance in the provisions for exit activities. This evaluation could result in an increase or decrease to the provisions, which could result in an increase or decrease in expense in future periods. As at March 28, 2008, we had provisions for exit activities of $3.9 (2007 - $1.3). Income Taxes We are subject to income taxes in Canada, Sweden, the United Kingdom, the United States and numerous other foreign jurisdictions. Our effective tax rate is based on pre-tax income and statutory tax rates in the jurisdictions where we operate. In determining taxable income, we are required to make estimates and judgments in determining the effective tax rate. In evaluating our effective tax rate, we are required to review ongoing audits and probable outcomes of filing positions. The final outcome of audits by taxation authorities may differ from the estimates and assumptions we have used in determining our tax provisions. Our ongoing assessments and closure of tax audits may materially impact our income tax expense and recoveries. Any revisions of our estimates will be recorded in the period of the change. We have recorded a valuation allowance on our 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. As at March 28, 2008, our valuation allowance was $240.0 (2007 - $193.5). In establishing our valuation allowance, we consider factors including forecasted future taxable income, loss carrybacks, and tax planning strategies. We periodically review our deferred tax assets and valuation allowance to determine whether these balances are reasonable. When we perform our quarterly assessments of our deferred tax assets and valuation allowance, we may record an adjustment, which may increase or decrease income tax expense in the period of the adjustment. Pension Liabilities We have defined benefit pension plans in Sweden and Germany. The pension liabilities related to these plans are determined from actuarial valuations, which require us to make certain judgments and estimates relating to expected discount rates, salary increase rates, and expected rates of returns on assets. These assumptions are evaluated on an annual basis, and a change in these assumptions could increase or decrease pension expense in future periods. Product Warranties In the normal course of business, we provide standard warranties, which cover the first twelve months of purchase and in some cases extended warranties; along with indemnification protection for our products. Our liability for breach of our warranty is limited, at our option, to repair, replace or credit the buyer the purchase price paid for the products returned during the applicable warranty period and determined by us to be subject to warranty relief and limited claims arising from epidemic failure. If we determine that a product sale is subject to warranty relief, we will record an accrual for the costs associated with resolving the warranty claim. As at March 28, 2008, we had provisions for warranty claims of $0.2 (2007 - $Nil). Goodwill and Long-Lived Assets We review our goodwill for impairment annually, or more frequently, if facts and circumstances warrant a review. In performing our goodwill impairment test, we compare the fair value of the related reporting unit to its carrying value. A reporting unit may be either an operating segment as a whole, or a unit one level below an operating segment, which is referred to as a component. If the fair value of the reporting unit exceeds its carrying value, then goodwill is not impaired. If the carrying value exceeds the fair value, then the implied fair value of the goodwill is calculated. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, then we would record an impairment loss equal to the difference. As at March 28, 2008, we had goodwill of $46.9 (2007 - $3.8). In determining the fair value of a reporting unit, we use a discounted cash flow model. Establishing fair value requires the use of estimates and assumptions, which include projected future cash flows, expected periods of cash flows, and discount rates. Changes in the estimates and assumptions used could materially affect the results of our evaluation, and could result in goodwill impairment charges in future periods. 18 We evaluate the recoverability of property, plant and equipment and definite life intangible assets in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. We assess the impairment of long-lived assets when events or changes in circumstances indicate that the carrying value of the assets or the asset groupings may not be recoverable. In assessing the impairment, we compare projected undiscounted net cash flows associated with the related asset or group of assets over their estimated remaining useful life against their carrying amounts. If projected undiscounted cash flows are not sufficient to recover the carrying value of the assets, the assets are written down to their estimated fair values based on expected discounted cash flows. In assessing impairment, we are required to estimate projected future cash flows, expected useful lives of assets, and discount rates. Changes in the estimates and assumptions used could result in asset impairment charges in future periods. Stock Compensation Expense On April 1, 2006, at the beginning of Fiscal 2007, we adopted SFAS 123R, Share-Based Payment. SFAS 123R requires that stock-based awards to employees be recorded at fair value. The estimated fair value of the options is amortized to expense over the requisite service period of the awards. Prior to adoption of SFAS 123R, we used the intrinsic value method of accounting for stock-based awards under the provisions of APB 25, Accounting for Stock Issued to Employees. Under the intrinsic value method, fixed stock compensation expense is recorded in instances where the option exercise price was set lower than the market price of the underlying stock at the date of grant. Fixed stock compensation cost is amortized to expense over the vesting period of the underlying option award. Stock compensation expense has also been recorded in circumstances where the terms of a previously fixed stock option were modified. In adopting SFAS 123R, we have estimated the fair value of our stock-based awards to employees using the Black-Scholes-Merton option pricing-model. This model considers, among other factors, share prices, option prices, share price volatility, the risk-free interest rate, and expected option lives. In addition, SFAS123R requires that we estimate the number of stock options which will be forfeited. Expected share price volatility is estimated using historical data on volatility of our stock. Expected option lives and forfeiture rates are estimated using historical data on employee exercise patterns. In Fiscal 2008, a 10% increase or decrease in estimated forfeiture rates would have resulted in an insignificant change in expense for the period. The risk-free interest rate is based on the yield of government bonds at the time of calculating the expense and for the period of the expected option life. If we change any of these assumptions, this could increase or decrease our stock compensation expense in future periods. Foreign Currency Translation We adopted the U.S. dollar as our functional currency on March 29, 2003. Since then, we have re-measured the carrying value of monetary balances denominated in currencies other than U.S. dollars at the balance sheet date rates of exchange. The gains or losses resulting from the re-measurement of these amounts have been reflected in earnings in the respective periods. We have measured non-monetary items and any related depreciation and amortization of such items at the rates of exchange in effect when the assets were acquired or obligations incurred. We have translated all other income and expense items at the average rates prevailing during the period the transactions occurred. Prior to March 29, 2003, we measured the financial statements of our foreign subsidiaries using the local currency as the functional currency. Translation gains and losses were recorded in the cumulative translation account within accumulated other comprehensive loss included in Shareholders' equity. In Fiscal 2008, we acquired certain foreign subsidiaries with a functional currency other than the U.S. dollar. As a result, the financial statements of these subsidiaries are measured using the local currency and translated using the period-end balance sheet rate and the average rate for the Statement of Income (Loss). Any translation gains and losses are recorded in the cumulative translation account within accumulated other comprehensive loss included in Shareholders' equity using the period-end balance sheet rate. Recently Issued Accounting Pronouncements In April 2008, the FASB issued FASB Staff position No. 142-3, Determination of the Useful Life of Intangible Assets. This FASB Staff Position ("FSP") amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. We are required to adopt FSP 142-3 in the first quarter of Fiscal 2010. The requirements of this FSP are to be applied prospectively to intangible assets acquired after the effective 19 date; we do not expect the adoption of FSP 142-3 to have a material impact on our financial position or results of operations. In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures About Derivative Instruments and Hedging Activities. The new standard requires enhanced disclosures to help investors better understand the effect of an entity's derivative instruments and related hedging activities on its financial position, financial performance, and cash flows. We are required to adopt SFAS 161 in the third quarter of Fiscal 2010. We do not expect the adoption of SFAS 161 to have a material impact on our financial disclosure. In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations ("SFAS 141(R)") and No. 160, Non-controlling interests in Consolidated Financial Statements ("SFAS 160"). The statements significantly change the accounting for acquisitions that close beginning in 2009, both at the acquisition date and in subsequent periods; however, certain requirements of the statement regarding income taxes will impact the disclosure and accounting of our previously completed acquisitions. SFAS 141(R) and SFAS 160 are effective for public companies for Fiscal years beginning on or after December 15, 2008. SFAS 141(R) will be applied prospectively. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS 160 shall be applied prospectively. Early adoption is prohibited for both standards. We are required to adopt SFAS 141(R) and SFAS 160 in the first quarter of Fiscal 2010. After the effective date of SFAS 141(R), we may be required to make an adjustment to income tax expense for changes in the valuation allowance for acquired deferred tax assets and to recognize changes in the acquired income tax positions in accordance with FASB Interpretation No. 48 ("FIN 48"). Previously, these amounts would be charged to goodwill or other intangible assets. We are not able to quantify the tax impact of this standard at this time. With the exception of the tax implications of SFAS 141(R) we do not expect the adoption of SFAS 141(R) or SFAS 160 to have any other material impact on our financial position or results of operations. In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue No. 07-3, Accounting for Advance Payments for Goods or Services Received for Use in Future Research and Development Activities ("EITF 07-3"). EITF 07-3 indicates that non-refundable advance payments for future research and development (R&D) activities should be deferred and capitalized until the goods have been delivered (assuming the goods have no alternative future use) or the related services have been performed. EITF 07-3 also indicates that companies should assess deferred R&D costs for recoverability. Companies are required to adopt EITF 07-3 for new contracts entered into in Fiscal years beginning after December 15, 2007. Earlier application is not permitted. We are required to adopt EITF 07-3 in the first quarter of Fiscal 2009. We do not expect the adoption of EITF 07-3 to have a material impact on our financial position and results of operations. In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 ("SFAS 159"). This statement allows companies to elect to measure certain eligible financial instruments and other items at fair value. Companies may choose to measure items at fair value at a specified election date, and subsequent unrealized gains and losses are recorded in income at each subsequent reporting date. SFAS 159 is effective for Fiscal years beginning after November 15, 2007, with earlier adoption permitted under certain circumstances. We do not anticipate electing to adopt SFAS 159 as the provisions of this standard will be negligible on our Company. In September 2006, the FASB issued SFAS 157, Fair Value Measurements. The statement clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosure requirements regarding fair value measurements. SFAS 157 is effective for Fiscal years beginning after November 15, 2007, with earlier adoption permitted. We are required to adopt SFAS 157, along with related interpretations, no later than the first quarter of Fiscal 2009. We do not expect the adoption of SFAS 157 or related interpretations to have a material impact on our financial position or results of operations. A. Operating Results You should read this Item 5.A. in combination with the accompanying audited consolidated financial statements prepared in accordance with United States generally accepted accounting principles ("GAAP"). 20 Business Overview For over 30 years, we have delivered semiconductor solutions that drive the capabilities of voice, enterprise, broadband and wireless communications. Our company is viewed as a single reporting segment, and, as such, no business segment information is being disclosed. The following discussion and analysis explains trends in our financial condition and results of operations for the Fiscal year ended March 28, 2008, compared with the two previous Fiscal years. This discussion is intended to help shareholders and other readers understand the dynamics of our business and the key factors underlying our financial results. Zarlink's year-end is the last Friday in March. The 2008 Fiscal year consisted of a 52-week period as compared to a 52-week period in Fiscal 2007, and a 53-week period in Fiscal 2006. Results of Operations 2008 2007 2006 ----------------------------- Consolidated revenue $ 183.6 $ 142.6 $ 144.9 Income (loss) from continuing operations (48.4) 15.8 2.0 Discontinued operations -- -- 46.8 Net income (loss) (48.4) 15.8 48.8 Income (loss) per common share From continuing operations (0.41) 0.11 (0.01) From discontinued operations -- -- 0.37 Basic and diluted (0.41) 0.11 0.36 Weighted average common shares outstanding - millions Basic 127.3 127.3 127.3 ============================= Diluted 127.3 127.4 127.4 ============================= Our Fiscal 2008 revenue increased by $41.0, or 29%, from Fiscal 2007. The revenue increase was driven mainly by an increase of $50.9 in our wired communications products, primarily as a result of the Legerity acquisition. This was partially offset by declines from our custom and foundry products. Our Fiscal 2007 revenue decreased by $2.3, or 2%, from Fiscal 2006. Revenue decreased mainly due to lower sales volumes of our legacy wired communications and medical ASIC products, which represented approximately 4% and 2%, respectively of the revenue decrease, partially offset by increased shipments of our foundry and timing products, which represented approximately 3% and 2%, respectively, of the increase. In Fiscal 2008, we recorded a loss from continuing operations of $48.4, or $0.41 per share, before preferred share dividends of $2.4 and premiums on preferred share repurchases of $1.2. This compares to Fiscal 2007 income from continuing operations of $15.8, or income of $0.11 per share, preferred share dividends of $2.2 and premiums on preferred share repurchases of $0.1. The loss in Fiscal 2008 was driven primarily by: a $20.3 write-off of in-process R&D ("IPR&D"); an $18.2 loss on sale of our Swindon foundry; higher costs as a result of the Legerity acquisition; which were partially offset by a $5.5 gain on insurance as a result of a flood at the Swindon facility. The loss from continuing operations in Fiscal 2008 also included the following: o A gain on sale of our Mitel investment of $12.9; o A gain on sale of land of $2.4; o A gain on the sale of our packet switching business of $0.7; o An impairment on design tools contracts of $4.2; o Severance and integration costs of $11.3, of which $4.9 was included in selling and administrative expenses, $5.7 was in cost of revenue, and $0.7 was included in research and development expenses; and o Amortization of intangibles of $5.0. 21 The income from continuing operations in Fiscal 2007 included the following: o A gain on sale of business of $4.1 resulting from the sale of the packet switching product line; o Contract impairment and other charges of $1.1, of which $0.5 related to the closure of our leased facility in Irvine, California, resulting from the sale of the packet switching product line; and o Severance costs of $1.5, of which $1.0 was, included in research and development expenses, $0.6 was included in cost of revenue, and a recovery of $0.1 was included in selling and administrative expense. The income from continuing operations in Fiscal 2006 included the following: o An impairment on a design tool contract of $5.4 and charges related to unused space of $0.3, both recorded in contract impairment and other; o Severance costs of $1.3, of which $1.0 was included in selling and administrative expense, $0.4 was included in cost of revenue, and a recovery of $0.1 was included in research and development expenses; and o A gain on sale of business of $1.9 resulting from payments received on a note receivable. Geographic Revenue Our revenue based on the geographic location of customers was distributed as follows: % of % of % of 2008 Total 2007 Total 2006 Total --------------------------------------------------- Europe $ 53.4 29% $ 56.0 40% $ 53.3 37% Asia/Pacific 84.9 46 40.5 28 46.2 32 United States 40.7 22 38.8 27 36.1 25 Canada 2.4 2 5.5 4 7.3 5 Other Regions 2.2 1 1.8 1 2.0 1 ------ --- ------ --- ------ --- Total $183.6 100% $142.6 100% $144.9 100% ====== === ====== === ====== === Europe Revenue from our European customers decreased by 5% in Fiscal 2008 from Fiscal 2007 due primarily to lower shipments of existing wired and foundry products, down 11% and 8% respectively. These declines were partially offset by sales from the acquired Legerity business, which represented 13% of the change in the region. Revenue from our European customers increased by 5% in Fiscal 2007 from Fiscal 2006 due primarily to higher shipments of our custom and wired communication products, of which each represented 2% of the change in the region. Asia/Pacific Revenue in this region increased by 110% in Fiscal 2008 compared to Fiscal 2007 primarily as a result of additional sales of $43.5 from the acquired Legerity business. Our revenue in the Asia/Pacific region decreased by 12% in Fiscal 2007 compared to Fiscal 2006 due mainly to lower sales volumes of our wired communication products. United States Our revenue in the United States increased by 5% in Fiscal 2008 from Fiscal 2007 primarily due to incremental revenue from the Legerity business. Our revenue in the United States increased by 7% in Fiscal 2007 from Fiscal 2006 primarily due to higher sales volumes of our medical products, which represented 10% of the change. These improvements were partially offset 22 by decreased shipments of our legacy communications products, which accounted for approximately 3% of the change. Canada Our Canadian revenues decreased by 56% in Fiscal 2008 from Fiscal 2007, and by 25% in Fiscal 2007 from Fiscal 2006. The decline in Fiscal 2008 was due primarily to lower shipments of our medical and foundry products, which represented approximately 16% and 34% of the change in Fiscal 2008. The decline in revenue in Fiscal 2007 compared to Fiscal 2006 was due to lower shipments from our wired communications products. Other Regions Our revenue from other regions increased by $0.4 or 22% in Fiscal 2008 compared with Fiscal 2007 due mainly to increased shipments of our wired business. Our revenue from other regions decreased by 10% in Fiscal 2007 compared with Fiscal 2006 as explained by decreased shipments of our custom and foundry products representing 25% of the change, partially offset by higher shipments of our legacy wired communications products representing 15% of the change. Revenue by Product Group % of % of % of 2008 Total 2007 Total 2006 Total ------------------------------------------------- Revenue: Wired Communications $115.4 63% $ 64.5 45 $ 67.5 47% Medical 28.0 15 28.2 20 32.2 22 Optical 16.0 9 15.3 11 14.2 10 Custom and Foundry 24.2 13 34.6 24 31.0 21 ----- --- ----- --- ----- --- Total 183.6 100% 142.6 100% 144.9 100% ----- --- ----- --- ----- --- Wired Communications Wired communications revenue increased by $50.9 or 79% in Fiscal 2008 when compared to Fiscal 2007. The increase was primarily a result of the incremental revenue from Legerity during the year of $56.9. Wired communications revenue in Fiscal 2007 was $64.5 compared to $67.5 in Fiscal 2006, a decrease of 4%. This decrease was the result of lower product shipments from our legacy wired products. Medical Our Medical revenue was flat in Fiscal 2008 compared to Fiscal 2007. A decrease of 12% from our legacy products was offset by growth in our new products. The change in this group is the result of a product transition away from our legacy products. Approximately two-thirds of the revenue from our medical products was recorded in the third and fourth quarter of Fiscal 2008. Our medical revenue decreased by 12% in Fiscal 2007 compared to Fiscal 2006, as a result of lower shipments from our legacy medical products. Optical Our optical revenue for Fiscal 2008 increased by 5% over Fiscal 2007 as a result of higher product shipments. Revenue in this group also included a full twelve months of revenue from our I/O product line that was acquired from Primarion compared to the ten months of revenue booked in Fiscal 2007. Our Optical revenue in Fiscal 2007 increased by 8% compared to Fiscal 2006 as a result of incremental revenue from the acquired I/O product line. 23 Custom and Foundry Custom and foundry revenue for Fiscal 2008 was $24.2 down 30% from Fiscal 2007. The decrease in revenue was the result of a flood at the Swindon facility in July, which resulted in a complete service shut down for over four months. The loss of revenue was partially offset by insurance proceeds for business interruption; however this was recorded against the associated cost of sales and not to the revenue line. Additionally, the sale of the foundry at the end of February resulted in only eleven months of revenue being recorded in the year compared to twelve months in Fiscal 2007. Revenue in Fiscal 2007 was up 12% compared to the previous year as a result of increased product shipments in the foundry business. Gross Margin 2008 2007 2006 ------------------------------ Gross margin $83.1 $74.4 $72.8 As a percentage of revenue 45% 52% 50% Our gross margin as a percentage of revenue was 45% for the year ended March 28, 2008, a decrease of 7% from Fiscal 2007 and a decrease of 5% from Fiscal 2006. Lower margins in Fiscal 2008 as compared to Fiscal 2007 were due mainly to a change in product mix in Fiscal 2008 as a result of the acquisition of Legerity. Gross margin in Fiscal 2008 was unfavorably impacted by severance costs of $1.9, as compared to $0.6 in the previous period. Our gross margin as a percentage of revenue was 52% for the year ended March 30, 2007, an increase of two percentage points from Fiscal 2006. Improvements in Fiscal 2007 as compared to Fiscal 2006 were due mainly to a more favorable product mix in Fiscal 2007. Gross margin in Fiscal 2007 was unfavorably impacted by severance costs of $0.6, as compared to $0.4 in the previous period. Operating Expenses Research and Development ("R&D") 2008 2007 2006 ------------------------------ R&D expenses - gross $51.8 $40.5 $41.4 Less: NRE and government assistance (4.1) (7.8) (3.9) ------------------------------ R&D expenses $47.7 $32.7 $37.5 As a percentage of revenue 26% 23% 26% In Fiscal 2008, R&D expenses increased by $15.0, or 46%, as compared to Fiscal 2007. The increase in Fiscal 2008 resulted primarily from incremental R&D expenses incurred from the acquired Legerity business along with related integration costs of $0.2. Contributing to the increase in costs was severance of $0.5 incurred in Fiscal 2008, which was down from the $1.0 incurred in Fiscal 2007. Our R&D expenses decreased by $4.8, or 13%, in Fiscal 2007 from Fiscal 2006. The decrease in Fiscal 2007 resulted primarily from higher reimbursement of development costs and government assistance in Fiscal 2007, and lower design tool costs. These cost reductions were partially offset by severance of $1.0 incurred in Fiscal 2007, as compared to a recovery of $0.1 in the previous year. Our medical product strategy comprises a blend of ASSPs and custom design and development. This strategy allows us to develop highly differentiated custom designs from our intellectual property for our key customers, and furthermore, by enjoying close relationships with market leaders, it ensures that we are investing wisely in developing the right standard products. For custom designs, we receive Non-Recurring Engineering ("NRE") reimbursements, which are recorded as recoveries of R&D expenditures. These NREs are recognized upon achievement of milestones within development programs, thus the amounts will fluctuate from period to period. 24 During Fiscal 2007, we entered into an agreement with the Government of Canada through Technology Partnerships Canada, which will provide partial funding for one of our research and development projects. This agreement will provide funding for reimbursement of up to $7.1 ($7.2 million Cdn) of eligible expenditures. The TPC grant is repayable in the form of royalties of 2.61% on certain of the Company's revenues. During the year ended March 28, 2008, we recorded government assistance of $2.4 related to this agreement, which resulted in reducing our research and development expenses by this amount in the period. Our R&D activities focused on the following areas: o Ultra low-power integrated circuits and modules supporting short-range wireless communications for implantable medical devices and associated monitoring and programming equipment; o Synchronous Ethernet timing products that support the delivery of time-sensitive services over packet-based networks; o Optical physical-layer integrated circuits, modules and complete solutions that provide communications systems customers with the ability to implement and easily manage high capacity, lower power fiber-optic interconnect links; and o Voice interface products for access and residential equipment that enables carrier-class voice over-cable and voice-over-packet applications. Selling and Administrative ("S&A") 2008 2007 2006 ------------------------------ S&A expenses $55.8 $37.3 $35.6 As a percentage of revenue 30% 26% 25% In Fiscal 2008, S&A expenses increased by $18.5, of 50%, as compared to Fiscal 2007. The increase in Fiscal 2008 resulted primarily from incremental expenses incurred from the acquired Legerity business along with related integration costs of $1.0. We also had higher severance costs, as we incurred severance of $4.0 in Fiscal 2008, compared to a recovery of $0.1 in Fiscal 2007. Our S&A expenses in Fiscal 2007 increased by $1.7, or 5%, as compared to Fiscal 2006. Higher expenses were attributed primarily to higher corporate governance costs, as we complied with Section 404 of the Sarbanes-Oxley Act. We also had higher costs to operate our facilities as compared to the previous year. These expense increases were partially offset by lower severance, as we incurred severance of $1.0 in Fiscal 2006 as compared to a recovery of $0.1 in Fiscal 2007. Stock Compensation Expense Effective April 1, 2006, at the beginning of Fiscal 2007, we adopted SFAS 123R, Share-Based Payment ("SFAS 123R"), and began expensing the fair value of stock-based awards to employees under the provisions of SFAS 123R. Prior to this date, we recorded stock compensation expense using the intrinsic value method. Under the intrinsic value method, fixed stock compensation expense is recorded in instances where the option exercise price is set lower than the market price of the underlying stock at the date of grant. Fixed stock compensation cost is amortized to expense over the vesting period of the underlying option award. On March 20, 2006, we accelerated all stock options with exercise prices equal to or greater than Cdn $4.00 and U.S. $3.48 per share. The accelerations resulted in eliminating our stock compensation expense in future years related to these options. As a result of adopting SFAS123R in Fiscal 2007, we recorded stock compensation expense of $2.0 for the year ended March 28, 2008 (2007 - $1.4). 25 Stock compensation expense in Fiscal 2008 and 2007 was recorded as follows: 2008 2007 ------ ------ Selling and administrative $1.6 $1.2 Research and development 0.3 0.1 Cost of revenue 0.1 0.1 ------ ------ $2.0 $1.4 ====== ====== During Fiscal 2006, we recorded stock compensation expense of $0.1 (2005 - $0.1). The stock compensation expense in Fiscal 2006 related to expense triggered upon the modification of stock options awarded to an employee within our RF Front-End Consumer business. This expense was recorded as a component of discontinued operations. The stock compensation expense in Fiscal 2005 represented the amortization of the fair value of stock options awarded to a former employee, and was recorded as a component of S&A expense. We adopted the provisions of SFAS 123R using the modified prospective approach, and thus have not restated our prior period results. As at March 28, 2008, total unrecognized compensation cost related to non-vested awards was $4.4 (2007 - $5.1), and the weighted-average period over which this expense is expected to be recognized is approximately three years. Our stock compensation expense in future periods will be impacted by many variables and thus is expected to fluctuate based on factors including number of options granted, options forfeited, share prices, option prices, share price volatility, the risk free interest rate, and expected option lives. Acquired In-Process Research and Development ("IPR&D") As a result of the acquisition of Legerity during the second quarter, we determined that $20.3 of the purchase price was attributable to in-process research and development, based upon recognized valuation principles. This value is attributable to the discounted expected future cash flows to be earned as a result of new products generated from research and development activities not yet completed by Legerity at the time of acquisition. In accordance with the respective generally accepted accounting principles, we expensed this value during the second quarter of Fiscal 2008. Contract Impairment and Other In conjunction with the integration of the acquired Legerity business during the second part of Fiscal 2008, we incurred contract impairment costs on unused design tools of $4.1 in Fiscal 2008 (2007 - $1.1; 2006 - $5.7). Additionally, in Fiscal 2008, we incurred contract impairment and other costs of $0.5, relating primarily to excess space resulting from the workforce reductions in our Caldicot facility. In Fiscal 2007, as a result of the sale of the assets of our packet switching product line, which is discussed elsewhere in this Item 5, we closed our leased facility in Irvine, California. We recorded a charge of $0.5 in contract impairment and other related to idle space under lease contract for this facility, and an additional $0.1 due to a change in estimated lease costs for idle and excess space from exit activities implemented and completed in prior years. We also recorded $0.5 of additional contract settlement costs related to our defined benefit pension plan in the U.K. This plan was wound up in Fiscal 2003; however, in Fiscal 2007, we received a final assessment of the individual employee liabilities provided by the plan administrator. We do not expect to incur additional costs related to this contract settlement. During Fiscal 2006, we performed a review of the usage of our software design tools. As a result of this review, we recognized impairment on design tools no longer in use of $5.4. In addition, we recorded an expense of $0.3 resulting from a change in estimated lease costs for idle and excess space from exit activities implemented and completed in prior years. 26 Asset Impairment During Fiscal 2008 and Fiscal 2007 we did not record any asset impairments. Acquisition of Business and Intangible Assets Legerity Acquisition On August 3, 2007, we acquired Legerity for $137.3 of cash, including $2.8 of direct transaction costs. We have accounted for the acquisition by using purchase accounting. Our consolidated statement of income (loss) for Fiscal 2008 includes results of operations of the acquired business subsequent to the acquisition date. The acquisition is expected to increase our presence in the voice-over-packet market. Both companies design complementary technologies that enable high-quality voice services, and the acquisition is expected to result in increased economies of scale, and enable use to have a broader offering of products and services with which to engage customers. The purchase price was allocated as follows: Current assets $ 22.7 Goodwill 43.1 Intangible assets 60.0 Long term assets 3.8 Current liabilities (11.0) Long term liabilities (1.6) Acquired in-process R&D 20.3 ------ Total purchase price $137.3 ====== Tangible assets and liabilities were recorded at fair value. Intangible assets were identified and valued through an analysis of data provided by Legerity and our company concerning revenue, earnings, and cash flow projections, customers and attrition factors, use of technologies, the stage of product development, and risk factors. Developed technology and acquired in-process R&D were valued using the income approach. This method reflects the present value of the future earnings capacity that is available for distribution to the owners of this asset. Customer relationship assets were valued using the income approach. This method reflects the present value of operating cash flows generated by these relationships. The Legerity acquisition was a non-taxable transaction for tax purposes. However, as part of the acquisition, we assumed approximately $50.5 of goodwill that is expected to be deductible for tax purposes. The allocation of purchase price has not been finalized with respect to our tax assets and liabilities, which if modified, would result in a change to recorded goodwill. Acquired in-process R&D was expensed upon acquisition during the second quarter of Fiscal 2008. The acquired intangible assets are being amortized on a straight-line basis over their weighted-average useful lives as follows: Developed technology 8 years Customer relationships 10 years Total (weighted-average life) 9 years In accordance with SFAS 142, Goodwill and Other Intangible Assets, goodwill is not amortized, however will be reviewed annually for impairment, or more frequently if impairment indicators arise. 27 The following table summarizes the intangible asset values as at March 28, 2008: Mar. 28, 2008 -------------------------------------- Accumulated Cost Amortization Net ----------- ------------- --------- Developed technology $37.7 $(3.1) $34.6 Customer relationships 22.3 (1.5) 20.8 ----- ----- ----- Total $60.0 $(4.6) $55.4 ===== ===== ===== Total amortization expense in Fiscal 2008 was $4.6. Future amortization expense is expected to be 2009 - $6.9, 2010 - $6.9, 2011 - $6.9, 2012 - $6.9, 2013 - $6.9, thereafter $20.9. The following unaudited pro forma information reflects the results of continuing operations as if the Legerity acquisition had been completed as of April 1, 2006. The results of operations for Fiscal 2008 included in-process R&D write-off of $20.3 related to the acquisition. -------------------------------- Mar. 28, 2008 Mar. 30, 2007 -------------- ------------- Revenue $219.8 $255.5 Net income (loss) (52.1) 8.4 ------ ------ Net income (loss) per share - basic and diluted $(0.43) $ 0.05 ====== ====== Optical Business of Primarion Inc. On May 19, 2006, we acquired the assets and intellectual property comprising the optical I/O (in/out) business of Primarion, Inc. (Primarion) for $7.1 in cash, including $0.1 of direct transaction costs. The acquisition enabled us to provide optical solutions that combine our existing technology with Primarion's products. The acquisition was accounted for in accordance with SFAS 141, Business Combinations. The purchase price was allocated as follows: Current Assets $0.4 Long term assets 6.7 ---- Total purchase price $7.1 ==== Tangible assets were recorded at fair value. Intangible assets were identified and valued through an analysis of data provided by Primarion and ourselves concerning target markets, the stage of product development, the anticipated timing of development of next generation versions of products, expected revenue generation, and risk factors. Proprietary technology was valued using both a cost method and the relief from royalty method. The relief from royalty method quantifies the benefit to our company on the basis that we are relieved from paying royalties for the continued use of the assets. Customer relationship assets were valued using the excess earnings approach. This method measures the benefit to the company which exceeds an appropriate rate of return on the assets. The non-competition agreements were valued at fair value. Approximately $2.9 of the goodwill is expected to be deductible for tax purposes. The acquired intangible assets are being amortized on a straight-line basis over their weighted-average useful lives as follows: Proprietary technology 4 years Customer relationships 6 years Non-competition agreements 3 years Total (weighted-average life) 5 years In accordance with SFAS 142, Goodwill and Other Intangible Assets, goodwill is not amortized, however will be reviewed annually for impairment, or more frequently if impairment indicators arise. 28 The following table summarizes the intangible asset values as at the year ended 2008 and 2007: Mar. 28, 2008 Mar. 30, 2007 ------------------------ ------------------------ Accumulated Accumulated Cost Amortization Net Cost Amortization Net ---- ------------ ---- ---- ------------ ---- Proprietary technology $0.6 $(0.3) $0.3 $0.6 $(0.1) $0.5 Customer relationships 0.8 (0.2) 0.6 0.8 (0.1) 0.7 Non-competition agreements 0.5 (0.3) 0.2 0.5 (0.1) 0.4 ---- ----- ---- ---- ----- ---- Total $1.9 $(0.8) $1.1 $1.9 $(0.3) $1.6 ==== ===== ==== ==== ===== ==== Amortization expense in Fiscal 2008 was $0.4. Estimated future amortization expense related to these intangible assets is expected to be as follows: 2009 - $0.4; 2010 - $0.3; 2011- $0.2, 2012 - $0.1 and thereafter - $0.1. Sale of Businesses Swindon Foundry On February 29, 2008, we sold our analog foundry in Swindon, UK to MHS, a subsidiary of MHS Industries Group for one British pound. In addition, Zarlink paid MHS (euro)2 million to support restructuring initiatives. The two companies signed a three-year wafer supply agreement to ensure continuity of wafer supply for Zarlink, under which Zarlink deposited $4.5, representing about nine months of product orders. Zarlink transferred all assets relating to the Swindon foundry to MHS, including the analog foundry and equipment, employees, third party inventory and other assets excluding cash on hand, accounts receivable and accounts payable pursuant to a sale and purchase agreement dated February 29, 2008. As a result of this asset sale, we recorded a loss of US$18.2, which was recorded on the income statement under loss (gain) on sale of business. As part of the sale of the Swindon foundry, we entered into a transition services agreement ("TSA") with MHS whereby we would provide IT, data transfer, finance, test and assembly, engineering support and supply chain management services for an initial period up to February 28, 2009. Additionally, under the TSA, MHS will provide Zarlink with rental space, IT support, health and safety and supply chain management support. The services under the TSA are being charged at their fair market value and the net payable or receivable at the end of the TSA will be settled in cash by the owing party. Packet Switching On October 25, 2006, we sold the assets of our packet switching product line to Conexant Systems Inc. (Conexant), for cash and other consideration, including a cash payment at closing of $5.0, and additional amounts contingently owing based on revenue performance of the product line over the next two years. If Conexant's revenue from sales in this product line exceeds certain revenue targets, then Conexant is required to pay us up to $2.5 of additional consideration. We recorded a gain on sale of business of $4.1 related to this transaction in Fiscal 2007. On the date of the sale, we determined that there was uncertainty surrounding whether the revenue targets will be met. As such, we did not include the contingent consideration as part of the sale proceeds. We will record the contingent consideration, if any, as a component of the gain on sale of business in the periods that the revenue targets are met. In the third quarter of Fiscal 2008 as a result of the product line meeting some of its revenue targets, we recorded a gain of $0.7. We are still eligible to receive a payment based on product line performance; however, any gain will only be recognized if and when the revenue target is met. 29 Wafer Fabrication Facility in Plymouth, U.K During Fiscal 2002, we sold our wafer fabrication facility in Plymouth, U.K., as well as certain intellectual property and related foundry businesses to companies controlled by X-FAB Semiconductor Foundries AG (X-FAB) of Erfurt, Germany for $30.0, represented by $12.0 in cash on closing and a note of $18.0 repayable over three years. At the time of the sale, the gain on sale was deferred and netted against the carrying value of the note receivable. We recognized the gain as payments were made on the note receivable, and accordingly recognized a gain on sale of business of $1.9 in Fiscal 2006 (2005 - $15.9). Other Non Operating Income and Expense Gain on Sale of Mitel Investment In August 2007, we exercised our amended put right on our share investment in Mitel Networks Corporation ("Mitel"). As these shares had been recorded with no book value, we realized a gain of $12.9, equivalent to the proceeds received. The investment was written down to its Nil book value in Fiscal 2003, when we believed that its original carrying value of $11.5 would not be realized in the foreseeable future. Gain on Insurance Settlement On July 20, 2007, a flood as a result of record rainfall and the breach of a nearby river affected our analog foundry in Swindon, UK. A complete services shutdown was required as a result of this flood. We carry insurance for the loss of physical plant and business interruption, with a deductible of $1.0. In Fiscal 2008, the net insurance claim was as follows: Business interruption insurance $ 6.0 Fixed assets $ 4.5 Other expenses $ 8.1 ----- Total insurance claim $18.6 ===== As at March 28, 2008, we have finalized all claims with our insurance carriers and have received insurance proceeds of $18.6, of which $14.1 was included in cash flows from operations, and $4.5 was included as cash flows from investing activities for amounts related to replacement of fixed assets. We recorded gains from insurance of $5.5, of which $4.5 related to fixed assets and $1.0 related to other expenses. Gain on Sale of Asset On November 29, 2007, we sold a parcel of surplus land in Jarfalla, Sweden. The proceeds from the sale of this parcel of land were $2.7 (17.7 million Swedish krona), resulting in a gain on sale of an asset net of transaction costs of $2.4. Amortization of Debt Issue Costs We incurred approximately $3.7 in costs associated with issuing our long-term debt - convertible debentures in Fiscal 2008. These costs have been capitalized, and will be amortized over the five-year term of the debt. As a result, we have recorded amortization costs of $0.5 related to these debt issue costs during the year, as compared to Nil in the same periods in Fiscal 2007. Interest Income Our interest income was $3.5 for the year ended March 28, 2008, as compared to $5.4 in Fiscal 2007 and $2.5 in Fiscal 2006. The decrease was mainly due to lower cash balances as a result of acquiring Legerity. 30 Interest Expense Our interest expense was $3.1 for the year ended March 28, 2008, as compared to $Nil in Fiscal 2007 and Fiscal 2006. The increase is principally due to eight months of interest on our convertible debentures. The convertible debentures bear interest at 6% per annum and were issued in order to partially fund the acquisition of Legerity. Foreign Exchange Gains and Losses Our foreign exchange losses in Fiscal 2008 were $1.5, as compared to gains of $0.1 and $1.1 in Fiscal 2007 and 2006, respectively. We record net gains and losses on monetary assets and liabilities denominated in currencies other than the U.S. dollar functional currency, according to period-end market rates. As a result of our convertible debentures being denominated in Canadian dollars, while our functional currency is the U.S. dollar, we are required to revalue these debentures to U.S. dollars at the period-end market rates. This revaluation will result in us incurring non-cash foreign currency gains or losses. The foreign exchange loss during Fiscal 2008 was primarily a result of the impact of the weakening U.S. dollar on our long-term debt. A five percentage point change in the Cdn/U.S. exchange rate will have a non-cash foreign exchange impact of approximately $4.0 to our earnings in a given Fiscal period. During Fiscal 2006, we secured our Swedish pension liability by directly pledging cash denominated in Swedish krona. As at March 28, 2008, the Swedish pension liability of $20.3 is comprised of $16.9 (100.7 million Swedish krona) as determined by the Pension Registration Institute, and an additional minimum pension liability of $3.4 as determined under the U.S. GAAP provisions of SFAS 87, Employers' Accounting for Pensions. This investment strategy has acted as a natural hedge against foreign exchange movements on the pension liability in Sweden. As a result, our exposure to foreign exchange gains and losses on this liability has been partially mitigated. Income Taxes Our effective tax rate is based on pre-tax income, statutory tax rates and tax planning strategies available to us in the various jurisdictions in which we operate. In determining net income, significant judgment is required in determining our effective tax rate, in evaluating our tax positions and in determining the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We establish reserves when, despite our belief that our tax return positions are supportable, we believe that these positions may be challenged. We adjust these reserves as warranted by changing facts and circumstances. Although we believe our estimates are reasonable, the final outcome of these matters may differ from what is reflected in our historical income tax provisions and accruals. At the beginning of the year we implemented FIN 48 relating to uncertain tax positions. This standard requires a company to assess its tax filing positions in all jurisdictions it operates and determine whether it is required to record benefits or charges with respect to any of the above filing positions. The implementation of this standard had no material impact on the financial statements in Fiscal 2008. A number of years may elapse before a particular matter for which we have established a reserve is audited and finally resolved. The number of years for which we have audits that are open varies depending on the tax jurisdiction. While it is often difficult to predict the final outcome or the timing of the resolution, we believe that our reserves reflect the probable outcome of known uncertain tax positions. Favorable resolutions will be recognized as a reduction of tax expense in the year of resolution. Unfavorable resolutions will be recognized as a reduction to our reserves, a cash outlay for settlement and a possible increase to our annual tax provision. Such differences could have a material impact on the income tax provision and operating results in the period in which such determination is made. Our income tax expense in Fiscal 2008 was $0.2, compared with an income tax recovery of $3.2 in Fiscal 2007 and $2.5 in Fiscal 2006. Our Fiscal 2008 expense relates primarily to a domestic current tax recovery offset by foreign taxes payable and accrued FIN 48 taxes in our domestic and foreign operations. The remaining expense relates primarily to the reversal of domestic deferred taxes related to the above recovery, which we had set up as recoveries in previous years. 31 The recovery of $1.9 in Fiscal 2007 relates primarily to the closure of past tax audits during the year, which resulted in additional tax refunds and the release of previously booked provisions. An additional $1.3 of the recovery in Fiscal 2007 relates to deferred tax benefits, which we expect to realize in the future. During Fiscal 2006, audits related to our 2001 Canadian federal tax return were substantially completed. Based on the results of these audits and our periodic review of the provision, we recorded a recovery of taxes related to items settled or closed during the year. This recovery was partially offset by an increase in our tax provision for estimated additional costs, expected to be incurred, to settle outstanding issues relating to Fiscal years still subject to audit. These adjustments resulted in a net recovery of $0.5. In addition, during Fiscal 2006, we sold our RF Front-End Consumer business in the U.K. In accordance with the provisions of SFAS 109, Accounting for Income Taxes, as a result of losses incurred in the U.K. in the latter part of the year, we recorded a tax benefit of $2.1 from continuing operations. An offsetting expense of $2.1 was recorded against the gain realized on discontinued operations. We have also recorded a provision for income taxes related to our estimate of tax expense on the gain. The remaining provision recorded in Fiscal 2006 relates to federal minimum taxes and taxes payable in foreign jurisdictions. In Fiscal 2008, our effective tax rate was lower than the 35% domestic tax rate due to an increase in our valuation allowance, net of tax recoveries in Canada and tax expense in our foreign jurisdictions. In Fiscal 2007, our effective tax rate was lower than the 35% domestic tax rate due to refunds received on settlement of past audits and the release of previously booked provisions. In Fiscal 2006, our effective tax rate was higher than the 35% domestic tax rate due to recoveries from provisions released and the impact of tax recoveries booked on continuing operations, partially offset by income tax expense booked in discontinued operations as a result of the sale of our RF Front-End Consumer Business. See also Note 23 to Item 18 of this Form 20-F. We must assess the likelihood that we will be able to recover our deferred tax assets. When we determine that it is more likely than not that some or all of our deferred tax assets may not be realized, we establish a valuation allowance against our deferred tax assets. Based on historical taxable losses and uncertainties relating to future taxable income in the periods in which the deferred tax assets may be utilized, we have established a valuation allowance at the end of Fiscal 2008 of $240.0 (2007 - $193.5). The increase in the valuation allowance relates primarily to the Legerity acquisition and changes in the foreign exchange rates in our domestic and foreign jurisdictions. This increase was partially offset by changes in corporate tax rates, and by the utilization of temporary differences in both our domestic and foreign operations. We periodically review our provision for income taxes and valuation allowance to determine whether the overall tax estimates are reasonable. When we perform our quarterly assessments of the provision and valuation allowance, we may record an adjustment, which may have a material impact on our financial position and results of operations. Discontinued Operations RF Front-End Consumer Business On November 15, 2005, we sold the assets of our RF Front-End Consumer Business to Intel Corporation, through its wholly-owned subsidiary Intel Corporation (UK) Limited ("Intel"), for $68.0. The sale resulted in a gain of $53.6 during Fiscal 2006. The following table shows the results of the RF Front-End Consumer Business, which are included as discontinued operations: 2008 2007 2006 ----- ----- ----- Revenue $ -- $ -- $34.1 ----- ----- ----- Operating loss from discontinued operations -- -- (6.8) Gain on disposal, net of tax of $3.9 -- -- 53.6 ----- ----- ----- Income (loss) from discontinued operations $ -- $ -- $46.8 ===== ===== ===== During Fiscal 2006, a provision for income taxes was recorded related to our estimate of the tax expense on the gain. When we perform future assessments of this liability, adjustments to this estimate could occur, which could increase or decrease the tax expense. Such adjustments could be material. 32 The following table shows the cash flows from investing activities in Fiscal 2006 related to the sale of the RF Front-End Consumer Business: Proceeds on sale $68.0 Payment of transaction and other costs (2.3) ----- Proceeds on sale - net $65.7 ===== Net Income (Loss) We recorded a net loss of $48.4, or $0.41 per share in Fiscal 2008, as compared to net income of $15.8, or $0.11 per share in Fiscal 2007. We reported net income of $48.8, or $0.36 per share in Fiscal 2006. The net loss in Fiscal 2008 included a loss on sale of our Swindon foundry of $18.2, an expense relating to IPR&D of $20.3, a gain on sale of shares of $12.9, a gain on sale of business $0.7, and a gain from flood insurance of $5.5. The net income in Fiscal 2007 included a gain on sale of business of $4.1 and income tax recovery of $3.2, which are discussed in the section called "Sale of Businesses" in this Item 5. We also benefited in Fiscal 2007 from lower operating expenses and contract impairment and other costs as compared to Fiscal 2006. The net income in Fiscal 2006 was primarily attributed to income from discontinued operations of $46.8 resulting from the sale of the RF Front-End Consumer Business, as well as an income tax recovery of $2.5, both of which are discussed in the section called "Sale of Businesses" in this Item 5. Common Shares Outstanding As at May 30, 2008, there were 127,345,682 Common Shares of Zarlink Semiconductor Inc., no par value, issued and outstanding. B. Liquidity and Capital Resources Our principal source of liquidity as at March 28, 2008, was cash, cash equivalents, and short-term investments totaling $42.6 (2007 - $114.6). Included in these amounts as at March 28, 2008, were cash and cash equivalents of $42.4 (2007 - $111.3), and short-term investments of $0.2 (2007 - $3.3). We believe that our existing cash, cash equivalents, short-term investments, and restricted cash balances, together with our existing financing facilities, will be sufficient to cover operating and working capital needs, capital expenditures, preferred share payments and repurchases, and other cash outflows for the foreseeable future. Operating Activities Cash used in operating activities during Fiscal 2008 was $12.1 as compared to cash generated from operating activities of $4.8 during Fiscal 2007. Cash flow used in operations before changes in working capital was $5.1 during Fiscal 2008 compared to cash flow generated from operations of $16.6 during Fiscal 2007. Our cash flows from operations deteriorated during Fiscal 2008 mainly due to the following items: o A net loss of $48.4 compared to a net income of $15.8 in Fiscal 2007; Partially offset by: o A gain on sale of our Mitel investment of $12.9; and o A $5.5 gain on insurance settlement. Since March 31, 2007, our non-cash working capital, as reflected in the consolidated statements of cash flows, decreased by $7.0. After considering the impact of Legerity acquisition our non-cash working capital changed, mainly as a result of the following: o An increase in receivable balances totaling $0.4, as a result of the timing of product revenues during the quarter; 33 o An increase in prepaid expenses and other totaling $3.7, as a result of the wafer supply agreement entered into as part of the Swindon foundry sale; and o An increase in inventories of $3.0 as a result of the inclusion of Legerity's operations during the year; Partially offset by: o An increase in payables and accrued liabilities totaling $0.2. In comparison, our non-cash working capital decreased by $11.8 during Fiscal 2007, mostly due to the following: o A reduction of payables and accrued liabilities of $9.4 due primarily to amounts paid to Intel of approximately $5.7 in conjunction with a transitional service agreement following the sale of our RF Front-End Consumer Business, and a reduction in our provisions for exit activities due mainly to a payment on a design tool contract; o An increase in accounts receivable due in part to the timing of sales and collections during the periods, and due to amounts owing under a foundry supply and wafer sourcing agreement; and o An increase in inventories of $1.6 due mainly to accommodate changes in customer order patterns, as in Fiscal 2007, we saw a trend whereby certain customers were starting to request shorter lead times; Partially offset by: o A decrease in prepayments of $2.4 due mainly to the timing of payments on software design tool contracts. Investing Activities Cash used in investing activities was $123.2 for the year ended March 28, 2008, compared to cash provided from investing of $16.9 during Fiscal 2007. The net cash outflow from investing activities during Fiscal 2008 included the following: o The acquisition of Legerity business for $136.0, including transaction costs, net of acquired cash from Legerity; o Expenditures for fixed assets of $7.6, including the replacement of assets damaged in the flood at our Swindon foundry; and o Disbursements of $3.6 related to the sale of our Swindon foundry; Partially offset by: o Proceeds of $12.9 from the sale of our investment in Mitel; o The maturity of short-term investments of $3.3; o Proceeds from insurance related to fixed assets of $4.5; and o Proceeds from the sale of land in Sweden of $2.7. The net cash inflow from investing activities during Fiscal 2007 included the following: o The maturity of short-term investments totaling $24.6; and o Net proceeds on the sale of our packet switching product line of $4.7; Partially offset by: o The acquisition of the Primarion business for $7.1; o The purchase of short-term investments totaling $3.3; and o Expenditures for fixed assets of $2.1, primarily related to improvements to information technology resources. In conjunction with the sale of the Systems business in Fiscal 2001, we obtained ownership of 10,000,000 common shares of Mitel. On August 16, 2007, we exercised our amended put right, and received payment from Mitel of $12.9. During Fiscal 2008, we recorded a gain of $12.9 on the sale of these shares, as they were written down to a Nil book value in Fiscal 2003, when we believed that the original carrying value of $11.5 would not be realized in the foreseeable future. 34 Financing Activities Cash generated from financing activities during Fiscal 2008 totaled $65.5. The cash inflow was primarily the result of the following: o The issuance of $74.5 in convertible debentures to assist in financing our acquisition of Legerity; Partially offset by: o A decrease in restricted cash and cash equivalents of $0.3; o The repurchase of $2.6 of preferred shares; o The payment of $2.4 for dividends on the preferred shares; and o Debt issue costs of $3.7 associated with issuing the convertible debentures. Cash used in financing activities during Fiscal 2007 totaled $1.7. The cash outflow was primarily the result of the following: o The payment of $2.2 for dividends on the preferred shares; Partially offset by: o A decrease in restricted cash and cash equivalents of $0.7. We pay quarterly dividends on our preferred shares of $0.49 (Cdn$0.50) per share. Subject to foreign exchange rate fluctuations, we expect to pay approximately $2.4 in dividends in Fiscal 2009. We are also required to make reasonable efforts to purchase 22,400 preferred shares in each calendar quarter at a price not exceeding $24.56 (Cdn$25.00) per share plus costs of purchase. If the market price of the shares falls below this price, we expect to repurchase approximately $2.2 of preferred shares in Fiscal 2009. In addition to our cash, cash equivalents and short-term investment balances, we have credit facilities of $1.5 (Cdn $1.5) available for letters of credit. As at March 28, 2008, we had used $1.5 of our credit facilities, accordingly, we had no unused facilities available for letters of credit. The outstanding letters of credit related to our Supplementary Executive Retirement Plan ("SERP"). As at March 28, 2008, we have pledged $17.3 (103 million Swedish krona) in restricted cash and cash equivalents to secure our pension liability of $20.3 in Sweden. The Swedish pension liability is comprised of $16.9 (100.7 million Swedish krona) as determined by the Pension Registration Institute, and an additional minimum pension liability of $3.4 as determined under the U.S. GAAP provisions of SFAS 87, Employers' Accounting for Pensions. While we have already pledged $17.3 of cash to secure the Swedish pension liability, we also have the option to purchase insurance to fully fund this pension liability in the future. If we were to fully fund this pension plan, we would have no further obligations under the plan. In order to fully fund this pension plan, we would be required to pay a premium equivalent to the net present value of the interest costs that would otherwise accrue in the future. The decision to fully fund the pension plan would result in an expense, and cash outflow, equivalent to this premium, which could materially affect our results of operations in that period. C. Research and Development, Patents, and Licenses, etc. Our R&D programs are primarily directed at developing intellectual property in the areas of IC and optical process development, communications ICs, optoelectronic components, and ultra low-power semiconductors. Our R&D expense amounted to $47.7 in Fiscal 2008, as compared to $32.7 and $37.5 in Fiscal 2007 and Fiscal 2006, respectively. R&D programs include development of intellectual property in the areas of network timing and synchronization, voice interface applications, and voice processing functions and data center and computer cluster interconnect. 35 In addition, research and development efforts are focused on developing ultra low-power integrated circuits supporting short-range communications for wireless telemetry applications. We maintain product design centers in Ottawa, Canada; Jarfalla, Sweden; San Diego, Austin and Phoenix in the United States; Caldicot, and Plymouth in the United Kingdom; and Rotterdam in the Netherlands. Refer also to Item 5A - Operating Results. D. Trend Information Refer to Item 5A - Operating Results, for a discussion of our most significant recent trends in production, sales and inventory. E. Off-balance Sheet Arrangements Performance 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. We have an outstanding performance guarantee related to a managed services agreement ("project agreement") undertaken by the Communications Systems business ("Systems"), which is now operated as Mitel Networks Corporation ("Mitel"). We continue to guarantee performance under the project agreement following the sale of the Systems business. The project agreement and performance guarantee extend until July 31, 2012. The terms of the project agreement continue to be fulfilled by Mitel. The maximum potential amount of future undiscounted payments we could be required to make under the guarantee at March 28, 2008, was $39.8 (20.0 million British pounds), assuming we are unable to secure the completion of the project. We are not aware of any factors 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, we believe that an alternate third-party contractor could be secured to complete the agreement requirements. We have not recorded a liability in our consolidated financial statements associated with this guarantee. In connection with the sale of the Systems business, we 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 March 28, 2008, we do not expect these tax indemnities to have a material impact on our financial statements. We periodically enter into agreements with customers and suppliers that include limited intellectual property indemnifications that are customary in our industry. These guarantees generally require that we 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 us from making a reasonable estimate of the maximum potential amount we could be required to pay to our customers and suppliers. Historically, we have 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. Supply Agreements We have wafer supply agreements with six independent foundries, which expire from Fiscal 2009 to 2011. Under these agreements, the suppliers are obligated to provide certain quantities of wafers per year. None of the agreements have minimum unit volume purchase requirements. These agreements are typically renewed prior to their expiry dates, or automatically renew for a specified period under the existing terms and conditions unless either party provides notification of these changes to the other party. 36 F. Tabular Disclosure of Contractual Commitments The following tables provide a summary of the effect on liquidity of our contractual obligations as of March 28, 2008: Payments Due by Period ------------------------------------------ Less than 1 - 3 4 - 5 More than Contractual Commitments Total 1 year years years 5 years ------------------------------------------ Operating Leases (1) $27.7 $ 9.0 $17.2 $1.5 $ -- Purchase Commitments (2) 10.6 2.6 6.9 1.1 -- Income tax contingency payments (3) $ 7.5 $ -- $ -- $ -- $7.5 ===== ===== ===== ==== ==== Total Contractual Commitments $45.8 $11.6 $24.1 $2.6 $7.5 ===== ===== ===== ==== ==== (1) Operating lease commitments does not include payments to be received under non-cancelable sublease agreements. (2) Purchase commitments consist primarily of purchase design tools and software for use in product development. Wafer purchase commitments have not been included in the above table, as the pricing and timeframe of payment are not fixed, and will vary depending on our manufacturing needs. We do not presently have commitments that exceed expected wafer requirements. (3) The recorded liability in accordance with FIN 48 as of March 28, 2008, is reflected as owing in more than five years in the table above, as we cannot reasonably estimate the years in which these liabilities may be settled. As at March 28, 2008, we had commitments that expire as follows: Total Less than 1 year --------- ---------------- Letters of Credit (4) $ 1.5 $ 1.5 Guarantees (5) 17.3 17.3 ----- ----- Total Commercial Commitments $18.8 $18.8 ===== ===== (4) Cash and cash equivalents of $Nil have been hypothecated under our credit facility to cover these letters of credit, as discussed elsewhere in this Item 5. (5) We have pledged $17.3 as security toward our Swedish pension liability. G. Safe Harbor Forward-Looking Statements Certain statements in this Annual Report on Form 20-F constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, and of any applicable Canadian securities legislation, including the Securities Act (Ontario) that are based on current expectations, estimates and projections about the industries in which we operate, our beliefs, and assumptions. Words such as "expect", "anticipate", "intend", "plan", "believe", "seek", "estimate" and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from results forecast or suggested in such forward-looking statements. Zarlink undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such risks, uncertainties and assumptions include, among others, the following: our dependence on the successful development and market acceptance of new products; our ability to successfully integrate future acquisitions; our dependence on our foundry suppliers and third-party subcontractors; our limited visibility of demand in our end 37 markets, our ability to operate profitably and generate positive cash flows in the future; and other factors referenced elsewhere in this Form 20-F. Item 6 Directors, Senior Management and Employees A. Directors and Senior Management The following table sets forth the name, age and position of each director and executive officer of our company.
Name Age Position held since Positions Dr. Adam Chowaniec(1) 58 February 19, 2007 Director Oleg Khaykin 43 November 12, 2007 Director Hubert T. Lacroix(2,3,4) 52 July 21, 1992 Director J. Spencer Lanthier(2,3) 67 May 14, 2003 Director Kirk K. Mandy(4) 52 July 23, 1998 (5) Director, President and Chief Executive Officer Jules Meunier (1,2) 52 July 31, 2002 Director Dennis Roberson (1) 59 November 11, 2004 Director Dr. Henry Simon(3,4,6) 77 July 21, 1992 Director and Chairman Henry Perret 62 August 3, 2007 Senior Vice President and General Manager, Wired Communications Donald G. McIntyre 60 October, 1998 Senior Vice President Human Resources, General Counsel and Corporate Secretary Scott Milligan 47 May 19, 2003 Senior Vice President Finance and Chief Financial Officer Stephen J. Swift 55 April, 2001 Senior Vice President and General Manager, Medical Communications Dr. Stan Swirhun 53 June 9, 2005 Senior Vice President and General Manager, Optical Communications Gary Tanner 55 August 3, 2007 Senior Vice President and General Manager, Operations
(1) Member of the Compensation and Human Resources Development Committee (2) Member of the Audit Committee (established in accordance with the Canada Business Corporations Act) (3) Member of the Nominating and Corporate Governance Committee (4) Member of the Executive Committee (5) Board member since July 23, 1998, President and Chief Executive Officer since February 16, 2005 (6) Director since July 21, 1992, Chairmen since July 21, 1994 Dr. Adam Chowaniec has been the Chairman and Chief Executive Officer of Amiga2 Corporation, a consulting and Investment Company, since 2002. Dr. Chowaniec was the founding Chief Executive Officer of Tundra Semiconductor Corporation on December 15, 1995 and served in that position until December 2005. Dr. Chowaniec is also Chairman of the Board of Directors of Tundra Semiconductor Corporation, former Chair of the Ontario Research and Innovation Council, and serves on numerous other boards of directors in Canada and the United States, including BelAir Networks, Liquid Computing Corporation, Acentru and Microbridge Corporations. Dr. Chowaniec is a member of the board of the Export Development Corporation of Canada and has held advisory positions with the Ottawa Economic Development Corporation, the National Research Council's Industrial Research Assistance Program, the Ottawa Health Research Institute and the Natural Science and Engineering Council of Canada. He is also the vice-chair of the Museum of Nature's national fundraising campaign. He holds a Master's degree in Electrical Engineering from Queen's University (Canada), as well as both a Bachelor of Engineering and a Ph.D. from the University of Sheffield (England). 38 Mr. Oleg Khaykin has been President and Chief Executive Officer and a member of the Board of Directors of International Rectifier Corporation, a manufacturer of power semiconductors, since March 2008. Mr. Khaykin acted as Executive Vice President and Chief Operating Officer of Amkor Technology, a leading provider of advanced semiconductor assembling and test services, from May 2003 to March 2008. From May 1999 to May 2003, Mr. Khaykin was the Vice President of Strategy and Business Development for Conexant Systems Inc./Mindspeed, a company that designs, develops and sells semiconductors for networking applications. Mr. Khaykin was also with the Boston Consulting Group, a strategic consulting firm, from July 1991 to June 1999. Mr. Khaykin began his career as a senior development engineer and product manager with Motorola. Mr. Hubert T. Lacroix has been President and Chief Executive Officer of the Canadian Broadcasting Corporation / Radio-Canada since January 1, 2008. Mr. Lacroix acted as Senior Advisor to Stikeman Elliott LLP (law firm) and as an adjunct professor at the Faculty of Law of Universite de Montreal from May 5, 2003 until December 31, 2007 and as a consultant to Telemedia Ventures Inc., a private investment company from May 5, 2003 until December 31, 2005. Mr. Lacroix was Executive Chairman of Telemedia Corporation from February 2000 to May 2003. From 1984 until his appointment as Executive Chairman of Telemedia Corporation, Mr. Lacroix was a partner with McCarthy Tetrault LLP (law firm). He is Chairman of the Board and a member of the Audit Committee and a member of the Strategic Development Committee of SFK Pulp Fund. In addition, he is a trustee of the Lucie and Andre Chagnon Foundation and a director of their private holding company. Mr. Lacroix is also a Director of the Montreal General Hospital Foundation and a Trustee of the Martlet Foundation of McGill University. Mr. Lacroix received his Bachelor of Law degree from McGill University, was admitted to the Quebec Bar in 1977 and holds a Master of Business Administration degree from McGill University. Mr. J. Spencer Lanthier has been a Corporate Director since his retirement in 1999 from KPMG Canada, where he had a long and distinguished career culminating in the position of Chairman and Chief Executive from 1993 until his retirement. A recipient of the Order of Canada, Mr. Lanthier is currently a member of the Board and Chair of the Audit Committee of the TSX Group, Inc., Torstar Corporation, Gerdau Ameristeel Inc., Rona Inc. and Ellis Don Inc. He also serves as Chair of the Wellspring Cancer Support Organization. Mr. Lanthier received an honorary Doctor of Laws degree from the University of Toronto in 2002. Mr. Kirk K. Mandy is President and Chief Executive Officer of our company. He served as Vice-Chairman of Zarlink's Board of Directors from 2001 until his appointment as President and Chief Executive Officer in February 2005. Over a distinguished career with our company spanning 15 years, Mr. Mandy held increasingly senior roles, culminating in the position of President and CEO from 1998 to 2001. He oversaw our strategic decision to focus on semiconductors, and the subsequent divestiture of the Business Communications Systems ("BCS") division. Mr. Mandy is also a member of the board of Epocal Inc., and Chairman of the Armstrong Monitoring Corporation. He has served on the Board of the Strategic Microelectronics Corporation ("SMC"), the Canadian Advanced Technology Association ("CATA"), The Canadian Microelectronics Corp. ("CMC"), The Ottawa Center for Research and Innovation ("OCRI"), and Micronet. He is also past Chairman of the Telecommunications Research Center of Ontario ("TRIO"), past Chairman of the National Research Council's Innovation Forum, and past Co-Chairman of the Ottawa Partnership. Mr. Mandy is a graduate of Algonquin College in Ottawa. Mr. Jules M. Meunier has been a management consultant since November 2002. He was President and Chief Executive Officer of Proquent Systems Inc. from January to November 2002. Prior to January 2002, over a 20-year career with Nortel Networks Corporation, he helped shape our direction as Chief Technical Officer, and held senior positions in our wired, wireless, and optical communications divisions, including serving as President of its Wireless Networks division. Mr. Meunier holds a Bachelor of Science degree in Mathematics and Computer Science from the University of Ottawa. Professor Dennis Roberson has been Vice Provost, Executive Director and Research Professor with the Illinois Institute of Technology ("IIT") since June 2003, where he established a new undergraduate business school focused on entrepreneurship and technology, a wireless research center (WiNCom), IIT's corporate relations initiative, and is developing research centers and business ventures in association with public and private sector partners. From April 1998 to April 2004, Professor Roberson was Executive Vice President and Chief Technical Officer of Motorola, Inc. From 1971 to 1998, he held senior executive positions with NCR Corporation, AT&T, Digital Equipment Corp. (now part of Hewlett Packard) and IBM. Professor Roberson is a Director of Advanced Diamond Technologies, Cleversafe, Sequoia Communications and Sun Phocus Technologies, LLC. He also serves on the Board of Directors of FIRST Robotics (For Inspiration and Recognition of Science and Technology), the National Advisory Council for the Boy Scouts of America and as an International Advisory Panel member for the Prime Minister of Malaysia. He holds Bachelor of Science Degrees in Physics and Electrical Engineering from Washington State University and a Master of Science in Electrical Engineering from Stanford University. 39 Dr. Henry Simon has been Chairperson of our Board of Directors since July 21, 1994. He is a Special Partner of Schroder Ventures Life Sciences Advisers, a venture capital company advising on investments in the life sciences. He joined Schroder Ventures in 1987 to head a venture capital group that developed a life sciences business in the U.K., and was CEO of its life sciences team until 1995. Dr. Simon holds an Electrical Engineering degree from the Institute of Technology in Munich, and a doctorate in Telecommunications from the Royal Institute of Technology in Stockholm. Mr. Henry Perret is Senior Vice President and General Manager, Wired Communications. Mr. Perret joined Zarlink in August 2007 through its acquisition of Legerity, where he served as President and CEO. Before joining Legerity, Mr. Perret was CFO and Vice President of Finance of Actel Corporation, a leading supplier of programmable logic solutions. Prior to his 5-year tenure at Actel, Mr. Perret was site controller for Applied Materials' manufacturing division in Austin, Texas. Previously he spent 12 years with National Semiconductor in a variety of financial roles. Mr. Perret serves as the President of the Foundation Board of the Capital Area Food Bank in Austin. Mr. Perret holds a Bachelor of Science Degree in Business Administration, with a concentration in accounting from San Jose State University. Mr. Donald McIntyre was appointed Senior Vice President Human Resources, General Counsel and Corporate Secretary in October 1998. Mr. McIntyre served as Vice President, Human Resources, General Counsel and Corporate Secretary from 1991 to October 1998. Mr. McIntyre also served as a director of our company from 1993 to 1996 and from 1998 to 2002. Mr. McIntyre joined our company in 1987. Mr. Scott Milligan was appointed Senior Vice President Finance and Chief Financial Officer on May 19, 2003. From 2000 to 2002, Mr. Milligan served as Vice President, Finance and Administration with UUNet Canada (now MCI Canada). Mr. Stephen J. Swift was appointed Senior Vice President and General Manager, Medical Communications in April 2001. Mr. Swift served as General Manager, Medical (renamed Medical Communications) from April 1998 to April 2001 and Manager, ASIC Engineering from September 1997 to April 1998. Mr. Swift joined our company in 1997. Dr. Stan Swirhun was appointed Senior Vice President and General Manager, Optical Communications in June 2005. Dr. Swirhun served as founder and Chief Executive Officer of Picolight Inc. from 1997 to 2004, and from 1993 to 1997 he served as Vice President of Engineering and then Chief Technology Officer of Vixel Corporation. Mr. Gary Tanner is Senior Vice President, Worldwide Operations, with responsibility for product and test engineering, global manufacturing, quality, logistics and purchasing activities. Mr. Tanner joined Zarlink in August 2007 through its acquisition of Legerity, where he was Vice President of Operations. Prior to joining Legerity, he was plant manager for Intel's Fab 23. Throughout his career with Intel Gary held various management positions in both greenfield and existing operations for multiple facilities, both domestic and international. Before Intel, Mr. Tanner held multiple fab operations management positions with National Semiconductor, Texas Instruments and NCR. There are no family relationships among directors or executive officers of our company. B. Compensation The aggregate compensation paid by us to our directors and executive officers for services rendered during Fiscal 2008 was $4.7. This amount includes salary, bonuses, severance payments, car allowances and other perquisites and excludes the amount set out below for pension, retirement and similar benefits paid to executive officers. The aggregate amount set aside or accrued by our company and our subsidiaries during Fiscal 2008 for the provision of pension, retirement and similar benefits to the directors and executive officers our company as a group was $0.3, excluding adjustments for market value fluctuations related to the current year. 40 Information concerning compensation is incorporated by reference from the information set forth in the sections entitled "Executive Compensation" and "Employment Agreements" in our Management Proxy Circular for the Fiscal 2008 Annual and Special Shareholders Meeting. C. Board Practices Zarlink Semiconductor Inc. fully complies with National Policy 58-201 Corporate Governance Guidelines of the Canadian Securities Administrators and other applicable stock exchange and regulatory requirements. Although there are certain differences between the corporate governance practices of Zarlink, as a foreign private issuer, and those required of domestic companies under the New York Stock Exchange ("NYSE") standards, we do not believe that any of these differences are significant. Further information on our corporate governance practices can be obtained on our website at http://ir.zarlink.com/corp_gov/, and in Schedule A to our Management Proxy Circular, which is Exhibit 15(c) to this Form 20-F. The Board of Directors consists of eight directors. Directors can be either elected annually by the shareholders at the annual meeting of shareholders or, subject to the By-Laws of the Company, appointed by the Board of Directors between annual meetings. Each director will hold office until the close of the next annual meeting of shareholders or until his successor is duly elected, unless the office is earlier vacated in accordance with the By-Laws of the Company. No director has any contract or arrangement with the Company entitling him to benefits upon termination of his directorship. The information concerning board practices is incorporated by reference from the information set forth in the sections entitled "Report of the Audit Committee", "Corporate Governance", "Report on Executive Compensation", and "Schedule A - Statement of Corporate Governance Practices" in our Management Proxy Circular for the Fiscal 2008 Annual and Special Shareholders Meeting. See Item 6A for additional information regarding our directors. D. Employees The following table shows Zarlink's total number of employees as at the end of each Fiscal year: 2008 2007 2006 ----------------------------------------- United States 198 55 67 Canada 157 167 180 United Kingdom 145 307 327 Sweden 120 115 137 Other 53 33 36 ----------------------------------------- Total 673 677 747 In Fiscal 2008, our total headcount decreased by 4 employees; however we obtained 215 employees as a result of the Legerity acquisition and transferred 122 employees to MHS as part of the sale of the analog foundry. The remaining change in headcount mainly related to the integration of Legerity. Zarlink considers the relationship with its employees to be good. Certain of our employees are covered by collective bargaining agreements or are members of a labor union. In the United Kingdom, 5 employees of Zarlink's Swindon operations are unionized. The unions representing the employees include the Transport and General Workers Union and AMICUS Union. Management considers our relationship with the unions in the United Kingdom to be satisfactory. In Sweden, three unions represent approximately 81 employees. The Metall Industriarbetarforbundet union represents approximately 15 production employees; the Svenska Industriarbetarforbundet union represents approximately 40 office professional employees; and the Civilingenjorsforbundet union represents approximately 26 other professional employees. It is common practice in Sweden for the national unions to negotiate minimum 41 standards with the employer association, supplemented by additional terms negotiated by the local branches. Each agreement is for a term of three years and the current agreement expires on March 31, 2010. Management considers our relationship with the unions in Sweden to be satisfactory. E. Share Ownership The following table shows the number of common shares and options to purchase common shares beneficially owned by each director and executive officer as of May 30, 2008.
=================================================================================================================== Common shares beneficially Percent of Options Name owned (1) Class outstanding Exercise Price Expiry Date - ------------------------------------------------------------------------------------------------------------------- Dr. Adam Chowaniec 116,410 (2) 20,000 Cdn$0.86 February 15, 2014 20,000 Cdn$2.47 February 19, 2013 Oleg Khaykin Nil (2) 20,000 $0.85 February 15, 2014 20,000 $1.16 November 12, 2013 Hubert T. Lacroix 170,000 (2) 20,000 Cdn$0.86 February 15, 2014 20,000 Cdn$2.49 February 6, 2013 20,000 Cdn$2.51 January 27, 2012 20,000 Cdn$2.26 February 24, 2011 20,000 Cdn$5.36 January 29, 2010 20,000 Cdn$5.10 February 6, 2009 J. Spencer Lanthier 135,400 (2) 20,000 Cdn$0.86 February 15, 2014 20,000 Cdn$2.49 February 6, 2013 20,000 Cdn$2.51 January 27, 2012 20,000 Cdn$2.26 February 24, 2011 20,000 Cdn$5.36 January 29, 2010 20,000 Cdn$6.68 May 14, 2009 Kirk K. Mandy 1,665,500 (2) 450,000 Cdn$0.86 February 15, 2014 450,000 Cdn$2.49 February 6, 2013 450,000 Cdn$2.51 January 27, 2012 750,000 Cdn$2.26 February 24, 2011 100,000 Cdn$2.12 February 3, 2011 20,000 Cdn$5.36 January 29, 2010 20,000 Cdn$5.10 February 6, 2009 Jules Meunier 175,000 (2) 20,000 Cdn$0.86 February 15, 2014 20,000 Cdn$2.49 February 6, 2013 20,000 Cdn$2.51 January 27, 2012 20,000 Cdn$2.26 February 24, 2011 20,000 Cdn$5.36 January 29, 2010 20,000 Cdn$5.10 February 6, 2009 20,000 Cdn$7.15 July 31, 2008 Dennis Roberson 78,522 (2) 20,000 $0.85 February 15, 2014 20,000 $2.11 February 6, 2013 20,000 $2.18 January 27, 2012 20,000 $1.83 February 24, 2011 20,000 $2.75 November 26, 2010
42
=================================================================================================================== Common shares beneficially Percent of Options Name owned (1) Class outstanding Exercise Price Expiry Date - ------------------------------------------------------------------------------------------------------------------- Dr. Henry Simon 245,000 (2) 20,000 $0.85 February 15, 2014 20,000 $2.11 February 6, 2013 20,000 $2.18 January 27, 2012 20,000 $1.83 February 24, 2011 20,000 $4.04 January 29, 2010 20,000 Cdn$5.10 February 6, 2009 Henry Perret 160,000 (2) n/a n/a n/a Donald G. McIntyre 360,766 (2) 125,000 Cdn$0.86 February 15, 2014 125,000 Cdn$2.49 February 6, 2013 125,000 Cdn$2.51 January 27, 2012 60,000 Cdn$1.57 August 8, 2011 80,000 Cdn$2.26 February 24, 2011 50,000 Cdn$5.36 January 29, 2010 35,000 Cdn$5.10 February 6, 2009 Scott Milligan 401,696 (2) 125,000 Cdn$0.86 February 15, 2014 125,000 Cdn$2.49 February 6, 2013 125,000 Cdn$2.51 January 27, 2012 80,000 Cdn$2.26 February 24, 2011 80,000 Cdn$5.36 January 29, 2010 50,000 Cdn$6.53 May 19, 2009 Stephen J. Swift 324,554 (2) 125,000 $0.85 February 15, 2014 125,000 $2.11 February 6, 2013 125,000 $2.18 January 27, 2012 80,000 $1.83 February 24, 2011 100,000 $4.04 January 29, 2010 35,000 Cdn$5.10 February 6, 2009 Stan Swirhun 431,437 (2) 125,000 $0.85 February 15, 2014 125,000 $2.11 February 6, 2013 125,000 $2.18 January 27, 2012 150,000 $1.31 June 9, 2011 Gary Tanner 200,000 (2) 200,000 $0.85 February 15, 2014 250,000 $1.42 August 31, 2013 ===================================================================================================================
(1) Common shares beneficially owned include options currently exercisable or exercisable within sixty days by the party indicated, and common shares that underly debentures owned. These holdings include stock options currently exercisable or exercisable within 60 days by: Mr. Chowaniec - 5,000; Mr. Lacroix - 70,000; Mr. Lanthier - 70,000; Mr. Mandy - 1,015,000; Mr. Meunier - 90,000; Mr. Roberson - 45,000; Dr. Simon - 70,000; Mr. Andrews - 56,250; Mr. McIntyre - 268,750; Mr. Milligan - 283,750; Mr. Swift - 288,750; Dr. Swirhun - 168,750 Common Shares that underly debentures owned by: Mr. Chowaniec - 20,410; Mr. Lanthier - 20,400. (2) Represents less than 1% of the class. Item 7 Major Shareholders and Related Party Transactions A. Major Shareholders The information concerning major shareholders is incorporated by reference from the information set forth in the section entitled "Voting Shares and Principal Holders Thereof" in our Management Proxy Circular for the Fiscal 2008 Annual and Special Shareholders Meeting. 43 B. Related Party Transactions None C. Interests of Experts and Counsel Not applicable Item 8 Financial Information A. Consolidated Statements and Other Financial Information See Item 18, "Financial Statements" Litigation We are a defendant in a number of lawsuits and party to a number of other claims or potential claims that have arisen in the normal course of our business. In our opinion, any monetary liabilities or financial impacts of such lawsuits and claims or potential claims that exceed the amounts already recognized would not be material to the consolidated financial position of our company or the consolidated results of our operations. Dividend Policy We have not declared or paid any dividends on our common shares and the Board of Directors anticipates that, with the exception of preferred share dividend requirements, all available funds will be applied in the foreseeable future to finance growth and improve our competitive position and profitability. Pursuant to the terms of the Cdn$2.00 Cumulative Redeemable Convertible Preferred Shares, 1983 R&D Series ("Preferred Shares - R&D Series"), we will not be permitted to pay any dividends on common shares unless all dividends accrued on the preferred shares have been declared and paid or set apart for payment. See also Note 18 to the Consolidated Financial Statements in Item 18. Dividends paid by our company to common shareholders not resident in Canada would generally be subject to Canadian withholding tax at the rate of 25% or such lower rate as may be provided under applicable tax treaties. Under the Canada - United States tax treaty, the rate of withholding tax applicable to such dividends paid to residents of the United States would generally be 15%. See Item 10E Taxation. B. Significant Changes There were no significant changes Item 9 The Offer and Listing A. Offer and Listing Details Our shares are traded on The New York Stock Exchange and The Toronto Stock Exchange. The annual high and low market prices for the five most recent Fiscal years are as follows: New York Stock Exchange (U.S. Dollars) --------------------------- Fiscal Year High Low --------------------------- 2004 5.76 2.60 2005 4.47 1.59 2006 2.95 1.22 2007 2.87 1.97 2008 2.22 0.56 44 Toronto Stock Exchange (Canadian Dollars) --------------------------- Fiscal Year High Low --------------------------- 2004 7.94 3.40 2005 5.88 1.94 2006 3.42 1.50 2007 3.35 2.21 2008 2.48 0.57 The high and low sales prices for each quarter of the last two Fiscal years are as follows: New York Stock Exchange (U.S. Dollars) 2008 2007 --------------------------- ------------------------- Fiscal Quarter High Low High Low --------------------------- ------------------------- 1st Quarter 2.22 1.68 2.87 1.97 2nd Quarter 1.84 1.26 2.37 2.01 3rd Quarter 1.42 0.64 2.49 1.97 4th Quarter 0.91 0.56 2.41 1.99 Toronto Stock Exchange (Canadian Dollars) 2008 2007 --------------------------- ------------------------- Fiscal Quarter High Low High Low --------------------------- ------------------------- 1st Quarter 2.48 1.79 3.35 2.21 2nd Quarter 1.90 1.33 2.70 2.24 3rd Quarter 1.39 0.65 2.82 2.25 4th Quarter 0.95 0.57 2.84 2.33 The high and low market prices for each Fiscal month for the most recent six Fiscal months are as follows: New York Stock Exchange (U.S. Dollars) --------------------------- Month High Low --------------------------- December 2007 0.74 0.64 January 2008 0.80 0.56 February 2008 0.91 0.77 March 2008 0.91 0.75 April 2008 0.88 0.75 May 2008 0.89 0.77 45 Toronto Stock Exchange (Canadian Dollars) --------------------------- Month High Low --------------------------- December 2007 0.72 0.65 January 2008 0.79 0.57 February 2008 0.95 0.76 March 2008 0.90 0.78 April 2008 0.88 0.76 May 2008 0.88 0.77 B. Plan of Distribution Not applicable C. Markets Our shares were first listed on the New York Stock Exchange on May 18, 1981 and on The Toronto Stock Exchange on August 13, 1979. Prior to September 7, 2001, the stock symbol of our shares was MLT. Effective September 7, 2001, the stock symbol of our shares was changed to ZL. D. Selling Shareholders Not applicable E. Dilution Not applicable F. Expenses of the Issue Not applicable Item 10 Additional Information A. Share Capital Not applicable B. Memorandum and Articles of Association The information required by this Item is incorporated by reference from the information set forth in Item 10B of our Annual Report on Form 20-F for the year ended March 25, 2005. C. Material Contracts On June 25, 2007, Zarlink Semiconductor Inc. entered into an agreement and plan of merger by and among Zarlink Semiconductor Inc., ZLE Inc., Legerity Holdings, Inc., and Navigant Capital Advisors, LLC. See Exhibit 4.10 under item 19 to this Form 20-F. To partially finance our acquisition of Legerity, we completed on July 30, 2007 a public offering of subscription receipts (the "Subscription Receipts") in the aggregate principal amount of Cdn$75,000,000. The Subscription Receipts were automatically exchanged for convertible unsecured subordinated debentures ("Convertible Debentures") on August 3, 2007, following the closing of our acquisition of Legerity. On August 30, 2007, the underwriters of the public offering exercised in part their over-allotment option and purchased additional Convertible Debentures in the aggregate principal amount of Cdn$3,750,000. The Convertible Debentures bear 46 interest at 6% per annum and are due on September 30, 2012. The indenture governing the Convertible Debentures is incorporated by reference to this annual report. See Exhibit 4.11 under Item 19 in this Form 20-F. On February 29, 2008, Zarlink entered into a sale and purchase agreement with MHS Electronics UK Limited, a subsidiary of MHS industries Group, to sell the assets of our Swindon foundry for one British pound. The assets sold consisted primarily of intellectual property and other intangible assets, and equipment. In addition, approximately 122 employees of the Swindon foundry transferred to MHS, as a result of this agreement. The transaction was completed on February 29, 2008. See Exhibit 4.12 under item 19 to this Form 20-F. Refer to the section entitled "Executive Compensation" in our Management Proxy Circular for the Fiscal 2008 Annual and Special Shareholders Meeting for information concerning executive employment contracts. Management considers all other contracts to which we are a party in the most recent two years to be in the ordinary course of business. D. Exchange Controls There are no government laws, decrees or regulations in Canada that restrict the export or import of capital or, subject to the following sentence, which affect the remittance of dividends or other payments to nonresident holders of our common shares. However, any such remittance to a resident of the United States is generally subject to non-resident tax pursuant to Article X of the 1980 Canada-United States Income Tax Convention. See "Item 10.E Taxation" for additional discussion on tax matters. E. Taxation The following discussion is not intended to be, nor should it be construed to be, legal or tax advice to any holder or prospective holder of our common and preferred shares ("shares") and no opinion or representation with respect to the Canadian or United States federal, state, provincial, local or other income tax consequences to any such holder or prospective holder is made. Accordingly, holders and prospective holders of our shares should consult their own tax advisors about the federal, state, provincial, local and foreign tax consequences of purchasing, owning and disposing of Zarlink's shares in respect of their own circumstances. Material Canadian Federal Income Tax Considerations The following section of the summary is applicable to a holder of shares who, for the purposes of the Income Tax Act (Canada) ("Tax Act") and the Canada-US Income Tax Convention ("Treaty"), at all relevant times, (i) is a resident of the United States (ii) is not, and is not deemed to be, a resident of Canada, (iii) is entitled to the benefits of the Treaty, (iv) does not, and is not deemed to, use or hold the shares in, or in the course of, carrying on a business in Canada or as "designated insurance property" (v) will hold the shares as capital property, (vi) deals at arm's length with, is not and will not be affiliated with Zarlink, and (vii) is not an "authorized foreign bank" or a "registered non-resident insurer" (as each such term is defined in the Tax Act) ("U.S. Holder"). This summary is based on the provisions of the Tax Act and the regulations there under and the Treaty, all in force as of the date of hereof, the current published administrative policies and assessing practices of the Canada Revenue Agency ("CRA") and takes into account all specific proposals to amend the Tax Act that have been publicly announced by or on behalf of the Minister of Finance (Canada) prior to the date hereof (Proposed Amendments). On September 21, 2007, Canada and the United States signed the fifth protocol amending the Treaty ("Protocol"). The Protocol contains provisions that address among other things, elimination of interest withholding tax, hybrid entities and limitation on benefits. The Protocol will enter into force on the later of January 1, 2008, and the date that both countries have provided notification that their applicable procedures have been satisfied. On December 14, 2007, the Department of Finance (Canada) announced that Canada had completed the steps required to give effect to the Protocol. However, the Protocol will not come into effect until the United States ratifies it and both countries have formally notified each other that their procedures are completed. It is the position of the CRA that a United States limited Liability Company (LLC) (other than that which elects to be taxed as a corporation for U.S. tax purposes) does not qualify as a resident of the United States under the Treaty 47 and, therefore, is not entitled to the benefits of the Treaty. The Protocol essentially provides that a member of an LLC may be entitled to certain Treaty benefits on an amount derived through the LLC provided that the member is taxed in the United States on the income, profit or gain in the same way as it would be if it had derived the amount directly. However, there can be no assurance when or if the Protocol will be ratified. U.S. Holders of shares should consult their own tax advisors to determine their entitlement to treaty relief based on their particular circumstances. No assurance can be given that the CRA will not change its administrative or assessing practices or that the Proposed Amendments or the Protocol will be enacted as currently proposed or at all. Except for the Proposed Amendments and the Protocol, this summary does not take into account or anticipate any changes in law or in the administrative or assessing policies of the CRA, whether by legislative, governmental or judicial decision or action, nor does it take into account provincial, territorial or foreign tax considerations, which may differ significantly from those discussed herein. Taxation of Dividends A U.S. holder will be subject to withholding tax under the Tax Act at a rate of 25% of amounts paid or credited, or deemed to be paid or credited under the Tax Act, as, on account or in lieu of payment of, or in satisfaction of dividends on their Zarlink shares. This withholding tax may be reduced pursuant to the terms of the Treaty. Under the Treaty, the rate of Canadian withholding tax which will apply on dividends paid by Zarlink to a U.S. Holder that beneficially owns such dividends is generally 15%, unless the beneficial owner is a company which owns at least 10% of the voting shares of Zarlink at that time, in which case the rate is reduced to 5%. Disposition of Shares A U.S. Holder will not be subject to tax under the Tax Act in respect of any capital gain realized on the disposition or deemed disposition of shares, provided that at the time of such disposition either (i) the shares do not constitute and are not deemed to constitute "taxable Canadian property" (as defined in the Tax Act) or (ii) the shares are "treaty-protected properties" (as defined in the Tax Act). Generally, shares of a corporation owned by a U.S. Holder will not be taxable Canadian property of the holder at a particular time provided that (i) the shares are listed on a designated stock exchange (which includes the TSX and NYSE) at that time, (ii) neither the U.S. Holder, persons with whom the U.S. Holder did not deal at arm's length, or the U.S. Holder together with such persons owned 25% or more of the issued shares of any class or series of shares of the corporation within the 60-month period ending on the date of the disposition; and (iii) shares were not acquired in a transaction as a result of which the shares were deemed to be taxable Canadian property of the U.S. Holder under the Tax Act. Even if the shares constitute, or is deemed to constitute, taxable Canadian property to the U.S. Holder, any capital gain arising on their disposition may be exempt from Canadian tax under the Treaty if they constitute "treaty-protected property". The shares would generally be treaty-protected property unless the value of the shares of Zarlink at the time of disposition is derived principally from real property situated in Canada. U.S. Holders that dispose of shares that are taxable Canadian properties to it, even if such shares are treaty-protected properties, may be subject to additional Canadian tax compliance. Any such U.S. Holders should consult their own tax advisors in this respect. Material United States Federal Income Tax Considerations The following discussion is based on the U.S. Internal Revenue Code of 1986, as amended (the "Code"), existing and proposed Treasury Regulations, published Internal Revenue Service rulings, published administrative positions of the Internal Revenue Service and court decisions that are currently applicable, any or all of which could be materially and adversely changed, possibly on a retroactive basis, at any time. In addition, this discussion does not consider the potential effects, both adverse and beneficial, of any recently proposed legislation that, if enacted, could be applied, possibly on a retroactive basis, at any time. In addition, this discussion does not cover any state, local or foreign tax consequences. The following is a discussion of United States federal income tax consequences, under current law, generally applicable to a U.S. Holder (as defined below) of shares of Zarlink who holds such shares as capital assets. This discussion does not address all potentially relevant federal income tax matters and it does not address consequences peculiar to persons subject to special provisions of federal income tax law, such as those described below that are excluded from the definition of a U.S. Holder. 48 As used in this section, the term "U.S. Holder" means a beneficial owner of the shares of Zarlink that is (a) a citizen or an individual resident of the United States; (b) a corporation (or an entity taxable as a corporation for United States federal income tax purposes) created or organized in or under the laws of the United States or any political subdivision of the United States; (c) an estate the income of which is subject to United States federal income taxation regardless of its source; or (d) a trust which (i) is subject to the primary supervision of a court within the United States and the control of a United States fiduciary as described in Section 7701(a)(30)(E) of the Code; or (ii) has properly elected under applicable Treasury Regulations to be treated as a United States person. Dividends Except as otherwise discussed below under "Passive Foreign Investment Company Considerations," U.S. Holders receiving dividend distributions (including constructive dividends) with respect to our shares are required to include in gross income for United States federal income tax purposes the gross amount of such distributions to the extent that we have current or accumulated earnings and profits, without reduction for any Canadian income tax withheld from such distributions. Such Canadian tax withheld may be credited, subject to certain limitations, against the U.S. Holder's United States federal tax liability or, alternatively, may be deducted in computing the U.S. Holder's federal taxable income (but in the case of individuals, only if they itemize deductions). See "Foreign Tax Credit." To the extent that distributions exceed current or accumulated earnings and profits of Zarlink, they will be treated first as a return of capital up to the U.S. Holder's adjusted basis in the shares (which adjusted basis must therefore be reduced) and thereafter as a gain from the sale or exchange of the shares. Preferential tax rates for long-term capital gains are applicable to a U.S. Holder that is an individual, estate or trust. Moreover, "qualified dividends" received by U.S. Holders who are individuals, during tax years beginning before January 1, 2011, from any "qualified foreign corporation" are subject to a preferential tax rate, provided such individual U.S. Holder meets a certain holding period requirement. A "qualified foreign corporation" is generally any corporation formed in a foreign jurisdiction which has a comprehensive income tax treaty with the United States or, if not, the dividend is paid with respect to stock that is readily tradable on an established United States market. However, a "qualified foreign corporation" excludes a foreign corporation that is a passive foreign investment company for the year the dividend is paid or the previous year. Zarlink believes that it qualifies as a "qualified foreign corporation". There are currently no preferential tax rates for a U.S. Holder that is a corporation. In general, dividends paid on our shares will not be eligible for the same dividends received deduction provided to corporations receiving dividends from certain United States corporations. A U.S. Holder which is a corporation may, under certain circumstances, be entitled to a dividends received deduction of the United States source portion of dividends received from Zarlink (unless Zarlink is a "passive foreign investment company" as defined below) if such U.S. Holder owns shares representing at least 10% of the voting power and value of Zarlink. The availability of this deduction is subject to several complex limitations that are beyond the scope of this discussion. Foreign Tax Credit A U.S. Holder who pays (or has withheld from distributions) Canadian or other foreign income tax with respect to the ownership of shares of Zarlink may be entitled, at the election of the U.S. Holder, to either a tax credit or a deduction for such foreign tax paid or withheld. This election is made on a year-by-year basis and generally applies to all foreign income taxes paid by (or withheld from) the U.S. Holder during that year. There are significant and complex limitations that apply to the credit, among which is the general limitation that the credit cannot exceed the proportionate share of the U.S. Holder's United States income tax liability that the U.S. Holder's foreign source income bears to his or its worldwide taxable income. In the determination of the application of this limitation, the various items of income and deduction must be classified into foreign and domestic sources and be separated into two categories of income: passive income and general income. In addition, U.S. Holders that are corporations and that own 10% or more of the voting stock of Zarlink may be entitled to an "indirect" foreign tax credit under Section 902 of the Code with respect to the payment of dividends by Zarlink under certain circumstances and subject to complex rules and limitations. The availability of the foreign tax credit and the application of the limitations on the foreign tax credit are fact specific and holders and prospective shareholders should consult their own tax advisors regarding their individual circumstances. Disposition of Shares Except as otherwise discussed below under "Passive Foreign Investment Company Considerations," a gain or loss realized on a sale of shares will generally be a capital gain or loss, and will be long-term if the shareholder has a holding period of more than one year. The amount of gain or loss recognized by a selling U.S. Holder will be measured by the difference between (i) the amount realized on the sale and (ii) his or its tax basis in the shares. 49 Gains and losses are netted and combined according to special rules in arriving at the overall capital gain or loss for a particular tax year. Deductions for net capital losses are subject to significant limitations. Individual U.S. Holders may carry over unused capital losses to offset capital gains realized in subsequent years. For U.S. Holders that are corporations (other than corporations subject to Subchapter S of the Code), any unused capital losses may only be carried back three and forward five years from the loss year to offset capital gains. Tax Consequences if We Are a Passive Foreign Investment Company If Zarlink is a "passive foreign investment company" or "PFIC" as defined in Section 1297 of the Code, U.S. Holders will be subject to U.S. federal income taxation under one of two alternative tax regimes at the election of each such U.S. Holder. Section 1297 of the Code defines a PFIC as a corporation that is not formed in the United States and either (i) 75% or more of its gross income for the taxable year is "passive income", which generally includes interest, dividends, certain rents and royalties, and gain from the sale or exchange of property that produces passive income, or (ii) the average percentage, by fair market value, of its assets that produce or are held for the production of "passive income" is 50% or more during the taxable year. Zarlink does not believe that it will be a PFIC for the current Fiscal year or for future years. Whether Zarlink is a PFIC in any year and the tax consequences relating to PFIC status will depend on the composition of Zarlink's income and assets, including cash. U.S. Holders should be aware, however, that if Zarlink becomes a PFIC, it may not be able or willing to satisfy record-keeping requirements that would enable U.S. Holders to make an election to treat Zarlink as a "qualified electing fund" for purposes of one of the two alternative tax regimes applicable to a PFIC. If Zarlink were to become a PFIC, special taxation rules under Section 1291 of the Code would generally apply to treat as ordinary income gains realized on the disposition of shares and certain "excess distributions" as defined in Section 1291(b) of the Code, plus impose an interest charge. Alternatively, if U.S. Holders were able to treat Zarlink as a qualified electing fund, U.S. Holders would generally treat any gain realized on the disposition of shares as capital gain and may either avoid interest charges resulting from PFIC status altogether, or make an annual election, subject to certain limitations, to defer payment of current taxes on their share of Zarlink's annual realized net capital gain and ordinary earnings subject, however, to an interest charge. U.S. Holders or potential shareholders should consult their own tax advisor concerning the impact of these rules on their investment in Zarlink. Information Reporting and Backup Withholding U.S. Holders generally are subject to information reporting requirements with respect to dividends paid on our shares and proceeds paid from the disposition of shares, if the dividends or disposition proceeds are paid within the United States or through certain U.S.-related financial intermediaries. Backup withholding at a current rate of 28% with respect to dividends and disposition proceeds paid within the United States or through certain U.S.-related financial intermediaries would generally apply unless the U.S. Holder provides a correct taxpayer identification number, certifies that it is not subject to backup withholding, and otherwise complies with applicable requirements of the backup withholding rules. Certain persons are exempt from information reporting and backup withholding, including corporations and financial institutions. The amount of any backup withholding from a payment to a U.S. Holder will be allowed as a credit against such holder's U.S. federal income tax liability and may entitle such holder to a refund provided that the required information is timely furnished to the Internal Revenue Service. F. Dividends and Paying Agents Not applicable G. Statements by Experts Not applicable H. Documents on Display Any statement in this Annual Report about any of our contracts or other documents is not necessarily complete. If the contract or document is filed as an exhibit to this Annual Report or is incorporated by reference, the contract or document is deemed to modify our description. You must review the exhibits themselves for a complete description of the contract or document. 50 You may review a copy of our filings with the SEC, including exhibits and schedules filed with this Annual Report, at the SEC's public reference facilities in Room 1580, 100 F Street, N.E. Washington, D.C. 20549. You may call the SEC at 1-800-SEC-0330 for further information on the public reference rooms. The SEC maintains a web site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC. We began to file electronically with the SEC in August 1996. You may read and copy any reports, statements or other information that we file with the SEC at the addresses indicated above and you may also access some of them electronically at the web site set forth above. These SEC filings are also available to the public from commercial document retrieval services. We also file reports, statements and other information with the Canadian Securities Administrators, or the CSA, and these can be accessed electronically at the CSA's System for Electronic Document Analysis and Retrieval web site (http://www.sedar.com). I. Subsidiary Information Not applicable Item 11 Quantitative and Qualitative Disclosures About Market Risk Market risk represents the risk of loss that may impact our financial statements due to adverse changes in financial market prices and rates. We are exposed to market risk from changes in foreign exchange and interest rates. To manage these risks, we use certain derivative financial instruments including foreign exchange forward contracts and other derivative instruments from time to time, which have been authorized pursuant to board-approved policies and procedures. We do not hold or issue financial instruments for trading or speculative purposes. We use forward contracts and foreign currency options to reduce the exposure to foreign exchange risk on operating cash flows. Our most significant foreign exchange exposures relate to the British pound, the Canadian dollar, and the Swedish krona. As at March 28, 2008, we had outstanding foreign currency options to purchase "call" the equivalent of $6.7 and we had written "put" options to buy the equivalent of $9.4 British pounds. These options have been marked to market with the change in fair value being charged to the profit and loss statement. We expect to continue to use these methods of reducing our exposure to foreign exchange risk in future periods. Our assets and liabilities denominated in foreign currencies are subject to the effects of exchange rate fluctuations of those currencies relative to the U.S. dollar. Our most significant liabilities denominated in a foreign currency are our long-term debt - convertible debentures denominated in Canadian dollars and our pension liability denominated in Swedish krona. We have partially mitigated the foreign exchange risk relating to the Swedish pension liability by holding Swedish krona in restricted cash; however, we are exposed to fluctuations in Canadian to U.S. dollar exchange rates in regards to the long-term debt - convertible debentures. Our long-term debt - convertible debentures bears a fixed 6% interest rate for the life of the debt; therefore we are not exposed to any interest rate risk on this debt. On the other hand, because our convertible debentures are denominated in Canadian dollars, while our functional currency is the U.S. dollar, we are required to revalue these debentures into U.S. dollars at the period-end market rate. As a result of this revaluation, we incur non-cash foreign currency gains or losses. A five percentage point change in the Cdn/U.S. exchange rate will have a non-cash foreign exchange impact of approximately $4.0 to our earnings in a given Fiscal period. Based on a sensitivity analysis performed on the financial instruments held at March 28, 2008, that are sensitive to changes in interest rates, the impact to the fair value of our cash equivalents and short-term investments portfolio by an immediate hypothetical parallel shift in the yield curve of plus or minus 50, 100 or 150 basis points would result in an insignificant decline or increase in portfolio value. The estimated potential losses discussed previously assume the occurrence of certain adverse market conditions. They do not consider the potential effect of favorable changes in market factors and do not represent projected losses in fair value that we expect to incur. Any future financial impact would be based on actual developments in global financial markets. We do not foresee any significant changes in the strategies used to manage foreign exchange and interest rate risks in the near future. 51 Item 12 Description of Securities Other than Equity Securities Not applicable PART II Item 13 Defaults, Dividend Arrearages and Delinquencies Not applicable Item 14 Material Modifications to the Rights of Security Holders and Use of Proceeds Not applicable Item 15 Controls and Procedures Disclosure Controls and Procedures Our management carried out an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) as of March 28, 2008. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 28, 2008. Management's Annual Report on Internal Control over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal controls over financial reporting are designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with United States generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Management maintains a system of controls intended to ensure that (a) transactions are authorized; (b) assets are safeguarded; and (c) financial records are accurately maintained in reasonable detail and fairly reflect the transactions of our company. Management assessed the effectiveness of the our internal control over financial reporting (ICFR) as of March 28, 2008, based on the criteria set forth in the Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management excluded from its assessment the internal controls over financial reporting relating to Legerity, which was acquired on August 3, 2007, because in management's view, it was not possible to conduct an assessment of an acquired business's internal control over financial reporting in the period between the acquisition date and the date of management's assessment. Legerity financial statements constitute 14.4% and 10.3% of net and total assets, respectively, 31.1% of revenues, and 0.4% of net income of the consolidated financial statement amounts as of and for the year ended March 28, 2008. Based on this assessment, management believes that, as of March 28, 2008, our internal control over financial reporting is effective. Our independent registered public accounting firm, Deloitte & Touche LLP, independently audited the financial statements included in this annual report containing the disclosure required by this Item and has assessed the effectiveness of the Company's internal control over financial reporting. Deloitte & Touche LLP has issued an unqualified attestation report on the Company's internal control over financial reporting which is included in Item 18 of this Form 20-F. Changes in internal control over financial reporting In conjunction with our review and evaluation of our internal control over financial reporting during the year ended March 28, 2008, we implemented measures to improve our internal control over financial reporting in various processes. Our management has assessed that, while these changes were an improvement to our control activities, there have not been any changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the year ended March 28, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Management continues to monitor our business processes, and expects that we will continue to make improvements to its processes and controls in upcoming periods, in efforts to improve process efficiency and effectively utilize our resources. 52 Although we have excluded the Legerity business from our assessment of internal controls over financial reporting, we have undertaken certain initiatives to align Legerity controls, policies and procedures with our existing controls, including transitioning Legerity to our business software as of December 1, 2007. We continue the processes of reviewing the design of the ICFR of Legerity and to date are not aware of any material weaknesses. Through this continued review process, we anticipate implementing further changes to enhance the ICFR of Legerity. Item 16A Audit committee financial expert Information concerning the audit committee financial expert is incorporated by reference from the information set forth in the section entitled "Schedule A - Statement of Corporate Governance Practices" in our Management Proxy Circular for the Fiscal 2008 Annual and Special Shareholders Meeting. Item 16B Code of Ethics Information concerning the code of ethics is incorporated by reference from the information set forth in the section entitled "Schedule A - Statement of Corporate Governance Practices" in our Management Proxy Circular for the Fiscal 2007 Annual and Special Shareholders Meeting. Information concerning our code of ethics is also available on our website at http://ir.zarlink.com/corp_gov/. Item 16C Principal Accountant Fees and Services The information concerning principal accountant fees and services is incorporated by reference from the information set forth in the section entitled "Appointment of Auditors" in our Management Proxy Circular for the Fiscal 2008 Annual and Special Shareholders Meeting. Item 16D Exemptions from the Listing Standards for Audit Committees Not applicable Item 16E Purchases of Equity Securities by the Issuer and Affiliated Purchasers Not applicable 53 PART III Item 17 Financial Statements Not applicable Item 18 Financial Statements The following financial statements and supplementary data have been filed as part of this Annual Report:
Page No. -------- Auditors' Report to the Shareholders - Opinion on consolidated financial statements 55 Auditors' Report to the Shareholders - Opinion on internal control over financial reporting 56 Auditors' Report to the Shareholders - Prior Years 57 Consolidated Balance Sheets as at March 28, 2008 and March 30, 2007 58 Consolidated Statements of Shareholders' Equity for the years ended March 28, 2008 March 30, 2007, March 31, 2006 59 Consolidated Statements of Income (Loss) for the years ended March 28, 2008 March 30, 2007, March 31, 2006 60 Consolidated Statements of Cash Flows for the years ended March 28, 2008, March 30, 2007, March 31, 2006 61 Notes to the Consolidated Financial Statements 62 Valuation and Qualifying Accounts 91
54 Report of Independent Registered Chartered Accountants To the Board of Directors and Shareholders of Zarlink Semiconductor Inc. We have audited the consolidated balance sheet of Zarlink Semiconductor Inc. and subsidiaries (the "Company") as of March 28, 2008, and the related consolidated statements of income (loss), shareholders' equity and cash flows for the year ended March 28, 2008. Our audit also included the financial statement schedule titled Valuation and Qualifying Accounts listed in the Index at Item 18 on Form 20-F. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audit. We conducted our audit in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of Zarlink Semiconductor Inc. and subsidiaries as of March 28, 2008 and the results of their operations and their cash flows for the year ended March 28, 2008 in accordance with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule titled Valuation and Qualifying Accounts listed in the Index at Item 18 on Form 20-F, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. The consolidated financial statements as at March 30, 2007, and for the years ended March 30, 2007 and March 31, 2006 were audited in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States) by other auditors who expressed an opinion without reservation on those statements in their report dated June 6, 2007. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of March 28, 2008, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 30, 2008 expressed an unqualified opinion on the Company's internal control over financial reporting. /s/ Deloitte & Touche LLP - ------------------------- Independent Registered Chartered Accountants Licensed Public Accountants Ottawa, Canada May 30, 2008 Comments by Independent Registered Chartered Accountants on Canada-United States of America Reporting Difference The standards of the Public Company Accounting Oversight Board (United States) require the addition of an explanatory paragraph (following the opinion paragraph) when there are changes in accounting principles that have a material effect on the comparability of the Company's financial statements, such as the change described in Note 23 to the financial statements. Our report to the Board of Directors and Shareholders of Zarlink Semiconductor Inc., dated May 30, 2008 is expressed in accordance with Canadian reporting standards which do not require a reference to such changes in accounting principles in the auditors' report when the change is properly accounted for and adequately disclosed in the financial statements. /s/ Deloitte & Touche LLP - ------------------------- Independent Registered Chartered Accountants Licensed Public Accountants Ottawa, Canada May 30, 2008 55 Report of Independent Registered Chartered Accountants To the Board of Directors and Shareholders of Zarlink Semiconductor Inc. We have audited the internal control over financial reporting of Zarlink Semiconductor Inc. and subsidiaries (the "Company") as of March 28, 2008, based on the criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in Management's Annual Report on Internal Control over Financial Reporting, management excluded from its assessment the internal control over financial reporting at Legerity Holdings Inc., which was acquired on August 3, 2007 and whose financial statements constitute 14.4% and 10.3 % of net and total assets, respectively, 31.1 % of revenues, and 0.4 % of net income of the consolidated financial statement amounts as of and for the year ended March 28, 2008. Accordingly, our audit did not include the internal control over financial reporting at Legerity Holdings, Inc. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control over Financial Reporting listed in the Index at Item 15 on Form 20-F. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of March 28, 2008, based on the criteria established in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules listed in the Index at Item 18 on Form 20-F as of and for the year ended March 28, 2008 of the Company and our report dated May 30, 2008 expressed an unqualified opinion on those financial statements and financial statement schedules. /s/ Deloitte & Touche LLP - ------------------------- Independent Registered Chartered Accountants Licensed Public Accountants Ottawa, Canada May 30, 2008 56 Report of Independent Registered Public Accounting Firm To the Shareholders of Zarlink Semiconductor Inc.: We have audited the accompanying consolidated balance sheets of Zarlink Semiconductor Inc. as at March 30, 2007 and March 31, 2006 and the related consolidated statements of shareholders' equity, income (loss), and cash flows for each of the years in the two year period ended March 30, 2007. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Zarlink Semiconductor Inc. as at March 30, 2007 and March 31, 2006 and the results of its operations and its cash flows for each of the years in the two year period ended March 30, 2007, in conformity with United States generally accepted accounting principles. Ottawa, Canada /s/ Ernst & Young LLP June 4, 2008 --------------------- Licensed Public Accountants 57 Zarlink Semiconductor Inc. (Incorporated under the laws of Canada) CONSOLIDATED BALANCE SHEETS (In millions of U.S. dollars, except share amounts, U.S. GAAP)
March 28, March 30, 2008 2007 -------------- -------------- ASSETS Current assets: Cash and cash equivalents $ 42.4 $ 111.3 Short-term investments 0.2 3.3 Restricted cash and cash equivalents 17.3 14.6 Trade accounts receivable - less allowance for doubtful accounts of $Nil (March 30, 2007 - $Nil) 23.4 16.3 Other accounts receivable - less allowance for doubtful accounts of $0.3 (March 30, 2007 - $Nil) 10.0 6.6 Inventories 28.8 19.1 Prepaid expenses and other 8.2 5.4 Deferred tax assets 1.3 - Current assets held for sale 3.1 3.1 -------------- -------------- 134.7 179.7 Fixed assets - net 14.7 21.0 Deferred income tax assets - net 7.5 4.9 Goodwill 46.9 3.8 Intangible assets - net 56.5 1.6 Other assets 3.6 - -------------- -------------- $ 263.9 $ 211.0 ============== ============== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Trade accounts payable $ 13.3 $ 6.5 Employee-related payables 12.7 11.5 Income and other taxes payable 0.4 4.7 Current portion of provisions for exit activities 3.5 0.8 Other accrued liabilities 9.6 3.2 Deferred credits 0.6 0.6 Deferred income tax liabilities - current portion 0.1 0.1 -------------- -------------- 40.2 27.4 Long-term debt - convertible debentures 77.4 - Long-term portion of provisions for exit activities 0.4 0.5 Pension liabilities 19.9 15.9 Deferred income tax liabilities - long-term portion 0.2 0.2 Long-term accrued income taxes 10.9 - Other long-term liabilities 0.8 - -------------- -------------- 149.8 44.0 -------------- -------------- Redeemable preferred shares, unlimited shares authorized; non-voting; 1,148,000 shares issued and outstanding (2007 - 1,260,800) 14.7 16.1 -------------- -------------- Commitments and contingencies (Notes 14, 16 and 17) Shareholders' equity: Common shares, unlimited shares authorized; no par value; 127,345,682 shares issued and outstanding (2007 - 127,343,183) 768.5 768.5 Additional paid-in capital 5.1 4.3 Deficit (638.4) (587.6) Accumulated other comprehensive loss (35.8) (34.3) -------------- -------------- 99.4 150.9 -------------- -------------- $ 263.9 $ 211.0 ============== ==============
/s/ Kirk K. Mandy /s/ Hubert T. Lacroix ----------------- --------------------- (Kirk K. Mandy) (Hubert T. Lacroix) President and Chief Executive Officer Director (See accompanying notes to the consolidated financial statements) 58 Zarlink Semiconductor Inc. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In millions of U.S. dollars, U.S. GAAP)
Common Shares ------------------------ Accumulated Additional Other Total Number Paid in Comprehensive Shareholders' (millions) Amount Capital Deficit Loss Equity ----------------------------------------------------------------------------------------- Balance, March 25, 2005 127.3 768.4 2.2 (646.5) (33.1) 91.0 Net income (loss) - - - 48.8 - 48.8 Minimum pension liability - - - - (1.6) (1.6) --------------- Comprehensive income 47.2 --------------- Issuance of common stock under stock benefit plans - 0.1 - - - 0.1 Stock compensation expense - - 0.1 - - 0.1 Redemption of preferred shares - - (0.6) - - (0.6) Preferred share dividends - - - (2.2) - (2.2) ----------------------------------------------------------------------------------------- Balance, March 31, 2006 127.3 768.5 1.7 (599.9) (34.7) 135.6 ----------------------------------------------------------------------------------------- Cumulative effect of adjustments from the adoption of SAB 108 - - 1.3 (1.3) - - ----------------------------------------------------------------------------------------- Adjusted balance, March 31, 2006 127.3 768.5 3.0 (601.2) (34.7) 135.6 ----------------------------------------------------------------------------------------- Net income (loss) - - - 15.8 - 15.8 Minimum pension liability - - - - 0.4 0.4 --------------- Comprehensive income 16.2 --------------- Stock compensation expense - - 1.4 - - 1.4 Redemption of preferred shares - - (0.1) - - (0.1) Preferred share dividends - - - (2.2) - (2.2) ----------------------------------------------------------------------------------------- Balance, March 30, 2007 127.3 $ 768.5 $ 4.3 $ (587.6) $ (34.3) $ 150.9 ----------------------------------------------------------------------------------------- Net income (loss) - - - (48.4) - (48.4) Minimum pension liability - - - - (1.5) (1.5) --------------- Comprehensive loss (49.9) --------------- Stock compensation expense - - 2.0 - - 2.0 Redemption of preferred shares - - (1.2) - - (1.2) Preferred share dividends - - - (2.4) - (2.4) ----------------------------------------------------------------------------------------- Balance, March 28, 2008 127.3 $ 768.5 $ 5.1 $ (638.4) $ (35.8) $ 99.4 =========================================================================================
(See accompanying notes to the consolidated financial statements) 59 Zarlink Semiconductor Inc. CONSOLIDATED STATEMENTS OF INCOME (LOSS) (In millions of U.S. dollars, except per share amounts, U.S. GAAP)
Years Ended March 28, March 30, March 31, 2008 2007 2006 ------------------------------------------------- Revenue $ 183.6 $ 142.6 $ 144.9 Cost of revenue 100.5 68.2 72.1 ------------- -------------- -------------- Gross margin 83.1 74.4 72.8 ------------- -------------- -------------- Expenses: Research and development 47.7 32.7 37.5 Selling and administrative 55.8 37.3 35.6 Contract impairment and other 4.1 1.1 5.7 Amortization of intangible assets 5.0 0.3 - Acquired in-process R&D 20.3 - - Loss (gain) on sale of business and foundry 17.5 (4.1) (1.9) ------------- -------------- -------------- 150.4 67.3 76.9 ------------- -------------- -------------- Operating income (loss) from continuing operations (67.3) 7.1 (4.1) Gain on sale of Mitel investment 12.9 - - Gain on insurance settlement 5.5 - - Gain on sale of assets 2.3 - - Amortization of debt issue costs (0.5) - - Interest income 3.5 5.4 2.5 Interest expense (3.1) - - Foreign exchange gain (loss) (1.5) 0.1 1.1 ------------- -------------- -------------- Income (loss) from continuing operations before income taxes (48.2) 12.6 (0.5) Income tax recovery (expense) (0.2) 3.2 2.5 ------------- -------------- -------------- Income (loss) from continuing operations (48.4) 15.8 2.0 Discontinued operations, net of tax - - 46.8 ------------- -------------- -------------- Net income (loss) $ (48.4) $ 15.8 $ 48.8 ============= ============== ============== Net income (loss) attributable to common shareholders after preferred share dividends and premiums on preferred share repurchases $ (52.0) $ 13.5 $ 46.0 ============= ============== ============== Income (loss) per common share from continuing operations: Basic and diluted $ (0.41) $ 0.11 $ (0.01) ============= ============== ============== Income (loss) per common share from discontinued operations: Basic and diluted $ - $ - $ 0.37 ============= ============== ============== Net income (loss) per common share: Basic and diluted $ (0.41) $ 0.11 $ 0.36 ============= ============== ============== Weighted average number of common shares outstanding (millions): Basic 127.3 127.3 127.3 ============= ============== ============== Diluted 127.3 127.4 127.4 ============= ============== ==============
(See accompanying notes to the consolidated financial statements) 60 Zarlink Semiconductor Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions of U.S. dollars, U.S. GAAP)
Years Ended March 28, March 30, March 31, 2008 2007 2006 ------------------------------------------------- CASH PROVIDED BY (USED IN) Operating activities: Income (loss) from continuing operations $ (48.4) $ 15.8 $ 2.0 Depreciation of fixed assets 5.7 5.0 6.3 Amortization of other assets 5.6 0.3 - Stock compensation expense 2.0 1.4 - Deferred income taxes 3.4 (1.4) (1.9) Other non-cash changes in operating activities 24.7 (4.5) (2.8) Gain on insurance settlement (5.5) - - Proceeds from insurance 14.1 - - Flood related expenditures (10.9) - - Contract impairment and other 4.2 - - Increase in working capital (7.0) (11.8) (3.1) -------------- -------------- ------------- Total (12.1) 4.8 0.5 -------------- -------------- ------------- Investing activities: Acquisition of business, net of cash received (136.0) (7.1) - Purchased short-term investments - (3.3) (52.7) Matured short-term investments 3.3 24.6 67.7 Expenditures for fixed assets (7.6) (2.1) (1.7) Proceeds from disposal of fixed assets 2.7 0.1 0.5 Proceeds from repayment of note receivable - - 2.0 Proceeds from sale of investment 12.9 - - Proceeds from sale of business 0.6 4.7 - Payment for sale of foundry (3.6) - - Proceeds from insurance for fixed assets 4.5 - - Proceeds from sale of discontinued operations - net - - 65.7 -------------- -------------- ------------- Total (123.2) 16.9 81.5 -------------- -------------- ------------- Financing activities: Issuance of long-term debt 74.5 - - Repayment of long-term debt - (0.1) - Debt issue costs (3.7) - - Decrease (increase) in restricted cash and cash equivalents (0.3) 0.7 (0.1) Payment of dividends on preferred shares (2.4) (2.2) (2.7) Repurchase of preferred shares (2.6) (0.1) (1.6) -------------- -------------- ------------- Total 65.5 (1.7) (4.4) -------------- -------------- ------------- Effect of currency translation on cash 0.9 0.6 (0.6) Net cash used in discontinued operations from operating activities - - (5.7) -------------- -------------- ------------- Increase (decrease) in cash and cash equivalents (68.9) 20.6 71.3 Cash and cash equivalents, beginning of year 111.3 90.7 19.4 -------------- -------------- ------------- Cash and cash equivalents, end of year $ 42.4 $ 111.3 $ 90.7 ============== ============== =============
(See accompanying notes to the consolidated financial statements) 61 ZARLINK SEMICONDUCTOR INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In millions of U.S. dollars, except per share amounts, U.S. GAAP) 1. NATURE OF OPERATIONS Zarlink is an international semiconductor product supplier. The Company's principal business activities comprise the design, manufacture and distribution of microelectronic components for the communications, medical and optical industry. The principal markets for the Company's products are the Asia/Pacific region, Europe and the United States. The Company has aggregated its operating segments under the criteria set forth in FASB Statement ("SFAS") No. 131, and is viewed as a single reporting segment, thus no business segment information is being disclosed. 2. ACCOUNTING POLICIES These consolidated financial statements have been prepared by management in accordance with United States (U.S.) generally accepted accounting principles ("GAAP"). The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Areas where management uses subjective judgment include, but are not limited to, business combinations, revenue, inventory valuation and cost, impairment of goodwill and other long-lived assets, restructuring charges, deferred income taxes, pension liabilities, stock based compensation and commitments and contingencies. Actual results could differ from those estimates and such differences may be material. (A) FISCAL YEAR END The Company's Fiscal year end is the last Friday in March. For Fiscal 2008, the Company's year-end was March 28, 2008, reflecting a fifty-two week year with four thirteen-week quarters. For Fiscal 2007, the Company's year-end was March 30, 2007, reflecting a fifty-two week year with four thirteen-week quarters. For Fiscal 2006, the year-end was March 31, 2006, resulting in a fifty-three week year. (B) BASIS OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and of its wholly owned subsidiary companies. Investments in associated companies in which the Company has significant influence are accounted for by the equity method. Investments in companies the Company does not control or over which it does not exercise significant influence are accounted for using the cost method. All significant inter-company balances and transactions have been eliminated on consolidation. (C) CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS All highly liquid investments with original maturities of three months or less are classified as cash and cash equivalents. The fair value of cash equivalents approximates the amounts shown in the financial statements. Short-term investments comprise highly liquid corporate debt instruments that are held to maturity with terms of not greater than one year. Short-term investments are carried at amortized cost, which approximates their fair value. (D) RESTRICTED CASH AND CASH EQUIVALENTS Restricted cash and cash equivalents consist of cash and cash equivalents used as security pledges against liabilities or other forms of credit. (E) INVENTORIES Inventories are valued at the lower of an adjusted standard basis, which approximates average cost, or net realizable value for work-in-process and finished goods. Raw material inventories are valued at the lower of an adjusted standard basis, which approximates average cost, or replacement cost. The cost of inventories includes 62 material, labor and manufacturing overhead. Inventory value is also assessed for any obsolescence based upon an estimated demand, which generally is twelve months or less. (F) FIXED AND ACQUIRED INTANGIBLE ASSETS Fixed assets are initially recorded at cost, net of related research and development and other government assistance. Acquired intangible assets are initially recorded at cost. Management assesses the impairment of long-lived assets when events or changes in circumstances indicate that the carrying value of the assets or the asset groups may not be recoverable. In assessing the impairment, the Company compares projected undiscounted net cash flows associated with the related asset or group of assets over their estimated remaining useful life against their carrying amounts. If projected undiscounted cash flows are not sufficient to recover the carrying value of the assets, the assets are written down to their estimated fair values based on expected discounted cash flows. Changes in the estimates and assumptions used in assessing projected cash flows could materially affect the results of management's evaluation. Depreciation and amortization is provided on the basis and at the rates set out below: Assets Basis Rate ------------------------------------------------------------------------ Buildings Straight-line 2 - 4 % Equipment Straight-line 10 - 50 % Leasehold improvements Straight-line lease term Acquired intangibles Straight-line 10 - 33.3 % (G) GOODWILL Goodwill is recorded as the excess of the purchase price of acquisitions over the fair value of the net identifiable assets acquired. Goodwill is not amortized, but is assessed for impairment annually or more frequently if circumstances indicate that goodwill might be impaired. Goodwill is assessed for impairment at the reporting unit level. The Company performs its annual goodwill impairment test at the component level, in accordance with guidance, at the end of the fourth quarter of each Fiscal year. (H) FOREIGN CURRENCY TRANSLATION The Company adopted the U.S. dollar as its functional currency on March 29, 2003. Accordingly the carrying value of monetary balances denominated in currencies other than U.S. dollars have been re-measured at the balance sheet date rates of exchange. The gains or losses resulting from the re-measurement of these amounts have been reflected in earnings in the respective periods. Non-monetary items and any related depreciation and amortization of such items have been measured at the rates of exchange in effect when the assets were acquired or obligations incurred. All other income and expense items have been translated at the average rates prevailing during the period the transactions occurred. Prior to March 29, 2003, the financial statements of the foreign subsidiaries, excluding those discussed above, were measured using the local currency as the functional currency. Translation gains and losses were recorded in the cumulative translation account within accumulated other comprehensive loss included in Shareholders' equity. (See also Note 20). In Fiscal 2008 the Company acquired certain foreign subsidiaries with a functional currency other than the U.S. dollar. As a result, the financial statements of these subsidiaries are measured using the local currency and translated using the period-end balance sheet rate and the average rate for the Statement of Income (Loss). Any translation gains and losses are recorded in the cumulative translation account within accumulated other comprehensive loss included in Shareholders' equity using the period-end balance sheet rate. (I) DERIVATIVE FINANCIAL INSTRUMENTS The Company recognizes and discloses its derivative financial instruments in accordance with Financial Accounting Standards Board ("FASB") Statement No. 133 ("SFAS 133"), Accounting for Derivative Instruments and Hedging Activities, as amended by FASB Statement No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment of FASB Statement No. 133, and Statement No. 149 ("SFAS 63 149"), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The standards require that all derivative financial instruments be recorded on the Company's consolidated balance sheets at fair value. They also provide criteria for designation and effectiveness of hedging relationships. The Company operates globally, and therefore incurs expenses in currencies other than its U.S. dollar functional currency. The Company utilizes certain derivative financial instruments, including forward and option contracts, to enhance its ability to manage foreign currency exchange rate risk that exists as part of its ongoing operations. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. Derivative instruments are carried on the Company's balance sheet at fair value, and are reflected in prepaid expenses and other or accrued liabilities. If the derivative is designated as a fair value hedge, changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in net income (loss). If the derivative is designated as a cash flow hedge, the effective portions of changes in fair value of the derivative are recorded in Other Comprehensive Income ("OCI") and are recognized in net income (loss) against the hedged item when that hedged item affects net income (loss). If the derivative is not designated as part of a hedging relationship, or the designation is terminated, changes in the fair value of the derivative are recognized in net income (loss) immediately with in the foreign exchange line item of the Statement of Income. (J) COMPREHENSIVE INCOME The Company records the impact of unrealized net derivative gains or losses on cash flow hedges, changes in foreign exchange related to subsidiaries with a functional currency other than the U.S. dollar and changes in minimum pension liabilities, as components of comprehensive income, in accordance with Statement of Financial Accounting Standards No. 130 Reporting Comprehensive Income ("SFAS 130") and No. 158 Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans ("SFAS 158"). (K) REVENUE RECOGNITION The Company recognizes revenue from the sale of semiconductor products, which are primarily non-commodity, specialized products that are proprietary in design and used by multiple customers. Customer acceptance provisions for performance requirements are generally based on seller-specified criteria, and are demonstrated prior to shipment. The Company generates revenue through direct sales and sales to distributors. In accordance with Securities and Exchange Commission Staff Accounting Bulletin ("SAB") 104, Revenue Recognition, the Company recognizes product revenue when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) transfer of title has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of the resulting receivable is reasonably assured. In addition, the Company has agreements with its distributors that cover three sales programs; specifically ship and debit claims, which relate to pricing adjustments based upon distributor resale, stock rotation claims, which relate to certain stock return rights earned against sales, and sales rebates, which relates to refunds on certain products purchased. The Company accrues for these programs as a reduction of revenue at the time of shipment, based on historical sales returns, analysis of credit memo data, and other factors known at the time. Distributor sales are recognized as revenue at the time of shipment in accordance with SFAS 48, Revenue Recognition When Right of Return Exists, because of the following: i) The Company's price to the buyer is substantially fixed or determinable at the date of sale; ii) The distributor is obligated to pay the Company, and the obligation is not contingent on resale of the product; iii) The distributor's obligation to the Company would not be changed in the event of theft or physical destruction or damage of the product; iv) The distributor has economic substance apart from that provided by the Company; 64 v) The Company does not have significant obligations for future performance to directly bring about resale of the product by the distributor; and vi) The amount of future returns can be reasonably estimated. The Company records all revenue net of all sales and related taxes, in accordance with Emerging Issues Task Force Issue No. 06-3 ("EITF 06-03"), How Taxes Collected from Customers and Remitted to Governmental Authorities should be Presented in the Income Statement. (L) INCOME TAXES Income taxes are accounted for using the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities are determined based on differences between the tax and accounting basis of assets and liabilities as well as for the benefit of losses available to be carried forward to future years for tax purposes that are more likely than not to be realized. Deferred income tax assets and liabilities are measured using enacted tax rates that apply to taxable income in the years in which temporary differences are expected to be recovered or settled. Deferred income tax assets are recognized only to the extent, in the opinion of management, it is more likely than not that the deferred income tax assets will be realized in the future. The Company implemented Fin 48 on March 31, 2007. Fin 48 requires company's to determine the likely outcome of uncertain tax positions ("UTP's") and record this amount as an expense or recovery during the year in which UTP's are identified. It also requires companies to identify specifically where interest and penalties associated with these UTP's are recorded. Consistent with prior years, interest and penalties associated with UTP's taken by the Company are charged to income tax expense. Management periodically reviews the Company's provision for income taxes and valuation allowance to determine whether the overall tax estimates are reasonable. When management performs its quarterly assessments of the provision and valuation allowance, it may be determined that an adjustment is required. This adjustment may have a material impact on the Company's financial position and results of operations. (M) RESEARCH AND DEVELOPMENT COSTS Research and development costs are charged to earnings in the periods in which they are incurred. Government assistance and non-recurring engineering ("NRE") reimbursements are reflected as a reduction of research and development costs in the period that the expenses were incurred or the milestones were met. Purchased in-process research and development is expensed at the time of acquisition. Related investment tax credits are deducted from income tax expense. (N) GOVERNMENT ASSISTANCE The Company accounts for government grants by recognizing the benefit as a reduction in the related expense or cost of the fixed asset in the period incurred when there is reasonable assurance that the grant will be received. (O) STOCK-BASED COMPENSATION Effective April 1, 2006, the Company adopted SFAS 123R, Share-Based Payment. SFAS 123R requires that stock-based awards to employees be recorded at fair value. The fair value of the Company's stock-based awards to employees was estimated using the Black-Scholes-Merton option pricing model. Prior to adoption of SFAS 123R, the Company used the intrinsic value method of accounting for stock-based awards under the provisions of the Accounting Principles Board Opinion ("APB") 25, Accounting for Stock Issued to Employees. Under the intrinsic value method, fixed stock compensation expense is recorded in instances where the option exercise price is set lower than the market price of the underlying stock at the date of grant. Fixed stock compensation cost is amortized to expense over the vesting period of the underlying option award. Stock compensation expense has also been recorded in circumstances where the terms of a previously fixed stock option were modified. Previous stock option modifications have included the extension of option lives for terminated employees and changes in vesting periods. The estimated fair value of the options is amortized to expense over the requisite service period of the awards. In adopting SFAS 123R, the Company has estimated the fair value of its stock-based awards to employees using the Black-Scholes-Merton option-pricing model. This model considers, among other factors, share prices, option 65 prices, share price volatility, the risk-free interest rate, and expected option lives. In addition, SFAS 123R requires that the Company estimate the number of stock options which will be forfeited. Expected share price volatility is estimated using historical data on volatility of the Company's stock. Expected option lives and forfeiture rates are estimated using historical data on employee exercise patterns. The risk-free interest rate is based on the yield of government bonds at the time of calculating the expense and for the period of the expected option life. When options are exercised the Company issues shares from treasury. During Fiscal 2007, the Company conducted a review of historical stock option grant practices and the related accounting implications for the period from Fiscal 1997 to Fiscal 2006 inclusive. See Note 3 for the impact of this review. (P) DEBT ISSUE COSTS The costs related to the issuance of debt are capitalized and amortized to interest expense using the straight-line method over the lives of the related debt. The straight-line method results in amortization that is not materially different from that calculated under the effective interest method. (Q) EMPLOYEE FUTURE BENEFITS Defined benefit pension expense, based on management's assumptions, consists of actuarially computed costs of pension benefits in respect of the current year's service, imputed interest on plan assets and pension obligations, and straight-line amortization of experience gains and losses, assumption changes, and plan amendments over the average remaining life expectancy of the employee group. The costs of retirement benefits, other than pensions, and certain post-employment benefits are recognized over the period in which the employees render services in return for those benefits. Other post-employment benefits are recognized when the event triggering the obligation occurs. (R) RECENTLY ISSUED ACCOUNTING STANDARDS In April 2008, the FASB issued FASB Staff position No. 142-3, Determination of the Useful Life of Intangible Assets. This FASB Staff Position ("FSP") amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. The Company is required to adopt FSP 142-3 in the first quarter of Fiscal 2010. The requirements of this FSP are to be applied prospectively to intangible assets acquired after the effective date. As a result, the Company does not expect the adoption of FSP 142-3 to have a material impact on its financial position or results of operations. In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures About Derivative Instruments and Hedging Activities. The new standard requires enhanced disclosures to help investors better understand the effect of an entity's derivative instruments and related hedging activities on its financial position, financial performance, and cash flows. The Company is required to adopt SFAS 161 in the first quarter of Fiscal 2010. The Company does not expect the adoption of SFAS 161 to have a material impact on its financial disclosure. In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations ("SFAS 141(R)") and No. 160, Non-controlling interests in Consolidated Financial Statements ("SFAS 160"). The statements significantly change the accounting for acquisitions that close after the implementation of the standard, both at the acquisition date and in subsequent periods; however, certain requirements of the statement regarding income taxes will impact the disclosure and accounting of the Company for previously completed acquisitions. SFAS 141(R) and SFAS 160 are effective for public companies for Fiscal years beginning on or after December 15, 2008. SFAS 141(R) will be applied prospectively. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS 160 shall be applied prospectively. Early adoption is prohibited for both standards. The Company is required to adopt SFAS 141(R) and SFAS 160 in the first quarter of Fiscal 2010. After the effective date of SFAS 141(R), the Company may be required to make an adjustment to income tax expense for changes in the valuation allowance for acquired deferred tax assets and to recognize changes in the acquired income tax positions in accordance with FIN 48. Previously, these amounts would be charged to goodwill or other intangible assets. The Company is not able to quantify the tax impact of this standard at this time. With the 66 exception of the tax implications of SFAS 141(R), the Company does not expect the adoption of SFAS 141(R) or SFAS 160 to have any other material impact on its financial position or results of operations. In June 2007, the FASB ratified the consensus reached by the Emerging Issues Task Force on Issue No. 07-3, Accounting for Advance Payments for Goods or Services Received for Use in Future Research and Development Activities ("EITF 07-3"). EITF 07-3 indicates that non-refundable advance payments for future R&D activities should be deferred and capitalized until the goods have been delivered (assuming the goods have no alternative future use) or the related services have been performed. EITF 07-3 also indicates that companies should assess deferred R&D costs for recoverability. Companies are required to adopt EITF 07-3 for new contracts entered into in Fiscal years beginning after December 15, 2007. Earlier application is not permitted. The Company is required to adopt EITF 07-3 in the first quarter of Fiscal 2009. The Company does not expect the adoption of EITF 07-3 to have a material impact on its financial position and results of operations. In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 ("SFAS 159"). This statement allows companies to elect to measure certain eligible financial instruments and other items at fair value. Companies may choose to measure items at fair value at a specified election date, and subsequent unrealized gains and losses are recorded in income at each subsequent reporting date. SFAS 159 is effective for Fiscal years beginning after November 15, 2007, with earlier adoption permitted under certain circumstances. The Company does not anticipate electing to adopt SFAS 159 as the provisions of this standard will be negligible on the Company. In September 2006, the FASB issued SFAS 157, Fair Value Measurements ("SFAS 157"). The statement clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosure requirements regarding fair value measurements. SFAS 157 is effective for Fiscal years beginning after November 15, 2007, with earlier adoption permitted. The Company is required to adopt SFAS 157, along with related interpretations, no later than the first quarter of Fiscal 2009. The Company does not expect the adoption of SFAS 157 and related interpretations to have a material impact on its financial position or results of operations. 3. HISTORICAL STOCK-BASED COMPENSATION ADJUSTMENT In September 2006, the SEC issued SAB 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. In conjunction with the issuance of this guidance, the Company performed a voluntary review of its historical stock option grants for the period from Fiscal 1997 to Fiscal 2006 inclusive. Applying SAB 108, the Company identified certain historical differences related to stock-based compensation. These differences resulted from two of the Company's practices for granting stock options. The Company uses an option pricing formula provided in the shareholder-approved Company stock option plan. The plan defines the option exercise price as the average market price for the five trading days preceding the date of the grant. This option pricing formula, which was and is in compliance with the rules of the Toronto Stock Exchange, the New York Stock Exchange, and the SEC, was used to minimize volatility and subjectivity in connection with the pricing of option grants. Based on the SEC's interpretive guidance, if the option exercise price is at a price which differs from any of the opening, average or closing price on the date of the grant, then this may result in stock compensation expense. Differences related to the use of this option pricing formula resulted in an adjustment of $1.0 for the whole of the ten-year period reviewed by the Company. The Company has historically followed a consistent practice of granting stock options to new employees at their acceptance date. Based on the SEC's interpretative guidance, if the grant price is set at a date which differs from the date of commencement of employment, then this may result in stock compensation expense. The differences related to the issuance of stock options at the acceptance date resulted in an adjustment of $0.3, for the whole of the ten-year period reviewed by the Company. 67 While the impact of these practices on compensation expense in each year from Fiscal 1997 through Fiscal 2006 was not material, the cumulative effect of this adjustment resulted in a net increase to deficit and a corresponding increase to additional paid-in capital as follows: March 31, 2006 ---------------------------------------------- As previously Adjusted reported Adjustment balance --------------- -------------- ------------- Additional paid-in capital $ 1.7 $ 1.3 $ 3.0 Deficit (599.9) (1.3) (601.2) Shareholders' equity 135.6 - 135.6 4. CASH, CASH EQUIVALENTS AND RESTRICTED CASH As at March 28, 2008, the Company had $17.3 recorded as restricted cash, which was pledged as security toward the Company's Swedish pension liability (See also Note 26). The Company has voluntarily restricted this cash as an alternative to letters of credit to guarantee this pension liability. 5. INVENTORIES 2008 2007 -------------------------- Raw materials $ 2.0 $ 2.9 Work-in-process 16.8 12.3 Finished goods 10.0 3.9 -------------------------- $ 28.8 $ 19.1 ========================== 6. FIXED ASSETS 2008 2007 --------------------------- Cost: Land $ 0.5 $ 3.7 Buildings 9.1 12.7 Leasehold improvements 4.4 4.0 Equipment 59.5 125.4 --------------------------- 73.5 145.8 --------------------------- Less accumulated depreciation: Buildings 7.6 8.9 Leasehold improvements 2.7 2.2 Equipment 48.5 113.7 --------------------------- 58.8 124.8 --------------------------- $ 14.7 $ 21.0 --------------------------- 7. ASSETS HELD FOR SALE 2008 2007 ----------------- ----------------- Fixed assets $ 3.1 $ 3.1 ----------------- ----------------- $ 3.1 $ 3.1 ================= ================= During Fiscal 2006, the Company sold the assets of its RF (radio frequency) Front-End Consumer Business (See also Note 24). Following this sale, the Company undertook actions to consolidate its office facilities in the U.K. In Fiscal 2007, certain of the land and buildings in the Company's U.K. facilities met the criteria to be classified as assets held for sale pursuant to SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Management performed an assessment of the fair value of these fixed assets and concluded that no impairment was considered necessary, as their fair value, less the anticipated selling costs, exceeded their carrying value of $3.1. 68 8. ACQUISITION OF BUSINESS AND INTANGIBLE ASSETS Legerity Acquisition On August 3, 2007, the Company acquired Legerity for $137.3 of cash, including $2.8 of direct transaction costs. The Company has accounted for the acquisition by using purchase accounting. The Company's consolidated statement of income (loss) for Fiscal 2008 includes results of operations of the acquired business subsequent to the acquisition date. The acquisition is expected to increase the Company's presence in the voice-over-packet market. Both companies design complementary technologies that enable high-quality voice services, and the acquisition is expected to result in increased economies of scale, and enable the Company to have a broader offering of products and services with which to engage customers. The purchase price was allocated as follows: Current assets $ 22.7 Goodwill 43.1 Intangible assets 60.0 Long term assets 3.8 Current liabilities (11.0) Long term liabilities (1.6) Acquired in-process R&D 20.3 ------------------ Total purchase price $ 137.3 ================== Tangible assets and liabilities were recorded at fair value. Intangible assets were identified and valued through an analysis of data provided by Legerity and the Company concerning revenue, earnings, and cash flow projections, customers and attrition factors, use of technologies, the stage of product development, and risk factors. Developed technology and acquired in-process R&D were valued using the income approach. This method reflects the present value of the future earnings capacity that is available for distribution to the owners of this asset. Customer relationship assets were valued using the income approach. This method reflects the present value of operating cash flows generated by these relationships. The Legerity acquisition was a non-taxable transaction for tax purposes. However, as part of the acquisition, the Company assumed approximately $50.5 of goodwill that is expected to be deductible for tax purposes. The allocation of purchase price has not been finalized with respect to its tax assets and liabilities, which if modified, would result in a change to recorded goodwill. Acquired in-process R&D was expensed upon acquisition during the second quarter of Fiscal 2008. The acquired intangible assets are being amortized on a straight-line basis over their weighted-average useful lives as follows: Developed technology 8 years Customer relationships 10 years Total (weighted-average life) 9 years In accordance with SFAS 142, Goodwill and Other Intangible Assets, goodwill is not amortized, however will be reviewed annually for impairment, or more frequently if impairment indicators arise. The following table summarizes the intangible asset values as at March 28, 2008: Mar. 28, 2008 ---------------------------------------------- Accumulated Cost Amortization Net -------------- ---------------- ------------ Developed technology $ 37.7 $ (3.1) $ 34.6 Customer relationships 22.3 (1.5) 20.8 -------------- ---------------- ------------ Total $ 60.0 $ (4.6) $ 55.4 ============== ================ ============ 69 Amortization expense in Fiscal 2008 was $4.6. Future amortization expense is expected to be 2009 - $6.9, 2010 - $6.9, 2011 - $6.9, 2012 - $6.9, 2013 - $6.9, thereafter $20.9. The following unaudited pro forma information reflects the results of continuing operations of the Company as if the Legerity acquisition had been completed as of April 1, 2006. The results of operations for Fiscal 2008 included in-process R&D write-off of $20.3 related to the acquisition. ------------------------------------- Mar. 28, Mar. 30, 2008 2007 ------------------ ------------------ Revenue $ 219.8 $ 255.5 Net income (loss) (52.1) 8.4 ------------------ ------------------ Net income (loss) per share - basic and diluted $ (0.43) $ 0.05 ================== ================== Optical Business of Primarion Inc. On May 19, 2006, the Company acquired the assets and intellectual property comprising the optical in/out ("I/O") business of Primarion Inc. (Primarion) for $7.1 in cash, including $0.1 of direct transaction costs. The acquisition enabled the Company to provide optical solutions that combine its existing technology with Primarion's products. The acquisition was accounted for in accordance with SFAS 141, Business Combinations. The purchase price was allocated as follows: Current Assets $ 0.4 Long term assets 6.7 ------------------ Total purchase price $ 7.1 ================== Tangible assets were recorded at fair value. Intangible assets were identified and valued through an analysis of data provided by Primarion and the Company concerning target markets, the stage of product development, the anticipated timing of development of next generation versions of products, expected revenue generation, and risk factors. Proprietary technology was valued using both a cost method and the relief from royalty method. The relief from royalty method quantifies the benefit to a Company on the basis that the company is relieved from paying royalties for the continued use of the assets. Customer relationship assets were valued using the excess earnings approach. This method measures the benefit to a Company which exceeds an appropriate rate of return on the assets. The non-competition agreements were valued at fair value. Approximately $2.9 of the Company's goodwill is expected to be deductible for tax purposes. The acquired intangible assets are being amortized on a straight-line basis over their weighted-average useful lives as follows: Proprietary technology 4 years Customer relationships 6 years Non-competition agreements 3 years Total (weighted-average life) 5 years 70 The following table summarizes the intangible asset values as at March 28, 2008:
March 28, 2008 March 30, 2007 ---------------------------------------------- ------------------------------------------------ Accumulated Accumulated Cost Amortization Net Cost Amortization Net -------------- ----------------- ----------- --------------- ---------------- ----------- Proprietary technology $ 0.6 $ (0.3) $ 0.3 $ 0.6 $ (0.1) $ 0.5 Customer relationships 0.8 (0.2) 0.6 0.8 (0.1) 0.7 Non-competition agreements 0.5 (0.3) 0.2 0.5 (0.1) 0.4 -------------- ----------------- ----------- --------------- ---------------- ----------- Total $ 1.9 $ (0.8) $ 1.1 $ 1.9 $ (0.3) $ 1.6 ============== ================= =========== =============== ================ ===========
Amortization expense in Fiscal 2008 was $0.4. Future amortization expense is expected to be as follows: 2009 - $0.4; 2010 - $0.3; 2011- $0.2, 2012 - $0.1 and thereafter - $0.1. The Company's results of operations for the Fiscal year ended March 30, 2007, include transactions resulting from the acquired business subsequent to the acquisition date. 9. OTHER ASSETS 2008 2007 -------------------------- Debt issuance costs - net $ 3.2 $ - Pension asset 0.3 - Other 0.1 - -------------------------- $ 3.6 $ - ========================== 10. PROVISIONS FOR EXIT ACTIVITIES The Company has implemented several restructuring activities in recent years: Workforce Reductions Fiscal 2008 In Fiscal 2008, as a result of the Legerity acquisition discussed in Note 8, the Company commenced an integration plan between the two companies. This integration initiated a workforce reduction, which consisted of reducing the Company's headcount by 93 employees during the year. These actions resulted in severance costs of $5.9, which included $4.2 in selling and administration, $0.8 in research and development and $0.9 in cost of revenue. Additionally, the Company ceased manufacturing of certain of its legacy hybrid products in its Caldicot facility. This action resulted in a workforce reduction of 24 employees and severance costs of $0.9, which were included in cost of revenue. Fiscal 2007 In Fiscal 2007, the Company continued efforts to reduce operations costs and reduced its workforce by approximately 10 employees, resulting in severance costs of $0.4, which were included in cost of revenue. These costs related to the 2006 Plan discussed below. The Company also recorded reversals of $0.3, which were included in selling and administrative costs, resulting from a change in estimate of costs accrued in prior years. Fiscal 2006 In Fiscal 2006, in addition to the sale of the RF Front-End Consumer Business (See also Note 24), the Company implemented a restructuring plan (the 2006 Plan) that resulted in a workforce reduction of approximately 20 employees. Costs of $1.0 were incurred, of which $0.7 were included in selling and administrative and $0.3 were included in cost of revenue. In addition, costs of $0.7 and reversals of $0.4 were recorded in Fiscal 2006 related to the 2005 Plan. 71 Lease and Contract Settlement Fiscal 2008 In Fiscal 2008 the Company incurred costs related to idle space under lease contract of $0.5, related primarily to the workforce reductions in its Caldicot facility. This amount was recorded in contract impairment and other. Additionally, the Company adjusted its costs related to idle space recorded in a prior year and recorded are reversal of $0.1. As a result of the acquisition of Legerity contract impairment costs of $3.7 were recorded. The impaired contracts were for design tools, which were used in both the Zarlink and Legerity businesses. Fiscal 2007 In Fiscal 2007, as a result of the sale of the assets of its packet switching product line (see also Note 12), the Company closed its leased facility in Irvine, California. Accordingly, the Company recorded a charge of $0.5 in contract impairment and other related to idle space under lease contract for this facility. The Company also recorded $0.1 in Fiscal 2007, related to revised estimates for idle space from activities implemented and completed in prior years. In Fiscal 2003, the Company wound up its defined benefit pension plan in the U.K. In Fiscal 2007, the Company recorded $0.5 of additional contract settlement costs related to this plan based on a final assessment of the individual employee liabilities provided by the plan administrator (see also Note 26). The Company does not expect to incur additional costs related to this contract settlement. This amount was recorded in contract impairment and other. Fiscal 2006 In Fiscal 2006, the Company performed a review of its usage of software design tools and as a result recorded an impairment loss of $5.4 on design tools no longer in use. This impairment resulted in a provision of $3.3 (which was included in provisions for exit activities). The remaining balance of the restructuring provision relates to lease costs for idle and excess space from exit activities implemented and completed in Fiscal 2002 to 2006. The cumulative amount recorded to date related to these activities is $11.1, and has been recorded as follows: (i) Costs of $2.2 have been recorded in Fiscal 2004 to 2006 in contract impairment and other; and (ii) Costs of $8.9 have been recorded in Fiscal 2002 as special charges, and related to the cost of excess space under lease contracts in Canada, the U.S., and U.K. 72 Restructuring Provisions Continuity The following table summarizes the continuity of restructuring provisions in connection with exit activities for the three years ended March 28, 2008: Lease and Workforce contract Reduction settlement Total ------------------------------------ Balance, March 25, 2005 6.8 2.0 8.8 Charges 1.7 3.6 5.3 Cash drawdowns (7.6) (1.1) (8.7) Reversals (0.4) - (0.4) ------------------------------------ Balance, March 31, 2006 0.5 4.5 5.0 ------------------------------------ Charges 0.4 1.1 1.5 Cash drawdowns (0.6) (4.3) (4.9) Reversals (0.3) - (0.3) ------------------------------------ Balance, March 30, 2007 - 1.3 1.3 ------------------------------------ Charges 7.0 4.2 11.2 Cash drawdowns (5.2) (1.4) (6.6) Reversals (0.2) (0.1) (0.3) Non-cash drawdowns - (1.7) (1.7) ------------------------------------ Balance, March 28, 2008 1.6 2.3 3.9 Less: Long-term portion - (0.4) (0.4) ------------------------------------ Current portion of provisions for exit activities as at March 28, 2008 $ 1.6 $ 1.9 $ 3.5 ============ ============ ========== The lease and contract settlements of $2.3 relate to the plans implemented from Fiscal 2002 to 2008, and will be paid over the lease terms, which expire between 2008 and 2012, unless settled earlier. The remaining severance payments of $1.6 will primarily be paid out by the end of Fiscal 2009. 11. SALE OF FOUNDRY On February 29, 2008, the Company sold its analog foundry in Swindon, UK to MHS, a subsidiary of MHS Industries Group for one British pound. In addition, Zarlink paid MHS (euro)2 million to support restructuring initiatives. The two companies have signed a three-year wafer supply agreement to ensure continuity of wafer supply for Zarlink, under which Zarlink has deposited $4.5, representing about nine months of product orders. Zarlink U.K. transferred all assets relating to the Swindon foundry business to MHS, including the analog foundry and equipment, employees, third party inventory and other assets but excluding cash on hand, accounts receivable and accounts payable pursuant to a sale and purchase agreement dated February 29, 2008. As a result of this asset sale, the Company recorded a loss of $18.2, which was recorded on the income statement under loss on sale of business. This loss was impacted by the assets purchased as a result of the flood at the Swindon facility, which resulted in the Company disposing of $4.5 of newly acquired fixed assets. See also Note 21 for details on the flood at the Swindon location. As part of the sale of the Swindon foundry, the Company entered into a transition services agreement ("TSA") with MHS whereby Zarlink will provide IT, data transfer, finance, test and assembly, engineering support and supply chain management services for an initial period up to February 28, 2009. Additionally, under the TSA, MHS will provide Zarlink with rental space, IT support, health and safety and supply chain management support. As at March 28, 2008, Zarlink had a net receivable from MHS of $0.8, which was included in other receivables. These amounts related primarily to costs paid for by Zarlink on behalf of MHS, partially offset facilities costs, which Zarlink is required to pay for under the TSA. 73 12. GAIN ON SALE OF BUSINESS On October 25, 2006, Zarlink sold the assets of its packet switching product line to Conexant Systems Inc. (Conexant), for cash and other consideration, including a cash payment at closing of $5.0, and additional amounts contingently owing based on revenue performance of the product line over the next two years. If Conexant's revenue from sales in this product line exceeds certain revenue targets, then Conexant is required to pay Zarlink up to $2.5 of additional consideration. In the third quarter of Fiscal 2007 Zarlink recorded a gain on sale of business of $4.1 related to this transaction. On the date of the sale, Zarlink determined that there was uncertainty surrounding whether the revenue targets would be met. As such, Zarlink did not include the contingent consideration as part of the sale proceeds. During the third quarter of Fiscal 2008, Zarlink recorded an additional gain of $0.7 based on revenue performance for the period of November 1, 2006 to October 31, 2007. Contingent consideration for the second year of revenue performance, if any, will be recorded as a component of the gain on sale of business only when the revenue targets are met and collection is reasonably assured. In addition, during Fiscal 2002, the Company sold its wafer fabrication facility in Plymouth, U.K., as well as certain intellectual property and related foundry businesses to companies controlled by X-FAB Semiconductor Foundries AG (X-FAB) of Erfurt, Germany for $30.0, represented by $12.0 in cash on closing and a note of $18.0 repayable over three years. At the time of the sale, the gain on sale was deferred and netted against the carrying value of the note receivable. The gain was recognized as payments were made on the note receivable, and accordingly a gain of $1.9 was recorded in Fiscal 2006 (2005 - $15.9) upon payment of the note receivable. 13. GAIN ON SALE OF ASSET During the third quarter of Fiscal 2008, the Company sold a parcel of land in Jarfalla, Sweden. The proceeds from the sale of this parcel of land were $2.7 (17.7 million Swedish krona), resulting in a gain on sale of an asset of $2.4, net of transaction costs. 14. 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 Communications Systems business ("Systems"), which is now operated as Mitel Networks Corporation (Mitel). This performance guarantee remained with the Company following the sale of the Systems business. The project agreement and the Company's performance guarantee extend until July 31, 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 March 28, 2008, was $39.8 (20.0 million British pounds), assuming the Company is unable to secure the completion of the project. The Company was not aware of any factors as at March 28, 2008, 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. The Company has not recorded a liability in its consolidated financial statements associated with this guarantee. In connection with the sale of the Systems business, 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 March 28, 2008, the Company does not expect these tax indemnities to have a material impact on its consolidated financial statements. 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. 74 The Company records a liability based upon its known product warranty obligations, and historical experience with warranty claims. The Company accrues for known warranty and indemnification issues if a loss is probable and can be reasonably estimated. As at March 28 2008, the warranty accrual was $0.2 (2007 - $Nil, 2006 - $0.6). 15. LONG-TERM DEBT - CONVERTIBLE DEBENTURE During the second quarter of Fiscal 2008, the Company partially funded its acquisition of Legerity through the issuance of convertible debentures of $74.5 ($78.8 million Cdn). This offering was completed by August 30, 2007. The convertible debentures bear interest at a rate of 6% per annum, and are repayable on September 30, 2012. The debentures are convertible under certain conditions, at the option of the holder, into 32.1 million common shares at a conversion price of $2.41 ($2.45 Cdn) per share. Currently this debt is not included in the calculation of diluted earning per share as it would be anti-dilutive. As a result of the convertible debentures being denominated in Canadian dollars, while the Company's functional currency is the U.S. dollar, the Company is required to revalue these debentures in U.S. dollars at the period-end market rate. As a result of this revaluation, the Company incurs non-cash foreign currency gains or losses. As at March 28, 2008, the convertible debentures were recorded at $77.4. 16. COMMITMENTS (A) OPERATING LEASES The future minimum lease payments for operating leases to which the Company was committed, and the future minimum payments to be recovered under non-cancelable subleases as at March 28, 2008, are as follows: Future lease Future lease Payments accrued Fiscal year payments recoveries in restructuring - -------------------- ------------------ -------------------- ------------------- 2009 9.0 1.4 0.2 2010 7.8 1.2 0.1 2011 6.7 1.1 0.3 2012 2.7 - - 2013 1.3 - - Thereafter 0.2 - - ----------------------------------------------------------- $ 27.7 $ 3.7 $ 0.6 =========================================================== Rental expense related to operating leases for the year ended March 28, 2008, was $5.0 (2007 - $5.5; 2006 - $5.6). Subtenant recoveries for the year ended March 28, 2008, were $2.2 (2007 - $1.7; 2006 - $2.1).
Payments Due by Period ----------------------------------------------------------------------------------- Less than More than Total 1 year 1 - 3 years 4 - 5 years 5 years ----------------------------------------------------------------------------------- Purchase Commitment 10.6 2.6 6.9 1.1 - ----------------------------------------------------------------------------------- $ 10.6 $ 2.6 $ 6.9 $ 1.1 $ - ===================================================================================
Purchase commitments consist primarily of purchase design tools and software for use in product development. Wafer purchase commitments have not been included in the above table, as the pricing and timeframe of payment are not fixed, and will vary depending on our manufacturing needs. The Company does not presently have commitments that exceed expected wafer requirements. (B) LETTERS OF CREDIT The Company had letters of credit outstanding as at March 28, 2008, of $1.5 (2007 - $1.3), which expire within nine months. Of this amount, $1.5 related to the Company's SERP. The Company has pledged $17.3 (103.0 million Swedish krona) as security toward the pension liability in Sweden of $20.3. The amount has been presented as restricted cash and cash equivalents. (C) SUPPLY AGREEMENTS The Company has wafer supply agreements with six independent foundries, which expire from Fiscal 2009 to 2011. Under these agreements, the suppliers are obligated to provide certain quantities of wafers per year. None of the agreements have minimum unit volume purchase requirements. These agreements are typically renewed 75 prior to their expiry dates, or automatically renew for a specified period under the existing terms and conditions unless either party provides notification of these changes to the other party. (D) INCOME TAX CONTINGENCY PAYMENTS During the first quarter of Fiscal 2008, the Company adopted FIN 48, Accounting for Uncertainty in Income Taxes. The adoption of FIN 48 resulted in the following change on our contractual obligations as of March 28, 2008:
Payments Due by Period ----------------------------------------------------------------------------------- Less than More than Total 1 year 1 - 3 years 4 - 5 years 5 years ----------------------------------------------------------------------------------- Income tax contingency payments 7.5 - - - 7.5 ----------------------------------------------------------------------------------- $ 7.5 $ - $ - $ - $ 7.5 ===================================================================================
The recorded liability in accordance with FIN 48 as of March 28, 2008, is reflected as owing in more than five years in the table above, as the Company cannot reasonably estimate the years in which these liabilities may be settled. 17. CONTINGENCIES The Company is a defendant in a number of lawsuits and party to a number of other claims or potential claims that have arisen in the normal course of its business. The Company recognizes a provision for estimated loss contingencies when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. In the opinion of the Company, any monetary liabilities or financial impacts of such lawsuits and claims or potential claims that exceed the amounts already recognized would not be material to the consolidated financial position of the Company or the consolidated results of its operations. The Company has recorded provisions for income taxes and valuation allowances related to its estimate of tax expenses and recoveries. Certain taxation years are still subject to audit by authorities in various jurisdictions, which could result in adjustments to the Company's tax provisions. Such adjustments could have a material impact on the consolidated financial position of the Company or the consolidated results of its operations. 18. REDEEMABLE PREFERRED SHARES Dividends Fixed cumulative cash dividends are payable quarterly at a rate of $0.49 (Cdn$0.50) per share. During the year ended March 28, 2008, the Company declared a $1.95 (Cdn$2.00) per share dividend. The Company paid dividends of $2.4 during the year. Redemption The shares are currently redeemable, at the option of the Company, at $24.56 (Cdn$25.00) per share plus accrued dividends. Purchase Obligation The Company is required to make reasonable efforts to purchase 22,400 shares in each calendar quarter at a price not exceeding $24.56 (Cdn$25.00) per share plus costs of purchase. During the year ended March 28, 2008, the Company purchased and cancelled 112,000 preferred shares for cash consideration of $2.6. Based upon the terms and conditions of these shares, the Company's obligation to purchase these shares is conditional upon specific market pricing, and the obligation is extinguished at the end of each calendar year. 76 19. CAPITAL STOCK (A) COMMON SHARES The authorized capital stock of the Company consists of an unlimited number of common shares. Holders of common shares are entitled to one vote for each share held on all matters submitted to a vote of shareholders. (B) NET INCOME (LOSS) PER COMMON SHARE The net income (loss) per common share figures were calculated based on net income (loss) after the deduction of preferred share dividends and premiums on preferred shares 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 and based on the average number of common shares and dilutive common share equivalents. Net income (loss) attributable to common shareholders is computed as follows:
March 28, March 30, March 31, 2008 2007 2006 ------------------------------------------------ Net income (loss) for the year, as reported $ (48.4) $ 15.8 $ 48.8 Dividends on preferred shares (2.4) (2.2) (2.2) Premiums on repurchase of preferred shares (1.2) (0.1) (0.6) ------------------------------------------------ Net income (loss) attributable to common shareholders $ (52.0) $ 13.5 $ 46.0 ================================================
The following table summarizes the common shares and dilutive common share equivalents used in the computation of the Company's basic and diluted net income (loss) per common share. Net income per common share is computed using the weighted-average common shares outstanding assuming dilution. Net loss per common share is computed using the weighted average number of common shares and excludes the dilutive effect of stock options, as their effect is anti-dilutive. For the year ended March 28, 2008, all stock options have been excluded from the computation of diluted loss per share because they were anti-dilutive due to the reported net loss for the period.
March 28, March 30, March 31, 2008 2007 2006 ------------------------------------------------ Weighted-average common shares outstanding 127,345,682 127,331,956 127,310,640 Dilutive effect of stock options - 47,899 49,491 ------------------------------------------------ Weighted-average common shares outstanding, assuming dilution 127,345,682 127,379,855 127,360,131 ================================================
The following stock options were excluded from the computation of diluted earnings per share because the options' exercise price exceeded the average market price of the common shares and, therefore, the effect would be anti-dilutive:
2008 2007 2006 ---------------------------------------------------- Number of outstanding options 10,199,625 6,500,394 10,450,709 Average exercise price per share $ 2.80 $ 2.10 $ 5.61
The average exercise price of stock options granted in Canadian dollars was translated at the year-end U.S. dollar exchange rate. 77 The following common share equivalents related to the Company's convertible debt have been excluded from the computation of diluted loss per share because they were anti-dilutive.
2008 2007 2006 ----------------- ----------------- --------------- Number of common share equivalents upon conversion of long-term debt - convertible debentures 32,142,857 - - Conversion price per share $ 2.41 $ - $ -
(C) DIVIDEND RESTRICTIONS ON COMMON SHARES The Company may not declare cash dividends on its common shares unless dividends on the preferred shares have been declared and paid, or set aside for payment. No common share dividend is currently being paid. (D) STOCK OPTION PLANS The Company adopted SFAS 123R using the modified-prospective approach. In accordance with this approach, the Company has not restated prior periods to reflect the impact of SFAS 123R. In the year ended March 28, 2008 and March 30, 2007, stock compensation expense was recorded as follows:
2008 2007 ------------------------- ------------------------- Selling and administrative $ 1.6 $ 1.2 Research and development 0.3 0.1 Cost of revenue 0.1 0.1 ------------------------- ------------------------- $ 2.0 $ 1.4 ========================= =========================
Stock compensation expense in Fiscal 2008 resulted in a reduction of net income of $2.0, or $0.01 per share (2007 - $1.4 or $0.01 per share). As at March 28, 2008, total unrecognized compensation cost related to non-vested awards was $4.4, and the weighted-average period over which this expense is expected to be recognized is approximately three years. For Fiscal 2008 and 2007 the weighted average per share fair value of options granted during the years were $0.47 and $0.95, respectively. The following table illustrates the impact on net income and net income per share if the Company had applied the fair value recognition principles of SFAS 123R to employee stock-based awards during the 2006 Fiscal year: 2006 ---------------- Net income, as reported $ 48.8 Adjustments: Stock compensation expense, as reported 0.1 Pro forma stock compensation expense (5.5) ---------------- Pro forma net income $ 43.4 ================ Net income per common share, as reported: Basic and diluted $ 0.36 ================ Pro forma net income per common share: Basic and diluted $ 0.32 ================ 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. 78 Stock compensation expense has been determined as if the Company had accounted for its employee stock options using the Black-Scholes-Merton option-pricing model with the following weighted-average assumptions:
2008 2007 2006 ----------------------------------------------- Risk free interest rate 3.41% 4.05% 4.00% Dividend yield Nil Nil Nil Volatility factor of the expected market price of the Company's common stock 43.3% 47.0% 59.0% Weighted-average expected life of the options 4.5 years 4.4 years 4.3 years
Using the Black-Scholes-Merton option-pricing model, the weighted-average fair values of stock options granted during the Fiscal years 2008, 2007 and 2006 were calculated as $0.47, $0.95 and $1.05, respectively. The weighted-average fair value of stock options granted in Canadian dollars was translated at the year-end exchange rate at the end of each Fiscal year. At the Company's 1991 Annual General Meeting, the shareholders approved resolutions authorizing stock options for key employees and non-employee directors ("the plan"). Certain amendments to the plan were approved by the shareholders at the 1993, 1995 and 1998 Annual and Special Meetings of shareholders allowing for 1,000,000, 2,000,000, and 10,200,000 additional shares, respectively, to be made available for grant. At a Special Meeting of the shareholders on December 7, 2001, the Company's shareholders approved an amendment to increase the maximum number of common shares in respect of which options may be granted under the plan to 20,227,033 common shares. As 5,037,033 common shares had been issued upon exercise of options up to May 9, 2001, this amendment increased the number of common shares issuable under outstanding options and options available for grant, each as of May 9, 2001, to 15,190,000 that represented 12% of the then outstanding common shares. The plan was also amended to provide that the maximum number of common shares in respect of which options may be granted under the plan to non-employee directors during any Fiscal year of the Company would be 20,000 common shares per director. Available for grant at March 28, 2008, were 2,071,688 (2007 - 4,208,935; 2006 - 3,701,847) options. All options granted prior to January 29, 1998 have ten-year terms and options granted thereafter have six-year terms. All options become fully exercisable at the end of four years of continuous employment. A summary of the Company's stock option activity and related information for Fiscal 2008, 2007 and 2006, is as follows:
2008 2007 2006 -------------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price -------------------------------------------------------------------------------------------- Outstanding options: Balance, beginning of year 10,255,877 $ 3.47 10,787,709 $ 5.42 13,249,465 $ 7.16 Granted 3,791,000 $ 1.08 2,730,000 $ 2.20 2,467,500 $ 2.02 Exercised (2,499) $ 1.83 (24,744) $ 1.93 (9,466) $ 1.78 Forfeited and expired (1,653,753) $ 8.66 (3,237,088) $ 9.22 (4,919,790) $ 8.94 -------------------------------------------------------------------------------------------- Balance, end of year 12,390,625 $ 2.3 10,255,877 $ 3.47 10,787,709 $ 5.42 ============================================================================================ Exercisable, end of year 5,718,525 $ 3.11 4,705,081 $ 5.08 6,588,648 $ 7.60 ============================================================================================
The weighted average exercise price of stock options granted in Canadian dollars was translated at the exchange rate as at the end of each Fiscal year and at the year's average exchange rate for changes in outstanding options during the year. At March 28, 2008, the intrinsic value for all vested and unvested options is $Nil as a result of the year end share price being below the exercise price for each option. 79 A summary of options outstanding at March 28, 2008, is as follows:
Total Outstanding Total Exercisable ------------------------------------------------------------------------------------------------------------------------------ Weighted Average Weighted Average Remaining Weighted Average Exercise Price Options Exercise Price Contractual Life Options Exercise Price ------------------------------------------------------------------------------------------------------------------------------ $0.84 - $1.21 2,301,000 $0.86 5.87 years 21,328 $0.97 $1.31 - $1.85 2,342,428 $1.54 4.12 years 754,678 $1.74 $1.98 - $2.92 5,690,064 $2.31 3.77 years 2,901,437 $2.29 $3.15 - $4.68 673,800 $3.98 1.51 years 657,749 $4.00 $5.00 - $7.07 1,373,833 $5.23 1.08 years 1,373,833 $5.23 $7.87 - $11.64 4,000 $8.81 0.22 years 4,000 $8.81 $12.12 - $15.23 5,500 $14.29 0.07 years 5,500 $14.29 ------------- -------------- 12,390,625 5,718,525 ============= ==============
The exercise price of stock options was based on prices in Canadian dollars translated at the year-end exchange rate. Additional information with respect to stock option activity is as follows: Weighted Average Number of Awards Exercise Price ------------------- ----------------- Unvested at March 30, 2007 5,550,796 $1.01 Granted 3,791,000 0.47 Vested (2,003,040) 0.87 Forfeited (666,656) 0.93 ------------------------------------- Unvested at March 28, 2008 6,672,100 $0.75 =================== On March 20, 2006, prior to the adoption of SFAS 123(R), the Company's Board of Directors approved the immediate acceleration of vesting of all options with exercise prices equal to or greater than Cdn $4.00 and U.S. $3.48 per share. Accordingly, options to purchase 848,819 shares of the Company's common stock were accelerated effective March 20, 2006. These transactions did not result in extending the terms of the options. During Fiscal 2006, no stock compensation expense was recorded related to these accelerations because the market price was below the exercise price of the options, and thus the options had no intrinsic value on the date that the Board of Directors approved the acceleration. As a result of these options being accelerated prior to the Company's adoption of SFAS 123(R) in the first quarter of Fiscal 2007 (see also Note 2(O)), the Company is not required to record additional stock compensation expense related to these options. On February 21, 2001, the Company offered an option exchange program to option holders (with the exception of directors, officers and certain executives) who received stock option grants after November 1, 1999, at an exercise price of Cdn$14.31 and higher. Under the terms of the program, and with the consent of the Toronto Stock Exchange, 2,691,350 options were cancelled and an equal number of new options were granted at an exercise price of Cdn$14.06 per share. The new grants have a term of six years. No stock compensation expense was recorded during Fiscal 2006 or 2005 related to this option exchange program. As a result of these options being accelerated prior to the Company's adoption of SFAS 123(R) in the first quarter of Fiscal 2007 (see also Note 2(O)), the Company is not required to record additional stock compensation expense related to these options. On July 12, 1999, the Company offered an option exchange program to option holders (with the exception of directors, officers and certain executives) who received stock option grants in calendar 1998 at an exercise price of Cdn$17.78 and higher. Under the terms of the program, and with the consent of the Toronto Stock Exchange, 1,750,000 options were cancelled and 1,000,657 new options were granted at an exercise price of Cdn$9.92 per share. The reduction in number of options was directly proportional to the decrease in the exercise price. The new grants have a term of six years. No stock compensation expense was recorded during Fiscal 2006 or 2005 related to this option exchange program. As a result of these options being accelerated prior to the Company's adoption of SFAS 123(R) in the first quarter of Fiscal 2007 (see also Note 2(O)), the Company is not required to record additional stock compensation expense related to these options. 80 20. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) The components of total comprehensive income (loss) were as follows:
March 28, March 30, March 31, 2008 2007 2006 ------------------------------------------------ Net income (loss) for the year $ (48.4) $ 15.8 $ 48.8 Other comprehensive income (loss): Unrealized net derivative gain (loss) on cash flow hedges 0.1 0.8 (0.3) Realized net derivative loss (gain) on cash flow hedges (0.1) (0.8) 0.3 Minimum pension liability (1.5) 0.4 (1.6) ------------------------------------------------ Total comprehensive income (loss) for the year $ (49.9) $ 16.2 $ 47.2 ================================================
The changes to accumulated other comprehensive loss for three years ended March 28, 2008, were as follows: Cumulative Minimum Translation Pension Account Liability Total ---------------------------------------------- Balance, March 25, 2005 (32.4) (0.7) (33.1) Change during the year - (1.6) (1.6) ---------------------------------------------- Balance, March 31, 2006 (32.4) (2.3) (34.7) Change during the year - 0.4 0.4 ---------------------------------------------- Balance, March 30, 2007 $ (32.4) $ (1.9) $ (34.3) Change during the year - (1.5) (1.5) ---------------------------------------------- Balance, March 28, 2008 $ (32.4) $ (3.4) $ (35.8) ============================================== In Fiscal 2008, the Company recorded an increase in the minimum pension liability of $1.5 (2007 - decrease of $0.4; 2006 - increase of $1.6) related to the Company's defined benefit plans in Sweden $2.2, offset by a decrease in minimum pension liability in Germany of $0.7 (See also Note 26). The Company records increases and decreases in other comprehensive income (loss) attributable to the change in the value of outstanding foreign currency forward and option contracts that were designated as cash flow hedges. The Company had no forward contracts designated as cash flow hedges outstanding as at March 28, 2008 or March 30, 2007, and accordingly there was no net change in accumulated other comprehensive loss during Fiscal 2008 related to derivatives. As at March 28, 2008, there were no derivative gains or losses included in accumulated other comprehensive loss. 21. FLOOD AT SWINDON FACILITY On July 20, 2007, a flood as a result of record rainfall and the breach of a nearby river affected the Company's analog foundry in Swindon, UK. A complete services shutdown was required as a result of this flood. Based on preliminary investigations of the facility, no spills, leakages or discharges were detected. The Company carries insurance for the loss of physical plant and business interruption, with a deductible of $1.0. In Fiscal 2008, the net insurance claim is as follows Business interruption insurance $ 6.0 Fixed assets $ 4.5 Other expenses $ 8.1 ----------------- Total insurance claim $ 18.6 ================= As at March 28, 2008, the Company has finalized all claims with its insurance carriers and has received insurance proceeds of $18.6, of which $14.1 was included in cash flows from operations, and $4.5 was included as cash flows from investing activities for amounts related to replacement of fixed assets. The Company recorded gains from insurance of $5.5, of which $4.5 related to fixed assets and $1.0 related to other expenses. Included in the cost of revenue is the $1.0 deductible. 81 22. GOVERNMENT ASSISTANCE During Fiscal 2007, the Company entered into an agreement with the Government of Canada through Technology Partnerships Canada ("TPC"), which will provide partial funding for one of the Company's research and development projects. This agreement will provide funding for reimbursement of up to $7.1 ($7.2 million Cdn) of eligible expenditures. During the year ended March 28, 2008, the Company's research and development expenses were reduced by $2.4 related to this agreement. To date, the Company has recognized reimbursement on expenses under this agreement of $4.1. The TPC grant is repayable in the form of royalties of 2.61% on certain of the Company's revenues. Royalties are owing for the period from Fiscal 2007 to Fiscal 2016. At the end of Fiscal 2016, if royalties meet or exceed $13.9 ($14.2 million Cdn), then the royalty period ceases. Otherwise, the royalty period continues until cumulative royalties paid equal $12.3 ($14.2 million Cdn) or until the end of Fiscal 2019, whichever is earlier. Royalty expense will be accrued in the period in which the related sales are recognized. As at March 28, 2008, accrued royalties related to this agreement were $0.1. 23. INCOME TAXES The component of income (loss), before provision of income taxes consists of the following:
2008 2007 2006 ---------------------------------- Income (loss) from continuing operations before income taxes: Canadian $ 8.9 $ 10.1 $ (2.3) Foreign (57.1) 2.5 1.8 ---------------------------------- $ (48.2) $ 12.6 $ (0.5) ================================== The provision (recovery) for income taxes consists of the following: Current: Canadian $ (2.0) $ (2.2) $ (0.5) Foreign 0.6 0.4 (2.0) ---------------------------------- (1.4) (1.8) (2.5) Deferred: Canadian 1.7 (1.0) - Foreign (0.1) (0.4) - ---------------------------------- 0.2 (3.2) (2.5) ==================================
The Company recorded income tax expense $0.2 in Fiscal 2008, as compared to recoveries of $3.2 in Fiscal 2007 and $2.5 in Fiscal 2006. The $2.0 Fiscal 2008 domestic current tax recovery relates primarily to a $3.0 recovery related to closure of past audits in the Company's domestic operations offset by accrued FIN 48 tax expenses. The $0.6 foreign tax expense relates primarily to accrued FIN 48 expenses. The $1.7 domestic deferred tax expense relates to the reversal of deferred taxes relating to the recovery above. In Fiscal 2007, the Company had a recovery of 3.2, of which $1.9 related primarily to the closure of past tax audits during the year, which resulted in additional tax refunds and the release of previously booked provisions. An additional $1.3 of the recovery in Fiscal 2007 relates to deferred tax benefits, which the Company expects to realize in the future. In Fiscal 2006, as a result of the sale of its RF Front-End Consumer business, and in accordance with the provisions of SFAS 109, Accounting for Income Taxes, the Company recorded a tax benefit of $2.1 relating to its continuing operations in the U.K. This related to current year losses and reversing temporary differences. In addition, the Company adjusted its income tax provision by $0.5 based on settlement of outstanding audit issues and passage of time in certain foreign jurisdictions. The remaining difference relates primarily to corporate minimum taxes payable and taxes payable by its foreign operations. 82 The reconciliation between the statutory Canadian income tax rate and the actual effective rate is as follows:
2008 2007 2006 --------------------------------------- Expected Canadian statutory income tax rate 34.5% 35% 35% --------------------------------------- Expense (recovery) at Canadian statutory income tax rate $ (16.6) $ 4.5 $ (0.2) Differences between Canadian and foreign taxes 1.2 0.1 0.1 Change in valuation allowance 1.4 (6.1) - Tax effect of non-taxable items (9.5) - (0.6) Corporate minimum taxes - - 0.1 Tax expense (recoveries) in excess of provisions 0.4 (0.4) - Previously recognized provision no longer required - (1.6) (0.5) Tax effect of nondeductible items and other 12.8 0.3 (1.4) Tax rate changes 10.5 - - --------------------------------------- Income tax expense (recovery) $ 0.2 $ (3.2) $ (2.5) =======================================
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of deferred income tax assets and liabilities were as follows:
2008 2007 ------------------------------- Deferred tax assets: Book and tax differences on provisions $ 3.9 $ 1.7 Book and tax differences on fixed assets 4.7 3.7 Income tax loss carry-forwards 130.0 109.5 Intangible assets 10.9 - Investment tax credits 74.4 64.4 Scientific Research and Experimental Development (SR&ED) expenditure pool 21.9 12.6 Other - net 3.6 6.5 ------------------------------- 249.4 198.4 Less: valuation allowance (240.0) (193.5) ------------------------------- 9.4 4.9 =============================== Deferred tax liabilities: Goodwill 0.6 - Other 0.3 0.3 ------------------------------- Deferred tax liabilities 0.9 0.3 =============================== Net deferred tax assets $ 8.5 $ 4.6 ===============================
The following table summarizes the amounts recognized on the Company's consolidated balance sheet:
2008 2007 ------------------------------ Current portion 1.3 - Long-term portion 7.5 4.9 ------------------------------ Deferred income tax assets - net $ 8.8 $ 4.9 ============================== Deferred income tax liabilities: Current portion 0.1 0.1 Long-term portion 0.2 0.2 ------------------------------ $ 0.3 $ 0.3 ==============================
83 The increase of $46.5 in the valuation allowance relates primarily to the Legerity acquisition, changes in foreign exchange rates offset partially by corporate tax rate changes, and the reversal of temporary deductible differences in the Company's domestic and foreign operations. Unremitted earnings of subsidiaries subject to withholding taxes will be indefinitely reinvested with no provision necessary for potential withholding taxes on repatriation of subsidiary earnings. The current year's loss before income taxes attributable to all foreign operations, including discontinued operations, was $57.1 (2007 - income of $2.5; 2006 - $52.4). As at March 28, 2008, the Company had income tax loss carry-forwards in Sweden and the United Kingdom of approximately $274.5 that may be carried forward indefinitely to reduce future years' income for tax purposes. The Company has recognized an accounting benefit on these losses of $0.3. The Company has $104.0 of U.S. federal income tax loss carry-forwards related to operations in the United States that expire between Fiscal 2012 and Fiscal 2028. The Company also has U.S. state net operating loss carry-forwards available that expire between Fiscal 2010 and Fiscal 2015. The Company has recognized an accounting benefit on these losses of $0.3. The Company also has $31.1 and $8.7 of federal and provincial non-capital loss carry-forwards respectively available in Canada. These losses expire between Fiscal 2014 and Fiscal 2028. The Company has recognized a benefit of $1.6 on its federal losses. As at March 28, 2008, the Company had $75.0 of Canadian investment tax credits available to offset federal income taxes payable. The Company has recognized an accounting benefit of $4.2 on these investment tax credits net of associated deferred tax credits. The investment tax credits expire between Fiscal 2009 and Fiscal 2018. The Company also has $9.7 of federal SR&ED expenditures and $2.8 of provincial SR&ED expenditures, which may be carried forward indefinitely. The Company has set up $1.2 and $0.7 respectively in deferred tax assets for these expenditures. On March 31, 2007, the Company adopted the provisions of FIN 48. The application of the provisions of FIN 48 had no material impact on the Company's accrued tax liabilities or accumulated deficit on March 31, 2007. In addition the Company reclassified certain tax liabilities for uncertain tax positions, as well as related potential penalties and interest, from current liabilities to long-term liabilities. A portion of these uncertain tax positions would be offset by deferred tax assets if not favorably settled by the Company. Our uncertain tax positions at March 28, 2008 relate primarily to various foreign jurisdictions. In the first quarter of Fiscal 2008, as a result of applying the provisions of FIN 48, the Company recognized the following as at March 31, 2007: o An increase in long-term deferred tax assets of $3.3; and o An increase in long-term accrued income taxes of $7.7, related to an increase in long-term uncertain tax positions, offset by a decrease in current income and other taxes payable of $4.4. The following table summarizes the activity related to our uncertain tax positions: 2008 2007 ------------------------------ Balance at March 30, 2007 $ 7.7 - Increases related to current year tax positions 0.4 - Increase related to prior year tax positions 0.9 - Acquisition related increases 0.6 - Settlements and other decreases 0.1 - Other 0.9 - ------------------------------ $ 10.6 $ - ============================== 2008 2007 ------------------------------ Long-term accrued income taxes $ 10.6 $ - Other 0.3 - ------------------------------ $ 10.9 $ - ============================== 84 As at March 28, 2008, the Company had $10.6 of uncertain tax positions compared to $7.7 at March 31, 2007 (the implementation date). The acquisition of Legerity accounted for an increase of $0.6, including $0.2 of accrued interest. The Company accrued taxes of $0.2 and additional interest of $1.0 for both its domestic and foreign operations. The other change relates to foreign exchange. Included in the uncertain tax positions of $10.6 at March 28, 2008 were $7.5 of tax benefits that, if recognized, would reduce our annual effective tax rate. We also accrued potential interest of $0.9, respectively, related to these uncertain tax positions during 2008, and in total, as of March 28, 2008, we have recorded a liability for potential interest of $2.0. While the Company continues to pursue the settlement of its uncertain tax positions, it is unable to quantify the amounts that will be settled, during the next 12 months. The Company files income tax returns in Canada, the US and several foreign jurisdictions. Currently, in Canada, tax returns are open for audit on all items from 2004 to 2008, and for specific types of transactions from 2001 to 2008. The Company's foreign jurisdictions have varying statutes of limitations. In its significant foreign operations, tax returns are generally open for audit for its tax years 2004 to 2008. Other jurisdictions are generally still open for audit for tax years 2000 to 2008. The Company is currently subject to ongoing audits in Canada for its 2002 through 2006 taxation years for international tax matters, in the UK for 2006 and in Germany for its 2000 through 2004 taxation years. 24. DISCONTINUED OPERATIONS On November 15, 2005, Zarlink sold the assets of its RF Front-End Consumer Business to Intel Corporation, through its wholly-owned subsidiary Intel Corporation (UK) Limited ("Intel"), for $68.0. The sale resulted in a gain of $53.6 during Fiscal 2006. The following table shows the results of the RF Front-End Consumer Business, which are included as discontinued operations:
2008 2007 2006 ------------- ------------ ------------ Revenue $ - $ - $ 34.1 ------------- ------------ ------------ Operating loss from discontinued operations - - (6.8) Gain on disposal, net of tax of $3.9 - - 53.6 ------------- ------------ ------------ Income (loss) from discontinued operations $ - $ - $ 46.8 ============= ============ ============
During Fiscal 2006, a provision for income taxes was recorded related to the Company's estimate of the tax expense on the gain. The following table shows the cash flows from investing activities in Fiscal 2006 related to the sale of the RF Front-End Consumer Business: Proceeds on sale $ 68.0 Payment of transaction and other costs (2.3) ------------- Proceeds on sale - net $ 65.7 ============= 25. INFORMATION ON GEOGRAPHIC SEGMENTS AND PRODUCT GROUPS Revenues from continuing operations from external customers are attributed to countries based on location of the selling organization. 85 Geographic information is as follows:
2008 2007 2006 Fixed Fixed Fixed Revenue Assets Revenue Assets Revenue Assets ---------------------------------------------------------------------------- Canada $ 2.5 $ 3.9 $ 5.4 $ 4.3 $ 7.3 $ 4.7 United Kingdom 92.5 1.8 81.3 9.5 78.7 10.9 United States 72.5 4.4 40.6 1.4 38.2 0.4 Sweden 16.1 4.6 15.3 5.8 20.7 7.2 ---------------------------------------------------------------------------- Total $ 183.6 $ 14.7 $ 142.6 $ 21.0 $ 144.9 $ 23.2 ============================================================================
Revenues from continuing operations from external customers are attributed to products groups based on the nature of the product being sold. Revenue by product group is as follows: 2008 2007 2006 ---------------------------------- Revenue: Wired Communications $ 115.4 $ 64.5 $ 67.5 Medical 28.0 28.2 32.2 Optical 16.0 15.3 14.2 Custom and Foundry 24.2 34.6 31.0 ---------------------------------- Total 183.6 142.6 144.9 ---------------------------------- Major Customers For the year ended March 28, 2008, the Company had revenues from one external customer, a major distributor, which exceeded 10% of total net revenues. Sales to this distributor in Fiscal 2008 were $38.4 (2007 - $48.4; 2006 - $43.7). 26. PENSION PLANS As at March 28, 2008, the Company sponsors a number of Canadian, U.S. and foreign pension plans to provide retirement benefits for its employees. The majority of these plans are defined contribution plans, although the Company does participate in defined benefit plans and multiemployer plans for certain employee groups. In Fiscal 2007, the Company adopted the provisions of SFAS 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans--an amendment of FASB Statements No. 87, 88, 106, and 132(R). This statement required the Company to record the funded status of its defined benefit pension plans on its consolidated balance sheet. The Company's defined benefit pension plan obligations relate primarily to inactive employees, and, as a result, the differences between the accumulated benefit obligations and projected benefit obligations on these plans are minimal. As a result, the adoption of SFAS 158 had an insignificant impact on both the benefit obligation and accumulated other comprehensive loss. Sweden The Swedish defined benefit plan covers employees over the age of twenty-eight in Sweden and provides pension benefits based on length of service and final pensionable earnings. Effective January 1, 2002, the Company began to fund its Swedish pension obligation with contributions to multiemployer plans. Based on cash contributions made by the Company, as determined by mutual pension insurance companies, the pension plan assets or liabilities associated with these multiemployer plans are not identifiable. Prior to January 1, 2002, the Company maintained an unfunded defined benefit plan. The associated pension liability is calculated each year by the Pension Registration Institute for pensions earned under this plan until December 31, 2001. An additional minimum pension liability is also calculated under the requirements of SFAS No. 87, Employers' Accounting for Pensions. The Company has pledged $17.3 (103.0 million Swedish krona) as security toward the pension liability of $20.3 (2007 - $15.3). This pension liability was actuarially determined based on the present value of the accrued future pension benefits and in accordance with applicable laws and regulations 86 in Sweden. In addition to the pension expense, the Company also incurred $0.1 (2007 - $Nil; 2006 - $0.1) of administrative costs with respect to this plan. The benefit obligation has been measured as of March 28, 2008. Germany The German defined benefit plan covers all employees in Germany with over ten years of active service and provides pension benefits based on length of service and final pensionable earnings. The pension obligation of $6.7 (2007 - $6.6) was actuarially determined based on the present value of the accrued future pension benefits and in accordance with applicable laws and regulations in Germany. There are no segregated pension fund assets under this plan. The Company has reinsured these obligations with Swiss Life Insurance Company, which is expected to fully fund those liabilities. Historically, the pension insurance contracts have been recorded in other assets, as the Company was the sole beneficiary of the contracts. In Fiscal 2006, the Company pledged the insurance contracts to the pensioners, and accordingly, under the provisions of SFAS 87, Employers' Accounting for Pensions, the contracts are now considered to be a plan asset. As the plan asset relates to insurance contracts, the Company does not control the investment strategy and thus cannot influence the return on investments. The benefit obligation of $6.7 is shown net of this asset of $7.0, and has been measured as of March 28, 2008. United Kingdom In Fiscal 2002, there was one contributory defined benefit plan ("the Plan") that covered substantially all employees of Zarlink Semiconductor Limited ("ZSL"), a wholly owned subsidiary of the Company. On November 30, 2001, ZSL suspended contributions to the Plan and ceased members' pension accruals. The Plan was replaced with a defined contribution pension plan at that time. On January 31, 2003, and under a "wind up" agreement, ZSL paid $8.0 in cash consideration of the pension obligation settlement to Legal and General Assurance Society Limited ("L&G"), a large, AAA-rated insurance company in the United Kingdom. On the same date, ZSL transferred $15.7, representing all of the pension plan assets to L&G. Pursuant to the terms of the wind-up agreement, the insurance company assumed the ongoing obligations to administer and make payments against the Plan. L&G purchased non-participating annuity contracts to cover the vested benefits. The plan settlement in Fiscal 2003 resulted in a loss of $6.6, which was recorded in other expense. The Company made a plan settlement payment of $2.3 in Fiscal 2005, and an additional payment of $0.5 in Fiscal 2007. The Company also has an unfunded pension liability of $0.3 (2007 - $0.4) in the U.K. related to amounts owing to a former employee of the Company. The following table shows the changes in the benefit obligations and plan assets for the plans discussed above:
2008 2007 -------------------------------- Change in accrued pension obligations: Benefit obligation at beginning of year $ 22.3 $ 20.5 Interest cost 1.0 0.9 Actuarial (gain) /loss 1.0 (0.5) Benefits paid (0.9) (0.8) Foreign exchange 3.9 2.2 -------------------------------- Benefit obligation at end of year $ 27.3 $ 22.3 ================================ 2008 2007 -------------------------------- Change in plan assets: Fair value of plan assets at beginning of year $ 5.9 $ 5.3 Actual return on plan assets - 0.3 Employer contributions 0.3 0.1 Benefit payments (0.3) (0.3) Foreign exchange 1.1 0.5 -------------------------------- Fair value of plan assets at end of year $ 7.0 $ 5.9 ================================ Net pension benefit liabilities - funded status $ 20.3 $ 16.4 Less: current portion (0.7) (0.5) Less: pension asset 0.3 - ================================ Long-term portion of pension liability $ 19.9 $ 15.9 ================================
87 The following table summarizes the amounts recognized on the Company's consolidated balance sheet: 2008 2007 ----------------------------- Employee-related payables $ (0.7) $ (0.5) Other assets 0.3 - Pension liabilities (19.9) (15.9) Accumulated other comprehensive loss 3.4 1.9 ----------------------------- Net amount recognized $ (16.9) $ (14.5) ============================= The amounts recorded in accumulated other comprehensive loss relate to unrealized net actuarial losses. The Company expects that $0.2 will be amortized into pension expense in Fiscal 2008. The following weighted-average assumptions were used to determine benefit obligations and pension expense: 2008 2007 2006 ---------------------------------- Discount rate 4.34% 4.18% 4.00% Expected rate of return on assets 4.75% 4.75% 4.75% Compensation increase rate 0.34% 0.59% 0.65% The fair value of plan assets consists of the value of the pension insurance contract, which was pledged to the pensioners during Fiscal 2006 and as such represented an adjustment to the asset value during that year. The expected rate of return on assets is based on the expected risk premium aggregated with the long-term government bond yield. The Company expects to make payments of $0.9 on the defined benefit plans during Fiscal 2008, consisting of interest and other administrative costs. The total benefits to be paid from the defined benefit plans are expected to be as follows: 2009 - $1.1; 2010 - $1.1; 2011 - $1.2; 2012 - $1.2; 2013 - $1.2; 2014 to 2017 - $6.5. Pension expense was calculated using the projected benefit method of valuation. The components of pension expense were as follows:
2008 2007 2006 ------------------------------------------------ Interest cost on projected plan benefits $ 1.0 $ 1.0 $ 0.9 Expected return on plan assets (0.3) (0.3) - ------------------------------------------------ Defined benefit pension expense - net 0.7 0.7 0.9 Defined contribution pension expense 3.4 3.4 3.8 ------------------------------------------------ Total pension expense $ 4.1 $ 4.1 $ 4.7 ================================================
In Fiscal 2008, defined contribution pension expense consists of expenses related to multiemployer plans of $1.2 (2007 - $1.4; 2006 - $1.4), and other defined contribution pension plans of $2.2 (2007 - $2.0; 2006 - $2.4), respectively. The Company's contributions to multiemployer and other defined contribution pension plans approximate the amount of annual expense presented in the table above. 27. FINANCIAL INSTRUMENTS (A) FAIR VALUE The Company's financial instruments include cash and cash equivalents, short-term investments, restricted cash and cash equivalents, accounts receivable, accounts payable, foreign exchange forward, option contracts and long-term debt. Due to the short-term maturity of cash and cash equivalents, short-term investments, restricted cash and cash equivalents, accounts receivable, and accounts payable, the carrying values of these instruments are reasonable estimates of their fair value. The fair value of the foreign exchange forward and option contracts 88 reflects the estimated amount that the Company would receive or would have been required to pay if forced to settle all outstanding contracts at year-end. This fair value represents a point-in-time estimate that may not be relevant in predicting the Company's future earnings or cash flows. The fair value of financial instruments approximates their carrying value with the exception of the long-term debt. The long-term debt - convertible debentures is traded on a public exchange and has a fair market value at March 28, 2008 of $52.8. (B) DERIVATIVE FINANCIAL INSTRUMENTS The Company operates globally, and therefore is subject to the risk that earnings and cash flows may be adversely impacted by fluctuations in foreign exchange. The Company uses forward and option contracts to manage foreign exchange risk. Forward and option contracts may be designated as hedging instruments for firmly committed or forecasted payroll and purchases that are expected to occur in less than one year. The notional amounts for forward and option contracts represent the U.S. dollar equivalent of an amount exchanged. During Fiscal 2008, the Company entered into $12.7 and $18.2 (2007 - $Nil) of simultaneous purchases and sales of foreign currency options, respectively. At March 28, 2008, the Company had $6.7 to $9.4 of options outstanding. The options are marked to market at the end of each reporting period based on the prevailing balance sheet exchange rate. At the end of Fiscal 2008, $0.2 unrealized gains (losses) have been recognized in earnings. During Fiscal 2008, the monthly average notional amounts of the forward contracts in U.S. dollars were: Swedish krona $0.4 (2007 - $Nil); Canadian dollars $Nil (2007 - $1.8); and British pounds $Nil (2007 - $Nil). During Fiscal 2008, the monthly average notional amounts in U.S. dollars of the options purchased were $2.9 (2007 - $3.9) and of the options sold were $4.1 (2007 - $5.1). (C) CREDIT RISK The Company's financial assets that are exposed to credit risk consist primarily of cash and cash equivalents, short-term investments, restricted cash and cash equivalents, accounts receivable and derivative contracts. Cash and cash equivalents, short-term investments and restricted cash and cash equivalents are invested in government and commercial paper with investment grade credit rating. The Company has one major customer, a distributor, as described in Note 25. Accounts receivable from this customer as at March 28, 2008, were $4.8 (2007 - $7.5). The Company believes that the concentration of credit risk resulting from accounts receivables owing from this major customer is substantially mitigated by the Company's credit evaluation process, relatively short collection periods, and the global orientation of the Company's sales. Zarlink is exposed to credit risk on its foreign exchange contracts in the event of non-performance by its counterparties. The Company does not anticipate non-performance by any of the counterparties, as it deals with counterparties that are major financial institutions. The Company anticipates the counterparties will satisfy their obligations under the contracts. (D) INTEREST RATE RISK The Company is not exposed to significant interest rate risk due to the short-term maturity of its monetary assets and current liabilities. Additionally, our long-term debt - convertible debentures bears a fixed 6% interest rate for the life of the debt; therefore we are not exposed to any interest rate risk on this debt. (E) UNUSED BANK LINES OF CREDIT The Company has a credit facility of $1.5 (U.S. $Nil and Cdn$1.5), available for letters of credit. At March 28, 2008, $1.5 (2007 - $1.3) in letters of credit were outstanding against this credit facility. Accordingly, the Company had an unused facility of $Nil (2007 - $0.3) available for letters of credit. As at March 28, 2008, cash and cash equivalents of $Nil (2007 - $0.3) were hypothecated under the Company's revolving global credit facility to cover certain outstanding letters of credit and were reported as restricted cash and cash equivalents. 89 28. SUPPLEMENTARY CASH FLOW INFORMATION
2008 2007 2006 ----------------------------------------------- Cash interest paid (included in cash flow from operations) $ 2.0 $ - $ - Cash taxes paid (included in cash flow from operations) $ 0.5 $ 0.4 $ 0.4 ===============================================
The following table summarizes the Company's other non-cash changes in operating activities:
2008 2007 2006 ----------------------------------------------- Cash provided by (used in) Loss (gain) on sale of business $ 17.5 $ (4.1) $ (1.9) In-process R&D 20.3 - - Gain on sale of Mitel investment (12.9) - - Change in pension liability 2.4 1.2 (0.9) Gain on disposal of fixed assets (2.3) - - Other (0.3) (1.6) - ----------------------------------------------- Other non-cash changes in operating activities $ 24.7 $ (4.5) $ (2.8) ===============================================
The following table summarizes the Company's other changes in working capital:
2008 2007 2006 ----------------------------------------------- Cash provided by (used in) Trade accounts and other receivables $ (0.4) $ (3.1) $ 7.3 Inventories (3.0) (1.6) (1.6) Payables and accrued liabilities 0.2 (9.4) (6.7) Deferred credits (0.1) (0.1) (0.7) Prepaid expenses and other (3.7) 2.4 (1.4) ----------------------------------------------- Other non-cash changes in operating activities $ (7.0) $ (11.8) $ (3.1) ===============================================
29. COMPARATIVE FIGURES Certain of the Fiscal 2007 comparative figures have been reclassified so as to conform to the presentation adopted in Fiscal 2008. The Company reclassified $0.3 in Fiscal 2007 from selling and administration expense to amortization of intangible assets and moved the disclosure of details of non-cash changes in operating activities for all periods presented from the Statement of Cash Flows to Note 28. 90 Valuation and Qualifying Accounts ZARLINK SEMICONDUCTOR INC. VALUATION AND QUALIFYING ACCOUNTS March 28, 2008 (in millions of U.S. dollars)
Additions ---------------------------------- Balance, Beginning Charged to Charged to Balance, End Description of Period expense revenue Deductions of Period Sales Provisions: Fiscal 2008 $ 3.2 - 11.1 (11.4) $ 2.9 Fiscal 2007 $ 2.6 - 15.4 (14.8) $ 3.2 Fiscal 2006 $ 1.6 - 11.9 (10.9) $ 2.6 Provisions for exit activities: Fiscal 2008 $ 1.3 10.9 - (8.3) $ 3.9 Fiscal 2007 $ 5.0 1.5 - (5.2) $ 1.3 Fiscal 2006 $ 8.8 5.3 - (9.1) $ 5.0 Litigation provisions: Fiscal 2008 $ - 0.1 - - $ 0.1 Fiscal 2007 $ 0.8 - - (0.8) $ - Fiscal 2006 $ 1.4 - - (0.6) $ 0.8 Fiscal 2005 Allowance for doubtful accounts (charged to both trade and other receivables): Fiscal 2008 $ - 0.3 - - $ 0.3 Fiscal 2007 $ 0.1 - - (0.1) $ - Fiscal 2006 $ 0.2 0.1 - (0.2) $ 0.1 Warranty Provision: Fiscal 2008 $ - 0.2 - - $ 0.2 Fiscal 2007 $ - - - - $ - Fiscal 2006 $ - - - - $ - Inventory Provision: Fiscal 2008 $ 7.3 4.8 - (3.4) $ 8.7 Fiscal 2007 $ 8.0 2.7 - (3.4) $ 7.3 Fiscal 2006 $ 12.6 3.2 - (7.8) $ 8.0
91 Item 19 Exhibits The following exhibits have been filed as part of this Annual Report:
Exhibit No. Description - ------------ ---------------------------------------------------------------------------------------------------------------------- 1.1 Conformed Composite Copy of the Company's Articles, as amended to date (incorporated by reference to Exhibit 4.3 to Registration Statement No. 333-83556 on Form S-8) 1.2 By-law No. 16 of the Company (incorporated by reference to Exhibit 3.2 to Form 10-K for the year ended March 28, 2003 filed on June 25, 2003) 2.1 Form of Specimen Certificate for Common Shares of the Company (incorporated by reference to Exhibit 3.3 to Form 10-K for the year ended March 28, 2003 filed on June 25, 2003) 4.1 Lease agreement between Mitel Research Park Corporation and Mitel Corporation (now Zarlink Semiconductor Inc.) dated March 27, 2001 (incorporated by reference to Exhibit 4.1 to Form 20-F for the year ended March 25, 2005 filed on June 10, 2005) 4.2 Lease agreement between Mitel Research Park Corporation and Mitel Corporation (now Zarlink Semiconductor Inc.) dated March 27, 2001 (Phase V) (incorporated by reference to Exhibit 4.2 to Form 20-F for the year ended March 25, 2005 filed on June 10, 2005) 4.3 Employment agreement between Kirk K. Mandy and Zarlink Semiconductor Inc. dated February 16, 2005, revised May 24, 2007. (incorporated by reference to Exhibit 4.3 to Form 20-F for the year ended March 30, 2007 filed on June 11, 2007) 4.4 Employment agreement between Scott Milligan and Zarlink Semiconductor Inc. dated May 13, 2003, revised May 24, 2007 (incorporated by reference to Exhibit 4.3 to Form 20-F for the year ended March 30, 2007 filed on June 11, 2007) 4.5 Executive employment termination agreement between Donald G. McIntyre and Mitel Corporation (now Zarlink Semiconductor Inc.) dated January 12, 2000 (incorporated by reference to Exhibit 4.6 to Form 20-F for the year ended March 25, 2005 filed on June 10, 2005) 4.6 Stock option plan for key employees and non-employee directors as amended December 7, 2001 and July 24, 2007 4.7 Executive employment agreement between Stan Swirhun and Zarlink Semiconductor Inc. dated May 31, 2005 4.8 Executive employment agreement between Henry Perret and Zarlink Semiconductor Inc. dated July 31, 2007 4.9 Asset purchase agreement by and among Zarlink Semiconductor Limited and Zarlink Semiconductor Inc. and Intel Corporation and Intel Corporation (UK) Limited (incorporated by reference to Exhibit 99.2 to Form 6-K filed on October 17, 2005) 4.10 Agreement and plan of merger by and among Zarlink Semiconductor Inc., ZLE Inc., Legerity Holdings, Inc., and Navigant Capital Advisors, LLC 4.11 Trust Indenture, dated as of the [30th] day of July, 2007, between Zarlink Semiconductor Inc. and Computershare Trust Company of Canada (incorporated by reference to exhibit 7.1 to registration statement on Form F-10 (File No. 333-144800) filed on July 24, 2007 4.12 Agreement for sale and purchase of the Swindon analog foundry business of Zarlink Semiconductor. (Incorporated by reference to Exhibit 99.1 to Form 6-K filed on April 2, 2008) 8.1 Subsidiaries of the Company. Refer to Item 4C of this form 20F 12.1 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 12.2 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 13.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, President and Chief Executive Officer 13.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, Senior Vice President of Finance and Chief Financial Officer 15(a) Consent of Deloitte & Touche LLP 15(b) Consent of Ernst & Young LLP 15(c) Management Proxy Circular for the Fiscal 2008 Annual and Special Shareholders meeting
92 Signatures Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ZARLINK SEMICONDUCTOR INC. By: /s/ Kirk Mandy ------------------ (Kirk K. Mandy) Dated: June 4, 2008 President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date /s/ Henry Simon Chairman of the Board June 4, 2008 ------------------------ (Henry Simon) /s/ Kirk K. Mandy President and Chief Executive Officer June 4, 2008 ------------------------ (Kirk K. Mandy) /s/ Adam Chowaniec Director June 4, 2008 ------------------------ (Adam Chowaniec) /s/ Oleg Khaykin Director June 4, 2008 ------------------------ (Oleg Khaykin) /s/ Hubert T. Lacroix Director June 4, 2008 ------------------------ (Hubert T. Lacroix) /s/ J. Spencer Lanthier Director June 4, 2008 ------------------------ (J. Spencer Lanthier) /s/ Jules Meunier Director June 4, 2008 ------------------------ (Jules Meunier) /s/ Dennis Roberson Director June 4, 2008 ------------------------ (Dennis Robertson)
93 EX-4.6 2 e31856ex4_6.txt STOCK OPTION PLAN Exhibit 4.6 [LOGO] ZARLINK SEMICONDUCTOR ZARLINK SEMICONDUCTOR INC. 1991 STOCK OPTION PLAN FOR KEY EMPLOYEES AND NON-EMPLOYEE DIRECTORS AS AMENDED DECEMBER 7, 2001 AND JULY 24, 2007 1. Purpose. The Zarlink Semiconductor Inc. 1991 Stock Option Plan for Key Employees and Non-Employee Directors (the "Plan") is intended to attract and retain highly qualified employees and non-employee directors who will be motivated toward the success of Zarlink Semiconductor Inc. (the "Company") and to encourage share ownership in the Company by certain key employees and non-employee directors of the Company and its subsidiaries. 2. Number of Common Shares to be Offered. The shares subject to the options to be granted under this Plan shall be Common Shares of the Company ("Common Shares"). The maximum number of Common Shares that may be issued under this Plan shall not exceed 20,227,033 Common Shares and no employee (as defined below) shall hold options to purchase more than 5% of the total number of Common Shares issued and outstanding from time to time. In addition, the maximum number of Common Shares in respect of which options may be granted to non-employee directors during any fiscal year of the Company shall be 20,000 per director. Upon the expiration, surrender or termination, in whole or in part, of an unexercised option, the Common Shares subject to such option shall be available for other options to be granted from time to time under this Plan. 3. Limits with Respect to Insiders. (a) The maximum number of Common Shares issuable to insiders (as defined in the Securities Act (Ontario) and the rules of any applicable stock exchange) ("insiders" and each an "insider"), at any time, under this Plan and any other security based compensation arrangement of the Company is 10% of the number of Common Shares outstanding. (b) The maximum number of Common Shares issued to insiders under this Plan and any other security based compensation arrangement of the Company, within any one-year period, is 10% of the number of Common Shares outstanding. 4. Terms and Conditions of Option. (a) Employees Eligible to Receive Options. The individuals who shall be eligible to receive options under this Plan shall be such key employees and non-employee directors of the Company and its subsidiaries as the Committee ("Committee" described in Section 6 of this Plan) from time to time shall determine. Any reference herein to "employee(s)" shall include "director(s)" except to the extent 1 that specific terms of the Plan apply to directors. More than one option may be granted to the same employee. (b) Option Price. The price at which Common Shares may be purchased under the Plan shall be as determined by the Committee on the date of grant of the option (the "Grant Date"), provided however, that such price may not be less than the average of the market price of the Common Shares on The Toronto Stock Exchange for the five trading day period immediately preceding the Grant Date. For the purpose hereof, "market price" shall mean: (i) the average of the high and low prices of the Common Shares on The Toronto Stock Exchange on a trading day, or (ii) if there was no trade for the Common Shares on the Toronto Stock Exchange on any particular relevant trading day, then the market price shall be the average of the bid and ask quotations for the Common Shares on such relevant trading day on the exchange. (c) Option Period. Subject to Section 4(h) and 6, each option for Common Shares granted under the Plan (the "Option Shares") may be exercised at any time or from time to time as follows: (i) in the case of employees (except for executive officers and non-employee directors) to whom an option is granted under the Plan for the first time, 25% of the Option Shares become vested and may be exercised as of and following the first anniversary of the date of grant of such option and, thereafter, 2.08% of the Option Shares become vested and may be exercised on a monthly basis as of the last day of each month following the first anniversary of the date of grant of such option until the 48th month after the date of grant of such option, and (ii) in the case of employees (except for executive officers and non-employee directors) who are already optionholders at the time of grant of an additional option under the Plan, 2.08% of the Option Shares become vested and may be exercised on a monthly basis as the last day of each month following the date of grant of such option until the 48th month after the date of grant of such option, or at such other time or times as may be determined by the Committee at the time of grant. On the date determined by the Committee at the time of grant which occurs within a maximum of six years following the date of grant of an option, the option shall expire and terminate and be of no further force or effect whatsoever. (d) Methods of Payment. The employee from time to time during the option period may elect to purchase all or part of the Option Shares which the employee is entitled to purchase by lump sum payment by delivering to the Company a completed stock option purchase form. Such form shall specify the number of Option Shares the employee desires to purchase and shall be accompanied by payment in full of the 2 purchase price for such Option Shares. Payment can be made by cash, certified cheque, bank draft or money order payable to the Company. (e) Withholding. No Option Shares shall be issued by the Company to an employee until appropriate arrangements have been made for the payment of any amounts which may be required under any law, regulation, rule or otherwise to be withheld or paid by the Company with respect thereto, including, without limitation, withholding the transfer of a portion of the shares of the Company's stock otherwise issuable in order to satisfy all or a portion of the required withholdings or payments. (f) Termination of Employment of an Employee. Subject to Sections 4(g) and 4(j), in the event that an employee's employment with the Company or any subsidiary is terminated prior to the expiry date of the employee's option, the employee's option may be exercised, at anytime during the period which is no more than 90 days following the date the employee's employment is terminated (but in no event after the expiry date of such option), as to such of the Option Shares in respect of which such option has not previously been exercised, but only to the extent that the employee was entitled at his termination of employment to purchase such Option Shares then exercisable pursuant to Section 4(c) above; provided, however, that in the event the employment of an employee who has received an option under the Plan is terminated as set forth above, the Board of Directors of the Company may, in its own discretion, amend the terms of any option to permit the employee to exercise such options as if such employee's employment had not been terminated (provided that the exercise period shall terminate on the earlier of (i) three years following the date the employee's employment is terminated and (ii) the expiry date of such option). For purposes of this Plan, the transfer of an employee's employment to the Company or to any subsidiary of the Company shall not be considered a termination of employment. (g) Termination of Employment of an Employee for Cause. Notwithstanding any other term or condition of the Plan, in the event that an employee's employment with the Company or any subsidiary is terminated for cause, the employee's option shall be immediately terminated and such employee shall forfeit all rights thereto as of the date of personal delivery of a written notice confirming such termination and the requirement to exercise options and not after, as to such of the Option Shares in respect of which such option has not previously been exercised. (h) Automatic Acceleration of Exercise Periods for Non-Employee Directors Upon Change of Control. In the event of a change of control (whether in fact or in law) of the Company which results in a non-employee director being replaced, the periods set forth under Section 4(c) shall be waived with respect to the options then held by such non-employee director in order to permit the full exercise of all outstanding options then held by such person. (i) Resignation of a Director. In the event that a non-employee director ceases to act as a director of the Company, all options held by such non-employee director, which are then exercisable pursuant to Section 4(c) or 4(h), as the case may 3 be, may be exercised within 180 days following the announcement of the quarterly results next following the date of resignation of such person (but in no event after the expiry date of such option). (j) Rights in the Event of an Employee's Death. In the event of the death or the permanent disability of an employee while in the employment of the Company or any subsidiary and on or prior to the expiry date of the employee's option and provided such employee shall have been in the employment of the Company or any subsidiary for at least five years prior to the date of such employee's death or permanent disability, the exercise date of 50% of the employee's option which is not exercisable on the date of such employee's death or permanent disability, shall be accelerated so that the employee's option may be exercised by the employee's legal personal representative(s) or the employee, as applicable, at any time after the date of the employee's death or permanent disability up to and including (but not after) a date which is one year following the date of the employee's death or permanent disability (but in no event after the expiry date of such option), as to any or all of the Option Shares in respect of which such option has not previously been exercised. In the event that such employee shall have been in the employment of the Company or any subsidiary for at least ten years prior to the date of such employee's death or permanent disability, the exercise date of 100% of the employee's option which is not exercisable on such date shall be so accelerated. For the purposes hereof, "permanent disability" has the meaning assigned to that term in the Zarlink Employee Canadian Benefits Plan, as amended from time to time. (k) No Employment Right. Nothing in this Plan shall confer upon the employee the right to continue in the employ of the Company or interfere in any way with the right of the Company to terminate the employee's employment at any time and for any reason. (l) No Shareholder Rights. An employee shall have no rights as a shareholder with respect to any Option Shares covered by the employee's option until the date of the valid issuance of such shares to the employee and only after such shares are fully paid for. No adjustment will be made for dividends or other distributions or rights for which the record date is prior to the date of such issuance. (m) Transfer and Assignment. The employee's rights with respect to options granted under the Plan are not assignable or transferable by the employee or subject to any other alienation, sale, pledge or encumbrance by such employee other than by will or by the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the U.S. Internal Revenue Code. Therefore the options are exercisable during the employee's lifetime only by the employee. The obligations of each employee shall be binding on his heirs, executors and administrators. (n) Compliance with United States Securities and Other Laws. Option Shares may be purchased only if the Company determines to and obtains the necessary 4 approvals to sell its Common Shares to employees who are citizens of or are employed in the United States under applicable United States securities and other laws. 5. Adjustments. Upon the happening of any of the following events, an employee's rights with respect to options granted under the Plan shall be adjusted as hereinafter provided. (a) In the event of any subdivision, redivision or change of the Common Shares into a greater number of shares at any time, or in the case of the issue of shares of the Company to the holders of its outstanding Common Shares by way of stock dividend or stock dividends (other than an issue of shares to shareholders pursuant to their exercise of options to receive dividends in the form of shares of the Company in lieu of cash dividends declared payable in the ordinary course by the Company on its Common Shares), the number of Common Shares deliverable by the Company upon the exercise of an option shall be appropriately increased proportionately, and appropriate adjustments shall be made in the purchase price per share to reflect such subdivision, redivision or change. (b) In the event of any consolidation or change of the Common Shares into a lesser number of shares at any time, the number of Common Shares deliverable by the Company upon the exercise of an option shall be appropriately decreased proportionately, and appropriate adjustments shall be made in the purchase price per share to reflect such consolidation. (c) In the event of any reclassification or reclassifications of the Common Shares, at any time an employee shall accept, at the time of purchase of Option Shares, in lieu of the number of Common Shares in respect of which the option to purchase is being exercised, the number of shares of the Company of the appropriate class or classes as the employee would have been entitled as a result of such reclassification or reclassifications had the option been exercised before such reclassification or reclassifications. (d) If the Company is to be amalgamated with or acquired by another entity in a merger, sale of all or substantially all of the Company's assets or otherwise (an "Acquisition"), the Committee or the Board of Directors of any entity assuming the obligations of the Company under the Plan (the "Successor Board"), shall, as to outstanding options, either (i) make appropriate provision for the continuation of such options by substituting on an equitable basis for the shares then subject to such options the consideration payable with respect to the outstanding Common Shares in conjunction with the Acquisition; or (ii) upon written notice to the employees, provide that all options must be exercised, to the extent then exercisable, within a specified number of days of the date of such notice, at the end of which period the options shall terminate; or (iii) terminate all options in exchange for a cash payment equal to the excess of the fair market value of the shares subject to such options (to the extent then exercisable) over the exercise price thereof. 5 (e) In the event of the proposed dissolution or liquidation of the Company, each option will terminate immediately prior to the consummation of such proposed action or at such other time and subject to such other conditions as shall be determined by the Committee. (f) Except as expressly provided herein, no issuance by the Company of shares of any class, or securities convertible into shares of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares subject to options. No adjustments shall be made for dividends paid in cash or in property other than securities of the Company. (g) No fractional shares shall be issued under the Plan and the employee shall receive from the Company cash in lieu of such fractional shares. (h) Upon the happening of any of the foregoing events described in subparagraphs (a), (b), (c) or (d) above, the class and aggregate number of shares set forth in paragraph 2 that are subject to options which previously have been or subsequently may be granted under the Plan shall also be appropriately adjusted to reflect the events described in such subparagraphs. The Committee or the Successor Board shall determine the specific adjustments to be made under this paragraph 5 and, subject to paragraph 6, its determination shall be conclusive. 6. Administration. This Plan shall be administered by the Compensation and Human Resources Development Committee (the "Committee"). Members of the Committee shall be appointed by the Board of Directors of the Company and shall serve as such at the pleasure of the Board of Directors. The Committee shall have full power and authority to designate those key employees of the Company and its subsidiaries who are to be granted options under this Plan, the number of options to be granted to each such key employee and otherwise to interpret and construe the terms and conditions of the options granted under this Plan. Without limiting the generality of the powers and discretions granted to the Committee herein, the Committee may determine that any option granted under the Plan shall include provisions which accelerate the date on which an option shall become exercisable upon the happening of such events as the Committee may determine and as may be prescribed in the applicable options agreement. Without limiting the generality of the foregoing the Committee may determine that such acceleration should occur in the event of an actual or anticipated change of effective control of the Company, or in the event of other fundamental changes to the Company or its business or affairs. Any determination by the Committee shall be final and conclusive unless otherwise determined by the Board of Directors of the Company, and in any such event such determination of the Board of Directors shall be final and conclusive. The day-to-day administration of this Plan may be delegated to such officers and employees of the Company or of any subsidiary of the Company as the Committee in its sole discretion shall determine. 6 7. Variation of Grant, Amendment and Discontinuance. The Board of Directors shall have the right to amend, modify or terminate this Plan or any option granted under this Plan at any time without notice; provided, however, that (a) any such amendment or modification of this Plan which increases the total number of Common Shares which are to be offered under this Plan, as so amended or modified, shall be approved by the shareholders of the Company, (b) any such amendment or modification of this Plan may not modify the rights of employees with respect to options granted under the Plan without their previous consent and any required regulatory approvals, (c) any program implemented by the Company at any time and from time to time to provide for the exchange of any option granted under this Plan for other options under this Plan shall be approved by the shareholders of the Company, (d) any reduction in the price at which Common Shares may be purchased under the Plan (except in connection with an adjustment to the share capital in accordance with Section 5 hereof) or any cancellation and reissuance of options shall be approved by the shareholders of the Company, (e) an extension of the original expiry date of an option shall be approved by the shareholders of the Company, (f) any increase of the maximum number of Common Shares issuable to insiders of the Company pursuant to the exercise of options under the Plan and any other security-based compensation arrangement of the Company shall be approved by the shareholders of the Company, (g) any amendment to the maximum number of Common Shares in respect of which options may be granted to non-employee directors during any fiscal year of the Company shall be approved by shareholders of the Company, (h) any amendment to the terms of this Plan which would permit options to be transferable or assignable (other than in the limited circumstances described in Section 4(m) hereof) shall be approved by shareholders of the Company, and (i) any amendment or modification of this Plan will be subject to the prior approval of the Toronto Stock Exchange and any regulatory body requiring similar approval. The Board of Directors of the Company shall have the full power and authority to approve any other amendments relating to the Plan or any option previously granted without further approval of the shareholders of the Company, including if such amendments relate to, among other things: 7 (a) any amendment to the eligibility for, and limitations or conditions on, participation in the Plan; (b) any amendment to any terms relating to the grant or exercise of options, including, but not limited to, the terms relating to the amount and payment of the exercise price (other than a reduction in the price of an option (except in connection with an adjustment to the share capital in accordance with Section 5 hereof)), vesting, expiry, adjustment of options, or the addition or amendment of terms relating to the provision of financial assistance to employees or of any cashless exercise features; (c) any amendment to the Plan to permit the grant of deferred or restricted share units under the Plan or to add or amend any other provisions which result in employees receiving securities of the Company while no cash consideration is received by the Company; (d) any change that is necessary or desirable to comply with applicable laws, rules or regulations of any governmental entity, agency, department or authority or any applicable stock exchange; (e) any correction or rectification of any ambiguity, defective provision, error or omission in the Plan or in any option; and (f) any amendment of the terms relating to the administration of the Plan, provided such amendment does not result in significant or unreasonable dilution in the Company's outstanding securities, or in any additional benefits to employees, particularly insiders, at the expense of the Company and its other shareholders. 8. Termination of the Plan. The Plan shall remain effective until terminated by the Board of Directors of the Company provided that the termination of the Plan shall have no effect on outstanding options, which shall remain in accordance with their terms and conditions and the terms and conditions of the Plan. 9. No Corporate Action Restriction. Nothing contained in the Plan shall be construed to prevent or preclude the Company from taking any corporate action which is deemed by the Company to be appropriate or in its best interest, whether or not such action would have an adverse effect on the Plan or any option award made under the Plan. No employee, beneficiary or other person shall have any claim against the Company as a result of such corporate action. 10. Governing Law. The Plan and the options granted under the Plan shall be construed in accordance with and be governed by the laws of the Province of Ontario and the laws of Canada applicable therein. Dated this 24th day of July, 2007. 8 EX-4.7 3 e31856ex4_7.txt EXECUTIVE EMPLOYMENT AGREEMENT Exhibit 4.7 May 31, 2005 Mr. Stan Swirhun 1471 Cassin Court Boulder, Colorado 80303 Dear Stan: I am pleased to offer you employment with Zarlink Semiconductor Inc. ("Zarlink" or "Company") on the following terms and conditions. This offer is conditional upon being able to obtain any necessary work permits or visas required to permit you to work part-time in Sweden over the first two years from your start date. This offer, once accepted by you and subject to work permit/visa requirements, will constitute an employment agreement between Zarlink and you. Please note that all amounts are in United States dollars. 1. Work Responsibilities You will be employed in the position of Vice President of the Optoelectronics Business Unit ("Opto B/U"), reporting to myself as President and CEO of the Company. Your U.S. office will be at your home office in Boulder, Colorado and your office in Sweden will be at the Zarlink offices located in Jarfalla, Sweden. For the first two (2) years, you will spend as much time as is reasonably required in Sweden to efficiently run the Opto B/U and the balance of your work time will be spent visiting customers and suppliers globally or pursuing other assignments as I may request from time to time. Your start date will be no later than June 13, 2005 and will be earlier if possible. In this position, you will devote your best efforts, and your full time, skill and attention to carrying out your duties and to promoting the interests of the Company. You will well and faithfully perform all services and duties customarily associated with your position, together with such additional duties and responsibilities as may be assigned by me from time to time. Your primary focus over the next two years will be to: (a) Grow the Opto B/U revenues and return that business to significant profitability; and, (b) Identify and develop an acceptable Sweden-based executive to succeed you in running the business unit. 2 You agree not to be employed or engaged in any other capacity (including as a director) in promoting, undertaking or carrying on any other business apart from that of Zarlink, without the prior written authorisation of the Board. This does not preclude you from any passive or personal investments that you may wish to hold, unless with a competitor of the company, in which case you will advise the Board prior to making such investments, unless the investments are made through an independently managed fund or your ownership represents less than 0.1 % of a corporation's publicly traded shares. 2. Salary and Incentives Your annual base salary will be $225,000. In addition, you will be eligible to earn an annual incentive payment under the terms of the Company's Pay For Performance (PFP) Executive Plan, conditional upon your successful achievement of specific target objectives in each fiscal year. Your target annual incentive will be 50% of your then current base salary. The incentive could increase to 75% of your base salary for exceptional performance as determined by me and approved by the Board of Directors. Objectives for each fiscal year will be reviewed and finalized with the Board and communicated to you no later than sixty (60) days after your start date or the commencement of each fiscal year, whichever is later. By the end of May each year (the "incentive assessment date"), Zarlink assesses the achievement of the previous year's objectives, and calculates any earned incentive amount. Please note that you must be employed by Zarlink on the incentive assessment date in order to be eligible to receive this incentive payment. 3. Stock Options The Board has approved a grant of one hundred thousand (100,000) stock options, pursuant to Zarlink's 1991 Employee Stock Option Plan (a copy of which is enclosed). Option pricing will be in accordance with the Plan formula and will be effective as of the date you accept this offer. The option grant has a term of 6 years and provides for staggered equal vesting over a period of 4 years commencing one year from the date of grant. Your specific rights and entitlements relating to the options, including any rights arising upon the cessation of employment, will be governed by the terms and conditions of the Plan. 4. Health, Dental and Related Benefits Zarlink will provide Health and Dental coverage for you and your family under its International Benefits Plan. Life insurance, AD&D, Business Travel and LTD coverage for yourself will be maintained on the U.S. employee group benefits plan. You will have the option to enroll your dependents in the U.S. Group Benefits Plan under the optional benefits for Life and AD&D insurance, Flexible Spending Account, and Vision care. Coverage under the optional benefits will be determined in accordance with the specific terms and conditions of the US Benefits Plan. 3 5. Company Car Zarlink will provide you the use in Sweden of one company car (inclusive of lease, fuel, insurance and maintenance costs). You may select your choice of vehicle in line with Zarlink Sweden's car policy for executives. 6. Accommodations While you are working at the Jarfalla, Sweden office, Zarlink will arrange a suitable furnished apartment for you to a maximum cost of $2,800. per month inclusive of all related costs such as utilities, maintenance, telephone, internet access, television and maid service. The terms of any apartment rental agreement must be approved by the company prior to finalizing the lease. 7. Pension You will be entitled to participate in the Zarlink U.S. employee 401K Plan. Zarlink will provide an annual company match payment in accordance with the terms of the Plan. 8. Vacation Zarlink will provide you four (4) weeks paid vacation leave per fiscal year, accrued in equal bi-weekly instalments. In accordance with Zarlink's US Vacation Policy, vacation accrual will cease at anytime during the year that your accrual reaches 160 hours. The accrual will re-start once that total comes back down below 160 hours. In addition Zarlink will provide paid U.S. statutory holidays and any other leave you are entitled to receive, all in accordance with U.S. employment standards legislation and Zarlink's policies. 9. Income Tax Your payroll will remain in the United States. For the duration of the Opto B/U assignment, Zarlink will provide you income tax protection for all relevant taxation years relative to this assignment using the U.S. baseline, such that it will reimburse you the grossed up cost of any tax liability you incur as a result of this assignment in excess of the amount you would have paid if you had worked throughout the relevant period only in the United States. Zarlink will pay or reimburse the reasonable income tax preparation costs charged by our designated accountants for the taxation years relative to your Opto B/U assignment. 10. Confidentiality of Information and Ownership of Proprietary Property As a condition of your acceptance of this offer, you are required to provide Zarlink with an executed original of the enclosed Confidentiality Agreement. Please note the ongoing nature of the obligations set out in the Agreement. The terms of this Agreement form part of the terms and conditions of this employment agreement. In addition, you will be required to sign Zarlink's "Code of Ethics and Business Conduct" as a condition of employment. This will be provided to you on your start date. 4 11. Cessation of Employment (a) Definitions For the purposes of this employment agreement, the following definitions apply: "Incapacity" means any permanent physical or mental incapacity or disability which prevents you from performing the essential duties of your position, with no reasonable prospect of recovery, as determined by Zarlink on the basis of medical evidence satisfactory to the Board. "Good Just Cause" means any grounds at common law for which an employer is entitled to dismiss an employee without notice or compensation in lieu of notice. "Termination Date" means: (i) if Zarlink terminates your employment, the date designated by the company as the last day of your employment (without reference to any applicable notice period to which you may be entitled, whether under statute, common law, contract, or otherwise); (ii) if you resign your employment with Zarlink, the date which is the end of the three months notice period or such shorter notice period as the parties agree; (iii) if you die, the date of death; (iv) if this employment agreement is frustrated, which includes but is not limited to Incapacity, the date designated by Zarlink as the last day of your employment. (b) Notice of Resignation You may resign at any time, for any reason, upon giving a minimum of three months advance written notice. Zarlink reserves the right to require you to immediately return all company property at any point during the resignation notice period, and to require you to refrain from attending at the workplace during any portion of the resignation notice period. (c) Entitlements upon Resignation, Termination for Good Just Cause If you resign or your employment is terminated for Good Just Cause, then you will be entitled to receive any compensation, benefits and perquisites which have accrued up to the Termination Date, but you will not be entitled to receive other compensation of any nature, whether under contract, statute, common law or otherwise. Your rights respecting any options, which have been granted to you, will be determined in accordance with the terms of the Zarlink 1991 Stock Option Plan. 5 (d) Entitlements upon Death, Frustration of Contract If you die, or frustration of this employment agreement occurs (which includes but is not limited to Incapacity), then you (or your estate, in the event of your death) will be entitled to receive any compensation, benefits and perquisites which have accrued up to the Termination Date, but you will not be entitled to receive other compensation of any nature, whether under contract, statute, common law or otherwise. Your rights respecting any options, which have been granted to you, will be determined in accordance with the terms of the Zarlink1991 Stock Option Plan. (e) Entitlements upon Termination without Good Just Cause If Zarlink terminates your employment without Good Just Cause, then you will be provided with the following termination package (which is inclusive of any statutory entitlements you may have under applicable employment standards legislation, and will be provided net of required deductions): (i) You will be paid for all time worked and your accrued vacation balance through the Termination Date. This payment will be made on the Termination Date. (ii) You will be paid in a lump sum an amount equal to one times your then current annual base salary net of required tax and other withholdings. This payment will be made within 30 business days following the Termination Date. (iii) You will be paid in a lump sum an amount in lieu of incentive equal to one times your average earned annual incentive over the previous three years or such shorter period if the period of employment is shorter than three years. (Note that any special project bonus arrangements will be excluded from this calculation.) This payment will be made within 30 business days following the Termination Date. (iv) You will receive an amount equivalent to the one-year cost of your current life, health and dental insurance coverage. You would be eligible to participate in benefits through COBRA following the Termination Date. You would need to contact our insurance carrier (currently Unum) for conversion or portability of your life insurance policy. (v) You will have six (6) months following the Termination Date (or until the natural expiry date of your stock options, whichever is earlier), to exercise any stock options which have been granted to you under the Zarlink 1991 Stock Option Plan and which have vested as of the last day of that six (6) month period. In all other respects, your rights respecting any options, which have been granted to you, will be determined in accordance with the terms of the Zarlink 1991 Stock Option Plan. 6 (vi) All perquisites such as company cars and the like will cease 30 days following the Termination Date. (f) Resignation of Office If your employment ends for any reason, you agree to resign in writing effective upon the Termination Date from any office or directorship held with Zarlink or with any subsidiary or affiliated company. 12. Non-Competition and Non-Solicitation Obligations We both agree that it could seriously harm Zarlink's legitimate business interests if you took unfair advantage of the special knowledge you will gain in your executive position, to compete with Zarlink. Accordingly, you agree that the restrictions set out below are reasonably required to protect Zarlink and its goodwill from unfair competition. You also acknowledge that your agreement to such restrictions is of essence to this employment agreement, and that Zarlink would not enter into this employment agreement without your agreement to the restrictions set out in this paragraph. If your employment with Zarlink ceases for any reason, you agree that for a period of one (1) year from the Termination Date : (a) you will not participate (as an employee or consultant, executive, director or significant investor (greater than 20%) in any business operating anywhere in the world that competes directly with the principal businesses of Zarlink (or its successors); (b) you will not directly or indirectly solicit any of Zarlink's customers for business in competition with Zarlink (or its successors); and, (c) you will not solicit, entice, approach or induce any of Zarlink's employees or consultants to leave their employment or to end their consultancy arrangements with Zarlink (or its successors) or to join another business or organization. 13. Choice of Law and Jurisdiction This employment agreement will be governed by and construed in accordance with the laws of the State of Colorado, U.S.A., without regard to the principles of conflicts of law, and will in all respects be treated as an Colorado contract. In the event of a dispute, you agree that any legal proceedings must be taken in the City of Boulder, in the State of Colorado and you hereby consent to attorn to the jurisdiction of the Colorado courts. 7 14. Whole Agreement By accepting this offer of employment, you are agreeing that the terms and conditions set out in this offer (including the terms and conditions of any documents enclosed) represent the entire agreement relating to your employment with the company; that any and all previous agreements or representations, written or oral, are hereby terminated and cancelled; and that you hereby release Zarlink from any and all claims whatsoever under or in respect of any such previous agreements or representations. We trust that you will find this offer of employment responsive to your needs. To signify your acceptance, please sign below, and return one complete signed original of this offer and of the enclosed Agreement to the attention of Don McIntyre, no later than close of business, June 3, 2005. All of us at Zarlink look forward to working with you to meet the challenges and opportunities facing our Opto B/U. Zarlink Semiconductor Inc. Per: \S\ Kirk Mandy ------------------ Kirk Mandy President & CEO Acknowledgement and Acceptance I, Stan Swirhun, have read and reviewed, in their entirety, this offer of employment dated May 19, 2005, and the documents enclosed. I have had an opportunity to ensure that I clearly understand the terms and conditions of my employment with Zarlink, and I have had the opportunity to confer with an independent legal advisor if I so wished, in advance of accepting this offer of employment. I hereby represent and confirm to Zarlink that I am not under any contractual or other legal obligation, which prevents me from accepting this offer of employment or from abiding by the terms and conditions of my employment with Zarlink. I accept this offer of employment, and agree to the terms and conditions as set out. DATED AT Boulder Co. this 1 day of June 1, 2005. ------------ --- --- Executive Witness \S\ Stan Swirhun \S\ Lesley Swirhun - ----------------- --------------------------- Stan Swirhun Witness name (please print) EX-4.8 4 e31856ex4_8.txt EXECUTIVE EMPLOYMENT AGREEMENT Exhibit 4.8 July 31, 2007 Henry Perret 9905 Oliver Drive Austin, Texas 78736 Dear Hank: I am pleased to offer you employment with Zarlink Semiconductor LE Inc. ("Zarlink" or "Company") on the following terms and conditions. This offer and its acceptance are conditional upon Zarlink Semiconductor Inc. completing the acquisition of Legerity Holdings, Inc. All amounts are in United States dollars. Zarlink is an "at will" employer and your employment with Zarlink is an at-will relationship, subject to any payments or other consideration due to you in the event of your termination without Cause. This means that either Zarlink or you may terminate the employment relationship at any time for any reason, with or without cause or advance notice. 1. Work Responsibilities You will be employed for a term of one (1) year in the position of Sr. Vice President and General Manager, Network Communications Product Group, reporting to Kirk Mandy, Company CEO and will be based in the Company's Austin, Texas offices. Your start date will be immediately following the closing of the Legerity acquisition. Your employment will automatically terminate one (1) year from your start date unless the term is extended by mutual agreement. In this position, you will devote your best efforts, and your full working time, skill and attention, to carrying out your duties and to promoting the interests of the Company. You will be expected to perform all services and duties customarily associated with your position, together with such additional duties and responsibilities as assigned from time to time. 2. Salary and Incentives Your annual base salary will be $350,000. In addition, you will be eligible to participate in the Zarlink Bonus Plan at 50% of base salary. Details of the plan will be communicated to you. In order to provide you with an incentive to remain in the employ of the Company, you will be entitled to receive a retention bonus equal to $350,000. The retention bonus, less applicable statutory deductions and withholdings, will be payable after the completion of one (1) year of employment; provided however, if your employment is earlier terminated by the Company without Cause, you will be entitled to receive 100% of the retention bonus or any unpaid portion thereof upon termination. The retention bonus payment will be made within 30 days after the anniversary date of employment, or in the case of termination without Cause, on the Termination Date. 3. Health, Dental and Related Benefits Zarlink will maintain Legerity's current comprehensive group employee benefits plan. Your eligibility for coverage and for benefits will be determined in accordance with the specific terms and conditions of the plan. We reserve the right to terminate or amend any of these plans from time to time. 4. Pension You will be entitled to participate in the Zarlink U.S. employee 401K Plan. Zarlink will provide an annual company match payment in accordance with the terms of the Plan. We reserve the right to terminate or amend this Plan at any time. 5. Vacation Zarlink will provide you four (4) weeks paid vacation leave per year, accrued in equal bi-weekly installments. In accordance with Zarlink's US Vacation Policy, vacation accrual will cease at anytime during the year that your accrual reaches 160 hours. The accrual will re-start once that total comes back down below 160 hours. You will be offered a reasonable time to reduce your current vacation accrual to the 160 hour cap, if applicable. In addition Zarlink will provide paid U.S. statutory holidays in accordance with company policy from time to time and any other leave you are legally entitled to receive, all in accordance with U.S. employment standards legislation and Zarlink's policies. 6. Expenses The Company will pay or reimburse you for all reasonable and necessary out-of-pocket expenses actually incurred by you in the performance of your services under this Agreement, provided you provide proper records and/or receipts for such expenses and otherwise properly account for such expenses in accordance with the Company's policy as presently in effect and amended from time to time. 7. D&O Insurance Coverage You will be entitled to director and officer insurance coverage for your acts and omissions while employed as an officer of the Company on a basis no less favorable to you than the coverage provided to all other similarly situated officers. 8. Confidentiality of Information and Ownership of Proprietary Property The Company agrees to and will impart to you and provide you with access to its Confidential Information. "Confidential Information" means all information and compilations of information of any kind, type or nature (tangible and intangible, written or oral, and including information contained, stored, or transmitted through any electronic medium), whether owned by the Company or licensed from third parties, which, at any time during your employment, is devised, developed, designed or discovered or otherwise acquired or learned by you to the extent it relates to the Company, including without limitation, products and services, including without limitation, plans, procedures, formulae, processes, pricing, and costs; customers, including without limitation, lists, contact information, pricing, preferences, and other non-public information concerning customers; sources of supply and vendors; good-will; marketing plans, strategies, and budget; management and employees, including without limitation, compensation, personal data, contact information, and other non-public information concerning employees; technology, technical data, research, manuals, drawings, designs, and documentation; financial condition, including without limitation, product or service fees, sales information, volume, pricing, costs, properties, assets, analysis, and reports and the information contained therein; accounting and business methods and plans; business development, including without limitation, plans, prospects, strategies, fees, costs, pricing, and new ideas and developments; inventions made, developed or conceived by the Company and/or its subsidiaries and affiliates; trade secrets; and computer software, specifications, source code, and executable code. You acknowledge and agree that the Confidential Information is valuable and is a unique asset that provides the Company an advantage over competitors; is developed or acquired by the Company at considerable time and expense, and is proprietary to the Company and is intended to be used solely for the benefit of the Company. You acknowledge and agree that, but for your agreement to the terms and conditions of this Agreement, the Company would not impart or provide access to such Confidential Information. As a condition of your acceptance of this offer, you are required to provide Zarlink with an executed original of the enclosed Intellectual Property Rights & Non-Solicitation Agreement. Please note the ongoing nature of the obligations set out in the Agreement. The terms of this Agreement form part of the terms and conditions of this employment agreement. In addition, you will be required to sign Zarlink's "Code of Ethics and Business Conduct" as a condition of employment. This will be provided to you on your start date. 9. Notification of Materials or Documents from Other Employers You warrant that you will not bring to Zarlink or use in the performance of your responsibilities at Zarlink any information, materials or documents of a former employer that are not generally available to the public, unless you obtained express written authorization from the former employer for their possession and use, and disclosed such circumstances to Zarlink. 10. Notification of Other Post-Employment Obligations As part of your employment with Zarlink, you are not to breach any obligation of confidentiality that you have to former employers (other than Legerity), and you agree to honor all such obligations to former employers during your employment with Zarlink. You warrant that you are not subject to an employment agreement or restrictive covenant preventing full performance of your duties under this Agreement. 11. Cessation of Employment a. Definitions For the purposes of this employment agreement, the following definitions apply: "Cause" means (i) your commission of any act of dishonesty, fraud, misrepresentation, misappropriation, embezzlement or the like, which was intended to result in substantial gain or personal enrichment for you at the expense of the Company; (ii) your unauthorized use or intentional disclosure of any confidential information or trade secrets of the Company (not including inadvertent or non-injurious disclosures), including your breach of that certain Intellectual Property Rights & Non-Solicitation Agreement entered into in connection herewith; (iii) any willful or intentional violation by you of a law or regulation applicable to the Company's business, which violation, in the reasonable discretion of the Board, is or is reasonably likely to be injurious to the Company; (iv) your commission of (a) a felony or (b) any other crime which involves moral turpitude or which would seriously damage the reputation of the Company; (v) gross negligence or willful misconduct in the performance of your duties after written notice from the Company identifying the misconduct, and if reasonably capable of being cured, a reasonable cure period of not less than thirty (30) days; or (vi) your willful or intentional violation of a material Company policy or procedure that is injurious to the Company. "Incapacity" means any permanent physical or mental incapacity, disability or condition which prevents you from performing the essential duties of your position, even with reasonable accommodation, for a period of not less than 90 consecutive days and with no reasonable prospect of recovery, as determined in good faith by Zarlink on the basis of medical evidence satisfactory to the Board. "Termination Date" means: (i) if Zarlink terminates your employment, the date designated by the Company as the last day of your employment (without reference to any applicable notice period to which you may be entitled, whether under statute, common law, contract, or otherwise); (ii) if you resign your employment with Zarlink, the date which is the end of the one year agreement term or, if more than three months remain, the three-month notice period or such shorter notice period as the parties agree; (iii) if you die, the date of death; (iv) in the event of Incapacity, the date designated by Zarlink as the last day of your employment after determination that such Incapacity exists. b. Notice of Resignation You may resign at any time, for any reason, upon giving a minimum of three month advance written notice or the balance of the one year employment term if shorter or such shorter notice period as the parties agree. Zarlink reserves the right to accelerate your Termination Date. c. Entitlements upon Resignation, Termination for Cause If you resign or your employment is terminated for Cause, then you will be entitled to receive any compensation, benefits and perquisites which have accrued up to the Termination Date. d. Entitlements upon Death, Incapacity If you die, or are determined to suffer an Incapacity, then you (or your estate, in the event of your death) will be entitled to receive any compensation, benefits and perquisites which have accrued up to the Termination Date. e. Entitlements upon Termination without Cause If your employment is terminated before the end of the one year term without Cause you will be provided with the following (which is inclusive of any statutory entitlements you may have under applicable employment standards legislation, and will be provided net of required deductions): (i) You will be paid for all time worked and your accrued vacation balance through to the Termination Date. This payment will be made on the Termination Date. (ii) You will be paid in a lump sum the amounts remaining (salary and bonus) for the balance of your one-year employment term. This payment will be made within 30 days following the Termination Date. (iii) You will be paid a gross amount in cash, less statutory deductions, sufficient to pay for the remaining number of months of the one year employment term of insurance premiums, such as COBRA premiums, in order to obtain (if you are eligible) life, health and dental insurance coverage at the same or similar premium basis and level that was available to you at the time of your termination. You will need to contact our insurance carrier (currently Unum) for conversion or portability of your life insurance policy. (iv) All other perquisites, if any, will cease 30 days following the Termination Date. f. Resignation of Office If your employment ends for any reason, you agree to resign in writing effective upon the Termination Date from any office or directorship held with Zarlink or with any subsidiary or affiliated company. 12. Non-Competition and Non-Solicitation Obligations You acknowledge and agree that your training, work and experience with the Company will enhance your value to competitors, and that the nature of the Confidential Information will make it difficult, if not impossible for you to work in any business that competes directly with the principal business of the Company without disclosing or utilizing the Confidential Information to which you have access during the course of your employment. You further acknowledge and agree that the Company's agreement to impart to and to provide you with access to its Confidential Information is ancillary to and contingent upon your agreement that you will not, for a period of twelve (12) months immediately following the Termination Date: a. participate (as an employee or consultant, executive, director or significant investor (greater than 20%) in any business operating anywhere in the world that competes directly with the principal businesses of Zarlink (or its successors); b. directly or indirectly solicit any of Zarlink's customers for business in competition with Zarlink (or its successors); and, c. solicit, entice, approach or induce any of Zarlink's employees or consultants to leave their employment or to end their consultancy arrangements with Zarlink (or its successors) or to join another business or organization. 13. Notices All notices, requests, and other communications hereunder must be in writing and will be deemed to have been duly given only if (i) delivered personally to a person authorized to accept, (ii) delivered by facsimile transmission with transmission confirmation, (iii) mailed (by U.S. certified or registered mail, return receipt requested), or (iv) delivered by overnight courier at the following addresses and facsimile numbers: To the Company: ---------------- Zarlink Semiconductor Inc ----------------------- 400 March Road ----------------------- Ottawa, Ontario, Canada K2K 3H4 ------------------------------- Facsimile: 613 270-7403 ----------------------- Attn: Don McIntyre ----------------------- To the Employee: ---------------- Henry (Hank Perret) ----------------------- 9905 Oliver Drive ----------------------- Austin Texas 78736 ----------------------- Facsimile: 512 228-5500 ----------------------- All such notices, requests, and other written communications will (i) if delivered personally or by overnight carrier to the address as provided herein, be deemed given upon delivery and (ii) if delivered by facsimile transmission or by U.S. mail in the manner and to the address as provided herein, be deemed given three (3) days after the date of the facsimile transmission verification or after deposit in the U.S. mail. Any party from time to time may change its address, facsimile number, or other information for the purpose of notices to that party by giving written notice specifying such change to the other parties hereto. 14. Choice of Law and Jurisdiction This employment agreement will be governed by and construed in accordance with the laws of the State of Texas, U.S.A., without regard to the principles of conflicts of law, and will in all respects be treated as a Texas contract. In the event of a dispute, you agree that any legal proceedings must be brought in the state or federal courts in the County of Travis in the State of Texas, and you hereby submit to personal jurisdiction in such courts in connection with any such dispute. 15. Whole Agreement By accepting this offer of employment, you are agreeing that the terms and conditions set out in this offer (including the terms and conditions of any documents enclosed) represent the entire agreement relating to your employment with the Company; that any and all previous agreements or representations, written or oral, are hereby terminated and cancelled; and that you hereby release Zarlink from any and all claims whatsoever under or in respect of any such previous agreements or representations. If any provision of this Agreement is held to be unenforceable in whole or in part, the remaining provisions shall remain in full force and effect, and such unenforceable provision shall be deemed to be automatically amended and replaced by a legal, valid and enforceable provision which accomplishes as far as possible the purposes and intent of such original provision. We trust that you will find this offer of employment responsive to your needs. To signify your acceptance, please sign below, and return one complete signed original of this offer and of the enclosed Agreement to the attention of Don McIntyre no later than 10 days before the closing of the Legerity acquisition. All of us at Zarlink look forward to working with you. Zarlink Semiconductor Inc. Per: \S\ Don McIntyre ------------------------------------ Don McIntyre Sr. VP General Counsel and Secretary Acknowledgement and Acceptance - ------------------------------ I, Henry (Hank) Perret, have read and reviewed, in their entirety, this offer of employment dated July 31st, 2007 and the documents enclosed. I have had an opportunity to ensure that I clearly understand the terms and conditions of my employment with Zarlink, and I have had the opportunity to confer with an independent legal advisor if I so wished, in advance of accepting this offer of employment. I hereby represent and confirm to Zarlink that, assuming the closing of the acquisition of Legerity and Zarlink, I am not under any contractual or other legal obligation (other than my obligations to Legerity), which prevents me from accepting this conditional offer of employment or from abiding by the terms and conditions of my employment with Zarlink. I accept this conditional offer of employment, to be effective as of and conditioned on the closing of the acquisition of Legerity by Zarlink, and agree to the terms and conditions as set out. DATED at Ottawa this 31st day of July, 2007 \S\ Hank Perret - ------------------- Henry (Hank) Perret EX-4.10 5 e31856ex4_10.txt AGREEMENT AND PLAN OF MERGER Exhibit 4.10 AGREEMENT AND PLAN OF MERGER BY AND AMONG ZARLINK SEMICONDUCTOR INC., ZLE INC., LEGERITY HOLDINGS, INC. AND NAVIGANT CAPITAL ADVISORS, LLC, AS COMPANY STOCKHOLDER REPRESENTATIVE, DATED AS OF JUNE 25, 2007 TABLE OF CONTENTS Page ---- Article 1 The Merger......................................................... 1 1.1 Certain Definitions................................................. 1 1.2 The Merger.......................................................... 11 1.3 Effective Time; Closing............................................. 11 1.4 Effect of the Merger................................................ 12 1.5 Certificate of Incorporation; By-Laws............................... 12 1.6 Directors and Officers.............................................. 12 1.7 Effect on Capital Stock............................................. 12 1.8 Treatment of Warrants............................................... 13 1.9 Repayment of Credit Agreement Debt.................................. 13 1.10 Payment of Common Merger Consideration.............................. 13 1.11 Delivery of Common Merger Consideration; Surrender of Certificates................................................... 14 1.12 Taking of Necessary Action; Further Action.......................... 17 1.13 Working Capital Adjustment to Merger Consideration.................. 17 1.14 Dissenters' Rights.................................................. 19 1.15 Company Stockholder Representative.................................. 20 1.16 Approvals........................................................... 23 Article 2 Representations and Warranties of the Company...................... 23 2.1 Organization........................................................ 23 2.2 Subsidiaries........................................................ 23 2.3 Authorization....................................................... 23 2.4 Execution and Validity.............................................. 24 2.5 Consents and Approvals; No Violations............................... 24 2.6 Capitalization...................................................... 25 2.7 Financial Statements................................................ 25 2.8 No Undisclosed Liabilities.......................................... 26 2.9 Absence of Certain Changes.......................................... 26 2.10 Title to Properties; Encumbrances................................... 28 2.11 Real Property; Leases............................................... 28 2.12 Contracts and Commitments........................................... 28 2.13 Litigation.......................................................... 30 2.14 Compliance with Laws................................................ 30 2.15 Employee Benefit Plans.............................................. 31 2.16 Tax Matters......................................................... 32 2.17 Intellectual Property............................................... 34 2.18 Labor Matters....................................................... 36 2.19 Environmental Compliance............................................ 37 2.20 Certain Transactions................................................ 37 2.21 Brokers or Finders.................................................. 38 2.22 Accounts Receivable................................................. 38 2.23 Accounts Payable.................................................... 38 -i- 2.24 Inventory........................................................... 38 2.25 Bank Accounts....................................................... 38 2.26 Indebtedness........................................................ 38 2.27 Large Customers..................................................... 38 2.28 Large Vendors....................................................... 39 2.29 Sufficiency of Assets............................................... 39 2.30 Previous Sales; Warranties.......................................... 39 2.31 Insurance........................................................... 39 2.32 Contracts with Indemnification/Warranty Provisions.................. 40 2.33 Disclosure.......................................................... 40 Article 3 Representations and Warranties of Purchaser and Merger Sub......... 40 3.1 Organization........................................................ 40 3.2 Authorization....................................................... 41 3.3 Execution and Validity.............................................. 41 3.4 Consents and Approvals; No Violations............................... 41 3.5 Availability of Funds............................................... 41 3.6 Litigation.......................................................... 41 3.7 Brokers or Finders.................................................. 41 Article 4 Conduct Prior to the Effective Time................................ 41 4.1 Interim Operations of the Company................................... 41 4.2 Tax Matters......................................................... 44 Article 5 Covenants.......................................................... 44 5.1 Stockholder Approval................................................ 44 5.2 Access.............................................................. 45 5.3 Confidentiality..................................................... 45 5.4 No Solicitation..................................................... 45 5.5 Public Disclosure................................................... 45 5.6 Reasonable Efforts; Notification.................................... 45 5.7 Antitrust and Other Filings......................................... 46 5.8 Disclosure.......................................................... 47 5.9 Employee Benefit Plans.............................................. 47 5.10 Indemnification, Exculpation and Insurance Plans.................... 47 5.11 Company 401(k) Plan(s).............................................. 48 5.12 Takeover Statutes................................................... 48 5.13 Saxon Divestiture................................................... 49 Article 6 Indemnification and Survival....................................... 50 6.1 Survival Period..................................................... 50 6.2 Indemnification of Purchaser........................................ 51 6.3 Indemnification of the Company Stockholders......................... 51 6.4 Procedure for Claims between Parties................................ 51 6.5 Arbitration......................................................... 52 6.6 Defense of Third-Party Claims....................................... 53 6.7 Limitation on Obligations of the Company Stockholder Representative.................................................... 54 -ii- 6.8 Limitations on Indemnification Obligations.......................... 54 6.9 No Duplication; Exclusive Remedy.................................... 55 6.10 No Additional Representations or Warranties......................... 56 Article 7 Certain Tax Matters................................................ 56 7.1 Tax Indemnification................................................. 56 7.2 Straddle Period..................................................... 57 7.3 Responsibility for Filing Tax Returns............................... 57 7.4 Cooperation on Tax Matters.......................................... 57 7.5 Tax-Sharing Agreements.............................................. 58 7.6 Certain Taxes and Fees.............................................. 58 7.7 Refunds............................................................. 58 Article 8 Closing Conditions................................................. 59 8.1 General Conditions to Obligations to Effect the Merger.............. 59 8.2 Additional Conditions to Obligations of the Company................. 59 8.3 Additional Conditions to Obligations of Purchaser and Merger Sub.... 60 Article 9 Termination, Amendment and Waiver.................................. 62 9.1 Termination......................................................... 62 9.2 Notice of Termination; Effect of Termination........................ 63 9.3 Fees and Expenses................................................... 63 9.4 Amendment........................................................... 63 9.5 Waiver; Right to Proceed............................................ 63 Article 10 General Provisions................................................ 64 10.1 Notices............................................................. 64 10.2 Interpretation; Certain Defined Terms............................... 65 10.3 Counterparts........................................................ 65 10.4 Entire Agreement; Third-Party Beneficiaries......................... 65 10.5 Severability........................................................ 65 10.6 Governing Law; Submission to Jurisdiction........................... 65 10.7 Rules of Construction; Legal Representation......................... 66 10.8 Assignment.......................................................... 66 10.9 Waiver of Jury Trial................................................ 66 Exhibit A - Form of Certificate of Merger Exhibit B - Form of Company Officer's Certificate Exhibit C - Form of Company Secretary's Certificate Exhibit D - Form of Opinions of Andrews Kurth LLP Exhibit E - Form of Indemnification Escrow Agreement Exhibit F - Form of Working Capital Escrow Agreement Schedule 8.3(j) - Employees -iii- AGREEMENT AND PLAN OF MERGER This Agreement and Plan of Merger (this "Agreement") is made and entered into as of June 25, 2007, by and among Zarlink Semiconductor Inc., a Canadian corporation ("Purchaser"), ZLE Inc., a Delaware corporation and a directly or indirectly wholly owned Subsidiary (as defined below) of Purchaser ("Merger Sub"), Legerity Holdings, Inc., a Delaware corporation (the "Company"), and Navigant Capital Advisors, LLC, as representative of the stockholders of the Company (the "Company Stockholder Representative"). Purchaser, Merger Sub, the Company and the Company Stockholder Representative are collectively referred to herein as the "Parties." RECITALS: The respective Boards of Directors of Purchaser, Merger Sub and the Company have adopted this Agreement as a plan of merger with respect to the merger of Merger Sub with and into the Company (the "Merger") upon the terms and subject to the conditions of this Agreement and in accordance with the Delaware General Corporation Law and all amendments and additions thereto ("Delaware Law"). AGREEMENT: In consideration of the foregoing and the representations, warranties, covenants and agreements set forth in this Agreement, the Parties agree as follows: Article 1 THE MERGER 1.1 Certain Definitions. For purposes of this Agreement, the following terms shall have the following meanings: "AAA Rules" shall have the meaning set forth in Section 6.5(a). "Acquisition Proposal" shall mean any offer or proposal (other than an offer or proposal by Purchaser or Merger Sub) relating to or involving: (i) any acquisition or purchase by any Person (as defined below) or "group" (as defined under Section 13(d) of the Exchange Act (as defined below) and the rules and regulations thereunder) of beneficial ownership (as defined in Rule 13d-3 under the Exchange Act) of more than fifty percent (50%) of the total number of outstanding voting securities of the Company; (ii) any tender offer or exchange offer that if consummated would result in any Person or "group" (as defined under Section 13(d) of the Exchange Act and the rules and regulations thereunder) having beneficial ownership (as defined in Rule 13d-3 under the Exchange Act) of more than fifty percent (50%) of the total number of outstanding voting securities of the Company; (iii) any merger, consolidation, business combination or similar transaction involving the Company pursuant to which the stockholders of the Company immediately prior to such transaction hold less than fifty percent (50%) of the equity interests of the Company or in the surviving or resulting entity following such transaction; (iv) any sale, lease, exchange, transfer, license (other than in the ordinary course of business), or disposition of substantially all of the assets of the Company; or (v) any liquidation or dissolution of the Company. "Affiliate" of a specified Person shall mean each other Person who controls, is controlled by, or is under common control with the specified Person. "Agreement" shall have the meaning set forth in the introductory paragraph hereof. "Antitrust Filings" shall have the meaning set forth in Section 5.7(a). "Arbitration Notice" shall have the meaning set forth in Section 6.5(a). "Balance Sheet" shall have the meaning set forth in Section 2.7. "Balance Sheet Date" shall have the meaning set forth in Section 2.7. "Certificate of Merger" shall have the meaning set forth in Section 1.2. "Certificates" shall have the meaning set forth in Section 1.11(b). "Claim Notice" shall have the meaning set forth in Section 6.4. "Closing" shall have the meaning set forth in Section 1.3. "Closing Date" shall have the meaning set forth in Section 1.3. "Closing Cash" shall have the meaning set forth in Section 8.3(n). "Closing Working Capital" shall have the meaning set forth in Section 1.13(c). "Code" shall mean the Internal Revenue Code of 1986, as amended. "Common Merger Consideration" shall mean the Merger Consideration less (i) the amount of Credit Agreement Debt as of immediately prior to the Effective Time and (ii) the amount, if any, of the Working Capital Deficit as finally determined in accordance with Section 1.13. "Common Stock" shall mean the common stock, par value $0.001 per share, of the Company. "Company" shall have the meaning set forth in the introductory paragraph hereof. "Company Closing Statement" shall have the meaning set forth in Section 1.13(b). "Company Common Stock" shall mean the Common Stock, the Series A Common Stock and the Series B Common Stock. "Company Disclosure Schedule" shall have the meaning set forth in the introductory clause of Article 2. "Company Employees" shall mean all those individuals who are employees of the Company or its Subsidiaries as of the date of this Agreement and those individuals who become -2- employees of the Company or its Subsidiaries in the ordinary course of business between the date of this Agreement and immediately prior to the Effective Time. "Company IP" shall mean IP owned by the Company or its Subsidiaries (other than Saxon). "Company Licenses" shall have the meaning set forth in Section 2.17(c). "Company Material Adverse Effect" shall mean any change, event, circumstance or effect that, individually or when taken together with any other change, event, circumstance or effect, is or would be materially adverse to the business, assets, liabilities, condition (financial or otherwise), operations or results of operations of the Company and its Subsidiaries, taken as a whole, or the ability of the Company to complete the transactions contemplated by this Agreement, except that none of the following shall be deemed in themselves, either alone or in combination, to constitute, and none of the following shall be taken into account in determining whether there has been or will be, a Company Material Adverse Effect: (i) any change, event, circumstance or effect attributable to general economic conditions in the United States, North America or any foreign jurisdiction in which the Company or any of its Subsidiaries has operations or sales; (ii) any change in any Legal Requirement or the interpretation thereof; (iii) any change in accounting rules; (iv) any change, event, circumstance or effect attributable to compliance with the terms of, or the taking of or failure to take any action required by, this Agreement or otherwise taken or not taken at the request of Purchaser; or (v) any change, event, circumstance or effect attributable to national or international political or social conditions, including the outbreak of war or international hostilities, acts of war, sabotage or terrorism or military actions or any escalation or material worsening of any such war, hostilities, acts of war, sabotage or terrorism or military actions, whether in the United States or elsewhere. "Company Officer's Certificate" shall mean a certificate, substantially in the form attached hereto as Exhibit B, dated as of the Closing Date and signed by a duly authorized officer of the Company. "Company Permits" shall have the meaning set forth in Section 2.14(b). "Company Restricted Stock Plan" shall mean the Company's Restricted Stock Plan adopted as of November 15, 2005. "Company Secretary's Certificate" shall mean a certificate, substantially in the form attached hereto as Exhibit C, dated as of the Closing Date and signed by the Secretary (or another duly authorized officer) of the Company, as to: (i) the absence of any amendments to the Certificate of Incorporation of the Company since the date of the copy of such document attached to such certificate, which copy shall have been certified by the Secretary of State of the State of Delaware; (ii) the By-Laws of the Company; and (iii) the resolutions of the board of directors and stockholders of the Company relating to this Agreement and the transactions contemplated hereby. "Company Stockholder Indemnified Parties" shall have the meaning set forth in Section 6.3. -3- "Company Stockholder Representative" shall have the meaning set forth in the introductory paragraph hereof, as may be modified from time to time pursuant to Section 1.13(b). "Company Stockholders" shall mean the holders of Company Common Stock. "Company Warrant" means a warrant to purchase Company Common Stock. "Confidentiality Agreement" shall have the meaning set forth in Section 5.3. "Contract" shall mean, with respect to any Person, any contract, agreement, instrument, license, lease, mortgage, note, bond, debenture, indenture, guarantee, franchise, concession, plan, warranty, purchase order, insurance policy, obligation, arrangement or other commitment (whether written or oral and whether express or implied) that is or purports to be legally binding, to which such Person is a party or by which such Person or such Person's properties or assets are bound, including Leases. "Covered Transaction Expense Amount" shall mean an amount equal to one-half of the Company's Transaction Expenses, up to a maximum of $1,500,000.00. "Credit Agreement" shall mean that certain Second Amended and Restated Credit Agreement dated as of November 15, 2005 among Legerity, Inc. as the Borrower, Legerity Holdings, Inc. and certain of Legerity, Inc.'s subsidiaries named therein as Guarantors, the Initial Lenders and Initial Issuing Bank named therein as Lender Parties, Morgan Stanley Senior Funding, Inc. as Administrative Agent, and Deutsche Bank Trust Company Americas as Syndication Agent. "Credit Agreement Debt" shall mean the aggregate principal amount of Indebtedness outstanding under the Credit Agreement and all accrued interest thereon (including without limitation any "PIK" interest), and all fees, expenses, and any other sums payable under the Credit Agreement by the Company or any of its Subsidiaries to the extent still owing on the Closing Date. "Delaware Law" shall have the meaning set forth in the recitals. "Dispute Notice" shall have the meaning set forth in Section 6.4. "Dissenting Shares" shall have the meaning set forth in Section 1.14(a). "Effective Time" shall have the meaning set forth in Section 1.3. "Encumbrances" shall mean liens, charges, security interests, options, encroachments, reservations, orders, decrees, judgments, conditions, restrictions, claims, mortgages, pledges, proxies, voting trusts or agreements, any third-party right, or similar obligations or encumbrances of any kind. "Enforceability Limitations" shall have the meaning set forth in Section 2.4. -4- "Environmental Claims" shall mean any and all administrative, regulatory or judicial actions, suits, demand letters, claims, liens or written notices of violation of or liability arising under any Environmental Law relating to the Company or any of its Subsidiaries. "Environmental Laws" shall mean any applicable Legal Requirement relating to (i) the protection, investigation or restoration of the environment, public health and safety or natural resources or (ii) the handling, use, presence, disposal, Release or threatened Release of any Hazardous Material. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended. "ERISA Affiliate" shall mean any entity, person or business, whether or not incorporated, that is treated as single employer with the Company under Section 414 of the Code or Section 4001 of ERISA. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. "Exchange Agent" shall have the meaning set forth in Section 1.11(a). "Financial Statements" shall have the meaning set forth in Section 2.7. "Governmental Entity" shall mean any court or any administrative, regulatory or governmental body, agency, department, board, commission, panel, authority, organization or instrumentality, whether domestic, foreign or international. "Hazardous Materials" shall mean any hazardous substance, the use, transportation or disposition of which is regulated by law or by any Governmental Entity, including any petroleum product or by-product, material containing asbestos, lead or polychlorinated biphenyls, radioactive material or radon. "HSR Act" shall mean the Hart Scott Rodino Antitrust Improvements Act of 1976, as amended. "Immediate Family" shall mean any spouse, child or other relative sharing the same household. "Indebtedness" shall mean, with respect to any Person, (i) all indebtedness for borrowed money or for the deferred purchase price of property or services; (ii) any other indebtedness that is evidenced by a note, bond, debenture or similar instrument; (iii) all obligations under financing and operating leases; (iv) all obligations in respect of acceptances issued or created; (v) all liabilities secured by any lien on any property; (vi) all guarantee obligations; and (vii) all other obligations, contingent or otherwise, which in accordance with GAAP would be required to be presented upon such Person's balance sheet as liabilities. "Indemnification Escrow Agent" shall have the meaning set forth in Section 1.10(ii). -5- "Indemnification Escrow Agreement" shall have the meaning set forth in Section 1.10(ii). "Indemnification Escrow Amount" shall have the meaning set forth in Section 1.10(ii). "Indemnified Party" shall have the meaning set forth in Section 6.4. "Indemnifying Party" shall have the meaning set forth in Section 6.4. "Intellectual Property Rights" shall mean any or all of the following statutory and/or common law rights throughout the world in, arising out of, or associated therewith: (i) all patents and applications therefor and all reissues, divisions, extensions, provisionals, continuations and continuations in-part thereof and applications for such reissues, divisions, extensions, provisionals, continuations and continuations in-part; (ii) all inventions (whether patentable or not), invention disclosures and improvements, all trade secrets, proprietary information, know-how and technology; (iii) all works of authorship, copyrights, copyright rights, moral rights, rights of attribution and integrity, sound recording rights and registrations and applications therefor; (iv) all industrial and other designs and registered designs and registrations and applications therefor; (v) all trade names, company names, logos, trade dress, trademarks, service marks, collective membership marks, certification marks, other indicia of origin and registrations and applications therefor; (vi) mask works, mask work registrations and applications therefore, and all other rights corresponding thereto throughout the world; (vii) all databases and data collections (including knowledge databases, customer lists and customer databases) and registrations and applications therefor; (viii) all rights in software; (ix) rights to Uniform Resource Locators, Web site addresses and domain names; (x) any similar, corresponding or equivalent rights to any of the foregoing or in any Technology; and (xi) any goodwill associated with any of the foregoing. "IP" shall mean Intellectual Property Rights and Technology. "IRS" shall mean the Internal Revenue Service. "Knowledge of the Company" with respect to a fact or matter shall mean the actual knowledge of the following officers of the Company, after reasonable inquiry of those employees of the Company or any of its Subsidiaries whom such officers reasonably believe would have actual knowledge of such fact or matter: Henry L. Perret, President and Chief Executive Officer; David Boikess, Vice President of Sales & Marketing; Gary Tanner, Vice President of Operations; Louis Riley, General Counsel and Secretary; Dr. Betsy Aylin, Director of Human Resources, solely with respect to Sections 2.15 and 2.18; and Michael Cramer, Controller. "Lease" shall mean each real property lease or sublease to which the Company or one of its Subsidiaries is a party. "Legal Proceeding" shall mean any action, claim (including any cross-claim or counter-claim), suit, litigation, arbitration, proceeding (including any civil, criminal, administrative investigation or appellate proceeding), hearing, inquiry, audit, examination or investigation -6- commenced, brought or heard by or before, or otherwise involving, any court or other Governmental Entity or any arbitrator or arbitration panel. "Legal Requirement" shall mean any federal, state, local, municipal, provincial, foreign, international or other law, statute, constitution, treaty, principle of common law, resolution, ordinance, code, edict, decree, rule, regulation, ruling or requirement issued, enacted, adopted, promulgated, implemented or otherwise put into effect by or under the authority of any Governmental Entity. "Losses" shall mean any and all actually incurred claims, costs, losses, liabilities, obligations, fines, penalties, awards, amounts paid in settlement, Taxes, liens, damages and expenses (including reasonable and actual out-of-pocket attorneys' fees and expenses) and any interest thereon; provided that in no event shall Losses include any consequential or punitive damages of any nature, regardless of the legal theory advanced. "Material" shall mean material, within the meaning of GAAP, as in effect on the date hereof, to the Company and its Subsidiaries taken as a whole. "Material Contract" shall mean any Contract that is disclosed in Section 2.12(a) of the Company Disclosure Schedule. "Merger" shall have the meaning set forth in the recitals. "Merger Consideration" shall mean an amount in cash equal to $133,000,000, (i) plus the value of the Closing Cash and (ii) plus the value of Working Capital Surplus or minus the value of the Working Capital Deficit, as applicable, and (iii) plus the Covered Transaction Expense Amount. "Merger Sub" shall have the meaning set forth in the introductory paragraph hereof. "Merger Sub Common Stock" shall have the meaning set forth in Section 1.7(d). "Neutral Accountant" shall have the meaning set forth in Section 1.13(d). "Order" shall mean any decision, judgment, order, writ, injunction, decree, award or determination (whether temporary, preliminary or permanent) of any Governmental Entity. "Other Filings" shall have the meaning set forth in Section 5.7(a). "Owned IP" shall have the meaning set forth in Section 2.17(a). "Parties" shall have the meaning set forth in the introductory paragraph hereof. "Payment Fund" shall have the meaning set forth in Section 1.10(i). "Per Share Portion of the Common Merger Consideration" means an amount equal to (x) the Common Merger Consideration divided by (y) the number of shares of Company -7- Common Stock (whether vested or unvested) outstanding immediately prior to the Effective Time, including any Dissenting Shares. "Permitted Encumbrances" shall mean (i) statutory liens for Taxes or other governmental charges or assessments or levies not yet due and payable; (ii) liens of landlords, carriers, warehousemen, mechanics, vendors or materialmen securing obligations arising in the ordinary course of business that are not yet due and payable; and (iii) liens incurred in the ordinary course of business in connection with workers' compensation, unemployment insurance and other types of social security or to secure the performance of tenders, statutory obligations, surety and appeal bonds, bids, leases, government contracts, performance and return of money bonds and similar obligations; provided, however, in each case, that the foregoing does not Materially affect the utility or value of the assets or other matters or items to which they relate. "Person" shall mean any individual, corporation (including any non-profit corporation), general partnership, limited partnership, limited liability partnership, joint venture, estate, trust, company (including any limited liability company or joint stock company), firm or other enterprise, association, organization, entity or Governmental Entity. "Plan" shall mean each bonus, pension, profit sharing, deferred compensation, incentive compensation, stock ownership, stock purchase, stock option, phantom stock or other equity-based retirement, vacation, severance, disability, death benefit, hospitalization, medical or other employee benefit plan, program, policy, practice, arrangement, agreement, fund or commitment, including any "employee benefit plan" as defined in section 3(3) of ERISA, whether or not subject to ERISA, and each employment, retention, consulting, change in control, salary continuation, termination or severance plan, program, policy, practice, arrangement or agreement entered into, maintained, sponsored or contributed to by the Company or any of its Subsidiaries or to which the Company or any of its Subsidiaries has any obligation to contribute, or with respect to which the Company or any of its Subsidiaries has any liability, direct or indirect, contingent or otherwise (including a liability arising out of an indemnification, guarantee, hold harmless or similar agreement) or otherwise providing benefits to any current, former or future employee, officer or director of the Company or any of its Subsidiaries or to any beneficiary or dependant thereof. "Pre-Closing Tax Period" shall have the meaning set forth in Section 7.1. "Pro Rata Portion" means, with respect to any Company Stockholder, a fraction, expressed as a percentage, equal to: (x) the total Common Merger Consideration payable to such Company Stockholder, divided by (y) the total Common Merger Consideration payable to all Company Stockholders. "Purchaser" shall have the meaning set forth in the introductory paragraph hereof. "Purchaser Indemnified Parties" shall have the meaning set forth in Section 6.2. "Purchaser Loss Threshold" shall have the meaning set forth in Section 6.8(a). "Purchaser's Post-Closing Statement" shall have the meaning set forth in Section 1.13(c). -8- "Registered Intellectual Property" shall mean all United States, state, international and foreign: (i) patents and applications therefor and all reissues, divisions, extensions, provisionals, continuations and continuations in-part thereof and applications for such reissues, divisions, extensions, provisionals, continuations and continuations in-part; (ii) registrations and applications for any other Intellectual Property Rights, including, copyrights, mask works, domain names, industrial design rights, database rights, trademarks and service marks. "Release" shall mean any spilling, leaking, pumping, emitting, emptying, discharging, injection, escaping, leaching, migrating, dumping, or disposing of Hazardous Materials (including the abandonment or discarding of barrels, containers or other closed receptacles containing Hazardous Materials) into the environment. "Required Stockholder Vote" shall mean the approval of this Agreement and the Merger by the holders of a majority of the Company Common Stock, voting together as one class. "Restricted Stock" shall mean any stock issued pursuant to the Company Restricted Stock Plan. "Saxon" shall mean Saxon IP Assets, LLC, a (direct or indirect) wholly-owned subsidiary of the Company that will be divested by the Company prior to the Closing, as described in Section 5.13. "Saxon Divestiture" shall have the meaning set forth in Section 5.13. "Saxon Divestiture Agreements" shall have the meaning set forth in Section 5.13. "Saxon IP" shall have the meaning set forth in Section 4.1(o). "Saxon IP License" shall mean the license and covenant not to sue regarding the Saxon IP that will be granted to the Company in connection with the Saxon Divestiture, as more fully described in Section 5.13. "Securities Act" shall mean the Securities Act of 1933, as amended. "Series A Common Stock" shall mean the Series A Common Stock, par value $0.001 per share, of the Company. "Series B Common Stock" shall mean the Series B Common Stock, par value $0.001 per share, of the Company. "Stockholder Notification" shall have the meaning set forth in Section 5.1. "Straddle Period" shall have the meaning set forth in Section 7.2. "Subsidiary" of a specified entity shall mean any corporation, partnership, limited liability company, joint stock company, joint venture or other legal entity of which the specified entity (either alone or through or together with any other Subsidiary) owns, directly or indirectly, -9- fifty percent (50%) or more of the stock or other equity, partnership or other ownership interests the holders of which are generally entitled to vote for the election of the Board of Directors or other governing body of such corporation or other legal entity; provided that for purposes of the Company's representations, warranties and covenants contained herein, Saxon shall be excluded from the definition of Subsidiary under this Agreement unless expressly stated otherwise. Included as "Subsidiary" separate from its owner(s) is any of the above-noted entities as to which an election has been made pursuant to Treas. Reg. ss. 301.7701-3(c). "Survival Period" shall have the meaning set forth in Section 6.1. "Surviving Corporation" shall have the meaning set forth in Section 1.2. "Tax" or "Taxes" (and, with correlative meaning, "Taxable" and "Taxation") shall mean any federal, state, local or foreign income, gross receipts, license, payroll, employment, excise, severance, stamp, occupation, premium, windfall profits, environmental (including Taxes under Section 59A of the Code), customs duties, capital stock, franchise, profits, withholding, social security (or similar), unemployment, disability, real property, personal property, sales, use, transfer, registration, value added, alternative or add-on minimum, estimated, or other Tax of any kind whatsoever, including any interest, penalty, or addition thereto, whether disputed or not, including any transferee or secondary liability for a Tax and any liability assumed by agreement or arising as a result of being or ceasing to be a member of any affiliated group, or being included or required to be included in any Tax Return thereto. "Tax Benefits" shall mean the Tax savings (whether measured in terms of a reduction of Taxes paid or that otherwise would have been paid or payable) arising from any increased deductions, losses, or credits then allowable or decreases in income, gains or recapture of Tax credits then allowable (including by way of amended Tax Returns). "Tax Return" shall mean any return, declaration, report, claim for refund, or information return or statement relating to Taxes required to be filed with any federal, state, local or foreign governmental authority, including any such document prepared on a consolidated, combined or unitary basis and also including any schedule or attachment thereto, and including any amendment thereof. "Technology" shall mean all technology, including all know-how, show-how, techniques, design rules, trade secrets, inventions (whether or not patented or patentable), business materials, algorithms, routines, software (including object code and source code therefor), files, databases, works of authorship, processes, test methodologies, any media on which any of the foregoing is recorded, any other tangible embodiments of any of the foregoing and all devices, prototypes, hardware, equipment, development tools and test systems, but not the Intellectual Property Rights in any of the foregoing. "Third Party IP" shall have the meaning set forth in Section 2.17(b). "Transaction Expenses" means all out-of-pocket fees and expenses incurred by the Company or any of its Subsidiaries in connection with the negotiation and effectuation of the terms and conditions of this Agreement and the transactions contemplated hereby, including, without limitation, all legal, accounting, financial advisory fees and expenses of third parties in -10- connection therewith, and the cost of the runoff insurance policy pursuant to Section 5.10(b) of this Agreement. "Vested" means that a person's Restricted Stock will not be forfeited and is not subject to forfeiture (i.e. not subject to repurchase at cost) upon termination of such person's employment without regard to whether a Code Section 83(b) election was made by such person with respect to such Restricted Stock. "Working Capital" shall mean, as of any applicable date, (i) the consolidated current assets of the Company and its Subsidiaries, including but not limited to, cash and cash equivalents (other than Closing Cash), accounts receivable, inventory, prepaid expenses and other current assets, minus (ii) the consolidated current liabilities of the Company and its Subsidiaries, including but not limited to accounts payable, accrued compensation and benefits, current taxes payable, current portion of capital leases, deferred revenue and other current liabilities, in each case as would be reflected on a consolidated balance sheet of the Company and its Subsidiaries as of such date prepared in accordance with GAAP and applied in the same manner as in the preparation of the audited consolidated financial statements of the Company and its Subsidiaries for the year ended December 31, 2006; provided that any estimates of Working Capital provided by the Company pursuant to this Agreement shall be prepared by the Company in good faith in a manner reasonably consistent with the preparation of the Company's financial statements but need not be in accordance with GAAP. For greater certainty, Working Capital excludes Closing Cash and Credit Agreement Debt. "Working Capital Adjustment" shall have the meaning set forth in Section 1.13(a). "Working Capital Deficit" shall mean the amount, if any, by which nine million dollars ($9,000,000) exceeds the Closing Working Capital as of the Effective Time. "Working Capital Escrow" shall have the meaning set forth in Section 1.10(iii). "Working Capital Escrow Amount" shall have the meaning set forth in Section 1.10(iii). "Working Capital Escrow Agreement" shall have the meaning set forth in Section 1.10(iii). "Working Capital Surplus" shall mean the amount, if any, by which the Closing Working Capital exceeds twelve million dollars ($12,000,000) as of the Effective Time. 1.2 The Merger. Upon the terms and subject to the conditions of this Agreement, the Certificate of Merger attached hereto as Exhibit A (the "Certificate of Merger") and the applicable provisions of Delaware Law, at the Effective Time (as defined below), Merger Sub shall be merged with and into the Company, the separate corporate existence of Merger Sub shall cease, and the Company shall continue as the surviving corporation of the Merger (the "Surviving Corporation"). 1.3 Effective Time; Closing. Subject to the provisions of this Agreement, the Parties shall cause the Merger to be consummated by filing the Certificate of Merger with the Secretary of State of the State of Delaware in accordance with the relevant provisions of -11- Delaware Law, the time of such filing (or such later time as may be agreed in writing by the Company and Purchaser and specified in the Certificate of Merger) being the "Effective Time", as soon as practicable on or after the Closing Date (as defined below). The closing of the Merger (the "Closing") shall take place at the offices of Andrews Kurth LLP, 111 Congress Avenue, Suite 1700, Austin, Texas, at 10:00 a.m., Austin time, on the later of (i) July 20, 2007 and (ii) the third business day following the satisfaction or waiver of the conditions set forth in Sections 8.1, 8.2 and 8.3, provided that Purchaser may extend the date of the Closing to a date not later than August 17, 2007 if and only if advised by its financial advisor or investment syndicate that such additional time is required in order to complete the financing(s) necessary to be completed by Purchaser in order to pay the Merger Consideration, or at such other time, date and location as Purchaser and the Company shall agree in writing (the "Closing Date"). 1.4 Effect of the Merger. At the Effective Time, the effect of the Merger shall be as provided in this Agreement, the Certificate of Merger and Section 259 of the Delaware Law. Without limiting the generality of the foregoing and subject thereto, at the Effective Time, all the property, rights, privileges, powers and franchises of the Company and Merger Sub shall vest in the Surviving Corporation, and all debts, liabilities and duties of the Company and Merger Sub shall become the debts, liabilities and duties of the Surviving Corporation. 1.5 Certificate of Incorporation; By-Laws. (a) The Certificate of Merger shall provide that, at the Effective Time, the Certificate of Incorporation of the Surviving Corporation shall be in the form of the Certificate of Incorporation of Merger Sub as in effect immediately prior to the Effective Time; provided, however, that, as of the Effective Time, Article I of the Certificate of Incorporation of the Surviving Corporation shall read: "The name of the corporation is: ZLE Inc." (b) At the Effective Time, the By-Laws of Merger Sub, as in effect immediately prior to the Effective Time, shall be the By-Laws of the Surviving Corporation until thereafter amended; provided, however, that, as of the Effective Time, the By-Laws of the Surviving Corporation shall reflect that the name of the Surviving Corporation is Zarlink Semiconductor LE Inc. 1.6 Directors and Officers. The initial directors of the Surviving Corporation shall be the directors of Merger Sub immediately prior to the Effective Time, until their respective successors are duly elected or appointed and qualified. The initial officers of the Surviving Corporation shall be the officers of Merger Sub immediately prior to the Effective Time, until their respective successors are duly appointed and qualified. 1.7 Effect on Capital Stock. (a) Company Stock. At the Effective Time and subject to and upon the terms and conditions of this Agreement, by virtue of the Merger and without any action on the part of Purchaser, Merger Sub, the Company, the Company Stockholder Representative or the holders of Company Common Stock each share of Company Common Stock outstanding (and not held by Purchaser) immediately prior to the Effective Time (including each share of Company Common Stock that vests pursuant to Section 1.7(b)), shall be automatically converted into the right to receive cash, without interest, in an amount equal to the Per Share Portion of the Common Merger Consideration. (b) Acceleration of Vesting of Restricted Stock. Purchaser shall take all actions necessary and desirable to cause each outstanding share of Restricted Stock that was not -12- vested immediately prior to the Effective Time to become fully vested and nonforfeitable as of the Effective Time. (c) Company or Purchaser Owned Stock. At the Effective Time, each share of Company Common Stock held by the Company or owned by Merger Sub, Purchaser or any direct or indirect wholly owned Subsidiary of the Company or Purchaser immediately prior to the Effective Time, shall be canceled and extinguished without any conversion thereof or payment of any consideration therefor. (d) Merger Sub Stock. At the Effective Time, each share of Merger Sub common stock, par value $0.001 per share ("Merger Sub Common Stock"), issued and outstanding immediately prior to the Effective Time shall be converted into and become one validly issued, fully paid and non-assessable share of common stock, par value $0.001 per share, of the Surviving Corporation. Following the Effective Time, each certificate evidencing ownership of shares of Merger Sub Common Stock shall evidence ownership of such shares of capital stock of the Surviving Corporation. (e) Adjustments. The Per Share Portion of the Common Merger Consideration shall be subject to adjustment to reflect appropriately the effect of any stock split, reverse stock split, stock dividend (including any dividend or distribution of securities convertible into any Company Common Stock), reorganization, recapitalization, reclassification or other like change with respect to any Company Common Stock occurring on or after the date hereof and prior to the Effective Time. 1.8 Treatment of Warrants. Purchaser shall take all actions necessary and desirable (including, without limitation, obtaining the written consent of the holder of each outstanding Company Warrant) to cause each outstanding Company Warrant to be automatically cancelled and terminated as of the Effective Time and to cease to represent a right to acquire shares of Company Common Stock. Neither Purchaser nor the Surviving Corporation shall assume any Company Warrants after the Merger. 1.9 Repayment of Credit Agreement Debt. At the Closing, Purchaser shall repay in full the amount of any Credit Agreement Debt, and the Credit Agreement shall be terminated. Thereafter neither the Company, Purchaser nor the Surviving Corporation shall have any obligations under the Credit Agreement. 1.10 Payment of Common Merger Consideration. On the Closing Date, Purchaser shall: (i) deposit, or cause to be deposited, in trust with the Exchange Agent for the benefit of the holders of shares of Company Common Stock, cash in an aggregate amount equal to the Common Merger Consideration less (a) the Indemnification Escrow Amount, (b) the Working Capital Escrow Amount (such amount being hereinafter referred to as the "Payment Fund") and (c) the amount of Closing Cash to be transferred by the Company to the Exchange Agent as provided in Section 8.3(n); (ii) deposit the sum of Six Million Dollars ($6,000,000) (such amount plus the earnings thereon, the "Indemnification Escrow Amount") with JPMorgan Chase Bank, N.A., as the Indemnification Escrow Agent (the "Indemnification Escrow -13- Agent"), to be held and disposed of pursuant and subject to the terms hereof and an escrow agreement by and among Purchaser, the Company Stockholder Representative and the Indemnification Escrow Agent, substantially in the form attached hereto as Exhibit E (the "Indemnification Escrow Agreement"), provided, however, that the Indemnification Escrow Amount shall be released twelve (12) months from the Closing Date. The amount released shall be reduced by the amount of any Unresolved Claims (as defined in the Indemnification Escrow Agreement). Any amounts remaining with the Indemnification Escrow Agent following termination of the Indemnification Escrow Agreement shall be distributed to the Company Stockholders in accordance with the Indemnification Escrow Agreement. Purchaser and the Company Stockholders, severally in accordance with their respective Pro Rata Portions, shall each pay one-half of any costs, expenses and fees charged by the Indemnification Escrow Agent, with the fees attributable to the Company Stockholders being deducted from their respective portions of the Indemnification Escrow Amount in priority to any other claims against the Indemnification Escrow. Neither the Company Stockholders nor the Company Stockholder Representative shall have any individual liability with respect to such fees. Any amount released to the Company Stockholders from the Indemnification Escrow shall be composed of two portions: one portion being part of the Common Merger Consideration and the other portion being interest income paid by Purchaser to the Company Stockholders as provided under the Indemnification Escrow Agreement; and (iii) deposit an amount in escrow (the "Working Capital Escrow") equal to the greater of (a) two million ($2,000,000) or (b) the Working Capital Deficit set forth in the Company Closing Statement (the "Working Capital Escrow Amount") with JPMorgan Chase Bank, N.A., as the Working Capital Escrow Agent (the "Working Capital Escrow Agent"), to be held for thirty (30) days (or such longer period as may be required to resolve any dispute under Section 1.13(c) or (d) of this Agreement regarding the calculation of the Working Capital or the Working Capital Deficit) pursuant and subject to the terms hereof and an escrow agreement by and among Purchaser, the Company Stockholder Representative and the Working Capital Escrow Agent, substantially in the form of Exhibit F attached hereto (the "Working Capital Escrow Agreement"). Purchaser and the Company Stockholders, severally in accordance with their respective Pro Rata Portions, shall each pay one-half of any costs, expenses and fees charged by the Working Capital Escrow Agent, with the fees attributable to the Company Stockholders being deducted from their respective portions of the Working Capital Escrow Amount in priority to any other claims against the Working Capital Escrow. Neither the Company Stockholders nor the Company Stockholder Representative shall have any individual liability with respect to such fees. Any amount released to the Company Stockholders from the Working Capital Escrow shall be composed of two portions: one portion being part of the Common Merger Consideration and the other portion being interest income paid by Purchaser to the Company Stockholders as provided under the Working Capital Escrow Agreement. 1.11 Delivery of Common Merger Consideration; Surrender of Certificates. (a) Prior to the Effective Time, Purchaser shall appoint a commercial bank or trust company reasonably acceptable to the Company to act as exchange and paying agent, registrar and transfer agent (the "Exchange Agent") for the purpose of exchanging certificates -14- representing, immediately prior to the Effective Time, Company Common Stock for the applicable portion of the Common Merger Consideration. The Exchange Agent shall use the Payment Fund to make the payments provided for in Section 1.7 of this Agreement (it being understood that any and all interest earned on the Payment Fund made available to the Exchange Agent pursuant to this Agreement shall be turned over to the party depositing such funds with the Exchange Agent). The Payment Fund shall not be used for any other purpose except as provided in this Agreement. (b) Promptly after the Effective Time (and in any event within three (3) business days thereof), Purchaser or the Surviving Corporation shall cause the Exchange Agent to mail to each holder of record of a certificate or certificates ("Certificates") that immediately prior to the Effective Time represented outstanding shares of Company Common Stock that were converted into the right to receive a portion of the Common Merger Consideration under Section 1.7 and to each holder of Dissenting Shares (i) a notice of the effectiveness of the Merger; (ii) a letter of transmittal in customary form (that shall specify that delivery shall be effected, and risk of loss and title to the Certificates shall pass, only upon proper delivery of the Certificates to the Exchange Agent and shall contain such other provisions as are reasonably satisfactory to Purchaser, the Surviving Corporation, the Company and the Company Stockholder Representative); (iii) instructions for use in surrendering such Certificates and receiving the applicable portion of the Common Merger Consideration in respect thereof; and (iv) such notification as may be required under Delaware Law to be given to the holders of Dissenting Shares. Upon surrender to the Exchange Agent of a Certificate, together with such letter of transmittal duly executed and completed in accordance with the instructions thereto, the holder of such Certificate shall be entitled to receive, in exchange therefor, cash in an amount equal to the applicable portion of the Common Merger Consideration deposited in the Payment Fund with respect to the shares of Company Common Stock represented by such Certificate, which amounts shall be paid by Exchange Agent by check or wire transfer in accordance with the instructions provided by such holder. No interest or dividends will be paid or accrued on the consideration payable upon the surrender of any Certificate. If the consideration provided for herein is to be delivered in the name of a Person other than the Person in whose name the Certificate surrendered is registered, it shall be a condition of such delivery that the Certificate so surrendered shall be properly endorsed or otherwise in proper form for transfer and that the Person requesting such delivery shall pay any transfer or other Taxes required by reason of such delivery to a Person other than the registered holder of the Certificate, or that such Person shall establish to the satisfaction of the Surviving Corporation that such Tax has been paid or is not applicable. (c) Until surrendered in accordance with the provisions of this Section 1.11, each outstanding Certificate (other than Certificates representing Dissenting Shares) will be deemed, from and after the Effective Time, for all corporate purposes, to evidence only the right to receive the applicable portion of the Common Merger Consideration (without interest) in accordance with this Article 1. Each Certificate so surrendered shall forthwith be canceled. (d) The applicable portion of the Common Merger Consideration issued upon the surrender of Certificates in accordance with this Agreement shall be deemed to have been issued in full satisfaction of all rights pertaining to such shares of Company Common Stock formerly represented thereby. After the Effective Time, there shall be no transfers on the stock -15- transfer books of the Surviving Corporation of any shares of Company Common Stock that were outstanding immediately prior to the Effective Time. If, after the Effective Time, Certificates are presented to the Surviving Corporation, they shall be canceled and exchanged as provided in this Article 1. (e) Any portion of the Payment Fund (including any amounts that may be payable to any holder of Company Common Stock in accordance with the terms of this Agreement) which remains unclaimed upon the first anniversary of the Closing Date shall be returned to Purchaser, upon demand, and any such holder who shall have not theretofore complied with this Article 1 shall, subject to the remainder of this Section 1.11, thereafter look to Purchaser only as a general unsecured creditor thereof for payment of any portion of the Common Merger Consideration, without any interest or dividends thereon, that may be payable to such holder. Following the Closing, the Exchange Agent shall retain the right to invest and reinvest the Payment Fund on behalf of the Surviving Corporation in securities listed or guaranteed by the United States government or certificates of deposit of commercial banks that have, or are members of a group of commercial banks that has, consolidated total assets of not less than $500,000,000, and the Surviving Corporation shall receive the interest earned thereon. None of Purchaser, Merger Sub, the Company or Exchange Agent shall be liable to a holder of Certificates or any other Person in respect of any cash delivered to a public official pursuant to any applicable abandoned property, escheat or similar law. If any Certificate (or an affidavit provided pursuant to Section 1.10(g)) shall not have been surrendered on or before the seventh anniversary of the Closing Date (or immediately prior to such earlier date on which any portion of the Common Merger Consideration with respect to shares of Company Common Stock in respect of such Certificate would otherwise escheat to or become the property of any Governmental Entity), the portion of the Common Merger Consideration in respect of such Certificate shall, to the extent permitted by applicable law, become the property of the Surviving Corporation, free and clear of all claims or interests of any person previously entitled thereto. (f) Each of Purchaser, the Surviving Corporation and the Exchange Agent shall be entitled to deduct and withhold from any consideration payable or otherwise deliverable pursuant to this Agreement to any holder of Company Common Stock such amounts as are required to be deducted or withheld therefrom under the Code or under any other applicable Legal Requirement. To the extent such amounts are so deducted or withheld, such amounts shall be treated for all purposes under this Agreement as having been paid to the Person to whom such amounts would otherwise have been paid. (g) If any Certificate shall have been lost, stolen or destroyed, the Person who is the record owner of such Certificate shall deliver to the Surviving Corporation an affidavit (in form and substance reasonably acceptable to the Surviving Corporation) with respect to such loss, theft or destruction. The Surviving Corporation may, in its discretion and as a condition precedent to the delivery of any portion of the Common Merger Consideration to such owner in respect of such Certificate, require such Person to indemnify the Surviving Corporation against any claim that may be made against the Surviving Corporation with respect to the Certificate alleged to have been lost, stolen or destroyed (but shall not require the posting of any bond or other surety). -16- (h) In addition, pursuant to the terms of the Indemnification Escrow Agreement and the Working Capital Escrow Agreement, as applicable, and in accordance with this Section, each Company Stockholder (other than any Company Stockholder whose Company Common Stock becomes Dissenting Shares) shall be paid such Company Stockholder's proportionate share of the remaining balance, if any, of (i) the Indemnification Escrow Amount within ten (10) business days after release thereof in accordance with the Indemnification Escrow Agreement and (ii) and the Working Capital Escrow Amount within ten (10) business days after release thereof in accordance with the Working Capital Escrow Agreement. References in Section 1.7 and this Section 1.11 to payment of the Common Merger Consideration shall be subject to, and deemed amended as required by, the provisions of Section 1.13, the Indemnification Escrow Agreement and the Working Capital Escrow Agreement, as applicable. 1.12 Taking of Necessary Action; Further Action. If, at any time after the Effective Time, any further action is necessary or desirable to carry out the purposes of this Agreement and to vest the Surviving Corporation with full right, title and possession to all assets, property, rights, privileges, powers and franchises of the Company and Merger Sub, the officers and directors of the Company and Merger Sub will take all such lawful and necessary action. Purchaser shall cause Merger Sub to perform all of its obligations relating to this Agreement and the transactions contemplated hereby. 1.13 Working Capital Adjustment to Merger Consideration. (a) Working Capital Adjustment. In the event there is a Working Capital Deficit or a Working Capital Surplus calculated and determined in accordance with paragraph (c) and (d) of this Section 1.13, then the Merger Consideration shall be reduced or increased, as the case may be, dollar-for-dollar by the amount of the Working Capital Deficit or Working Capital Surplus (the "Working Capital Adjustment"). If there is a Working Capital Deficit and it is less than $2 million, then an amount equal to the Working Capital Deficit shall be released from the Working Capital Escrow to Purchaser and the balance of the Working Capital Escrow Amount shall be released from the Working Capital Escrow to be distributed to the Company Stockholders in accordance with this Agreement and the Working Capital Escrow Agreement. If there is a Final Working Capital Deficit and it is $2 million or greater, then the entire Working Capital Escrow Amount shall be released from the Working Capital Escrow to Purchaser; and Purchaser may make a claim against the Indemnification Escrow Amount for the payment of such difference; and if there is any balance still due to Purchaser that is not otherwise satisfied by the Indemnification Escrow Amount, then the Company Stockholders shall be responsible for payment, severally in accordance with their respective Pro Rata Portions and not jointly, the balance to Purchaser within ten (10) business days after Purchaser's request. If there is a Working Capital Surplus, then (i) Purchaser shall within five (5) business days following the determination of Closing Working Capital deposit the amount of such Working Capital Surplus with the Exchange Agent or the Working Capital Escrow Agent for payment to the Company Stockholders, (ii) the Working Capital Escrow Amount shall be released from the Working Capital Escrow, and (iii) each of (i) and (ii) shall be distributed to the Company Stockholders in accordance with this Agreement and the Working Capital Escrow Agreement. If there is neither a Working Capital Deficit nor a Working Capital Surplus, then the Working Capital Escrow Amount shall be released from Working Capital Escrow to be distributed to the Company Stockholders in accordance with this Agreement and the Working Capital Escrow Agreement. -17- (b) Closing Statement. Not less than five (5) business days prior to the Closing Date, the Company shall prepare and deliver to Purchaser and the Company Stockholder Representative a statement ("Company Closing Statement") setting forth in reasonable detail the Company's pre-closing calculations of estimated Working Capital and the estimated Working Capital Deficit, if any, or estimated Working Capital Surplus, if any, as of the Closing Date. (c) Working Capital Adjustment Procedures. A final determination of Working Capital (the "Closing Working Capital") and the Working Capital Deficit, if any, or Working Capital Surplus, if any, as of the Closing Date shall be made after Closing in accordance with this Section for the purpose of determining any Working Capital Adjustment, if any, required under Section 1.13(a). Not later than thirty (30) days after the Closing Date, Purchaser shall prepare and deliver to the Company Stockholder Representative a statement (the "Purchaser's Post-Closing Statement") setting forth in reasonable detail Purchaser's final determinations of the Closing Working Capital and Working Capital Deficit, if any, or Working Capital Surplus, if any. The Purchaser's Post-Closing Statement shall be accompanied by supporting schedules setting forth in reasonable detail all assets and liabilities included in such calculations. The Company Closing Statement and Purchaser's Post-Closing Statement shall be prepared in accordance with GAAP and otherwise in accordance with the same accounting principles and policies used in the preparation of the Financial Statements, except as otherwise expressly provided in this Agreement. In the event that the Company Stockholder Representative disagrees with the Purchaser's Post-Closing Statement, then the Company Stockholder Representative shall submit a written notice of objection thereto to Purchaser within 15 days after the Company Stockholder Representative's receipt of the Purchaser's Post-Closing Statement. If within such 15 day period the Company Stockholder Representative does not submit such a notice of objection, the Closing Working Capital and Working Capital Deficit, if any, set forth in Purchasers' Post-Closing Statement shall be deemed accepted, but if the Company Stockholder Representative does timely object to Purchaser's Post-Closing Statement, such objection shall be resolved as provided in Section 1.13(d). The Common Merger Consideration shall be adjusted as provided in Section 1.13(a) based upon the Working Capital Deficit, if any, or Working Capital Surplus, if any, as so agreed by the parties or finally determined as provided herein. (d) Resolution of Objections. Purchaser and the Company Stockholder Representative shall negotiate in good faith to resolve any dispute arising under Section 1.13(c) for a period not to exceed 30 days (except by mutual agreement and which may be shortened by mutual agreement). Any objection timely made under Section 1.13(c) that the Company Stockholder Representative and Purchaser are unable to so resolve shall be determined by a "Neutral Accountant" as defined below. A "Neutral Accountant" means an accountant or accounting firm mutually agreed by the Parties or, if the Parties fail or are unable to agree, an independent accounting firm which satisfies each of the following requirements: (i) neither the accountant nor the firm that employs the accountant shall have performed any material accounting or consulting services for any Party or its Affiliates at any time during the five (5) year period immediately preceding the date of the notice from the Company Stockholder Representative under Section 1.13(c); (ii) is not related in any way to any Party or any executive officer, director or Affiliate of any Party; -18- (iii) has been a certified public accountant duly licensed to practice in the state where he or she has his or her primary office for a period of not less than ten (10) years; (iv) is willing to accept engagement as the Neutral Accountant on the terms and conditions of this Agreement. Purchaser and the Company Stockholder Representative agree to use their reasonable best efforts in good faith to select a Neutral Accountant who is reasonably acceptable to both of them not later than fifteen (15) days after the date on which the Company Stockholder Representative timely objects to Purchaser's Post-Closing Statement. Initially, it is agreed that the Toronto office of KPMG LLP shall be the Neutral Accountant unless such firm shall hereafter fail to satisfy the requirements for the Neutral Accountant specified above. Within ten (10) days after the Neutral Accountant is appointed as described above (or within 10 days after the termination of negotiations mandated pursuant to the first sentence of this subsection (d) if the Neutral Accountant remains the firm named above), Purchaser shall promptly forward a copy of the Purchaser's Post-Closing Statement to the Neutral Accountant, and the Company Stockholder Representative shall promptly forward a copy of the written objection(s) thereto delivered pursuant to Section 1.13(c) to the Neutral Accountant. The Neutral Accountant's role shall be limited to resolving such objections. In resolving such objections, the Neutral Accountant shall apply the provisions of this Agreement concerning determination of the Closing Working Capital and Working Capital Deficit, as applicable. The Neutral Accountant shall promptly provide written notice of its resolution of such objections to Purchaser and the Company Stockholder Representative and the resulting determinations of the Closing Working Capital and Working Capital Deficit, if any, shall be final and binding on the Parties. The Neutral Accountant shall be instructed to use reasonable efforts to perform its services within thirty (30) days of submission of the statement(s) and objection(s) to it and, in any case, as soon as practicable after such submission. If the Neutral Accountant selected as described above is unable or unwilling to act when called upon pursuant to this Section 1.13(d), then the parties shall promptly appoint a substitute to act in substitution for the original designee, (or if no substitute is so appointed within fifteen (15) days, then such dispute shall be resolved by a single arbitrator, sitting in New York, New York, appointed by the American Arbitration Association upon application by either Purchaser or the Company Stockholder Representative), and, upon acceptance of such appointment such substitute, or arbitrator so appointed, shall for purposes of this Agreement be deemed the Neutral Accountant, as applicable, and the time periods prescribed above in this Section 1.13(d) shall run from the date of such substitute's or arbitrator's acceptance of appointment hereunder. 1.14 Dissenters' Rights. (a) Notwithstanding any provision of this Agreement to the contrary other than Section 1.14(b), any shares of Company Common Stock held by a holder who duly and validly demands appraisal of such shares in accordance with Delaware Law and is in compliance with all the provisions of Delaware Law concerning the right of such holder to demand appraisal of such shares in connection with the Merger and who, as of the Effective Time, has not effectively withdrawn or lost such appraisal or dissenters' rights ("Dissenting Shares"), shall not be converted into or represent a right to receive any portion of the Common Merger Consideration pursuant to Section 1.7, but instead shall be converted into the right to receive -19- only such consideration as may be determined to be due with respect to such Dissenting Shares under Delaware Law. (b) Notwithstanding the provisions of Section 1.7, if any holder of shares of Company Common Stock who demands payment for such shares under Delaware Law shall effectively withdraw or lose (through failure to perfect or otherwise) such holder's appraisal rights, then, as of the later of the Effective Time and the occurrence of such event, such holder's shares shall no longer be Dissenting Shares and shall automatically be converted into and represent only the right to receive the applicable portion of the Common Merger Consideration, as provided in Section 1.7, without interest thereon, upon surrender of the certificate representing such shares in accordance with Section 1.11. (c) The Company shall give Purchaser (i) prompt notice of the receipt of any written notice of any demand for payment or intent to demand payment for any shares of Company Common Stock, withdrawals of such demands, and any other instruments served pursuant to Delaware Law and received by the Company which relate to any such demand for payment and (ii) the opportunity to participate in all negotiations and proceedings which take place prior to the Effective Time with respect to demands for payment under Delaware Law. The Company shall not, except with the prior written consent of Purchaser, either (y) voluntarily make any payment with respect to any demands for payment for Company Common Stock or offer to settle or settle any such demands or (z) make any offer to buy, or accept any offer to sell, any shares of Company Common Stock. 1.15 Company Stockholder Representative. (a) Appointment; Powers. In order to administer efficiently the assertion, defense, settlement and resolution of any claims for indemnification pursuant to Article 6 and any other disputes or matters arising in connection with this Agreement, the Indemnification Escrow Agreement, the Working Capital Escrow Agreement or any other agreement entered into by the Company Stockholder Representative on behalf of the Company Stockholders as contemplated hereunder, upon the approval of this Agreement by the Company Stockholders in accordance with Delaware Law, the Company Stockholder Representative shall be exclusively (except in case of clause (iv) and clause (v) below in the event of a claim not generally applicable to the Stockholders (a "Particular Claim"), in which case such authorization shall be non-exclusive) authorized and empowered to: (i) to the extent permitted by applicable law, amend, modify or waive any of the provisions of this Agreement, the Indemnification Escrow Agreement, the Working Capital Escrow Agreement or any other agreement contemplated hereby on behalf of the Company Stockholders in any manner in which the Company Stockholder Representative believes to be in the best interests of the Company Stockholders; (ii) give all notices (including service of process) required to be given by or on behalf of any Company Stockholder under this Agreement or any other agreement contemplated hereby; (iii) take any action (or determine to take no action) in connection with the defense, settlement, compromise, arbitration and/or other resolution of any claim for indemnification by any Purchaser Indemnified Party (as defined below) pursuant to Article 6 hereof, including compliance with any Order in connection with any such claim, or any other claim, arbitration, dispute, action, suit, or other proceeding in connection with this Agreement; (iv) assert, bring, prosecute, maintain, settle, compromise, arbitrate and/or otherwise resolve on behalf of the Company Stockholders any claim for indemnification by any Company Stockholder Indemnified Party (as defined -20- below) pursuant to Article 6 hereof or any other claim, arbitration, dispute, action, suit, or other proceeding in connection with this Agreement; and (v) take all such other actions (or determine to take no action) as the Company Stockholder Representative may deem necessary or appropriate in his sole judgment to carry out the foregoing. By his/its execution hereof, the Company Stockholder Representative hereby accepts such appointment. (b) Removal. The Company Stockholders may, at any time, remove the Company Stockholder Representative and appoint a substitute representative by written consent signed by Company Stockholders (or, if applicable, their respective heirs, legal representatives, successors and assigns) who held a majority of the voting power represented by the shares of Company Common Stock issued and outstanding immediately prior to the Effective Time. If the Company Stockholder Representative dies, becomes unable to perform his responsibilities hereunder or resigns from such position, the Company Stockholders shall, by such written consent, appoint a substitute representative to fill such vacancy. Any such substitute representative shall be deemed to be the Company Stockholder Representative for all purposes of this Agreement. Upon the selection of such substitute representative, the substituted representative shall promptly notify Purchaser in writing of his or her appointment pursuant to this Section 1.15(b), which written notice shall be accompanied by a copy of the written consent effectuating such appointment. (c) Exclusive Right. Any claim, arbitration, action, suit, or other proceeding, whether in law or equity, to enforce any right, benefit or remedy granted to the Company Stockholders under this Agreement shall be asserted, brought, prosecuted or maintained only by the Company Stockholder Representative, except with respect to Particular Claims in connection with which the affected Stockholders may act independently of the Stockholder Representative. Except with respect to Particular Claims, all actions, decisions and instructions of the Company Stockholder Representative, including the defense, settlement, compromise and/or other resolution of any claims for indemnification by any Purchaser Indemnified Party pursuant to Article 6, shall be conclusive and binding upon all of the Company Stockholders, and no Company Stockholder shall have any right to object, dissent, protest or otherwise contest the same, nor have any claim or cause of action against the Company Stockholder Representative for any action taken or not taken, decision made or instruction given by the Company Stockholder Representative under this Agreement, except for fraud, gross negligence or willful misconduct by the Company Stockholder Representative. (d) Reliance. Except with respect to Particular Claims, Purchaser shall be able to rely conclusively on the actions, decisions and instructions of the Company Stockholder Representative as to the settlement, compromise and/or other resolution of any claims for indemnification by any Purchaser Indemnified Party pursuant to Article 6 or any other actions required or permitted to be taken by the Company Stockholder Representative under this Agreement, and no Party hereunder shall have any claim or cause of action against any Purchaser Indemnified Party for any action taken by such Purchaser Indemnified Party in reliance upon the actions, decisions and instructions of the Company Stockholder Representative. (e) Information and Access. The Company Stockholder Representative and its representatives and agents shall have reasonable access to information about the Company, Surviving Corporation and Purchaser and the reasonable assistance of the Company's, Surviving -21- Corporation's and Purchaser's officers and employees for purposes of performing its duties and exercising its rights hereunder, including in the case of the Working Capital Adjustment, access to working papers and other books and records the Company Stockholder Representative and/or its representatives and agents may reasonably request; provided, however, that the Company Stockholder Representative shall treat confidentially and not disclose any nonpublic information from or about the Company, Surviving Corporation or Purchaser to anyone other than its representatives and agents (except on a need to know basis to individuals who agree to treat such information confidentially). (f) Indemnification. The Company Stockholder Representative shall be indemnified and held harmless by the Company Stockholders from all Losses arising out of or in connection with the Company Stockholder Representative's execution, delivery and performance of this Agreement, except for fraud, gross negligence or willful misconduct by the Company Stockholder Representative. If at any time the Company Stockholder Representative and any other Person shall have any unsatisfied claims against the Company Stockholders pursuant to the terms of this Agreement, the claims of the Company Stockholder Representative shall be satisfied first including out of funds comprising the Indemnity Escrow Amount and the Working Capital Escrow Amount, subject to the limits set forth in the Indemnification Escrow Agreement and the Working Capital Escrow Agreement, as applicable. The Company Stockholder Representative shall have the right to make demands of the Company Stockholders directly, pro rata in accordance with their respective Pro Rata Portions of the Common Merger Consideration, for such indemnification and for payment of any fees and expenses (including attorneys' fees and expenses) incurred in the discharge of the Company Stockholder Representative's duties hereunder, which demand shall be promptly honored by the Company Stockholders. Without in any way limiting the rights of the Company Stockholder Representative as against the Company Stockholders, neither the Company nor Purchaser shall have any liability or obligation whatsoever to the Company Stockholder Representative arising out of or relating to any breach or alleged breach by the Company Stockholders of their indemnification obligations to the Company Stockholder Representative as contemplated hereby. (g) Attorney-in-fact. Upon approval of this Agreement by the Company Stockholders, the Company Stockholder Representative, or any assignee or successor thereof, acting as hereinafter provided, shall be irrevocably appointed as the attorney-in-fact and agent of the Company Stockholders (except with respect to Company Stockholders, if any, who have caused their Company Common Stock to become Dissenting Shares) to act in its, his or her name, place and stead in connection with all matters arising from and under this Agreement, the Indemnification Escrow Agreement, the Working Capital Escrow Agreement and any other agreement entered into by the Company Stockholder Representative on behalf of the Company Stockholders, and acknowledges that such appointment is coupled with an interest. (h) Severability. The provisions of this Section 1.15 are independent and severable, are irrevocable and coupled with an interest and shall be enforceable notwithstanding any rights or remedies that any Company Stockholder may have in connection with the transactions contemplated by this Agreement. (i) Binding Effect. The provisions of this Section 1.15 shall be binding upon the heirs, legal representatives, successors and assigns of each Company Stockholder, and any -22- references in this Agreement to a Company Stockholder or the Company Stockholders shall mean and include the successors to the rights of the Company Stockholders hereunder, whether pursuant to testamentary disposition, the laws of descent and distribution, assignment or otherwise. 1.16 Approvals. The approval of this Agreement by the Company Stockholders shall constitute approval of the Indemnification Escrow Agreement and the Working Capital Escrow Agreement and the appointment of the Company Stockholder Representative, the Indemnification Escrow Agent and the Working Capital Escrow Agent. Article 2 REPRESENTATIONS AND WARRANTIES OF THE COMPANY Except as set forth in the Company Disclosure Schedule attached hereto, the Company makes the following representations and warranties to Purchaser as of the date hereof: 2.1 Organization. The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. The Company has all requisite corporate power and authority to carry on its business as now being conducted and to own the properties and assets it now owns and is duly qualified or licensed to do business as a foreign corporation in good standing in every jurisdiction in which such qualification is required, except where the failure to be so qualified or licensed would not have, individually or in the aggregate, a Company Material Adverse Effect. The Company has provided Purchaser with true, correct and complete copies of the Certificate of Incorporation and By-laws of the Company as currently in effect. 2.2 Subsidiaries. (a) Section 2.2 of the Company Disclosure Schedule sets forth: (i) the name of each Subsidiary of the Company, (ii) the number and type of outstanding equity interest of each such Subsidiary and a list of the holders thereof; and (iii) the jurisdiction of organization of each such Subsidiary. (b) Each Subsidiary of the Company is duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization. Each Subsidiary of the Company has the power to own its properties and to carry on its business as currently conducted. Each Subsidiary of the Company is duly qualified or licensed to do business and in good standing as a foreign entity in each jurisdiction where the properties owned, leased or operated by it, or the business conducted by it, require such qualification or license, except in those jurisdictions where the failure to be so qualified or licensed would not have a Company Material Adverse Effect. The Company has delivered a true, correct and complete copy of each of each of its Subsidiaries' organization documents, each as amended to date and in full force and effect on the date hereof, to Purchaser. 2.3 Authorization. (a) The Company has full corporate power and authority to execute and deliver this Agreement and to perform its obligations hereunder, and to consummate the transactions contemplated hereby. The execution and delivery by the Company of this Agreement, the performance by the Company of its obligations hereunder and the consummation by the Company of the transactions contemplated hereby have been duly authorized by all -23- necessary corporate action on the part of the Company, subject only to the filing of Certificate of Merger pursuant to Delaware Law. (b) The board of directors of the Company, at a meeting duly called and held, has (i) adopted the plan of merger set forth in this Agreement and approved this Agreement, (ii) declared that the Merger is advisable and in the best interests of the Company and its stockholders, and (iii) recommended that the stockholders of the Company approve this Agreement and the Merger. 2.4 Execution and Validity. This Agreement has been duly executed and delivered by the Company. Assuming the due and valid authorization, execution and delivery hereof by Purchaser, Merger Sub and the Company Stockholder Representative, this Agreement is a valid and binding obligation of the Company enforceable against the Company in accordance with its terms except (a) as limited by applicable bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance and other similar laws of general application affecting enforcement of creditors' rights generally and (b) the availability of the remedy of specific performance or injunctive or other forms of equitable relief may be subject to equitable defenses and would be subject to the discretion of the court before which any proceeding therefor may be brought ((a) and (b) together, the "Enforceability Limitations"). 2.5 Consents and Approvals; No Violations. (a) Except for the filing of the Certificate of Merger with the Secretary of State of the State of Delaware, and the Antitrust Filings and Other Filings, none of the execution and delivery by the Company of this Agreement, the performance by the Company of its obligations hereunder, nor the consummation by the Company of the transactions contemplated hereby, including without limitation the Saxon Divestiture, will (i) conflict with or result in any breach of any provision of the Certificate of Incorporation or By-Laws of the Company, each as amended to date; (ii) require any declaration or filing with, or permit, authorization, consent or approval of, any Governmental Entity; (iii) result in any violation or breach of, constitute a default under or give rise to any right of termination, cancellation or acceleration, increase any liability or result in the loss of any right or benefit, or create in another Person a put-right, purchase obligation or similar right (with or without notice or the lapse of time or both) pursuant to any term or provision of any Contract to which the Company or any of its Subsidiaries is a party or by which any of the Company's property or assets or the property or assets of its Subsidiaries (whether tangible or intangible) may be bound; or (iv) result in or require the creation or imposition of any Encumbrance of any nature upon, or result in the creation or acceleration of any Indebtedness with respect to the assets of the Company or its Subsidiaries, other than such violations, breaches, defaults or rights of termination which would not, individually or in the aggregate, have a Company Material Adverse Effect on the Company's ability to consummate the transactions contemplated hereby. (b) No Governmental Entity or any other Person has notified the Company that such Governmental Entity or other Person intends to object to the transactions contemplated hereunder. To the Knowledge of the Company, there is no fact or circumstance relating to the Company, its Subsidiaries, any of the Company's assets or any of its Subsidiaries' assets that would (i) cause the filing of any objection to any application for any authorization required by any Governmental Entity required in connection with the transactions contemplated hereby; (ii) -24- lead to any delay in processing any such application; or (iii) require any waiver of any rule, policy or other applicable law of any Governmental Entity. 2.6 Capitalization. (a) The authorized capital stock of the Company consists of 330,000,000 shares, of which 5,000,000 shares are designated preferred stock, par value $0.001 per share, 25,000,000 shares are designated Common Stock, 150,000,000 shares are designated Series A Common Stock and 150,000,000 shares are designated Series B Common Stock. As of the date of this Agreement, (i) there are no shares of preferred stock outstanding; (ii) 10,085,648 shares of Common Stock are issued and outstanding; (iii) 72,125,247 shares of Series A Common Stock are issued and outstanding; and (iv) 16,836,413 shares of Series B Common Stock are issued and outstanding. All the outstanding shares of Company Common Stock are duly authorized, validly issued, fully paid and non-assessable and not subject to preemptive rights created by statute, the Certificate of Incorporation or By-laws of the Company, or any Contract to which the Company is a party or by which any of the Company's property or assets (whether tangible or intangible) may be bound, and have been issued in compliance in all Material respects with all applicable federal, state and foreign securities laws. The Company has not repurchased or redeemed any shares of is capital stock except in compliance in all Material respects with all applicable federal, state, foreign, or local statutes, laws, rules or regulations, including federal, state and foreign securities laws and any agreements applicable thereto. There are no declared or accrued but unpaid dividends with respect to any shares of capital stock of the Company. (b) Section 2.6(b) of the Company Disclosure Schedule sets forth the following information with respect to each share of Restricted Stock outstanding on the date of this Agreement: (i) the name of the holder of Restricted Stock; (ii) the number of shares of Restricted Stock held by such holder; and (iii) the date on which such Restricted Stock was issued. The Company has delivered to Purchaser an accurate and complete copy of the Company Restricted Stock Plan. (c) Except for the Company Restricted Stock Plan, pursuant to which the Company intends to issue all authorized but unissued shares of Common Stock reserved for issuance under such plan prior to the Closing to certain Company Employees, (i) there are no equity-based compensation plans of the Company; (ii) there are no existing options, warrants, calls, preemptive rights, subscriptions or other rights, agreements, arrangements or commitments of any character, relating to the issued or unissued capital stock of the Company, obligating the Company to issue, transfer, redeem, purchase or sell or cause to be issued, transferred, redeemed, purchased or sold any shares of capital stock of the Company or to otherwise make any payment in respect of any such shares; and (iii) there are no rights, agreements or arrangements of any character which provide for any stock appreciation, phantom stock, profit participation or similar right. 2.7 Financial Statements. Section 2.7 of the Company Disclosure Schedule includes accurate and complete copies of (a) the unaudited consolidated balance sheet and statements of income, stockholders' equity and cash flows of the Company as of the fiscal quarter ended April 1, 2007, (b) the unaudited consolidated balance sheet and statements of income, stockholders' equity and cash flows of the Company as of the fiscal five month period ended May 27, 2007 (the "Balance Sheet Date") and (c) the audited consolidated balance sheets -25- and statements of income, stockholders' equity and cash flows of the Company as of the fiscal years ended December 25, 2005 and December 31, 2006, respectively, and for the fiscal years ended December 25, 2005 and December 31, 2006, respectively. The financial statements referred to in the immediately preceding sentence are sometimes referred to herein as the "Financial Statements," and the Company's balance sheet as of the Balance Sheet Date is referred to herein as the "Balance Sheet". Each balance sheet included in the Financial Statements (including any related notes) has been prepared from the books and records of the Company or its Subsidiaries and fairly presents in all Material respects the Company's and its Subsidiaries' consolidated financial positions as of its date, and each other statement included in the Financial Statements (including any related notes) has been prepared from the books and records of the Company or its Subsidiaries and fairly presents in all Material respects the Company's and its Subsidiaries' consolidated results of operations, stockholders' equity and cash flows, as the case may be, for the period covered thereby, in each case in accordance with GAAP consistently applied, except as otherwise noted thereon and except that the unaudited Financial Statements referred to in clause (a) above may not contain all the footnotes required by GAAP, and are subject to normal year-end adjustments. 2.8 No Undisclosed Liabilities. Neither the Company nor any of its Subsidiaries has any liabilities of the type required to be disclosed in the liabilities column of a balance sheet prepared in accordance with GAAP, except for (i) liabilities and obligations shown on the Balance Sheet; (ii) liabilities and obligations incurred since the Balance Sheet Date in the ordinary course of business consistent with past practice (none of which is a liability resulting from a breach of Contract that the Company or any of its Subsidiaries is a party to or binds the property or assets (whether tangible or intangible) of the Company or any of its Subsidiaries, breach of warranty, fraud, tort, infringement or Legal Proceeding); (iii) Transaction Expenses incurred in connection with the transactions contemplated hereby; and (iv) liabilities and obligations created by this Agreement or the Merger or disclosed in this Agreement or the Company Disclosure Schedule. 2.9 Absence of Certain Changes. (a) During the period from the Balance Sheet Date through the date hereof, there has not been, occurred or arisen any event or condition of any character that has had or, to the Knowledge of the Company, would have a Company Material Adverse Effect. (b) There has not been, occurred or arisen since the Balance Sheet Date any of the following events, except in the ordinary course of business as conducted on that date and consistent with past practices or in connection with the divestiture of Saxon by the Company: (i) (y) any change by the Company in (A) its accounting methods, principles or practices (except to the extent required by GAAP), or (B) its pricing policies or payment or credit practices; or (z) any failure by the Company to pay any creditor any amount owed to such creditor when due (other than immaterial deviations from the stated payment terms of a vendor or supplier); (ii) any declaration, payment or setting aside for payment by the Company of any dividend or other distribution in respect of its capital stock or redemption, purchase or other acquisition, directly or indirectly, of any shares of capital stock or other securities of the Company; -26- (iii) the sale, transfer or other disposition of any of the Company's assets or any of the assets of its Subsidiaries having an aggregate value of more than $250,000; (iv) any loans or advances to, or guarantees for the benefit of, any Person by the Company or any of its Subsidiaries, except for advances made to directors, officers and employees of the Company or such Subsidiary in the ordinary course of business; (v) any amendment of, acceleration of, affirmative waiver of any Material right under, termination of, cancellation of or permitting to lapse of, any Material Contract, or entering into, or permitting any of the Company's assets or any of its Subsidiaries' assets to become subject to, any Contract; (vi) any capital expenditures by the Company or its Subsidiaries exceeding $250,000 in the aggregate; (vii) any increase in the compensation payable or to become payable (including bonuses, profit sharing, severance, retention or vacation pay) to any of the Company Employees, including the establishment or adoption of any employee benefit plan; (viii) any payment or agreement to pay any bonuses or other compensation to any Company Employee in connection with the transactions contemplated hereby; (ix) any loss, damage or destruction to the Company's or any of its Subsidiaries' properties or assets, whether or not covered by insurance and whether or not in the ordinary course of business, in an aggregate amount in excess of $500,000; (x) any subjection of any of the Company's or any of its Subsidiaries' assets to any Encumbrance other than Permitted Encumbrances; (xi) any commencement, settlement or agreement to settle any Legal Proceeding related to the Company or its Subsidiaries; (xii) any Tax election that does or would adversely affect the Company or any of the Company's assets, or any Subsidiary of the Company or any of such Subsidiaries' assets; (xiii) (y) license, waiver or relinquishment of any Material right to or for the benefit of any other Person by the Company or any of its Subsidiaries or (z) writing up or writing down the value of any of the Company's or any of its Subsidiaries' assets, individually or in the aggregate, in an amount greater than $250,000; (xiv) any grant or transfer by the Company or any of its Subsidiaries of any rights, ownership or interests (including any license, sublicense or covenant not to sue) to any other Person with respect to any IP; -27- (xv) any agreement by the Company or any of its Subsidiaries pursuant to which the Company or any of its Subsidiaries acquires any rights to IP by assignment, license or otherwise and is required to pay consideration in excess of $50,000; (xvi) any amendment or modification, or authorization of any amendment or modification of, the Certificate of Incorporation, By-laws or other organizational or governance documents of the Company; (xvii) any agreement, contract or other binding commitment by the Company or any of its Subsidiaries to do any of the foregoing; and (xviii) any other Material agreement or commitment. 2.10 Title to Properties; Encumbrances. Except for properties and assets sold in the ordinary course of business, the Company or one of its Subsidiaries has good and valid title to all properties and assets reflected on the Balance Sheet and not shown as leased, in each case free and clear of all Encumbrances other than Permitted Encumbrances. 2.11 Real Property; Leases. The Company and its Subsidiaries do not own any real property. Section 2.11 of the Company Disclosure Schedule sets forth a list of the Leases. The Leases grant leasehold estates free and clear of all Encumbrances other than Permitted Encumbrances. The Leases are, to the Knowledge of the Company, in full force and effect and enforceable against each of the other parties thereto in all Material respects in accordance with their respective terms, subject to the Enforceability Limitations. The Company and its Subsidiaries are not in Material breach of or default under any Lease, nor has there occurred any event that with the passage of time or the giving of notice or both would constitute a Material breach or default by the Company or its Subsidiaries under any Lease. The Company has not received any notice that the Company or any of its Subsidiaries is in Material breach of or default under any Lease. To the Knowledge of the Company, no other party to any Lease is in Material breach of or default under any Lease, nor, to the Knowledge of the Company, has there occurred any event that with the passage of time or the giving of notice or both would constitute such a breach or default. To the Knowledge of the Company, the operations of the Company and its Subsidiaries on the real property underlying the Leases or such real property underlying the Leases, including the improvements thereon, in any case, do not violate in any Material manner any applicable building code, zoning requirement, or classification or statute relating to the particular property or such operations, and such non-violation is not dependent, in any instance, on so-called non-conforming use exceptions. There are no other parties occupying, or with a right to occupy granted by the Company or its Subsidiaries, the real property underlying the Leases. The Closing will not affect the enforceability against any person of any Lease or the rights of Purchaser or the Surviving Corporation to the use and possession of the real property underlying the Lease for the conduct of business as currently conducted by the Company and its Subsidiaries. The Company has provided Purchaser with a true, correct and complete copy of all Leases, together with all amendments thereto or modifications thereof. 2.12 Contracts and Commitments. (a) Neither the Company nor any of its Subsidiaries is party to any: (i) Contract with any current or former director, officer, employee, consultant or agent providing for (A) severance, change-in-control or retention benefits, -28- (B) except as provided in the agreements with respect to the Restricted Stock, the increase or acceleration of benefits payable as a result of the Merger (or any termination of employment following the Merger), or (C) the indemnification of any such party; (ii) Contract to forgive any indebtedness in excess of $250,000 of any Person to the Company or any of its Subsidiaries; (iii) Contract regarding the purchase of real property; (iv) loan agreement, promissory note, debenture, credit or financing agreement, instrument or other Contract evidencing indebtedness for borrowed money; (v) Contract providing security for indebtedness or the deferred purchase price of assets (other than any asset or group of related assets having a purchase price of less than $250,000); (vi) Contract to guarantee the obligations of, or to indemnify, any third party (other than (A) indemnification of customers, distributors, resellers, agents, suppliers, licensors or licensees in the ordinary course of business and (B) indemnification obligations set forth in the Certificate of Incorporation or By-Laws of the Company, the organizational documents of its Subsidiaries or in any written indemnification agreement with directors, officers and agents of the Company or its Subsidiaries); (vii) Contract which restricts the ability of the Company or its Subsidiaries to (A) engage in any business activity in any geographic area or line of business, which prohibits the Company or its Subsidiaries from competing with, or soliciting the services or employment of, any Person or (B) develop, use, sell or license any IP which otherwise prohibits or Materially impairs any current business practice of the Company or its Subsidiaries; (viii) Other than the Saxon IP License and the Saxon Divestiture Agreements, Contract for the sale or other disposition of any assets of the Company or its Subsidiaries, other than in the ordinary course of business; (ix) Contract creating any partnership or joint venture; (x) Contract obligating the Company or its Subsidiaries to make aggregate payments in excess of $500,000 to any third party which is not terminable by the Company or such Subsidiaries without any liability upon 30 days' notice or less; (xi) Other than the Saxon IP License and the Saxon Divestiture Agreements, Contract pursuant to which the Company or its Subsidiaries reasonably expect to receive aggregate payments in excess of $500,000; (xii) Contract containing any change of control, consent or other similar provisions that may be or are triggered or otherwise affected by any of the transactions contemplated by this Agreement; -29- (xiii) Contract relating to any Legal Proceeding or any Order; (xiv) Contract that contains an obligation of confidentiality on the part of the Company or its Subsidiaries other than non-disclosure agreements entered into in the ordinary course of business; (xv) any other Material agreement or commitment. (b) The Company has made available to Purchaser a correct and complete copy of each Material Contract (including all amendments thereto) and a summary description of any oral or unwritten Material Contract. Each Material Contract is, to the Knowledge of the Company, in full force and effect and enforceable against the other party or parties thereto in accordance with its terms, subject to the Enforceability Limitations. Neither the Company nor any of its Subsidiaries is in Material breach of or default under any Material Contract, nor has there occurred any event that with the passage of time or the giving of notice or both would constitute a Material breach or default by the Company or its Subsidiaries under any Material Contract. The Company has not received any notice that the Company or any of its Subsidiaries is in Material breach of or default under any Material Contract. To the Knowledge of the Company, no other party to any Material Contract is in Material breach of or default under any Material Contract, nor, to the Knowledge of the Company, has there occurred any event that with the passage of time or the giving of notice or both would constitute such a breach or default. 2.13 Litigation. There is no Material Legal Proceeding pending or, to the Knowledge of the Company, threatened, against the Company or its Subsidiaries, and, to the Knowledge of the Company, no facts or circumstances exist that would reasonably be expected to result in a Legal Proceeding. There is no Order outstanding against the Company or its Subsidiaries or, to the Knowledge of the Company, any director, officer or employee of the Company or its Subsidiaries. 2.14 Compliance with Laws. (a) The Company and its Subsidiaries are in compliance in all Material respects with all Legal Requirements and Orders of all Governmental Entities that apply to the Company and its Subsidiaries; provided, however, that no representation is made in this Section 2.14 as to (i) matters relating to Taxes (it being understood that all representations relating to Taxes are set forth in Section 2.16); (ii) matters relating to employee benefit plans (it being understood that all representations relating to employee benefit plans are set forth in Section 2.15); and (iii) matters relating to environmental matters (it being understood that all representations relating to environmental matters are set forth in Section 2.19). (b) Section 2.14 of the Company Disclosure Schedule lists all Material governmental permits, licenses or authorizations held by the Company or its Subsidiaries (the "Company Permits"). The Company Permits constitute all Material governmental permits, licenses and authorizations required to conduct the business of the Company as currently conducted. Neither the Company nor any of its Subsidiaries is in Material breach of or default under any Company Permit. -30- 2.15 Employee Benefit Plans. (a) Section 2.15 of the Company Disclosure Schedule sets forth all of the Plans. Prior to the date hereof, the Company has made available to Purchaser true, correct and complete copies of each of the following, as applicable, with respect to each Plan: (i) the plan document or agreement or, with respect to any Plan that is not in writing, a written description of the terms thereof; (ii) the trust agreement, insurance contract or other documentation of any related funding arrangement; (iii) the summary plan description; (iv) the three most recent annual reports, actuarial reports and/or financial reports; (v) the three most recent required IRS Form 5500s, including all schedules thereto; (vi) any communication during the six year period preceding the execution of this Agreement to or from any Governmental Entity or to or from any Plan participant regarding a dispute with respect to the operation or administration of the Plan and any other dispute other than routine claims for benefits that are in dispute; (vii) all amendments or modifications to any such documents; and (viii) the most recent determination letter received from the IRS with respect to each Plan that is intended to be a "qualified plan" under Section 401 of the Code. Except as specifically provided in the foregoing documents delivered to Purchaser, there are no amendments to any Plan that have been adopted or approved nor has the Company or any of its Subsidiaries undertaken to make any such amendments or to adopt or approve any new Plan. No Plans cover employees outside the United States or are otherwise subject to the Laws of any jurisdiction outside the United States. (b) With respect to each Plan, (i) all payments due from the Company or any of its Subsidiaries to date have been timely made and all amounts properly accrued to date or as of the Effective Time as liabilities of the Company or any of its Subsidiaries which are not yet due have been properly recorded on the books of the Company and, to the extent required by GAAP, adequate reserves are reflected on the financial statements of the Company, (ii) all premiums due or payable with respect to insurance policies funding any Plan, for any period through the date hereof have been timely made or paid in full, and (iii) there are no Legal Proceedings pending (other than routine claims for benefits) or, to the Knowledge of the Company, threatened or anticipated with respect to such Plan, any fiduciaries of such Plan with respect to their duties to any Plan, or against the assets of such Plan or any trust maintained in connection with such Plan, (iv) it has been established, operated and administered in Material compliance with its terms and all applicable Legal Requirements, including ERISA and the Code. (c) Each Plan which is intended to meet the requirements of a "qualified plan" under Section 401(a) of the Code is subject to a currently effective determination from the Internal Revenue Service that such Plan is so qualified or is based on an approved prototype document that is subject to a currently effective opinion letter from the Internal Revenue Service, and to the Knowledge of the Company there are no facts or circumstances that would adversely affect the qualified status of any such Plan. (d) No Plan is under audit or is the subject of an investigation by the IRS, the U.S. Department of Labor, the Pension Benefit Guaranty Corporation, the Securities and Exchange Commission or any other Governmental Entity, nor to the Company's Knowledge, is any such audit or investigation pending or threatened. -31- (e) Neither the Company nor any of its Subsidiaries nor any of its ERISA Affiliates has ever maintained, established, sponsored, participated in or contributed to or had any obligation to contribute to any (i) pension plan (within the meaning of Section 3(2) of ERISA) that is subject to Title IV of ERISA or Section 412 of the Code, (ii) multi-employer plan (within the meaning of Section 3(37) of ERISA), (iii) "multiple employer plan" as defined in ERISA or the Code, or (iv) "funded welfare plan" within the meaning of Section 419 of the Code. (f) Neither the Company nor any of its Subsidiaries has any obligations for retiree health or life benefits under any Plan, other than coverage as may be required under Section 4980B of the Code or Part 6 of ERISA, or under any comparable continuation of coverage provisions of any Legal Requirement. (g) None of the execution and delivery by the Company of this Agreement, the performance by the Company of its obligations hereunder or the consummation by the Company of the transactions contemplated hereby will (i) entitle any Company Employee to severance pay or any increase in severance pay upon any termination of employment after the date hereof; (ii) accelerate the time of payment or vesting or trigger any payment or funding (through a grantor trust or otherwise) of compensation or benefits under, increase the amount payable or trigger any other Material obligation pursuant to, any Plan; (iii) result in any breach or violation of, or a default under, any Plan; or (iv) result in any payment that would be a "parachute payment" to a "disqualified individual" as those terms are defined in Section 280G of the Code, without regard to whether such payment is reasonable compensation for personal services performed or to be performed in the future. Prior to the Closing, the Company will have provided Purchaser with reasonable estimates of the potential excess parachute payments (within the meaning of Section 280G of the Code) paid or payable by the Company or any of its Subsidiaries in connection with the transactions contemplated by this Agreement, either as a result of the transactions contemplated by this Agreement. or in conjunction with any other event. At no time since January 1, 2005 has the Company or any of its Subsidiaries had any liability for payment any "nonqualified deferred compensation" within the meaning of Section 409A of the Code that could subject any employee, independent contractor or agent of the Company or any of its Subsidiaries to taxation under Section 409A. 2.16 Tax Matters. (a) All Tax Returns required to be filed by or on behalf of the Company and each of its Subsidiaries have been timely filed (except as reflected in Section 2.16(a) of the Disclosure Schedule, in each case to the extent that the Company or any of its Subsidiaries is the beneficiary of any extension of time within which to file any such Tax Return). All such Tax Returns were correct and complete in all Material respects. All Taxes due and owing by the Company and each of its Subsidiaries (whether or not shown on such Tax Returns) have been paid. There are no Liens for Taxes (other than Taxes not yet due and payable) upon any of the assets of the Company or any of its Subsidiaries. There is no Material dispute or claim concerning any Tax liability of the Company or any of its Subsidiaries claimed or raised by any Governmental Entity in writing. (b) None of the federal, state, local and foreign Tax Returns filed by the Company or any of its Subsidiaries on or before the date of this Agreement have been, or are -32- currently the subject of audit and no written notice of any such audit or intent to audit or similar examination or a request for information from the relevant governmental authority has been received, (ii) no deficiencies for any Taxes are outstanding or have been proposed, asserted or assessed in writing by any governmental authority; and (iii) there is no currently effective agreement or other document extending, or having the effect of extending, the period of statute of limitations in respect of Taxes or the assessment or collection of Taxes nor has there been any request in writing for such extension. The statute of limitations in respect of Taxes with respect to each of the Company and its Subsidiaries for Tax Returns filed in respect of taxable years ending on or before December 31, 2003 is closed. The Company has made available to Purchaser correct and complete copies of all of the Company's and its Subsidiaries' federal, state, local and foreign Tax Returns filed on or before the date of this Agreement, examination reports, and statements of deficiencies assessed against or agreed to by the Company or any of its Subsidiaries in respect of taxable years ending after December 31, 2003. (c) The Company will not be required to include any item of income in, or exclude any item of deduction from, taxable income for any taxable period (or portion thereof) ending after the Closing Date as a result of any: (i) change in method of accounting for a taxable period ending on or before the Closing Date; (ii) "closing agreement" as described in Section 7121 of the Code (or any corresponding or similar provision of state, local or foreign income Tax law) executed on or before the Closing Date; (iii) inter-company transactions or any excess loss account described in Treasury Regulations under Section 1502 of the Code (or any corresponding or similar provision of state, local or foreign income Tax law); (iv) installment sale or open transaction disposition made on or before the Closing Date; or (v) prepaid amount received on or before the Closing Date. (d) Neither the Company nor any of its Subsidiaries has distributed stock of another Person, or had its stock distributed by another Person, in a transaction that was purported or intended to be governed in whole or in part by Section 355 of the Code or Section 361 of the Code. (e) The Company and each of its Subsidiaries has withheld and paid all Taxes required to have been withheld and paid in connection with amounts paid or owing to any employee, independent contractor, creditor, stockholder or other third party. (f) Neither the Company nor any of its Subsidiaries has any liability for the Taxes of any Person (other than the Company or any of its Subsidiaries) (i) under Treas. Reg. ss. 1.1502-6 (or any similar provision of state, local or foreign law) or as a transferee or successor, by contract or otherwise, or (ii) under a Tax allocation or sharing agreement. -33- (g) Neither the Company nor any of its Subsidiaries has Tax liabilities (whether due or to become due) with respect to the income, property and operations of the Company or its Subsidiaries that relate to any taxable period (or portion thereof) ending on or before the Closing Date, except for Tax liabilities (rather than any reserve for deferred Taxes established to reflect timing differences between book and Tax income) reflected in the Financial Statements or that have arisen after the Balance Sheet Date. (h) The Company and its Subsidiaries have made proper reserves and allowances on its books to satisfy all of its liabilities for Taxes (rather than any reserve for deferred Taxes established to reflect timing differences between book and Tax income) through the Closing Date. 2.17 Intellectual Property. For the purpose of clarity, the Parties acknowledge and agree that, unless expressly stated otherwise, Saxon is excluded from the definition of Subsidiary as used in this Section 2.17 (or elsewhere in this Agreement), and, accordingly, the representations and warranties set forth below regarding IP of the Company and its Subsidiaries do not apply to Saxon or the Saxon IP (other than as specifically stated in Section 2.17(k)). (a) Section 2.17(a) of the Company Disclosure Schedule sets forth (i) a true and complete list of all Registered Intellectual Property owned by the Company or any of its Subsidiaries and (ii) a list of all unregistered trade names, logos, trademarks, service marks, and a brief summary of all unregistered mask works, copyrights and other Intellectual Property Rights (other than Registered Intellectual Property) that are Material to and that are owned by the Company or any of its Subsidiaries and (iii) a brief summary of all other IP not listed or summarized pursuant to clause (i) or (ii) that is Material to and that is owned by the Company or any of its Subsidiaries (collectively, the "Owned IP"). To the Knowledge of the Company, the Intellectual Property Rights in the Owned IP are valid, subsisting, enforceable, and in full force and effect and neither the Company nor any of its Subsidiaries has received any notice claiming or asserting that any of such Intellectual Property Rights are not valid, subsisting, enforceable, owned by the Company, and in full force and effect. (b) Section 2.17(b) of the Company Disclosure Schedule sets forth a true and complete list of all Contracts to which the Company or any of its Subsidiaries is a party pursuant to which the Company or any of its Subsidiaries has received, acquired or obtained a license, other right (including an ownership right) or covenant not to sue respecting any IP of any Person that is Material (collectively, "Third Party IP"), other than shrink wrap and other generally available commercial licenses with respect to which no future license or royalty payment will become due, or free software that is distributed without restrictions on use. (c) Section 2.17(c) of the Company Disclosure Schedule sets forth a true and complete list of all Contracts to which the Company or any of its Subsidiaries is a party pursuant to which the Company or any of its Subsidiaries has granted, transferred or given to any Person a license, other right (including an ownership right) or covenant not to sue with respect to any Company IP that is Material, (such Contracts, together with the agreements set forth in Section 2.17(b) of the Company Disclosure Schedule, the "Company Licenses"). True and complete copies of the Company Licenses have been provided to Purchaser. -34- (d) The Company or its Subsidiaries owns all right, title and interest in and to, and has possession and control of, the Owned IP, free and clear of all Encumbrances and claims of joint or co-ownership. The Company and its Subsidiaries have a valid and enforceable license or right to use the Third Party IP in the manner that it is used by the Company or any of its Subsidiaries pursuant to a Company License, and has possession of such Third Party IP. The rights of the Company and its Subsidiaries to and under the Company Licenses are free of any Encumbrances. Each Company License is in full force and effect and enforceable against the other party or parties thereto in accordance with its terms, subject to the Enforceability Limitations. Neither the Company nor any of its Subsidiaries is in Material breach of or default under any Company License, nor has there occurred any event that with the passage of time or the giving of notice or both would constitute a Material breach or default by the Company or any of its Subsidiaries under any Company License or give any Person any right to terminate or limit such Company License or any of the rights of the Company or any of its Subsidiaries under the Company License. The Company has not received any notice that the Company or any of its Subsidiaries is in breach of or default under any Company License or there has been an occurrence of any event that with the passage of time or the giving of notice or both would constitute a breach or default by the Company or any of its Subsidiaries under any Company License or give any Person any right to terminate or limit such Company License or any of the rights of the Company or any of its Subsidiaries under such Company License . To the Knowledge of the Company, no other party to any Company License is in Material breach of or default under any Company License, nor, to the Knowledge of the Company, has there occurred any event that with the passage of time or the giving of notice or both would constitute such a breach or default. The execution, delivery and performance of this Agreement does not breach or violate or give rise to any right to terminate or limit any Company License or any license or rights granted, given or obtained thereunder. (e) The Company has not received any notice of any claim or assertion that the products or services of the Company or any of its Subsidiaries, nor the manufacture, use, importation or sale thereof, nor any of the operations of the Company or any of its Subsidiaries infringe, violate, misappropriate, breach or conflict with any Intellectual Property Rights or other rights of any Person, and there are no actions, suits or proceedings pending or, to the Knowledge of the Company, threatened, by any Person against the Company or its Subsidiaries alleging infringement, misappropriation or violation of or conflict with such Person's Intellectual Property Rights or other rights. To the Knowledge of the Company, none of the products or services of the Company or any of its Subsidiaries, nor the manufacture, use, importation or sale thereof, nor any of the operations of the Company or any of its Subsidiaries, infringes, violates, misappropriates, breaches or conflicts with any Intellectual Property Rights of any Person. (f) To the Knowledge of the Company, there is no Material Company IP that will not be available to the Company and its Subsidiaries as of and after the Closing on the same terms and conditions and in the same manner that such IP was available to the Company and its Subsidiaries prior to the Closing, with the exception of the terms of the Saxon IP License. (g) To the Knowledge of the Company, no Intellectual Property Rights owned by the Company or its Subsidiaries that are Material are being infringed, violated, misappropriated or breached by any Person. -35- (h) No federal, state, provincial or other regulatory agency or body has provided any funding to the Company or any of its Subsidiaries which would give such federal, state, provincial or other regulatory agency or body any rights, titles or interest in or to the any Owned IP and no university, academic institution or similar type of entity nor any of their employees has any rights, titles or interests in or to the Owned IP. (i) To the Knowledge of the Company, no open source software or code is or was (i) used in the development, compilation, manufacture or creation of, (ii) incorporated into, (iii) integrated or bundled with, any product or service offered by the Company or any of its Subsidiaries. (j) The Company and its Subsidiaries have taken commercially reasonable measures to protect and maintain the confidential and proprietary nature of trade secrets and other confidential information that are Material. (k) Neither the Company nor any of its Subsidiaries (including in this case Saxon if Saxon remains a subsidiary of the Company following the Closing), has or will have following the Saxon Divestiture any indemnification or other obligation or liability, contingent or otherwise, under, arising from or related to: (i) any of the Saxon Divestiture Agreements, (ii) any of the Saxon IP, (iii) the Saxon Divestiture or (iv) Saxon that is or will be inconsistent with the provisions of Section 5.13. 2.18 Labor Matters. (a) There is no labor strike, dispute, slowdown, stoppage or lockout pending, or, to the Knowledge of the Company, threatened with respect to the Company Employees. (b) Neither the Company nor its Subsidiaries is party to or bound by any labor or collective bargaining agreement applicable to the Company, any of its Subsidiaries or to any Company Employees. (c) To the Knowledge of the Company, none of the Company Employees is represented by a labor union, and no petition has been filed, nor has any proceeding been instituted by any Company Employee or group of Company Employees with any labor relations board or commission seeking recognition of a collective bargaining representative. To the Knowledge of the Company, there is no organizational effort currently being made or threatened by or on behalf of any labor union to organize any Company Employees. (d) There is no Material grievance, unfair labor practice charge or complaint against the Company or any of its Subsidiaries or regarding any Company Employee or group of Company Employees (or any former employees of the Company or any of its Subsidiaries) pending or, to the Knowledge of the Company, threatened before any Governmental Entity. (e) The Company and its Subsidiaries are in Material compliance with all Legal Requirements applicable to the Company or any of its Subsidiaries regarding the terms and conditions of employment or other labor related matters, including Legal Requirements relating to discrimination, fair labor standards and occupational health and safety or wrongful discharge, and there are no, in each case, Material complaints, lawsuits or other Legal Proceedings pending or, to the Knowledge of the Company, threatened against the Company or any of its Subsidiaries -36- brought by or on behalf of any applicant for employment, any current or former employee or any class of the foregoing, relating to any such Legal Requirements, or alleging breach of any express or implied contract of employment, wrongful termination of employment, or alleging any other discriminatory, wrongful or tortious conduct in connection with the employment relationship. (f) Since January 1, 2007, none of the Company nor any of its Subsidiaries has effectuated (i) a "plant closing" (as defined in the Worker Adjustment and Retraining Notification Act (the "WARN Act") or any similar Law) affecting any site of employment or one or more facilities or operating units within any site of employment or facility of the Company or any of its Subsidiaries or (ii) a "mass layoff" (as defined in the WARN Act, or any similar Law) affecting any site of employment or facility of the Company or any of its Subsidiaries. 2.19 Environmental Compliance. The Company and its Subsidiaries are in compliance in all Material respects with applicable Environmental Laws and have not in the past five (5) years, received written notice of any Material noncompliance with applicable Environmental Laws. The Company has not received notice of any Material Environmental Claim, nor, to the Knowledge of the Company, is the Company or any of its Subsidiaries subject to any Material Environmental Claim. To the Knowledge of the Company, neither the Company nor any of its Subsidiaries nor any other Person acting on its or their behalf has disposed of, transported, stored, or arranged for the disposal of any Hazardous Materials to, at or upon: (a) any location other than a site lawfully permitted to receive such Hazardous Materials; (b) any premises owned or leased by the Company or its Subsidiaries, except for the use of household cleaners and office products in the ordinary course of business in Material compliance with applicable Environmental Laws; or (c) any site which has been placed on the National Priorities List, CERCLIS or their state equivalents. To the Knowledge of the Company, there has not occurred during the period the Company or its Subsidiaries operated or possessed any premises owned or leased by the Company or its Subsidiaries, nor is there presently occurring, a Material Release of any Hazardous Materials on, into or beneath the surface of, or adjacent to, any premises owned or leased by the Company or its Subsidiaries. Except for the use of household cleaners and office products in the ordinary course of business in Material compliance with applicable Environmental Laws, no Hazardous Materials are used, stored, manufactured, or otherwise present at any property leased or owned by the Company or any of its Subsidiaries. 2.20 Certain Transactions. The Company and its Subsidiaries are not indebted, directly or indirectly, to any of its or their directors or officers or to any member of their Immediate Families in any amount whatsoever, except for indebtedness to employees for accrued salaries, bonuses and other employee benefits not yet payable or for reasonable business expenses actually incurred. None of the directors or officers of the Company or its Subsidiaries, nor any member of their Immediate Families, is indebted to the Company or its Subsidiaries or, to the Knowledge of the Company, has any direct or indirect economic interest in, or otherwise serves as a director, officer or employee of, or consultant to, any firm or business entity with which the Company or its Subsidiaries has a Material business relationship or competes (other than the ownership of five percent (5%) or less of the outstanding voting securities of any such firm or business entity). To the Knowledge of the Company, no officer or director of the Company or its Subsidiaries, or any member of his or her Immediate Family, is, directly or indirectly, interested in any Material Contract. -37- 2.21 Brokers or Finders. Except for Merrill, Lynch, Pierce, Fenner & Smith Incorporated, neither the Company nor any of its Subsidiaries has entered into any Contract entitling any agent, broker, investment banker, financial advisor or other firm or Person to any broker's or finder's fee or any other commission or similar fee in connection with any of the transactions contemplated hereby. 2.22 Accounts Receivable. All accounts receivable which are reflected in the Balance Sheet have been generated in the ordinary course of business of the Company and its Subsidiaries. All accounts receivable of the Company and its Subsidiaries included in the Balance Sheet and those incurred in the ordinary course of business of the Company and its Subsidiaries since the Balance Sheet Date, are valid receivables subject to no set offs or counterclaims, are from bona fide transactions and are collectible and in accordance with their terms at their recorded amounts, subject only to reasonable reserves for bad debts, returns, allowances and rebates that have been determined in accordance with GAAP consistent with the past practices of the Company and reflected in the books and records of the Company and its Subsidiaries. 2.23 Accounts Payable. Other than Transaction Expenses incurred after the date hereof or for which the Company has not received an invoice, the Balance Sheet sets forth all amounts payable by the Company or any of its Subsidiaries to any vendor, supplier or customer arising out of or relating to any sale actually made or service actually performed through such date. Except as accrued for or reserved against in the Balance Sheet, neither the Company nor any of its Subsidiaries has any obligations or liabilities to any vendors, suppliers or its customers including with out limitation any refund or returns of products sold prior to the Closing Date or any rebate by the Company or any of its Subsidiaries to any of its customers. 2.24 Inventory. All inventory of the Company and of its Subsidiaries consists of raw materials and supplies, manufactured and purchased parts, goods in process and finished goods (the "Inventory"), all of which is merchantable and fit for the purpose for which it was procured or manufactured, and none of which is slow-moving, obsolete, damaged, or defective, subject only to the reserve for Inventory write-down reflected in the Financial Statements, as adjusted for the sale of Inventory through the Closing Date in accordance GAAP. The quantities of each item of Inventory (whether raw materials, work-in-process or finished goods) are reasonable in the present circumstances of the Company. 2.25 Bank Accounts. Section 2.25 of the Company Disclosure Schedule sets forth the names and locations of all banks and other financial institutions at which the Company or any of its Subsidiaries maintain a safe deposit box, lock box, or monetary account of any nature, together with the type, identifying number, and the authorized signatories of each such account. 2.26 Indebtedness. Section 2.26 of the Company Disclosure Schedule sets forth all of the outstanding Indebtedness of the Company (the "Scheduled Debt") as of the date hereof, together with any prepayment or other penalties that would result from the prepayment or refinancing of such Indebtedness. All of the Scheduled Debt has been incurred in the ordinary course of business of the Company and its Subsidiaries and has been used for valid corporate purposes. The Company has no Indebtedness other than the Scheduled Debt. 2.27 Large Customers. Section 2.27 of the Company Disclosure Schedule sets forth the 10 largest customers or group of related customers of the Company and its Subsidiaries (the "Large Customers") for the fiscal year ended December 31, 2006. No other customer made payments which equaled or exceeded five percent (5%) of the gross sales of the Company and its Subsidiaries for the fiscal year ended December 31, 2006 or is projected to make -38- payments which equal or exceed such percentage for the current fiscal year. None of the Large Customers has terminated, or, to the Knowledge of the Company, threatened to terminate, its relationship with the Company or has during the last twelve (12) months significantly decreased or limited, or threatened to significantly decrease or limit, its usage or purchase of the goods or services of the Company. To the Knowledge of the Company, none of the Large Customers presently intend to otherwise modify its relationship with the Company in a manner adverse to the Company (other than seeking standard price reductions), and the transactions contemplated by this Agreement will not, to the Knowledge of the Company, adversely affect the relationship of the Surviving Corporation, the business of the Surviving Corporation or Purchaser, as successor owner of the Company, with any of the Large Customers. 2.28 Large Vendors. Section 2.28 of the Company Disclosure Schedule sets forth the 10 largest vendors or group of related vendors of the Company and its Subsidiaries (the "Large Vendors") for the fiscal year ended December 31, 2006. No other vendor made sales which equaled or exceeded five percent (5%) of the gross purchases of the Company and its Subsidiaries for the fiscal year ended December 31, 2006 or is projected to make sales which equal or exceed such percentage for the current fiscal year. None of the Large Vendors has terminated, or threatened to terminate, its relationship with the Company or any its Subsidiaries or has during the last twelve (12) months significantly decreased or limited, or threatened to significantly decrease or limit, its sale of goods or services to the Company or any of its Subsidiaries (other than seeking standard cost increases). To the Knowledge of the Company, none of the Large Vendors presently intend to otherwise modify its relationship with the Company or its Subsidiaries in a manner adverse to the Company or its Subsidiaries (other than seeking standard cost increases), and the transactions contemplated by this Agreement will not, to the Knowledge of the Company, adversely affect the relationship of the Surviving Corporation, the business of the Surviving Corporation or Purchaser, as successor owner of the Company, with any of the Large Vendors. 2.29 Sufficiency of Assets. Following consummation of the Saxon Divestiture and the delivery of the Saxon IP License, the Company and its Subsidiaries will continue to have all of the assets, property and rights that, to the Knowledge of the Company, are necessary for the operation of the business of the Company and each of its Subsidiaries as presently conducted by the Company or any such Subsidiary. None of the Saxon IP constitutes, individually or in the aggregate, any assets, property or rights used in connection with the business of the Company or any of its Subsidiaries as presently conducted by the Company or any of its Subsidiaries. 2.30 Previous Sales; Warranties. Except for such defects and other breaches that have been reserved for in the Financial Statements or are not, individually or in the aggregate, Material, all goods sold or distributed and all services performed by the Company and its Subsidiaries were of merchantable quality; and neither the Company nor any of its Subsidiaries has breached any express or implied warranties offered by it in connection with the sale or distribution of such goods or services. 2.31 Insurance. Set forth in Section 2.31 of the Company Disclosure Schedule is a complete and accurate list and description of all policies (including fire, liability, product liability, workers compensation, health and other forms of insurance) issued to the Company or any of its Subsidiaries with respect to the business or properties of the Company or any of its Subsidiaries. The Company separately has provided or made available to Purchaser the following information with each such policy: (i) the name, address, and telephone number of the agent; -39- (ii) the name of the insurer, the name of the policyholder, and the name of each covered insured; (iii) the policy number and the period of coverage; (iv) the scope (including an indication of whether the coverage was on a claims made, occurrence, or other basis) and amount (including a description of how deductibles and ceilings are calculated and operate) of coverage; and (v) a description of any retroactive premium adjustments or other loss-sharing arrangements. With respect to each such insurance policy listed in Section 2.31 of the Company Disclosure Schedule: (A) the policy is legal, valid, binding and in full force and effect; (B) to the Knowledge of the Company, the policy will continue to be legal, valid, binding and in full force and effect on identical terms immediately following the consummation of the transactions contemplated hereby; (C) neither the Company, any of its Subsidiaries nor any other party to the policy is in Material breach or default (including with respect to the payment of premiums or the giving of notices), and no event has occurred that, with notice or the lapse of time, would constitute such a Material breach or default, or permit termination, modification, or acceleration, under the policy; and (D) no party to the policy has repudiated any Material provision thereof. Neither the Company nor any of its Subsidiaries has been refused any insurance with respect to any aspect of the operations of its business nor has its coverage been limited by any insurance carrier to which it has applied for insurance or with which it has carried insurance during the last three (3) years. There is no claim by the Company or any of its Subsidiaries pending under any such policies as to which coverage has been questioned, denied or disputed by the underwriters of such policies, and the Company has no Knowledge of any basis for denial of any pending claim under any such policy. 2.32 Contracts with Indemnification/Warranty Provisions. Each Contract for the provision of goods or services to which the Company or any of its Subsidiaries is a party that imposes or imposed indemnification or warranty obligations on the part of the Company or any such Subsidiary that survive as of the date of this Agreement or as of the Closing Date expressly provides that the liability of the Company or any such Subsidiary under such indemnification or warranty provision is limited to an amount not in excess of the aggregate dollar amount paid by the other party or parties to the Company or its Subsidiary, as the case may be, under such Contract. 2.33 Disclosure. To the Knowledge of the Company, no representation or warranty by the Company set forth in this Agreement (taking into account the information provided in the Company Disclosure Schedule) contains any untrue statement of a Material fact or omits to state any Material fact necessary in order to make such representations and warranties, in light of the circumstances under which they are made, not misleading. Article 3 REPRESENTATIONS AND WARRANTIES OF PURCHASER AND MERGER SUB Purchaser and Merger Sub represent and warrant to the Company as set forth in this Article 3. 3.1 Organization. Each of Purchaser and Merger Sub (a) is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction in which it is organized; (b) has all requisite corporate power and authority to carry on its business as now -40- being conducted and to own the properties and assets it now owns; and (c) is duly qualified or licensed to do business as a foreign corporation in good standing in every jurisdiction in which such qualification is required, except where the failure to be so qualified or licensed would not have, individually or in the aggregate, a material adverse effect on the business, assets, liabilities conditions (financial or otherwise), operations, prospects or results of operations of Purchaser and its Subsidiaries, taken as a whole. 3.2 Authorization. Each of Purchaser and Merger Sub has full corporate power and authority to execute and deliver this Agreement and to consummate the transactions contemplated hereby. The execution and delivery by Purchaser and Merger Sub of this Agreement, the performance by Purchaser and Merger Sub of their respective obligations hereunder and the consummation by Purchaser and Merger Sub of the transactions contemplated hereby have been duly authorized by all necessary corporate action on the part of Purchaser and Merger Sub, subject only to the filing of Certificate of Merger pursuant to Delaware Law. 3.3 Execution and Validity. This Agreement has been duly executed and delivered by Purchaser and Merger Sub. Assuming the due and valid authorization, execution and delivery hereof by the Company and the Company Stockholder Representative, this Agreement is a valid and binding obligation of each of Purchaser and Merger Sub enforceable against Purchaser and Merger Sub in accordance with its terms except for the Enforceability Limitations. 3.4 Consents and Approvals; No Violations. Except for the filings, permits, authorizations, consents and approvals as may be required under, and other applicable requirements of, the HSR Act and the filing of the Certificate of Merger with the Secretary of State of the State of Delaware, none of the execution and delivery by Purchaser and Merger Sub of this Agreement, the performance by Purchaser and Merger Sub of their respective obligations hereunder, nor the consummation by Purchaser and Merger Sub of the transactions contemplated hereby will (a) conflict with or result in any breach of any provision of the Certificate of Incorporation or By-Laws (or similar organization documents) of Purchaser and Merger Sub, each as amended to date, or (b) require any declaration or filing with, or permit, authorization, consent or approval of, any Governmental Entity. 3.5 Availability of Funds. As of the date hereof, Purchaser has, and as of the Closing Date, Purchaser will have, sufficient immediately available funds in cash to (i) repay the Credit Agreement Debt, (ii) pay the Merger Consideration, and (iii) pay any and all other amounts payable pursuant to this Agreement and to effect the transactions contemplated hereby. 3.6 Litigation. There is no action, suit or proceeding, at law or in equity, pending by or before any Governmental Entity or, to the knowledge of Purchaser or Merger Sub, threatened, against Purchaser or Merger Sub that challenges the validity of this Agreement or the ability of Purchaser or Merger Sub to consummate the Merger. 3.7 Brokers or Finders. The Company Stockholders shall not have any liability for any Contract to which Purchaser or Merger Sub is subject entitling any agent, broker, investment banker, financial advisor or other firm or Person to any broker's or finder's fee or any other commission or similar fee in connection with any of the transactions contemplated hereby. Article 4 CONDUCT PRIOR TO THE EFFECTIVE TIME 4.1 Interim Operations of the Company. From the date hereof through the Effective Time, except (i) as otherwise expressly contemplated by this Agreement or (ii) as may -41- be consented to by Purchaser in writing, the Company shall, and shall cause its Subsidiaries to, comply with the following: (a) The Company and its Subsidiaries shall conduct its and their business in the usual and ordinary course and shall use commercially reasonable efforts to maintain the value of such business as a going concern and its relationships with its current customers, suppliers, vendors, employees, agents and other Persons having Material business relationships with the Company and its Subsidiaries and preserve for Purchaser the goodwill of such customers, suppliers, vendors, employees, agents and other Persons. Without limiting the foregoing, the Company shall continue all pending and planned research and development projects and shall provide no less than the level of resources (human and financial) in connection therewith as have been provided in accordance with past practices. (b) The Company shall not (i) amend, modify, or repeal any provision of its Certificate of Incorporation or By-Laws or consent to any such amendment, modification or repeal; (ii) issue, sell, transfer, pledge, dispose of or encumber any shares of any class or series of its capital stock, or securities convertible into or exercisable or exchangeable for, or options, warrants, calls, commitments or rights of any kind to acquire, any shares of any class or series of its capital stock (other than the issuance of up to the balance of authorized by unissued shares of Common Stock under the Company Restricted Stock Plan to current or new Company Employees or service providers); (iii) except for the Saxon Divestiture effected in the form of a "spin-off" (as described in Section 5.13), declare, set aside or pay any dividend or other distribution payable in cash, stock or property with respect to any shares of any class or series of its capital stock; (iv) split, combine or reclassify any shares of any class or series of its stock; or (v) redeem, purchase or otherwise acquire directly or indirectly any shares of any class or series of its capital stock, or any instrument or security which consists of or includes a right to acquire such shares (other than any redemption, purchase or acquisition pursuant to the Company Restricted Stock Plan). (c) The Company and its Subsidiaries shall not, except in the ordinary course of business consistent with past practice (i) create, incur, assume, guarantee, endorse, refinance, modify, extend, renew or otherwise become liable for any Indebtedness, obligation or other liability; (ii) other than with respect to the Credit Agreement, pay, agree to cancel or pay, or otherwise provide for a complete or partial discharge in advance of a scheduled payment date with respect to any Indebtedness, obligation or other liability; (iii) waive, cancel or compromise any right to receive any direct or indirect Material payment or other benefit under any debt, obligation or other liability owing to the Company or such Subsidiary; (iv) other than in connection with the Saxon Divestiture, sell, lease or otherwise dispose of any Material assets; or (v) grant any loans or extensions of credit to any third party. (d) Except in connection with the Saxon Divestiture, the Company and its Subsidiaries shall not (i) sell, license or transfer to any Person any rights to any IP or enter into any agreement with respect to any IP with any Person with respect to any IP of any Person; (ii) buy or license any IP or enter into any agreement with respect to the IP of any Person; or (iii) enter into any agreement with respect to the development of any IP with a third party; (e) The Company and its Subsidiaries shall not commence or settle any Legal Proceeding other than collection of debts in the ordinary course of business; -42- (f) Except in connection with the Saxon Divestiture, the Company and its Subsidiaries shall not enter into any licensing (other than non-exclusive end user licenses in the ordinary course of business and on standard terms and conditions), distribution, joint venture, strategic alliance or joint marketing or any similar arrangement or agreement; (g) The Company and its Subsidiaries shall not enter into any partnership, joint venture or other similar arrangement or agreement involving a sharing of profits or losses; (h) The Company and its Subsidiaries shall not (i) amend, terminate or waive any right in any Material respect under any Material Contract, except in the ordinary course of business consistent with past practice; (ii) merge or consolidate with any Person; (iii) purchase any capital stock of or other equity interest in any Person; (iv) purchase assets constituting a business, (v) create or suffer the imposition of any Encumbrance upon any of its assets, except for Permitted Encumbrances; (vi) make any change in its pricing policies or payment or credit policies; or (vii) fail to pay any creditor any Material amount owed to such creditor when due (other than amounts disputed in good faith in the ordinary course of business consistent with past practice). (i) Neither the Company nor any of its Subsidiaries shall (i) increase the compensation payable or to become payable (including bonuses) to any of the Company Employees (other than normal increases in the ordinary course of business consistent with past practice or pursuant to plans, programs or agreements existing on the date hereof), including the establishment or adoption of any employee benefit plan, except as may be provided in any outstanding employment or severance agreement or pursuant to the acceleration of vesting of any Restricted Stock pursuant to an outstanding agreement, or (ii) pay or agree to pay any bonus or other compensation to any Person in connection with the transactions contemplated hereby. (j) The Company shall not adopt or become a party to any plan of complete or partial liquidation, dissolution, restructuring, recapitalization or other reorganization of the Company. (k) The Company shall not change in any Material respect any of the accounting methods used by it or revalue any of its assets (whether tangible or intangible) unless required by GAAP or change its annual accounting period. (l) The Company and its Subsidiaries shall continue to make capital expenditures in the ordinary course of business consistent with past practices and the capital expenditure budget heretofore provided to Purchaser; provided, however, the Company and its Subsidiaries shall not make any capital expenditures exceeding $250,000 in the aggregate. (m) The Company and its Subsidiaries shall not enter into any agreement, contract or binding commitment to do any of the foregoing. (n) The Company shall provide to Purchaser, as soon as available but in no event later than 15 days after the end of each calendar month, the Company's consolidated unaudited balance sheet as at the end of such month and the related statements of income, retained earnings for such month covering the Company's and Subsidiaries' operations during such month and for the portion of the fiscal year then ended. -43- (o) A list of all Registered Intellectual Property held by Saxon and a summary of any other IP (if any) held by Saxon (collectively, the "Saxon IP") and a list of any other assets transferred to Saxon or included in the Saxon Divestiture is set forth in Section 4.1(o) of the Company Disclosure Schedule. After the date of this Agreement, without the approval of Purchaser, neither the Company nor any of its Subsidiaries will assign or transfer to Saxon any IP or other assets of the Company or any of its Subsidiaries not set forth in Section 4.1(o) of the Company Disclosure Schedule; provided that the foregoing shall not be deemed to restrict the Company from completing any assignment or re-registration of IP that has been listed in Section 4.1(o) of the Company Disclosure Schedule as currently pending or in progress, or, subject to Purchaser's approval, which approval shall not be unreasonably withheld or delayed, from correcting any administrative errors. 4.2 Tax Matters. Without the prior written consent of Purchaser, which consent shall not be unreasonably withheld, delayed or conditioned, neither the Company nor any of its Subsidiaries shall make or change any Tax election, file any amended Tax Return, enter into any closing Contract, settle any Tax claim or assessment, Knowingly surrender any right to claim a refund of Taxes, consent to any extension or waiver of the limitation period applicable to any Tax claim or assessment, or take any other similar action relating to the filing of any Tax Return or the payment of any Tax, if such election, amendment, Contract, settlement, surrender, consent or other action would have the effect of increasing the Tax liability of the Company or any of its Subsidiaries for any period ending after the Closing Date; provided, however, that this Section 4.2 shall not apply to the filing by the Company and its Subsidiaries of their respective federal and state income Tax Returns in the ordinary course of business consistent with past practice. Article 5 COVENANTS 5.1 Stockholder Approval. Promptly after the execution of this Agreement, the Company shall take such action as shall be necessary under Delaware Law to submit this Agreement to the Company Stockholders for their approval by written consent. The Company shall solicit the written consent of such Company Stockholders as shall be necessary to achieve the Required Stockholder Vote as promptly as practicable following the execution of this Agreement. Within ten business days after the execution by Company Stockholders holding at least a majority of the Company Common Stock of an action by written consent of Company Stockholders approving this Agreement, the Company shall circulate to the remaining holders of Company Common Stock written notice and appropriate informational materials as and to the extent required under Delaware Law of the taking of corporate action by less than unanimous written consent of the Company Stockholders (the "Stockholder Notification"). The Stockholder Notification (if any be required) shall be in form and substance reasonably acceptable to each of Purchaser and the Company. The Stockholder Notification shall include (i) notice under Delaware Law that the holders of Company Common Stock are or may be entitled to assert dissenters' or appraisal rights under such law, (ii) a copy of this Agreement, and (iii) other appropriate informational materials. Each of Purchaser and the Company shall provide promptly to the other such information concerning its business and affairs as the other shall reasonably request for inclusion in such Stockholder Notification. The Company will promptly advise Purchaser, and Purchaser will promptly advise the Company, if at any time prior to the Effective Time either the Company or Purchaser, as applicable, shall obtain knowledge of any -44- facts that might make it necessary or appropriate to amend or supplement the Stockholder Notification in order to make the statements contained or incorporated by reference therein not misleading or to comply with applicable law. 5.2 Access. Until the earlier of the Effective Time or the termination of this Agreement pursuant to its terms, the Company shall give Purchaser and its authorized representatives reasonable access to all books, records, personnel, offices and other facilities and properties of the Company and its Subsidiaries; provided, however, that any such access to the Company's and its Subsidiaries' facilities shall be conducted at Purchaser's expense in the sole discretion of the Company, at a reasonable time during normal business hours, under the supervision of the Company's personnel and in such a manner as to maintain the confidentiality of this Agreement and the transactions contemplated hereby and not to interfere unreasonably with the normal operation of the business of the Company. Nothing herein shall require the Company to disclose any information to Purchaser if such disclosure would (i) jeopardize any attorney-client or other legal privilege; or (ii) contravene any applicable Legal Requirements, fiduciary duty or binding agreement entered into prior to the date of this Agreement (including any confidentiality agreement to which the Company or any of its Subsidiaries is a party); provided that the Company shall advise Purchaser of any such information that is withheld solely by reason of a confidentiality agreement with a third party and the parties will use all commercially reasonable efforts to obtain the consent of such third party to such disclosure. 5.3 Confidentiality. Purchaser and the Company acknowledge that they are parties to that certain Nondisclosure Agreement, dated as of April 27, 2006 (the "Confidentiality Agreement"), which agreement shall continue in full force and effect in accordance with its terms. 5.4 No Solicitation. From and after the date of this Agreement until the earlier of the Effective Time, sixty (60) days following the date hereof or the termination of this Agreement pursuant to its terms, the Company will not, nor will the Company authorize or permit (to the extent within its power and authority) any of its directors, officers, Subsidiaries, Affiliates or employees or any investment banker, advisor, representative or other agent of the Company to, directly or indirectly, (i) solicit, initiate or induce the making, submission or announcement of any Acquisition Proposal or (ii) participate in or encourage any discussions or negotiations regarding, or furnish to any Person any nonpublic information with respect to, or take any other action to facilitate any inquiries or the making of any proposal that constitutes, or may reasonably be expected to lead to, any Acquisition Proposal. 5.5 Public Disclosure. Purchaser, Merger Sub, the Company and the Company Stockholder Representative will not make any public disclosure concerning the Merger or any of the other transactions contemplated hereby without the prior written consent of Purchaser and the Company, except as may be required by any applicable Legal Requirement. 5.6 Reasonable Efforts; Notification. (a) Upon the terms and subject to the conditions set forth in this Agreement, each of the Parties agrees to use all commercially reasonable efforts to take, or cause to be taken, all actions, and to do, or cause to be done, and to assist and cooperate with the other Parties in doing, all things necessary, proper or advisable (subject to any applicable Legal Requirements) to consummate and make effective, in the most expeditious manner practicable, the Merger and the other transactions contemplated by this Agreement, including using all commercially reasonable efforts to accomplish the following: (i) causing the conditions precedent set forth in Article 7 to be satisfied; (ii) defending any Legal Proceeding challenging this Agreement or the -45- consummation of the transactions contemplated hereby, including seeking to have any stay or temporary restraining order entered by any court or other Governmental Entity vacated or reversed; and (iii) executing and delivering any additional instruments necessary to consummate the transactions contemplated by, and to fully carry out the purposes of, this Agreement. (b) Promptly after the date hereof, the Company shall give all notices required to be given to third parties in connection with the transactions contemplated hereby, and the Company shall obtain prior to the Closing all consents identified or required to be identified in Section 2.5 of the Company Disclosure Schedule. (c) Purchaser and Merger Sub, on the one hand, and the Company, on the other hand, will give prompt notice to the other of (i) any notice or other communication from any Person alleging that the consent of such Person is or may be required in connection with the Merger; (ii) any notice or other communication from any Governmental Entity in connection with the Merger; and (iii) any Legal Proceeding relating to, involving or otherwise affecting the consummation of the Merger or the other transactions contemplated hereby. 5.7 Antitrust and Other Filings. (a) As promptly as practicable after the execution of this Agreement, in the case of the Antitrust Filing required under the Hart-Scott-Rodino Act, not later than three Business Days following such execution, each of Purchaser and the Company shall prepare and file (i) any pre-merger notification forms required by the merger notification or control laws and regulations of any applicable jurisdiction, as agreed to by Purchaser and the Company (the "Antitrust Filings") and (ii) any other filings required to be filed by it under the Exchange Act, the Securities Act or any other Legal Requirement relating to the Merger and the transactions contemplated hereby (the "Other Filings"). Each of Purchaser and the Company shall promptly supply the other with any information which may reasonably be required in order to effectuate any filings pursuant to this Section 5.7. Concurrently with the filing of the Antitrust Filings, or as soon thereafter as practicable, Purchaser and the Company shall each request early termination of any waiting period under any applicable Legal Requirement that permits such request for early termination. (b) Each of Purchaser, Merger Sub and the Company shall notify the other promptly upon the receipt of any comments from any Governmental Entity in connection with any filing made pursuant hereto and of any request for amendments or supplements to any Antitrust Filing or Other Filing or for additional information and shall supply the other with copies of all correspondence between such Party or any of its representatives, on the one hand, and any Governmental Entity, on the other hand, with respect to the Merger or any Antitrust Filing or Other Filing. Each of Purchaser, Merger Sub and the Company shall cause all documents that it is responsible for filing with any Governmental Entity to comply in all material respects with all Legal Requirements. Whenever any event occurs which is required to be set forth in an amendment or supplement to any Antitrust Filing or Other Filing, Purchaser or the Company, as the case may be, shall promptly inform the other of such occurrence and cooperate in filing such amendment or supplement with the appropriate Governmental Entity. Purchaser and the Company shall each pay fifty percent (50%) of any and all filing fees, assessments or charges imposed by any Governmental Entity in connection with any Antitrust Filings or Other Filings. -46- 5.8 Disclosure. Prior to the Effective Time, each Party shall give prompt notice to the other Parties of: (a) the occurrence or non-occurrence of any event, the occurrence or non-occurrence of which is likely to cause any representation or warranty of such Party contained in this Agreement to be untrue or inaccurate in any Material respect at or prior to the Effective Time, and (b) any failure of such Party to comply with or satisfy, in any Material respect, any covenant, condition or agreement to be complied with or satisfied by it hereunder; provided, however, that the delivery of any notice pursuant to this Section 5.8 shall not (i) limit or otherwise affect any remedies available to the Party receiving such notice or (ii) constitute an acknowledgement or admission of a breach of this Agreement. In addition, until the Closing, the Company may from time to time deliver to Purchaser such additions to or modifications of any section of the Disclosure Schedule necessary to make the information set forth therein and in the Sections and subsections of this Agreement true, accurate and complete in all Material respects; provided, however, that such supplemental disclosure shall not be deemed to be included in the Company's representations for purposes of satisfying the condition to Closing in Section 8.3(a) unless accepted (or not objected to) by Purchaser, in which case such additional disclosures shall be deemed to modify and supplement the Company's representations for all purposes hereunder. 5.9 Employee Benefit Plans. For a period of six (6) months after the Effective Time, Purchaser and the Surviving Corporation shall either (i) maintain in effect, on the same terms and conditions as shall be in effect immediately prior to the Effective Time, the Plans that are "group health plans" subject to Section 4980B of the Code in which any Company Employee shall participate as of immediately prior to the Effective Time or (ii) provide substantially equivalent group health benefits to the Company Employees (and other covered persons). Group health benefits under a plan shall not be "substantially equivalent" for purposes of this Section 5.9 unless such plan shall (to the extent applicable) (x) recognize expenses and claims that were incurred by the Company Employees (and other covered persons) in the year in which the Effective Time occurs for purposes of computing deductible amounts, co-payments or other limitations on coverage under such plan; (y) provide coverage for pre-existing health conditions of any Company Employee (and other covered persons), except to the extent that such pre-existing condition would have been excluded under the terms of the Plan in effect immediately prior to the Effective Time; and (z) take into account the service of the Company Employee for the Company or any of its Subsidiaries prior to the Effective Time for eligibility, vesting, benefit computation, accrual and other purposes. Nothing in this Section 5.9 shall require the inclusion of any Company Employee (or any other covered person) in any benefit plan of Purchaser. Nothing in this Section 5.9 shall obligate the Surviving Corporation to employ any person for any period of time after the Closing, and this Section 5.9 shall not be construed to limit the ability of the Surviving Corporation to alter the terms and conditions of, or terminate, the employment of any person (other than with respect to benefits as provided herein). 5.10 Indemnification, Exculpation and Insurance Plans. (a) Purchaser and Merger Sub agree that all rights to indemnification and exculpation (including the advancement of expenses) from liabilities for acts or omissions occurring at or prior to the Effective Time (including with respect to the transactions contemplated hereby) now existing in favor of the current or former directors or officers of the Company or its Subsidiaries as provided in the Company's Certificate of Incorporation and By-Laws or other organizational documents of a Subsidiary, or in any written indemnification agreement with the officers, directors or agents of the Company or its Subsidiaries, shall be assumed by the Surviving Corporation in the Merger, without further action, as of the Effective -47- Time and shall survive the Merger and shall continue in full force and effect in accordance with their terms, and Purchaser shall cause the Surviving Corporation to honor all such rights. The Certificate of Incorporation and By-Laws of the Surviving Corporation will contain provisions with respect to exculpation and indemnification (including the advancement of expenses) that are at least as favorable to the current or former directors, officers, employees and agents of the Company as those contained in the Certificate of Incorporation and By-Laws of the Company as in effect on the date hereof, which provisions will not be amended, repealed or otherwise modified for a period of seven years after the Effective Time in any manner that would adversely affect the rights thereunder of individuals who, immediately prior to the Effective Time, were directors, officers, employees or agents of the Company, unless such modification is required by law. (b) On or before the Closing Date, Purchaser shall cause the Surviving Corporation to obtain, at Purchaser's expense, a non-cancelable runoff insurance policy for a period of not less than six (6) years after the Closing Date to provide insurance coverage (which coverage shall be at least as favorable to the insureds as the coverage now in effect) for events, acts or omissions occurring on or prior to the Closing Date for all persons who were directors or officers of the Company on or prior to the Closing Date. (c) In the event that the Surviving Corporation or any of its successors or assigns (i) consolidates with or merges into any other Person and is not the continuing or surviving corporation or entity of such consolidation or merger or (ii) transfers or conveys all or substantially all of its properties and assets to any Person, or otherwise dissolves, then, and in each such case, Purchaser shall cause proper provision to be made so the successors and assigns of the Surviving Corporation assume the obligations set forth in this Section 5.10. (d) The provisions of this Section 5.10: (i) are intended to be for the benefit of, and will be enforceable by, each indemnified party and his or her heirs, executors and legal representatives and (ii) are in addition to, and not in substitution for, any other rights to indemnification or contribution that any such person may have by contract or otherwise; provided, however, that such third parties shall have no rights or remedies under this Agreement until after the Effective Time. 5.11 Company 401(k) Plan(s). Prior to the Effective Time, the Company shall terminate its 401(k) plan(s) effective as of the date immediately prior to the Effective Time, but contingent on the Effective Time. Purchaser hereby agrees that it will use its commercially reasonable efforts to cause its 401(k) plan to accept direct rollovers of notes representing participant loans that constitute "eligible rollover distributions" within the meaning of Section 402(c) of the Code from or relating to the Company's 401(k) plan(s) by employees of the Company who become employees of Purchaser or Merger Sub by reason of the transactions contemplated hereby. Rollover amounts contributed to Purchaser's 401(k) plan in accordance with this Section 5.11 shall at all times be one hundred percent (100%) vested and shall be invested in accordance with the provisions of Purchaser's 401(k) plan. 5.12 Takeover Statutes. If any Takeover Statute is or may become applicable to the Merger or the other transactions contemplated hereby, each of the Parties shall grant such approvals and take such lawful actions as are necessary to eliminate or minimize the effects of such Takeover Statute and any regulations promulgated thereunder on such transactions. -48- 5.13 Saxon Divestiture. (a) Divestiture. Prior to the Closing, the Company intends to sell either its ownership interest in Saxon or all of Saxon's assets, or, alternatively, at the Company's sole discretion the equity interests of Saxon may be distributed to the Company's Stockholders by means of a dividend (i.e., a "spin-off"), which spin-off the Company shall be required to effect if the sale of Saxon or its assets shall not have occurred prior to Closing (referred to herein as the "Saxon Divestiture"). (b) License. The Saxon IP shall remain subject to each of those certain Patent License Agreements, dated May 4, 2007 and March 24, 2006, by and between Legerity, Inc. and Saxon, as amended in accordance with this Section (the "Saxon License Agreements"). Within five days of the date hereof, and before entering into the Saxon Divestiture, the Company shall: (i) have each such Saxon License Agreement amended to specify that such agreement may be assigned to Purchaser and its Affiliates (whether now existing or in the future becoming so) after the closing hereunder; and (ii) if the Saxon IP encompasses IP in addition to the IP included in the Saxon License Agreements, the May 4, 2007 Saxon License Agreement shall be further amended to include such additional IP. (c) Other Agreements. In connection with the Saxon Divestiture, the Company and its Subsidiaries also will be granted a covenant not to sue with respect to the Saxon IP and a release, in form and substance reasonably satisfactory to the Purchaser, releasing the Purchaser, the Company and its Subsidiaries from any and all claims, actions and all other liabilities which the acquiror of the Saxon IP then has or ever will have against the Purchaser, the Company or such Subsidiaries arising out of the Saxon Divestiture or the Saxon Divestiture Agreements (except to the limited extent of escrows established as provided below). The Saxon IP shall be subject to such Saxon License Agreements and covenant, regardless of any future transfer thereof or any other right granted therein. The purchaser of the ownership interest in Saxon or all of Saxon's assets shall acknowledge in writing the Saxon License Agreements and such covenant, and any future purchaser of or holder of right in or to any such Saxon IP shall be obligated to acknowledge in writing such licenses and covenant if reasonably requested by Purchaser (or its successors under the license terms). (d) Saxon Divestiture Agreements; Escrow for Liabilities. Prior to execution and delivery thereof by Saxon, the Company or any Subsidiary of the Company, the Company shall provide Purchaser with copies of all agreements and documents to be entered into or executed by Saxon, the Company or any Subsidiary of the Company in connection with the Saxon Divestiture (collectively, the "Saxon Divestiture Agreements"). The Saxon Divestiture Agreements shall be in form and substance reasonably satisfactory to Purchaser, provided that in no event shall the Company or any of its Subsidiaries, or, if it is to remain as a subsidiary of the Company following the Closing, Saxon, have any indemnification or other obligation or liability, contingent or otherwise, under or arising from or related to the Saxon Divestiture Agreements, any of the Saxon IP or otherwise following the Saxon Divestiture. Notwithstanding anything to the contrary stated herein, (A) if the Saxon Divestiture Agreements contain any representations, warranties, covenants or agreements of the Company or any of its Subsidiaries (including, for purposes of this provision only, Saxon if it remains a subsidiary of -49- Purchaser or the Surviving Corporation following the Merger) that survive the closing the Saxon Divestiture and that impose or reasonably could be expected to impose any indemnification obligation, liability, loss, cost or expense on Purchaser, the Company or any of its Subsidiaries (collectively, "Liability") and, notwithstanding the inclusion of such provisions Purchaser has deemed the Saxon Divestiture Agreements satisfactory as contemplated above, then (i) if the Saxon Divestiture Agreements provide for an overall cap on the indemnification obligations of Saxon, the Company or any of its Subsidiaries in favor of the purchaser thereunder (the "Saxon Indemnity Cap"), such portion of the cash proceeds from the Saxon Divestiture as is equal to the Saxon Indemnity Cap shall be deposited into escrow pursuant to the terms of an escrow agreement, in form and substance substantially consistent with the Indemnification Escrow Agreement, to secure any claims that may be made against Purchaser, the Company or any of its Subsidiaries, and (ii) if the Saxon Divestiture Agreements do not provide for an overall cap on such indemnification, such portion of such cash proceeds as is equal to the dollar amount of the mutually agreed (which mutual agreement will not be unreasonably withheld by the Company or Purchaser) potential Liability under the Saxon Divestiture Agreements shall be so deposited, in each case for a period of time equal to the post-closing period during which any such representations, warranties, covenants and agreements or potential Liability survive under the terms of the applicable Saxon Divestiture Agreements; and (B) The Saxon Divestiture Agreements shall expressly provide that Saxon (or the Company or any of its Subsidiaries, as the case may be), shall have the right to terminate the Saxon Divestiture Agreements if for any reason the closing thereunder shall not have occurred on or before July 20, 2007. (e) Spin-off. Notwithstanding the foregoing, in the event that the Company and Purchaser are unable to reach agreement regarding the matters in this Section 5.13, the Company shall effect the Saxon Divestiture prior to Closing by means of a dividend or distribution of Saxon's equity interests to the Company Stockholders; provided that the spun-off entity remains subject to the Saxon License Agreements. Article 6 INDEMNIFICATION AND SURVIVAL 6.1 Survival Period. The representations and warranties of Purchaser, Merger Sub and the Company contained in this Agreement or in any certificate delivered at the Closing shall survive the Closing Date and continue in effect for a period of 12 months after the Closing Date except for representations and warranties of the Company set forth in Sections 2.6 (Capitalization), 2.15 (Employee Benefit Plans), 2.16 (Tax Matters) and 2.19 (Environmental Compliance) and except for the obligation to indemnify pursuant to Article 7, which shall survive for the period of the applicable statutes of limitation (as applicable, the "Survival Period"), after which such representations and warranties shall terminate immediately. Claims -50- based upon or arising out of such representations and warranties may only be asserted on or before the expiration of the applicable Survival Period. All covenants and agreements that by their terms are to be performed after the Closing shall expire upon the completion of performance or waiver thereof. Claims based upon or arising out of covenants and agreements of the Company to be performed at or prior to the Closing may only be asserted on or before the expiration of the applicable Survival Period. No knowledge of, or investigation by or on behalf of, any Party shall constitute or effectuate a waiver of such Party's rights to indemnification under this Article 6. The termination of representations, warranties, covenants and agreements provided in this Section 6.1 shall not affect the rights of any Indemnified Party (as defined below) in respect of any claim made by any Indemnified Party in a writing received by the Indemnifying Party (as defined below) pursuant to and in compliance with the provisions of this Article 6 and Article 7 prior to the expiration of the applicable Survival Period. Except to the extent provided herein, the Parties intend to shorten the statute of limitations and agree that no claims or causes of action based upon, directly or indirectly, any of the representations, warranties, covenants or agreements terminated as provided in this Section 6.1 may be brought after the expiration of the applicable Survival Period. No representation, warranty, covenant or agreement of any Party contained in this Agreement shall survive any termination of this Agreement except as provided in Section 9.2. 6.2 Indemnification of Purchaser. Subject to the limitations set forth in this Article 6, Purchaser, the Surviving Corporation, their respective directors, officers, employees, agents and Affiliates, and the respective heirs, executors, personal representatives, successors and assigns of the foregoing Persons (the "Purchaser Indemnified Parties"), shall be indemnified and held harmless by the Company Stockholders, severally in accordance with their respective Pro Rata Portions and not jointly, from and against and in respect of all Losses arising out of or resulting from (i) any breach of, or inaccuracy in, any representation or warranty contained in Article 2 of this Agreement, the Company Officer's Certificate or the Secretary's Certificate; (ii) any breach of any covenant or agreement of the Company contained in this Agreement; (iii) indemnification for Taxes under Section 7.1; and (iv) any matter arising out of or relating to the Saxon Divestiture. 6.3 Indemnification of the Company Stockholders. Subject to the limitations set forth in this Article 6, the Company Stockholders, their respective directors, officers, employees, agents, Subsidiaries and Affiliates, and the respective heirs, executors, personal representatives, successors and assigns of the foregoing Persons (the "Company Stockholder Indemnified Parties"), shall be indemnified and held harmless by Purchaser and the Surviving Corporation from and against and in respect of all Losses arising out of or resulting from (i) any breach of, or inaccuracy in, any representation or warranty contained in Article 3 of this Agreement or any certificate delivered by Purchaser or Merger Sub at the Closing, (ii) indemnification for Taxes under Article 7, or (iii) any breach of any covenant or agreement of Purchaser or Merger Sub contained in this Agreement. 6.4 Procedure for Claims between Parties. If a claim for Losses is to be made by a Person entitled to indemnification hereunder (an "Indemnified Party"), the Indemnified Party shall give written notice (a "Claim Notice"), in the case of claims pursuant to Section 6.2 and Section 7.1, to the Company Stockholder Representative, and in the case of claims pursuant to Section 6.3, to Purchaser (each Person so notified being referred to as the "Indemnifying Party") promptly after the Indemnified Party becomes aware of any fact, condition or event which may give rise to Losses for which indemnification may be sought under this Article 6 or -51- Article 7. Any failure to provide any such Claim Notice in a timely manner to the Indemnifying Party shall not relieve the Indemnifying Party of any liability hereunder, except to the extent the Indemnifying Party is actually prejudiced by such failure. Each Claim Notice shall set forth: (i) the specific representation, warranty, covenant or agreement alleged to have been breached; (ii) the nature and amount of the claim asserted, together with sufficient facts relating thereto so that the Indemnifying Party may reasonably evaluate such claim; and (iii) a calculation or good faith estimate, if such can be reasonably calculated, of the aggregate Losses to which the Indemnified Party believes it is entitled in connection with the claim. If the Indemnifying Party, within twenty (20) business days after receipt of the Claim Notice, does not give written notice to the Indemnified Party stating its intent to contest such claim, the claim shall be deemed accepted and the amount of the claim shall be deemed a valid claim, and the Indemnifying Party shall, within ten (10) business days after expiration of the prior notice period, deliver to the Indemnified Party the amount of the Losses with respect to the claim. If the Indemnifying Party shall contest the assertion of a claim by giving such written notice to the Indemnified Party within such period (a "Dispute Notice"), then the Parties shall act in good faith to reach agreement regarding such claim. 6.5 Arbitration. (a) If the Indemnified Party and the Indemnifying Party shall not have reached agreement regarding the claim that is the subject of a Dispute Notice within thirty (30) days of delivery of the Dispute Notice, then each of the Indemnified Party and the Indemnifying Party shall have the right, by delivery of written notice to the other (the "Arbitration Notice"), to submit the matter to binding arbitration in Austin, Texas. Such matter shall then be settled by three arbitrators in accordance with the Commercial Arbitration Rules then in effect of the American Arbitration Association (the "AAA Rules"). Each of the Indemnified Party and the Indemnifying Party shall designate one arbitrator within thirty (30) days of the delivery of the Arbitration Notice. The Indemnified Party and the Indemnifying Party shall cause such designated arbitrators mutually to agree upon and designate a third arbitrator; provided, however, that (i) failing such agreement within sixty (60) days of delivery of the Arbitration Notice, the third arbitrator shall be appointed in accordance with the AAA Rules and (ii) if either the Indemnified Party or the Indemnifying Party shall fail to timely designate an arbitrator, the dispute shall be resolved by the one arbitrator timely designated. The fees and expenses of designated arbitrators and the third arbitrator, if any, shall be borne equally by the Indemnified Party and the Indemnifying Party (and, if the Company Stockholder Representative shall be the Indemnifying Party, the Company Stockholder Representative's portion of such fees and expenses shall be paid exclusively by the Company Stockholders). The Indemnified Party and the Indemnifying Party shall cause the arbitrators to decide the matter to be arbitrated pursuant hereto within sixty (60) days after confirmation of the appointment of the last arbitrator. The arbitrators' decision shall relate solely to whether the Indemnified Party is entitled to receive the claimed damages (or a portion thereof) pursuant to the terms of this Agreement. The final decision of the majority of the arbitrators shall be furnished to the Indemnified Party and the Indemnifying Party in writing and shall constitute a conclusive, final and non-appealable determination of the issue in question, binding upon the Indemnified Parties and the Indemnifying Parties, as applicable, and their successors and assigns. Such decision may be used in a court of law only for the purpose of seeking enforcement of the arbitrators' award. Any award granted by the arbitrators will be subject to the limitations contained in this Article 6. -52- (b) Each of the Parties hereby irrevocably and unconditionally waives its right to file claims in any court of law or equity (other than to enforce the arbitrators' award) with respect to any and all disputes arising out of or from or relating to the transactions contemplated hereby. Each of the Parties hereby irrevocably and unconditionally consents to submit any and all such disputes to the exclusive jurisdiction of the American Arbitration Association. (c) The Parties hereby exclude and waive any right of appeal to any court of law or equity on the merits of any and all disputes. Subject to Section 10.6, the provisions of this Section 6.5 may be enforced in any court having jurisdiction over the arbitrators' award or any of the Parties or any of their respective assets, and judgment on the award (including equitable remedies) granted in any arbitration hereunder may be entered in any such court. (d) The prevailing Party in any arbitration (or any action, suit or proceeding to enforce the arbitrators' award) shall be entitled to recover such Party's reasonable costs and attorneys' fees incurred in connection with such arbitration (or such action, suit or proceeding). 6.6 Defense of Third-Party Claims. If any action, suit or proceeding is filed or any claim is made against any Indemnified Party by a third party, and such Indemnified Party may be entitled to indemnification under this Agreement with respect to such claim, such Indemnified Party shall give written notice thereof to the Indemnifying Party as promptly as practicable (and in any event within five (5) calendar days after receipt of service of process or other notice of such action, suit, proceeding or claim). The failure of any Indemnified Party to give timely notice hereunder shall not affect any rights to indemnification hereunder, except to the extent that the Indemnifying Party is actually prejudiced by such failure. After such notice, the Indemnifying Party shall be entitled, if it so elects and at its own expense (subject to the limitations set forth in this Article 6), (a) to take control of the defense and investigation of such action, suit, proceeding or claim; (b) to employ and engage attorneys of its own choice to handle and defend the same; provided, however, that the Indemnified Party may participate in any action, suit, proceeding or claim with attorneys of its own choice and at its own expense; and provided further that if the named parties to such action, suit, proceeding or claim include both the Indemnified Party and the Indemnifying Party (or, if the Company Stockholder Representative is the Indemnifying Party, any Company Stockholder), and the Indemnified Party has been advised in writing by its counsel that there may be one or more legal defenses available to such Indemnified Party that are different from or in addition to those available to the Indemnifying Party, the Indemnified Party shall be entitled, at the Indemnifying Party's expense (subject to the limitations set forth in this Article 6), to separate counsel of its own choosing; and (c) to negotiate, compromise or settle such claim, which compromise or settlement shall be made only with the prior written consent of the Indemnified Party, such consent not to be unreasonably withheld. The Indemnified Party shall cooperate with the Indemnifying Party and its attorneys in the investigation, trial and defense of such action, suit, proceeding or claim and any appeal arising therefrom. In the case of Purchaser and the Surviving Corporation, such cooperation shall include the retention, and the provision to the Company Stockholder Representative upon request, of records and information reasonably relevant to such third-party claim, and making employees of Purchaser and the Surviving Corporation available on a mutually convenient basis to provide additional information and explanation of any materials provided hereunder. The Parties shall cooperate with each other in any notifications to insurers. If the Indemnifying Party fails to assume the defense of such claim within fifteen (15) calendar days after receipt of notice -53- of the third-party action, suit, proceeding or claim, the Indemnified Party against which such claim has been asserted will (upon delivering notice to such effect to the Indemnifying Party) have the right to undertake, at the Indemnifying Party's expense (subject to the limitations set forth in this Article 6), the defense, compromise or settlement of such claim on behalf of the Indemnifying Party; provided, however, that such claim shall not be compromised or settled without the prior written consent of the Indemnifying Party, such consent not to be unreasonably withheld. If the Indemnified Party assumes the defense of the claim, the Indemnified Party will keep the Indemnifying Party reasonably informed of the progress of any such defense, compromise or settlement. The Indemnifying Party shall be liable (subject to the limitations set forth in this Article 6 and Article 7) for any settlement of any action, suit, proceeding or claim effected pursuant to and in accordance with this Section 6.6 and for any final judgment (subject to any right of appeal), and the Indemnifying Party shall indemnify and hold harmless (subject to the limitations set forth in this Article 6 and Article 7) an Indemnified Party from and against any Losses by reason of such settlement or judgment. No Indemnified Party shall take any action the purpose of which is to prejudice the defense of any claim subject to indemnification hereunder or to induce a third party to assert a claim subject to indemnification hereunder. 6.7 Limitation on Obligations of the Company Stockholder Representative. If the Company Stockholder Representative is the Indemnifying Party, (a) the Company Stockholder Representative shall be indemnified and held harmless by the Company Stockholders severally (and not jointly) for all Losses incurred by or on behalf of the Company Stockholder Representative pursuant to this Article 6 except where incurred as a result of the Company Stockholder Representative's fraud, willful misconduct or gross negligence and (b) if at any time the Company Stockholders fail to pay or provide for payment of any and all Losses so incurred by the Company Stockholder Representative, the Company Stockholder Representative shall have no further obligation to pursue any arbitration, defend any third-party claim or otherwise to take any action whatsoever pursuant to this Article 6. For purposes of clarity, in no event shall the Company Stockholder Representative have any liability or obligation to any Indemnified Party except out of, and solely to the extent of, amounts paid by or provided for payment by the Company Stockholders. 6.8 Limitations on Indemnification Obligations. (a) The Purchaser Indemnified Parties shall not be entitled to recover for any Losses unless and until such time as the Losses in the aggregate for which the Purchaser Indemnified Parties are entitled to be indemnified hereunder, including the indemnification for Taxes set forth in Article 7, exceed $250,000 (the "Purchaser Loss Threshold"), at which time the Purchaser Indemnified Parties shall be entitled to recover all such Losses in excess of the amount of the Purchaser Loss Threshold. Except for those Losses which arise out of the indemnification for Taxes under Article 7 or a breach of the representations and warranties contained in Section 2.1 (Organization), Section 2.2 (Subsidiaries), Section 2.4 (Execution and Delivery), Section 2.6 (Capitalization), and Section 2.16 (Tax Matters) or actual fraud, in no event shall the Losses for which the Purchaser Indemnified Parties are entitled to be indemnified hereunder exceed, with respect to any Company Stockholder, an amount equal to $6.0 million, and in any event Losses with respect to the indemnification for Taxes under Article 7 or with respect to breaches of Sections 2.1 (Organization), 2.2 (Subsidiaries), 2.4 (Execution and Delivery), 2.6 (Capitalization) and 2.16 (Tax Matters) of this Agreement and actual fraud shall not exceed with respect to a Company Stockholder such Company Stockholder's Pro Rata Portion of the Common Merger Consideration actually received by such Company Stockholder. -54- Each Loss for which the Purchaser Indemnified Parties are entitled to be indemnified hereunder shall be reduced by (i) the amount of any insurance proceeds which the Purchaser Indemnified Parties recover with respect to such Loss; (ii) any indemnity, contribution or other similar payment which the Purchaser Indemnified Parties receive from any third party with respect to such Loss; and (iii) an amount equal to any net Tax Benefits of the Purchaser Indemnified Parties attributable to such Loss. The liability of any Company Stockholder for damages under this Agreement shall be several and not joint, and any assertion of Losses against any Company Stockholder may only be made pro rata based on such Company Stockholder's Pro Rata Portion and limited to the Common Merger Consideration actually received by such Company Stockholder. If a Tax Benefit attributable to a Loss is realized by the Purchaser Indemnified Parties after the taxable year of payment of the Loss, Purchaser shall pay to each Company Stockholder an amount in cash equal to such stockholder's Pro Rata Portion of the amount of such Tax Benefit. (b) Each Loss for which the Company Stockholder Indemnified Parties are entitled to be indemnified hereunder shall be reduced by (i) the amount of any insurance proceeds which the Company Stockholder Indemnified Parties recover with respect to such Loss; and (ii) any indemnity, contribution or other similar payment which the Company Stockholder Indemnified Parties receive from any third party with respect to such Loss. (c) This Section 6.8 is in no way intended to affect the obligation of Purchaser to deliver the Merger Consideration and the aggregate amount of Credit Agreement Debt being paid by Purchaser at Closing in accordance with the terms of this Agreement. (d) Notwithstanding anything to the contrary contained herein, in the Indemnification Escrow Agreement, the Working Capital Escrow Agreement, or the Stockholder Representative Agreement, and in any of the agreements contemplated hereby or thereby, the maximum aggregate liability of any Company Stockholder to the Purchaser and Merger Sub, whether by reason of indemnification, reimbursement or other payment obligation of any type, any liability in tort, contract or otherwise, shall never exceed the amount of Common Merger Consideration actually received by such Company Stockholder. 6.9 No Duplication; Exclusive Remedy. (a) Any liability for indemnification hereunder and under Article 7 shall be determined without duplication of recovery by reason of the state of facts giving rise to such liability constituting a breach of more than one representation, warranty, covenant or agreement or constituting a breach of a representation under Section 2.16 and an indemnification obligation under Article 7. Without limiting the foregoing, amounts paid in accordance with Section 1.13 with respect to a Working Capital Deficit shall not be subject to duplication (e.g., in the event or to the extent that an inaccuracy in the Company's financial statement representations gave rise to such adjustment). (b) From and after the Closing, the sole remedy of the Purchaser Indemnified Parties and the Company Stockholder Indemnified Parties with respect to any breach of, or inaccuracy in, a representation or warranty contained in this Agreement, the Company Officer's Certificate, the Company Secretary's Certificate or any certificate delivered by Purchaser or Merger Sub at the Closing, or any breach of any covenant or agreement in this Agreement shall -55- be pursuant to the indemnification provisions set forth in this Article 6 and Article 7. The foregoing sentence is in no way intended to affect the obligation of Purchaser to deliver the Merger Consideration and the aggregate amount of Credit Agreement Debt being paid by Purchaser at Closing in accordance with the terms of this Agreement. (c) This Section 6.9 shall not affect the rights or remedies of third-party beneficiaries under Section 5.9 and Section 5.10; provided, however, that such third parties shall have no rights or remedies under this Agreement until after the Effective Time. 6.10 No Additional Representations or Warranties. Purchaser has conducted its own independent investigation, review and analysis of the business, operations, properties, premises, personnel, assets, liabilities, results of operations, financial condition, software, technology and prospects of the Company, which investigation, review and analysis was done by Purchaser and, to the extent Purchaser deemed appropriate, by Purchaser's representatives. Purchaser acknowledges that it and its representatives have been provided access to the properties, premises, personnel and records of the Company which Purchaser deemed sufficient for such purpose. In entering into this Agreement, Purchaser acknowledges that it has relied solely upon the aforementioned investigation, review and analysis and not on any representations, warranties or statements of the Company, the Company Stockholders or their respective representatives, except the representations and warranties of Company specifically set forth in Article 2 of this Agreement. Article 7 CERTAIN TAX MATTERS 7.1 Tax Indemnification. The Company Stockholders, severally in accordance with their respective Pro Rata Portions and not jointly, shall indemnify the Surviving Company and Purchaser and hold them harmless from and against without duplication, any Losses, claim, liability, expense, or other damage attributable to (i) all Taxes (or the non-payment thereof) of the Company and its Subsidiaries for all taxable periods ending on or before the Closing Date and the portion through the end of the Closing Date for any taxable period that includes (but does not end on) the Closing Date ("Pre-Closing Tax Period"), (ii) all Taxes of any member of an affiliated, consolidated, combined or unitary group of which the Company or any of its Subsidiaries (or any predecessor of any of the foregoing) is or was a member at or prior to the Effective Time, including pursuant to Treas. Reg. ss. 1.1502-6 or any analogous or similar state, local, or foreign law or regulation, and (iii) any and all Taxes of any person (other than the Company and its Subsidiaries) imposed on the Company or any of its Subsidiaries as a transferee or successor, by contract or pursuant to any law, rule, or regulation, which Taxes relate to an event or transaction occurring before the Closing; provided, however, that (A) in the case of clauses (i), (ii), and (iii) above, the Company Stockholders shall be liable only to the extent that such Taxes exceed the amount, if any, reserved for such Taxes (excluding any reserve for deferred Taxes established to reflect timing differences between book and Tax income) and taken into account in calculating the Closing Working Capital pursuant to Section 1.13; and (B) the Company Stockholders shall not be liable for any Taxes attributable to actions not in the ordinary course of business and not contemplated by this Agreement taken by Purchaser or the Company after the Effective Time. The Company Stockholders shall, severally and not jointly, be liable to Purchaser for such Company Stockholder's Pro Rata Portion of any Taxes of Company or its Subsidiaries that are the responsibility of Company Stockholders pursuant to this -56- Section 7.1 after determination and resolution pursuant to the procedures and subject to the limitations set forth under Article 6. During any period in which the Indemnification Escrow is in effect, Purchaser shall first be reimbursed for such amounts from the Indemnification Escrow Amount, and only after exhausting that amount, from the Company Stockholders, severally in accordance with their respective Pro Rata Portions. 7.2 Straddle Period. In the case of any taxable period that includes (but does not end on) the Closing Date (a "Straddle Period"), the amount of any Taxes based on or measured by income or receipts of Company and its Subsidiaries for the Pre-Closing Tax Period shall be determined based on an interim closing of the books as of the close of business on the Closing Date (and for such purpose, the taxable period of any partnership or other pass-through entity in which Company or any of its Subsidiaries holds a beneficial interest shall be deemed to terminate at such time); and the amount of other Taxes of Company and its Subsidiaries for a Straddle Period that relates to the Pre-Closing Tax Period shall be deemed to be the amount of such Tax for the entire taxable period multiplied by a fraction the numerator of which is the number of days in the taxable period ending on the Closing Date and the denominator of which is the number of days in such Straddle Period. 7.3 Responsibility for Filing Tax Returns. Purchaser shall in good faith prepare or cause to be prepared and timely file or cause to be timely filed all Tax Returns for Company and its Subsidiaries relating to a Pre-Closing Tax Period or a Straddle Period that are filed after the Closing Date. Purchaser shall permit the Company Stockholder Representative to review and comment on each such Tax Return and the records and work papers used in the preparation thereof. All such Tax Returns shall be prepared on a basis consistent with the most recent Tax Returns unless Purchaser determines that there is no reasonable basis for such position, and shall be true, correct and complete in all material respects. Purchaser shall make such changes to such Tax Returns as the Company Stockholder Representative shall reasonably request (unless there is no reasonable basis for such position), and shall not file such Tax Returns without the Company Stockholder Representative's consent, which shall not be unreasonably withheld, delayed or conditioned. 7.4 Cooperation on Tax Matters. (a) Purchaser, the Surviving Corporation and its Subsidiaries, and the Company Stockholder Representative shall cooperate fully, as and to the extent reasonably requested by the other Party, in connection with the filing of Tax Returns pursuant to this Section 7.4 and any audit, litigation or other proceeding with respect to Taxes. Such cooperation shall include the retention and (upon the other Party's request) the provision of records and information that are reasonably relevant to any such audit, litigation or other proceeding and making employees available on a mutually convenient basis to provide additional information and explanation of any material provided hereunder. The Surviving Corporation and its Subsidiaries agree (A) to retain all books and records with respect to Tax matters pertinent to the Surviving Corporation and its Subsidiaries relating to any taxable period beginning before the Closing Date until the expiration of the statute of limitations (and, to the extent notified by Company Stockholder Representative or Purchaser, any extensions thereof) of the respective taxable periods, and to abide by all record retention agreements entered into with any taxing authority, and (B) to give the other Party reasonable written notice prior to transferring, destroying or discarding any such books and records and, if the other Party so requests, the Surviving Corporation and its Subsidiaries or the Company Stockholder Representative, as the case may be, shall allow the other Party to take possession of such books and records. -57- (b) Purchaser and the Company further agree, upon request, to use their reasonable best efforts to obtain any certificate or other document from any governmental authority or any other Person as may be necessary to mitigate, reduce or eliminate any Tax that could be imposed (including, but not limited to, with respect to the transactions contemplated hereby). (c) Purchaser and the Company Stockholder Representative further agree, upon request, to provide the other Party with all information that either Party may be required to report pursuant to Code Section 6043A or the Treasury Regulations promulgated thereunder. (d) It is understood that following the Effective Time the Company will be a wholly owned Subsidiary of Purchaser and that as a result Purchaser shall be liable for any breach by the Company or its Subsidiaries of their respective obligations under this Article 7. 7.5 Tax-Sharing Agreements. All Tax-sharing agreements or similar agreements with respect to or involving the Company and its Subsidiaries shall be terminated as of the Effective Time and, after the Effective Time, the Surviving Company and its Subsidiaries shall not be bound thereby or have any liability thereunder. 7.6 Certain Taxes and Fees. Any sales or other similar Tax and any transfer, recording or similar fee imposed on the Company with respect to the transactions provided for in this Agreement, and any interest or penalties related thereto, shall be shared on a 50/50 basis by the Company and by Purchaser; provided, however, the Company shall be responsible for any Taxes imposed on the Company or its Subsidiaries with respect to a transfer of Closing Cash occurring on or before the Closing Date contemplated by Section 8.3(n) of this Agreement. With respect to the Company's share of such Taxes and fees, such Taxes and fees, including any interest or penalties related thereto, shall either be paid by the Company prior to the Closing Date or shall be accrued for by the Company as of the Closing Date and be considered in determining the Closing Working Capital. 7.7 Refunds. Purchaser or the Surviving Corporation, as the case may be, shall pay to the Company Stockholders in accordance with their respective Pro Rata Portion, in cash any amount received as a refund, rebate, credit or set-off of Taxes for which the Company Stockholders are responsible pursuant to this Article 7 within fifteen (15) business days of such receipt by Purchaser or the Surviving Corporation, except to the extent that such amount was taken into account in calculating final Closing Working Capital; provided that (a) Purchaser may offset its payment obligations under this Section 7.7 with indemnifiable Tax Losses pursuant to Section 7.1, and (b) the obligation of Purchaser under this Section 7.7 shall only take effect after the earlier to occur of (i) amounts of Tax refunds, credits or set-offs so received or offset against exceed $250,000 or (ii) Purchaser shall have made claims for Losses in excess of the Purchaser Loss Threshold. Any such payment may, while the Indemnification Escrow remains in existence, be deposited into the Indemnification Escrow. Upon termination for the Indemnification Escrow (or within such 15 business day period if the Indemnification Escrow shall have already terminated) any such amounts shall be distributed (x) to the Company Stockholders in accordance with their respective Pro Rata Portions. -58- Article 8 CLOSING CONDITIONS 8.1 General Conditions to Obligations to Effect the Merger. The respective obligations of the Company, Purchaser and Merger Sub to effect the Merger shall be subject to the satisfaction at or prior to the Closing Date of the following conditions, any of which may be waived, in writing, by the Company and Purchaser: (a) Stockholder Approval. The Required Stockholder Vote shall have been obtained. (b) No Order. No Governmental Entity shall have enacted, issued, promulgated, enforced or entered any Legal Requirement or Order which is in effect and which has the effect of making the Merger illegal or otherwise prohibiting consummation of the Merger. (c) Governmental Consents. All Antitrust Filings and Other Filings pursuant to Section 5.7 shall have been made or obtained (and all relevant waiting periods shall have expired or early termination thereof have been granted). 8.2 Additional Conditions to Obligations of the Company. The obligation of the Company to consummate and effect the Merger shall be subject to the satisfaction at or prior to the Closing Date of each of the following conditions, any of which may be waived, in writing, exclusively by the Company: (a) Representations and Warranties. Each representation and warranty of Purchaser and Merger Sub contained in this Agreement shall be true and correct on and as of the Closing Date with the same force and effect as if made on the Closing Date. The Company shall have received a certificate with respect to the foregoing signed on behalf of Purchaser by an authorized officer of Purchaser. (b) Agreements and Covenants. Purchaser and Merger Sub shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by them on or prior to the Closing Date, and the Company shall have received a certificate to such effect signed on behalf of Purchaser by an authorized officer of Purchaser. (c) Available Funding. Purchaser shall have sufficient immediately available funds in cash to (i) repay the Credit Agreement Debt, (ii) pay the Merger Consideration, and (iii) pay any and all other amounts payable pursuant to this Agreement at the Effective Time and to effect the transactions contemplated hereby, and shall have deposited with the Exchange Agent the Payment Fund. (d) Indemnification Escrow. A counterpart, duly executed by each of Purchaser and the Indemnification Escrow Agent, of the Indemnification Escrow Agreement. (e) Working Capital Escrow. A counterpart, duly executed by each of Purchaser and the Working Capital Escrow Agent, of the Working Capital Escrow Agreement. -59- (f) Saxon Divestiture. The Company shall have completed the Saxon Divestiture, subject to and in accordance with Section 5.13; provided that this shall cease to be a condition to Closing if the Saxon Divestiture shall not have been consummated prior to July 20, 2007. 8.3 Additional Conditions to Obligations of Purchaser and Merger Sub. The obligations of Purchaser and Merger Sub to consummate and effect the Merger shall be subject to the satisfaction at or prior to the Closing Date of each of the following conditions, any of which may be waived, in writing, exclusively by Purchaser: (a) Representations and Warranties. Each representation and warranty of the Company contained in this Agreement (other than those which address matters only as of a particular date) shall be true and correct in all Material respects (except that any representation and warranty expressly qualified as to Materiality or with respect to the Knowledge of the Company or a Company Material Adverse Effect shall be true and correct in all respects giving effect to such qualifier) on and as of the date hereof and as of the Closing Date with the same force and effect as if made on such dates, and each representation and warranty which addresses matters only as of a particular date shall have been true and correct in all Material respects (except that any representation and warranty expressly qualified as to Materiality or with respect to the Knowledge of the Company or a Company Material Adverse Effect shall be true and correct in all respects giving effect to such qualifier) as of such particular date as though made on the date hereof and as of the Closing Date. (b) Agreements and Covenants. The Company and its Subsidiaries shall have performed or complied in all Material respects with all agreements and covenants required by this Agreement to be performed or complied with by it on or prior to the Closing Date, except that with respect to the covenants and agreements contained in Section 5.13, the Company and its Subsidiaries shall have performed or complied with all such agreements or covenants on or prior to the Closing Date. (c) Certificates. Purchaser shall have received the Company Officer's Certificate and the Company Secretary's Certificate. (d) No Restraints. There shall not be pending any Legal Proceeding (i) seeking to restrain, prohibit or otherwise interfere with the ownership or operation by Purchaser or any of its Subsidiaries of all or any Material portion of the business of the Company or of Purchaser or any of its Subsidiaries or to compel Purchaser or any of its Subsidiaries to dispose of or hold separate all or any Material portion of the business or assets of the Company or of Purchaser or any of its Subsidiaries; (ii) seeking to impose or confirm limitations on the ability of Purchaser or any of its Subsidiaries effectively to exercise full rights of ownership of the shares of Company Common Stock (or shares of stock of the Surviving Corporation), including the right to vote on any matter; or (iii) seeking to require divestiture by Purchaser or any of its Subsidiaries of any such shares or any other Material assets. (e) Legal Opinion. Purchaser shall have received from counsel to the Company an opinion with respect to the matters set forth in Exhibit D. -60- (f) FIRPTA. On or before the Closing Date, the Company shall have delivered to Purchaser a certification that shares of Company Common Stock are not "U.S. real property interests" in accordance with Treasury Regulations under Sections 897 and 1445 of the Code, together with authorization for Purchaser, as agent for the Company, to deliver a copy of the certification, along with the appropriate notification, to the IRS on behalf of the Company, in accordance with the provisions of Section 1.897-2(h)(2) of the Treasury Regulations. (g) Release of Liens. Against and conditioned on repayment in full of the amounts owing under the Credit Agreement, each lender party to the Credit Agreement (or the administrative agent thereunder as applicable) shall have delivered to Purchaser (i) a payoff letter with respect to such Credit Agreement and (ii) a completed UCC-3 termination statement releasing all liens against assets of the Company and its Subsidiaries, in each case to be held in escrow until receipt by the lenders of all principal and interest outstanding under the Credit Agreement. (h) Indemnification Escrow. A counterpart, duly executed by each of the Company Stockholder Representative and the Indemnification Escrow Agent, of the Indemnification Escrow Agreement. (i) Working Capital Escrow. A counterpart, duly executed by each of the Company Stockholder Representative and the Working Capital Escrow Agent, of the Working Capital Escrow Agreement. (j) Employee Agreements. (i) A counterpart, duly executed by each of the individuals identified on Schedule 8.3(j)(1) attached hereto, of an employment letter agreement with the Surviving Corporation, in the form agreed to by each such employee and Purchaser prior to execution of this Agreement. (ii) In addition, at least 18/30 of the employees identified on Schedule 8.3(j)(2) attached hereto shall have agreed to continue in the employ of the Surviving Corporation; provided that this condition in part (ii) shall only be applicable if the terms of employment (including location, responsibilities, salary and benefits, but excluding the equity-based compensation and bonus) that have been offered by Purchaser or Surviving Corporation to each such employee are on terms not materially inconsistent with such employees' current terms of employment by the Company or its Subsidiaries. (k) Payment of Company's Fees and Expenses. All Transaction Expenses shall have been paid in full by the Company and Purchaser shall have received evidence of such payment to its reasonable satisfaction. (l) Working Capital Deficit. The Working Capital Deficit, if any, estimated prior to Closing pursuant to Section 1.13, shall not be greater than two million dollars ($2,000,000) unless the Company Stockholder Representative shall have agreed (but without obligation to do so) to an increase in the Working Capital Escrow Amount to an amount equal to such estimated Working Capital Deficit. (m) Dissenting Shares. Purchaser shall have received evidence, in form and substance reasonably satisfactory to Purchaser, that the number of Dissenting Shares shall -61- constitute no more that five percent (5.0%) of the total number of shares of the Company Common Stock Shares outstanding immediately prior to the Effective Time. (n) Deposit of Closing Cash with Exchange Agent. Not later than three business days prior to the anticipated Closing Date, the Company shall deliver to Purchaser a certificate of the Company's principal financial officer which shall set forth an estimate of the Covered Transaction Expense Amount and an estimate of the amount of cash and cash equivalents of the Company and each its Subsidiaries as of the Closing Date. The Company shall provide an updated certificate as of the Closing Date, which shall include evidence satisfactory to Purchaser of the amount of cash and cash equivalents (if any) that will be transferred in immediately available funds to the Exchange Agent for disbursement in accordance with Section 1.11 (such amount referred to herein as "Closing Cash"). (o) Saxon Divestiture. The Saxon Divestiture shall have been consummated at least one business day prior to the date set for Closing in accordance with Section 1.3 on terms consistent with, and no less favorable to Purchaser and the Surviving Corporation, than those set forth in Section 5.13. Article 9 TERMINATION, AMENDMENT AND WAIVER 9.1 Termination. This Agreement may be terminated at any time prior to the Effective Time, whether before or after the Required Stockholder Vote shall have been obtained: (a) by the written consent of Purchaser and the Company; (b) by either the Company or Purchaser if the Merger shall not have been consummated within sixty (60) days of the date hereof for any reason; provided, however, that the right to terminate this Agreement under this Section 9.1(b) shall not be available to (i) the Company if any action or failure to act by the Company shall have been a principal cause of or resulted in the failure of the Merger to occur on or before such date and such action or failure to act shall have constituted a material breach of this Agreement, or (ii) Purchaser if any action or failure to act by Purchaser or Merger Sub shall have been a principal cause of or resulted in the failure of the Merger to occur on or before such date and such action or failure to act shall have constituted a material breach of this Agreement; (c) by either the Company or Purchaser if a Governmental Entity shall have issued an Order or taken any other action, in any case having the effect of permanently restraining, enjoining or otherwise prohibiting the Merger, which Order or other action is final and non-appealable; (d) by the Company, upon a breach of any representation, warranty, covenant or agreement on the part of Purchaser or Merger Sub set forth in this Agreement, or if any representation or warranty of Purchaser or Merger Sub shall have become untrue, in either case such that the conditions set forth in Section 8.2(a) or Section 8.2(b) would not be satisfied as of the time of such breach or as of the time such representation or warranty shall have become untrue, provided that if such breach by Purchaser or Merger Sub or such inaccuracy in the representations and warranties of Purchaser or Merger Sub is curable by Purchaser or Merger -62- Sub, then the Company may not terminate this Agreement under this Section 9.1(d) until thirty (30) days after delivery of written notice to Purchaser of such breach and intent to terminate, provided Purchaser and Merger Sub continue to exercise commercially reasonable efforts to cure such breach (it being understood that the Company may not terminate this Agreement pursuant to this Section 9.1(d) if such breach by Purchaser or Merger Sub is cured during such thirty (30) day period, or if the Company shall have materially breached this Agreement); or (e) by Purchaser, upon a breach of any representation, warranty, covenant or agreement on the part of the Company set forth in this Agreement, or if any representation or warranty of the Company shall have become untrue, in either case such that the conditions set forth in Section 8.3(a) or Section 8.3(b) would not be satisfied as of the time of such breach or as of the time such representation or warranty shall have become untrue in any respect, provided that if such breach by the Company or such inaccuracy in the representations and warranties of the Company is curable by the Company, then Purchaser may not terminate this Agreement under this Section 9.1(e) until thirty (30) days after delivery of written notice to the Company of such breach and intent to terminate, provided the Company continues to exercise commercially reasonable efforts to cure such breach (it being understood that Purchaser may not terminate this Agreement pursuant to this Section 9.1(e) if such breach by the Company is cured during such thirty (30) day period, or if Purchaser shall have materially breached this Agreement). 9.2 Notice of Termination; Effect of Termination. Any proper termination of this Agreement under Section 9.1 will be effective immediately upon the delivery of written notice of termination by the terminating Party, in the case of Purchaser, to the Company, and in the case of the Company, to Purchaser (it being understood that, in the case of any termination pursuant to Section 9.1(d) or Section 9.1(e) based on any breach or inaccuracy which is curable, delivery of notice of intent to terminate pursuant to Section 9.1(d) or Section 9.1(e) shall not be construed as notice of termination). In the event of the termination of this Agreement as provided in Section 9.1, this Agreement shall be of no further force or effect, except (i) as set forth in Section 9.1, this Section 9.2 and Sections 10.1 through 10.9, each of which shall survive the termination of this Agreement, and (ii) nothing herein shall relieve any Party from liability for any breach of this Agreement. No termination of this Agreement shall affect the obligations of the Parties contained in the Confidentiality Agreement, all of the obligations of which shall survive termination of this Agreement in accordance with its terms. 9.3 Fees and Expenses. Except to the extent otherwise provided in this Agreement, all fees and expenses incurred in connection with this Agreement and the transactions contemplated hereby shall be paid by the Party incurring such expenses whether or not the Merger is consummated. 9.4 Amendment. Subject to applicable Legal Requirements, this Agreement may be amended by the Parties hereto at any time by execution of an instrument in writing signed on behalf of Purchaser, Merger Sub and the Company (and, as to any amendment adversely affecting the rights and obligations of the Company Stockholder Representative, the Company Stockholder Representative). 9.5 Waiver; Right to Proceed. Any Party hereto may, to the extent legally allowed, (i) extend the time for the performance of any of the obligations of the other Parties hereto to such Party; (ii) waive any inaccuracies in the representations and warranties made to such Party contained herein or in any document delivered pursuant hereto; and (iii) waive compliance with any of the agreements or conditions for the benefit of such Party contained -63- herein. Any agreement by a Party hereto to any such extension or waiver shall be valid only if set forth in an instrument in writing signed by such Party. Delay in exercising any right under this Agreement shall not constitute a waiver of such right. Article 10 GENERAL PROVISIONS 10.1 Notices. All notices and other communications hereunder shall be in writing and shall be deemed given upon delivery either personally or by commercial delivery service, or sent via facsimile (receipt confirmed) to the Parties at the following addresses or facsimile numbers (or at such other address or facsimile numbers for a Party as such Party shall specify by like notice): (a) if to Purchaser or Merger Sub, to: Zarlink Semiconductor Inc. 400 March Road Ottawa, Ontario, Canada K2K 3H4 Facsimile: (613) 270-7403 Attention: General Counsel with a copy (which shall not constitute notice) to: Sonnenschein Nath & Rosenthal LLP 1221 Avenue of the Americas New York, New York 10020 Facsimile: (212) 768-6800 Attn: Denise M. Tormey (b) if to the Company, to: Legerity Holdings, Inc. 4509 Freidrich Lane Building 2, Suite 200 Austin, Texas 78744-1812 Attention: General Counsel Facsimile: (512) 228-5510 with a copy (which shall not constitute notice) to: Andrews Kurth LLP 111 Congress Avenue, Suite 1700 Austin, Texas 78701 Facsimile: (512) 320-9292 Attention: J. Matthew Lyons, Esq. -64- (c) if to the Company Stockholder Representative, to: Navigant Capital Advisors, LLC 3414 Peachtree Rd., Ste. 450 Atlanta, GA 30326 Facsimile: (404) 816-0248 Attention: Gerald R. Benjamin 10.2 Interpretation; Certain Defined Terms. When a reference is made in this Agreement to Exhibits, such reference shall be to an Exhibit to this Agreement unless otherwise indicated. When a reference is made in this Agreement to Sections, such reference shall be to a Section of this Agreement unless otherwise indicated. The words "include," "includes" and "including" when used herein shall be deemed in each case to be followed by the words "without limitation." The headings contained in this Agreement are only for reference purposes and shall not affect in any way the meaning or interpretation of this Agreement. When reference is made herein to "the business of" an entity, such reference shall be deemed to include the business of all direct and indirect Subsidiaries of such entity, taken as a whole. Reference to the Subsidiaries of an entity shall be deemed to include all direct and indirect Subsidiaries of such entity. Reference to an agreement herein is to such agreement as amended in accordance with its terms up to the date hereof. Reference to a statute herein is to such statute, as amended. References to "dollars" or "$" mean the lawful tender of the United States of America. 10.3 Counterparts. This Agreement may be executed in one or more counterparts, all of which shall be considered one and the same agreement and shall become effective when one or more counterparts have been signed by each of Purchaser, Merger Sub, the Company, and the Company Stockholder Representative and delivered to each of Purchaser and the Company, it being understood that all such Parties need not sign the same counterpart. 10.4 Entire Agreement; Third-Party Beneficiaries. This Agreement, its Exhibits and the documents and instruments and other agreements among the Parties hereto as contemplated by or referred to herein, including the Company Disclosure Schedule, (a) constitute the entire agreement among the Parties with respect to the subject matter hereof and supersede all prior agreements and understandings, both written and oral, among the Parties with respect to the subject matter hereof, it being understood that the Confidentiality Agreement shall continue in full force and effect and shall survive any termination of this Agreement in accordance with its terms; and (b) except as expressly set forth in Section 5.9 and Section 5.10, are not intended to confer upon any other Person any rights or remedies hereunder. 10.5 Severability. In the event that any provision of this Agreement or the application thereof becomes or is declared by a court of competent jurisdiction to be illegal, void or unenforceable, the remainder of this Agreement will continue in full force and effect and the application of such provision to other Persons or circumstances will be interpreted so as reasonably to effect the intent of the Parties hereto. The Parties further agree to replace such void or unenforceable provision of this Agreement with a valid and enforceable provision that will achieve, to the extent possible, the economic, business and other purposes of such void or unenforceable provision. 10.6 Governing Law; Submission to Jurisdiction. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS, REGARDLESS OF THE LAWS THAT MIGHT OTHERWISE GOVERN UNDER APPLICABLE PRINCIPLES OF CONFLICTS OF LAWS THEREOF. EXCEPT AS -65- PROVIDED IN SECTION 6.5, THE PARTIES (i) AGREE AND CONSENT TO THE JURISDICTION OF THE DISTRICT COURTS OF TRAVIS COUNTY, TEXAS, AND OF THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF TEXAS; (ii) ACKNOWLEDGE THAT SUCH COURTS SHALL CONSTITUTE PROPER AND CONVENIENT FORUMS FOR THE RESOLUTION OF ANY ACTIONS AMONG THE PARTIES WITH RESPECT TO THE SUBJECT MATTER HEREOF; AND (iii) AGREE THAT SUCH COURTS SHALL BE THE SOLE AND EXCLUSIVE FORUMS FOR THE RESOLUTION OF ANY ACTIONS AMONG THE PARTIES WITH RESPECT TO THE SUBJECT MATTER HEREOF. 10.7 Rules of Construction; Legal Representation. The Parties agree that they have been represented by counsel during the negotiation and execution of this Agreement, which they agree is their joint product, and therefore waive the application of any Legal Requirement, holding or rule of construction providing that ambiguities in an agreement or other document will be construed against the Party drafting such agreement or document. In connection with the transactions contemplated by this Agreement, the parties acknowledge and agree that Andrews Kurth LLP solely represented the Company, and not any of its stockholders, employees, officers or directors. 10.8 Assignment. No Party may assign either this Agreement or any of its rights, interests, or obligations hereunder without the prior written consent of Purchaser, Merger Sub and the Company. Subject to the preceding sentence, this Agreement shall be binding upon and shall inure to the benefit of the Parties hereto and their respective successors and permitted assigns. Any purported assignment in violation of this Section 10.8 shall be void. 10.9 Waiver of Jury Trial. EACH OF PURCHASER, MERGER SUB, THE COMPANY AND THE COMPANY STOCKHOLDER REPRESENTATIVE HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY IN ANY ACTION, SUIT, PROCEEDING OR COUNTERCLAIM (WHETHER BASED ON CONTRACT, TORT OR OTHERWISE) ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE ACTIONS OF PURCHASER, MERGER SUB, THE COMPANY OR THE COMPANY STOCKHOLDER REPRESENTATIVE IN THE NEGOTIATION, ADMINISTRATION, PERFORMANCE AND ENFORCEMENT HEREOF. [SIGNATURE PAGE FOLLOWS] -66- IN WITNESS WHEREOF, Purchaser, Merger Sub, the Company and the Company Stockholder Representative have caused this Agreement and Plan of Merger to be executed by their respective duly authorized officers as of the date first written above. PURCHASER: ZARLINK SEMICONDUCTOR INC. By: \s\ Scott Milligan -------------------------------------- Name: Scott Milligan Title: S.R.V.P, finance and CFO By: \s\ Don McIntyre -------------------------------------- Name: Don McIntyre Title: S.R.V.P, General counsel MERGER SUB: ZLE INC. By: \s\ Scott Milligan -------------------------------------- Name: Scott Milligan Title: S.R.V.P, finance and CFO By: \s\ Don McIntyre -------------------------------------- Name: Don McIntyre Title: S.R.V.P, General Counsel THE COMPANY: LEGERITY HOLDINGS, INC. By: \s\Henry Perret -------------------------------------- Henry L. Perret President and Chief Executive Officer Solely for purposes of agreeing to its appointment and the provisions of this Agreement that relate to the rights and obligations of the Company Stockholder Representative: COMPANY STOCKHOLDER REPRESENTATIVE: NAVIGANT CAPITAL ADVISORS, LLC By: \s\ G.H. Bejour -------------------------------------- Name: G.H Bejour Title: [Signature page to Merger Agreement] F-1 EX-12.1 6 e31856ex12_1.txt SECTION 302 CERTIFICATION Exhibit 12.1 Section 302 Certification by Chief Executive Officer of Annual Report CERTIFICATION PURSUANT TO RULE 13a-14(a), AS ADOPTED PURSUANT TO SECTION 302 (a) OF THE SARBANES-OXLEY ACT OF 2002 I, Kirk K. Mandy, certify that: 1. I have reviewed this annual report on Form 20-F of Zarlink Semiconductor Inc. (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: June 4, 2008 -------------- /s/ KIRK K. MANDY ------------------------------------- Kirk K. Mandy President and Chief Executive Officer EX-12.2 7 e31856ex12_2.txt SECTION 302 CERTIFICATION Exhibit 12.2 Section 302 Certification by Chief Financial Officer of Annual Report CERTIFICATION PURSUANT TO RULE 13a-14(a), AS ADOPTED PURSUANT TO SECTION 302 (a) OF THE SARBANES-OXLEY ACT OF 2002 I, Scott Milligan, certify that: 1. I have reviewed this annual report on Form 20-F of Zarlink Semiconductor Inc. (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the period covered by the annual report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: June 4, 2008 -------------- /s/ Scott Milligan ------------------------------------- Scott Milligan Senior Vice President of Finance and Chief Financial Officer EX-13.1 8 e31856ex13_1.txt SECTION 906 CERTIFICATION Exhibit 13.1 Section 906 Certification by Chief Executive Officer of Annual Report CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Zarlink Semiconductor Inc. (the "Company") on Form 20-F for the period ending March 28, 2008 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Kirk K. Mandy, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: June 4, 2008 /s/ KIRK K. MANDY ------------------------------------- Kirk K. Mandy President and Chief Executive Officer EX-13.2 9 e31856ex13_2.txt SECTION 906 CERTIFICATION Exhibit 13.2 Section 906 Certification by Chief Financial Officer of Annual Report CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Zarlink Semiconductor Inc. (the "Company") on Form 20-F for the period ending March 28, 2008 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Scott Milligan, Senior Vice President of Finance and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: June 4, 2008 /s/ SCOTT MILLIGAN ------------------------------------------ Scott Milligan Senior Vice President of Finance and Chief Financial Officer EX-15.(A) 10 e31856ex15_a.txt CONSENT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS Exhibit 15(a) CONSENT OF INDEPENDENT REGISTERED CHARTERED ACCOUNTANTS We consent to the incorporation by reference in the Registration Statements (Forms S-8 numbers 33-45716, 33-98946, 333-66315, 333-83556 and Form F-10 number 333-144800) pertaining to the 1991 Stock Option Plan for Key Employees and Stock Option Grant to Anthony F. Griffiths, the 1991 Stock Option Plan for Key Employees and Non-Employee Directors, and the 1991 Stock Option Plan for Key Employees and Non-Employee Directors, as amended, respectively, of our reports relating to the financial statements of Zarlink Semiconductor Inc. and the effectiveness of Zarlink Semiconductor Inc.'s internal control over financial reporting dated May 30, 2008, appearing in the Annual Report on Form 20-F of Zarlink Semiconductor Inc. for the year ended March 28, 2008. Our audit also included the financial statement schedule of Zarlink Semiconductor Inc. listed in Item 18. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ DELOITTE & TOUCHE LLP Ottawa, Canada, Chartered Accountants June 4, 2008. Licensed Public Accountants EX-15.(B) 11 e31856ex15_b.txt CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Exhibit 15(b) CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in the Registration Statements (Forms S-8 numbers 33-45716, 33-98946, 333-66315 and 333-83556 and Form F-10 number 333-144800) pertaining to the 1991 Stock Option Plan for Key Employees and Stock Option Grant to Anthony F. Griffiths, the 1991 Stock Option Plan for Key Employees and Non-Employee Directors, and the 1991 Stock Option Plan for Key Employees and Non-Employee Directors, as amended, respectively, of our report dated June 6, 2007, with respect to the consolidated financial statements of Zarlink Semiconductor Inc. included in its Annual Report on Form 20-F for the year ended March 30, 2007. Our audits also included the financial statement schedule of Zarlink Semiconductor Inc. listed in Item 18. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Ottawa, Canada, Chartered Accountants June 3, 2008. Licensed Public Accountants EX-15.(C) 12 e31856ex15_c.txt MANAGEMENT PROXY CIRCULAR Exhibit 15(c) [LOGO] ZARLINK SEMICONDUCTOR Dear Shareholder: Your Board of Directors and management of Zarlink Semiconductor Inc. cordially invite you to attend the Company's 2008 Annual and Special Meeting of Shareholders. The meeting will take place at the head offices of the Company, 400 March Road, Ottawa, Ontario, Canada, at 10:30 a.m. on Wednesday, July 23, 2008. Related to this, you will find enclosed the Company's annual report, notice of meeting, management proxy circular and YELLOW form of proxy for the meeting. It is important that all shareholders be represented at the meeting. If you are unable to attend, please take a moment to complete, date and sign the enclosed YELLOW form of proxy, and return it as instructed, or follow the instructions included with the form of proxy to vote by telephone or over the Internet. Please refer to my Chairman's letter and the President's letter in the annual report for our detailed comments on the state of the Company's business. We look forward to seeing you at the meeting. Yours truly, /s/ Henry Simon - ------------------------ Dr. Henry Simon Chairperson of the Board Your vote is extremely important. Submit your YELLOW proxy today. [LOGO] ZARLINK SEMICONDUCTOR Notice of Annual and Special Meeting of Shareholders Notice is hereby given that the Annual and Special Meeting of Shareholders of Zarlink Semiconductor Inc. (the "Company") will be held at the head offices of the Company, 400 March Road, Ottawa, Ontario, Canada, on Wednesday, July 23, 2008, at 10:30 a.m. (the "Meeting"), for the following purposes: 1. to receive the consolidated financial statements of Zarlink Semiconductor Inc. prepared in accordance with United States generally accepted accounting principles for the fiscal year ended March 28, 2008 and the Auditors' Report thereon; 2. to elect directors; 3. to appoint auditors; 4. to consider and, if deemed advisable, to adopt, with or without amendments, an ordinary resolution approving an amendment to By-Law No. 16 of the Company to make the Company eligible for direct registration of its common shares, as required by the New York Stock Exchange; 5. to consider and, if deemed advisable, to adopt, with or without amendments, a special resolution to reduce the stated capital account maintained in respect of the Company's common shares from US$479,000,000 to US$149,000,000; and 6. to transact such further or other business as may properly come before the meeting or any adjournment or adjournments thereof. A management proxy circular (the "Circular") providing additional information relating to the matters to be dealt with at the Meeting and a YELLOW form of proxy (the "Form of Proxy") prepared in respect of the Meeting accompany this notice. In order to be represented by proxy at the Meeting, registered shareholders of the Company must complete, date and sign the Form of Proxy, or other appropriate form of proxy and, in either case, (i) deliver the completed proxy to the Company's transfer agent, Computershare Investor Services Inc., 100 University Avenue, 9th Floor, Toronto, Ontario, Canada M5J 2Y1 in the addressed prepaid envelope enclosed; or (ii) submit the completed proxy to Computershare Investor Services Inc., facsimile number (416) 263-9524 or 1-866-249-7775, by no later than 10:30 a.m. on Monday, July 21, 2008 or, if such meeting is adjourned, at the latest 48 hours prior to the adjourned meeting, excluding Saturdays, Sundays and statutory holidays. Registered shareholders of the Company may also vote by telephone or over the Internet. Instructions on how to vote by telephone or over the Internet are provided in the Circular and Form of Proxy. Non-registered shareholders of the Company should follow the instructions on how to complete their voting instruction form or form of proxy and vote their shares on the YELLOW forms that they receive or contact their broker, trustee, financial institution or other nominee for instructions. Ottawa, Ontario, June 4, 2008. BY ORDER OF THE BOARD OF DIRECTORS /s/ Donald G. McIntyre ---------------------- Donald G. McIntyre Corporate Secretary MANAGEMENT PROXY CIRCULAR TABLE OF CONTENTS MANAGEMENT PROXY CIRCULAR......................................................1 SOLICITATION OF PROXIES........................................................1 VOTING SHARES AND PRINCIPAL HOLDERS THEREOF....................................1 VOTING INFORMATION.............................................................2 CONSOLIDATED FINANCIAL STATEMENTS AND AUDITORS' REPORT.........................5 ELECTION OF DIRECTORS..........................................................6 APPOINTMENT OF AUDITORS.......................................................10 AMENDMENT OF BY-LAWS..........................................................11 REDUCTION OF STATED CAPITAL...................................................11 EXECUTIVE COMPENSATION........................................................13 REPORT ON EXECUTIVE COMPENSATION..............................................20 PERFORMANCE GRAPH.............................................................23 EQUITY COMPENSATION PLAN INFORMATION..........................................26 COMPENSATION OF NON-EMPLOYEE DIRECTORS........................................27 INDEBTEDNESS OF DIRECTORS, EXECUTIVE OFFICERS AND SENIOR OFFICERS.............28 DIRECTORS' AND OFFICERS' LIABILITY INSURANCE..................................28 STATEMENT OF CORPORATE GOVERNANCE PRACTICES...................................28 AUDIT COMMITTEE MEMBERS.......................................................30 REPORT OF THE AUDIT COMMITTEE.................................................31 AUDIT AND OTHER FEES..........................................................31 NORMAL COURSE ISSUER BID......................................................32 OTHER MATTERS.................................................................33 ADDITIONAL INFORMATION........................................................33 [LOGO] ZARLINK SEMICONDUCTOR MANAGEMENT PROXY CIRCULAR This Management Proxy Circular (the "Circular") is furnished in connection with the solicitation of proxies by the Board of Directors and management of Zarlink Semiconductor Inc. (the "Company"), on behalf of the Company, for use at the Annual and Special Meeting (the "Meeting") of the holders of the common shares of the Company (the "Common Shares") to be held on Wednesday, July 23, 2008 at the head offices of the Company, 400 March Road, Ottawa, Ontario, Canada, at 10:30 a.m., and any adjournment thereof, for the purposes set out in the accompanying Notice of Annual and Special Meeting of Shareholders (the "Notice of Meeting"). Unless otherwise specifically indicated, the information contained in the Circular is given as of May 30, 2008, the record date established for holders of Common Shares to receive notice of and to vote at the Meeting (the "Record Date"). Minutes of the 2007 Annual and Special Meeting of Shareholders are available for viewing on the Company's website at ir.zarlink.com/corp_gov/. All dollar amounts in this Circular are in United States dollars unless otherwise stated. SOLICITATION OF PROXIES The enclosed proxy is being solicited by the management of the Company. The solicitation is being made primarily by mail, but proxies may also be solicited by employees or agents of the Company, personally, in writing, by e-mail or by telephone. The entire cost of the solicitation will be borne by the Company. VOTING SHARES AND PRINCIPAL HOLDERS THEREOF Only the holders of Common Shares of record (the "Shareholders") at the close of business on the Record Date will be entitled to receive notice of the Meeting and to vote at the Meeting. Each Shareholder is entitled to one vote for each Common Share registered in the name of such Shareholder. As at May 30, 2008, there were 127,345,682 Common Shares outstanding. The Company shall prepare, no later than 10 days after the Record Date, an alphabetical list of Shareholders entitled to vote at the Meeting that indicates the number of Common Shares held by each Shareholder. The list of Shareholders entitled to vote at the meeting is available for inspection during usual business hours at the office of the Company's transfer agent and registrar, Computershare Investor Services Inc. (the "Transfer Agent"), located at 100 University Avenue, 9th Floor, Toronto, Ontario, Canada, M5J 2Y1. To the knowledge of the directors and senior officers of the Company, as of May 30, 2008, no person or corporation owned, directly or indirectly, or exercised control or direction over more than 10% of the outstanding Common Shares. However, the following entities have reported to the U.S. Securities and Exchange Commission ("SEC") ownership of more than 5% of the outstanding Common Shares: - -------------------------------------------------------------------------------- Beneficial Owner Common Shares Per Cent - -------------------------------------------------------------------------------- T. Rowe Price Associates, Inc. 10,256,300(1) 8.0% - -------------------------------------------------------------------------------- National Bank Financial 6,702,835(2) 5.2% - -------------------------------------------------------------------------------- (1) Based on information contained in a Schedule 13G filed with the SEC on February 12, 2008 by T. Rowe Price Associates, Inc. ("Price Associates"), an investment advisor registered under Section 203 of the Investment Advisers Act of 1940. Price Associates has sole power to vote or direct the vote of 1,574,800 Common Shares and the sole power to dispose or direct the disposition of 10,256,300 Common Shares. For purposes of the reporting requirements of the U.S. Securities Exchange Act of 1934, Price Associates is deemed to be a beneficial owner of such securities; however Price Associates expressly disclaims that it is, in fact, the beneficial owner of such securities. (2) Based on information contained in a Schedule 13D jointly filed on May 16, 2005 by Aquilon Capital Corp., Scott Leckie and Jeffrey Francoz, as updated by National Bank Financial ("NBF") (the successor of Aquilon Capital Corp.) on May 1, 2008, certain managed accounts and an investment partnership managed by Scott Leckie on behalf of NBF beneficially own 6,702,835 Common Shares. VOTING INFORMATION Voting by Proxy Voting by proxy means that you are giving the person or people named on your form of proxy (proxyholder) the authority to vote your Common Shares for you at the Meeting or any adjournment thereof. A YELLOW form of proxy (the "Form of Proxy") is included in this package. You can choose from three different ways to vote your shares by proxy: 1. by mail or delivery; 2. by telephone; or 3. on the Internet. A Shareholder has the right to appoint a person, who need not be a Shareholder, other than the persons designated in the Form of Proxy, to attend and act on behalf of the Shareholder at the Meeting. Unless you appoint someone else to be your proxyholder in accordance with the instructions provided herein, the directors or officers who are named on the Form of Proxy will vote your shares for you. If you appoint someone else, he or she must be present at the Meeting to vote your shares. If you are voting your shares by proxy, the Transfer Agent must receive your completed form of proxy by no later than 10:30 a.m. on Monday, July 21, 2008 or, if the Meeting is adjourned, at the latest 48 hours prior to the adjourned Meeting. Registered and Non-Registered (or Beneficial) Shareholders You are a registered shareholder if your name appears on your share certificate. You will receive the Form of Proxy if you are a registered shareholder. You are a non-registered (or beneficial) shareholder if your bank, trust company, securities broker or other financial institution holds your shares for you (your nominee). If you are a non-registered (or beneficial) shareholder, you will receive a voting instruction form or form of proxy from the Company, the institution that holds your shares or their respective agents. -2- How to vote -- registered shareholders A. By proxy 1. By mail or delivery o To vote by mail or delivery, your paper proxy must be completed, signed, dated and returned in accordance with the instructions on the Form of Proxy. 2. By telephone o To vote by telephone, call the toll-free number shown on the Form of Proxy. Using a touch-tone telephone to select your voting preferences, follow the instructions of the "vote voice" and refer to the directions on the Form of Proxy. o Note that voting by telephone is not available if you wish to appoint a person as a proxy holder other than the persons named on the Form of Proxy. In such a case, your proxy should be voted by mail, delivery or the Internet. 3. On the Internet o To vote your proxy on the Internet, visit the website address as shown on the Form of Proxy. Follow the on-line voting instructions given on the Form of Proxy. 4. By appointing another person to go to the Meeting and vote your shares for you o This person does not have to be a Shareholder. o Strike the names that are printed on the Form of Proxy and write the name of the person you are appointing in the space provided. Complete your voting instructions, date and sign the Form of Proxy, and return it to the Transfer Agent as instructed. o Make sure that the person you appoint is aware that he or she has been appointed and attends the Meeting. o At the Meeting, the person appointed should see the scrutineers from the Transfer Agent at the registration table. B. In person at the Meeting You do not need to complete or return the Form of Proxy. You should see a representative of the Transfer Agent before entering the Meeting to register your attendance at the Meeting. Voting in person at the Meeting will automatically cancel any proxy you completed and submitted earlier. -3- How to vote -- non-registered (or beneficial) shareholders o These securityholder materials are being sent to both registered and non-registered owners of the Common Shares, either directly by the Company or indirectly through your nominee or your nominee's agent. o If you are a non-registered owner of Common Shares and the Company or its agent has sent these materials directly to you, your name and address and information about your holdings of Common Shares have been obtained in accordance with applicable securities regulatory requirements from the intermediary holding Common Shares on your behalf. In such case, the Company (and not the intermediary holding Common Shares on your behalf) assumes responsibility for (i) delivering these materials to you, and (ii) executing your proper voting instructions. Please return your voting instructions as specified in the Form of Proxy. o If you have received these materials indirectly through your nominee or your nominee's agent, you will receive the nominee's form of proxy, which is substantially similar to the Form of Proxy, the sole purpose of which is to instruct the registered holder of the Common Shares (i.e. the nominee) how to vote on your behalf (the "Voting Instruction Form"). A. By proxy o Please contact your nominee or the Company if you did not receive a Voting Instruction Form or the Form of Proxy in this package. o In most cases, you will receive a Voting Instruction Form that allows you to provide your voting instructions by telephone, on the Internet or by mail or delivery. If you want to provide your voting instructions on the Internet, go to the website noted on your Voting Instruction Form or Form of Proxy and follow the instructions on the screen. o Some Voting Instruction Forms may be required to be completed and returned, as directed in the instructions provided; or have been pre-authorized by your nominee indicating the number of shares to be voted, which is to be completed, dated, signed and returned to the Transfer Agent by mail. B. In person at the Meeting o The Transfer Agent does not have access to the names or holdings of our non-registered shareholders. That means you can only vote your shares in person at the Meeting if you appoint yourself proxy holder by printing your name in the space provided on the Voting Instruction Form or Form of Proxy provided to you. o Your vote will be taken and counted at the Meeting. o Prior to the Meeting, you should see the scrutineers from the Transfer Agent at the registration table. Completing the Form of Proxy On any ballot that may be called for at the Meeting, the Common Shares represented by the enclosed Form of Proxy will be voted or withheld from voting in accordance with the instructions of the -4- Shareholder indicated thereon and, where a choice is specified, the Common Shares will be voted accordingly. You can choose to vote "For", "Against" or "Withhold", depending on the items listed on the Form of Proxy. When you sign the Form of Proxy, you authorize Kirk K. Mandy or Donald G. McIntyre, who are officers of the Company, or the individual that you have named on the Form of Proxy in accordance with the instructions provided herein, to vote or withhold from voting your shares for you at the Meeting according to your instructions on any ballot that may be called for. If you specify a choice on the Form of Proxy with respect to any matter to be acted upon at the Meeting, your shares will be voted accordingly. If you return the Form of Proxy and do not tell us how you want to vote your Common Shares, your vote will be counted: (i) FOR the election of the nominees for director listed under "Election of Directors"; (ii) FOR the appointment of the auditors named under "Appointment of Auditors"; (iii) FOR the ordinary resolution amending the Company's by-laws; and (iv) FOR the special resolution to reduce the Company's stated capital account for the Common Shares. Your proxy holder will also vote your shares as he sees fit on any amendment or variation to matters identified in the Notice of Meeting or any other matter that may properly come before the Meeting. As of the date of this Circular, management is unaware of any such amendment, variation or other matter proposed or likely to come before the Meeting. If you have appointed a person other than Mr. Mandy or Mr. McIntyre to vote your shares and you do not specify how you want your shares voted, your proxy holder will vote your shares as he or she sees fit on each item and on any other matter that may properly come before the Meeting. If you are an individual Shareholder, you or your authorized attorney must sign the Form of Proxy. If you are a corporation or other legal entity, an authorized officer or attorney must sign the Form of Proxy. Changing your vote You can revoke a vote you made by proxy by: o voting again by telephone or on the Internet by no later than 10:30 a.m. on Monday, July 21, 2008 or, if the Meeting is adjourned, at the latest 48 hours prior to the adjourned Meeting; o completing a form of proxy that is dated later than the form of proxy you are changing and mailing it or faxing it to the Transfer Agent or sending a notice to our Secretary, Mr. Donald McIntyre at 400 March Road, Ottawa, Ontario K2K 3H4 so that it is received by no later than 10:30 a.m. on Monday, July 21, 2008 or, if the Meeting is adjourned, at the latest 48 hours prior to the adjourned Meeting; o giving a notice in writing to the Chairman of the Meeting, at the Meeting or any adjournment thereof. The notice can be from you or your authorized attorney. CONSOLIDATED FINANCIAL STATEMENTS AND AUDITORS' REPORT The consolidated financial statements of the Company and the auditors' report thereon for the fiscal year ended March 28, 2008 (the "2008 Annual Report"), which is available on SEDAR at -5- www.sedar.com and on EDGAR at www.sec.gov. will be submitted to the Shareholders at the Meeting but no vote with respect thereto is required or proposed to be taken. The financial statements included in the 2008 Annual Report for the fiscal year ended March 28, 2008 ("Fiscal 2008") are stated in United States dollars and have been prepared in accordance with United States generally accepted accounting principles ("U.S. GAAP"). ELECTION OF DIRECTORS Eight directors are nominated for election at the Meeting. Each director elected at the Meeting will hold office until the close of the next annual general meeting or until his successor is duly elected, unless he resigns or the office is earlier vacated in accordance with the by-laws of the Company and applicable law. Except where authority to vote in respect of the election of directors is withheld by the Shareholder, the appointees named in the accompanying Form of Proxy will vote the Common Shares represented by such proxy FOR the election of the eight nominees for director listed below. The Board of Directors recommend that Shareholders vote FOR the election of the nominees listed below. For each proposed nominee, the information below indicates his jurisdiction of residence; any positions and offices held by him with the Company; his principal occupation or employment for at least the past five years; the year from which he has continually served as a director of the Company; and the number of voting securities of the Company which he beneficially owns, or controls or directs, directly or indirectly, as at May 30, 2008. The information as to voting securities beneficially owned, or controlled or directed, directly or indirectly, by each proposed nominee has been furnished by the respective nominee individually.
DR. ADAM CHOWANIEC Dr. Chowaniec has been the Chairman and Chief Executive Officer of Amiga2 Ottawa, Ontario, Canada Corporation, a consulting and investment company, since 2002. Dr. Chowaniec was the founding Chief Executive Officer of Tundra Semiconductor Corporation on Director since: 2007-02-19 December 15, 1995 and served in that position until December 2005. Dr. Chowaniec is also Chairman of the Board of Directors of Tundra Semiconductor Corporation, Total voting former Chair of the Ontario Research and Innovation Council, and serves on securities: approximately 116,410, numerous other boards of directors in Canada and the United States, including consisting of: BelAir Networks, Liquid Computing Corporation, Acentru and Microbridge Corporations. Dr. Chowaniec is a member of the board of the Export Development 91,000 Common Shares Corporation of Canada and has held advisory positions with the Ottawa Economic Development Corporation, the National Research Council's Industrial Research 5,000 Common Shares underlying Assistance Program and the Ottawa Health Research Institute and the Natural options(1) Science and Engineering Council of Canada. He is also the vice-chair of the Museum of Nature's national fundraising campaign. He holds a Master's degree in approximately 20,410 Common Shares Electrical Engineering from Queen's University (Canada), as well as both a underlying Convertible Bachelor of Engineering and a Ph.D. from the University of Sheffield (England). Debentures(2)
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OLEG KHAYKIN Mr. Oleg Khaykin has been President and Chief Executive Officer and a member of Scottsdale, Arizona, U.S.A. the Board of Directors of International Rectifier Corporation, a manufacturer of power semiconductors, since March 2008. Mr. Khaykin acted as Executive Vice Director since: 2007-11-12 President and Chief Operating Officer of Amkor Technology, a leading provider of advanced semiconductor assembling and test services, from May 2003 to March Total voting securities: Nil 2008. From May 1999 to May 2003, Mr. Khaykin was the Vice President of Strategy and Business Development for Conexant Systems Inc./Mindspeed, a company that designs, develops and sells semiconductors for networking applications. Mr. Khaykin was also with the Boston Consulting Group, a strategic consulting firm, from July 1991 to June 1999. Mr. Khaykin began his career as a senior development engineer and product manager with Motorola. HUBERT T. LACROIX Mr. Hubert T. Lacroix has been President and Chief Executive Officer of the Montreal, Quebec, Canada Canadian Broadcasting Corporation / Radio-Canada since Director since: 1992 January 1, 2008. Mr. Lacroix acted as Senior Advisor to Stikeman Elliott LLP (law firm) and as an adjunct professor at the Faculty of Law of Universite de Total voting securities: 170,000, Montreal from May 5, 2003 until December 31, 2007 and as a consultant to consisting of: Telemedia Ventures Inc., a private investment company from May 5, 2003 until December 31, 2005. Mr. Lacroix was Executive Chairman of Telemedia Corporation 100,000 Common Shares from February 2000 to May 2003. From 1984 until his appointment as Executive Chairman of Telemedia Corporation, Mr. Lacroix was a partner with McCarthy 70,000 Common Shares underlying Tetrault LLP (law firm). He is Chairman of the Board and a member of the Audit options(1) Committee and a member of the Strategic Development Committee of SFK Pulp Fund. In addition, he is a trustee of the Lucie and Andre Chagnon Foundation and a director of their private holding company. Mr. Lacroix is also a Director of the Montreal General Hospital Foundation and a Trustee of the Martlet Foundation of McGill University. Mr. Lacroix received his Bachelor of Law degree from McGill University, was admitted to the Quebec Bar in 1977 and holds a Master of Business Administration degree from McGill University. J. SPENCER LANTHIER Mr. J. Spencer Lanthier has been a Corporate Director since his retirement in Toronto, Ontario, Canada 1999 from KPMG Canada, where he had a long and distinguished career culminating in the position of Chairman and Chief Executive from 1993 until his retirement. Director since: 2003 A recipient of the Order of Canada, Mr. Lanthier is currently a member of the Board and Chair of the Audit Committee of the TSX Group, Inc., Torstar Total voting securities: Corporation, Gerdau Ameristeel Inc., Rona Inc. and Ellis Don Inc. He also serves approximately 135,410, consisting of: as Chair of the Wellspring Cancer Support Organization. Mr. Lanthier received an honorary Doctor of Laws degree from the University of Toronto in 2002. 45,000 Common Shares 70,000 Common Shares underlying options(1) approximately 20,410 Common Shares underlying Convertible Debentures(2)
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KIRK K. MANDY Mr. Kirk K. Mandy is President and Chief Executive Officer of the Company. He Woodlawn, Ontario, Canada served as Vice-Chairman of the Company's Board of Directors from 2001 until his appointment as President and Chief Executive Officer of the Company in February Director since: 1998 2005. Over a distinguished career with the Company spanning 15 years, Mr. Mandy held Total voting securities: 1,655,500, increasingly senior roles, culminating in the position of President and Chief consisting of: Executive Officer from 1998 to 2001. He oversaw the Company's strategic decision to focus on semiconductors, and the subsequent divestiture of the Business 640,500 Common Shares Communications Systems (BCS) division. 1,015,000 Common Shares underlying Mr. Mandy is also a member of the Board of Epocal Inc. and Chairman of the options(1) Armstrong Monitoring Corporation. He has served on the Board of the Strategic Microelectronics Corporation (SMC), the Canadian Advanced Technology Association (CATA), The Canadian Microelectronics Corp. (CMC), The Ottawa Center for Research and Innovation (OCRI) and Micronet. He is also past Chairman of the Telecommunications Research Center of Ontario (TRIO), past Chairman of the National Research Council's Innovation Forum and past Co-Chairman of the Ottawa Partnership. Mr. Mandy is a graduate of Algonquin College in Ottawa. JULES M. MEUNIER Mr. Jules M. Meunier has been a management consultant since November 2002. He Vancouver, British Columbia, Canada was President and Chief Executive Officer of Proquent Systems Inc. from January to November 2002. Prior to January 2002, over a 20-year career with Nortel Director since: 2002 Networks Corporation, he helped shape the company's direction as Chief Technical Officer, and held senior positions in its wired, wireless, and optical Total voting securities: 175,000, communications divisions, including serving as President of its Wireless consisting of: Networks division. 85,000 Common Shares Mr. Meunier holds a Bachelor of Science degree in Mathematics and Computer Science from the University of Ottawa. 90,000 Common Shares underlying options(1)
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DENNIS ROBERSON Professor Dennis Roberson has been Vice Provost, Executive Director and Research Wheaton, Illinois, USA Professor with the Illinois Institute of Technology ("IIT") since June 2003, where he established a new undergraduate business school focused on Director since: 2004 entrepreneurship and technology, a wireless research center (WiNCom), IIT's corporate relations initiative, and is developing research centers and business ventures in association with public and private sector partners. From April 1998 Total voting securities: 78,522, to April 2004, Professor Roberson was Executive Vice President and Chief consisting of: Technical Officer of Motorola, Inc. From 1971 to 1998, he held senior executive positions with NCR Corporation, AT&T, Digital Equipment Corp. (now part of Hewlett Packard) and IBM. 33,522 Common Shares Professor Roberson is a Director of Advanced Diamond Technologies, Cleversafe, Sequoia Communications and Sun Phocus Technologies, LLC. He also serves on the 45,000 Common Shares underlying Board of Directors of FIRST Robotics (For Inspiration and Recognition of Science options(1) and Technology), the National Advisory Council for the Boy Scouts of America and as an International Advisory Panel member for the Prime Minister of Malaysia. He holds Bachelor of Science Degrees in Physics and Electrical Engineering from Washington State University and a Master of Science in Electrical Engineering from Stanford University. DR. HENRY SIMON Dr. Henry Simon has been Chairperson of the Company's Board of Directors since London, England July 21, 1994. He is a Special Partner of Schroder Ventures Life Sciences Advisors, a venture capital company advising on investments in the life Director since: 1992 sciences. He joined Schroder Ventures in 1987 to head a venture capital group that developed a life sciences business in the U.K., and was Chief Executive Total voting securities: 245,000, Officer of its life sciences team until 1995. Dr. Simon holds an Electrical consisting of: Engineering degree from the Institute of Technology in Munich, and a doctorate in Telecommunications from the Royal Institute of Technology in Stockholm. 175,000 Common Shares underlying options(1)
- ---------- (1) Reflects options to purchase Common Shares which are currently exercisable or exercisable within 60 days of May 30, 2008. (2) Reflects convertible debentures convertible into Common Shares at a conversion price of Cdn$2.45 (being a ratio of approximately 408.2 Common Shares per Cdn $1,000 principal amount convertible debenture) at the option of the holder at any time. In Fiscal 2008, 17 meetings of the Board of Directors were held. All directors attended all of the meetings held during the period they served as directors of the Company, with the exception of J. Spencer Lanthier, who missed two meetings, Jules Meunier, who missed one meeting and Andre Borrel, who, prior to his resignation from the Board of Directors on February 4, 2008, missed two meetings. In each case, each of these individuals reviewed the agenda material and gave input to the Chairperson in advance of the meeting. Dr. Adam Chowaniec was a director of IceFyre Semiconductor Inc., a private company, from May 21, 2001 to March 23, 2005. IceFyre Semiconductor Inc. appointed a receiver in bankruptcy in May 2005. -9- Kirk K. Mandy was a director of a private start-up photonics company, Optenia, Inc., in which the Company held a minority equity interest which was reduced proportionally as other equity investments were made. Optenia, Inc., which focused on reducing the cost of bandwidth distribution in optical networks, made an assignment in bankruptcy in March 2002 due to its inability to obtain additional financing and obtained a discharge in the fall of 2003. Independence and Board Committees The following table indicates whether the Board of Directors considers each nominee to be "independent" within the meaning of the Governance Guidelines and NYSE Rules (as such terms are defined below under "Statement of Corporate Governance Practices"). This table also sets out the members of the standing committees of the Board of Directors as of May 30, 2008 and the number of meetings held by each standing committee during Fiscal 2008.
- --------------------------------------------------------------------------------------------------------- Compensation and Human Resources Nominating and Directors Audit Development Corporate Governance Executive Committee Committee Committee Committee - --------------------------------------------------------------------------------------------------------- Independent Directors - --------------------------------------------------------------------------------------------------------- Adam Chowaniec X - --------------------------------------------------------------------------------------------------------- Oleg Khaykin(1) - --------------------------------------------------------------------------------------------------------- Hubert T. Lacroix Chairperson X X - --------------------------------------------------------------------------------------------------------- J. Spencer Lanthier X X - --------------------------------------------------------------------------------------------------------- Jules Meunier X Chairperson - --------------------------------------------------------------------------------------------------------- Dennis Roberson X - --------------------------------------------------------------------------------------------------------- Henry Simon Chairperson Chairperson - --------------------------------------------------------------------------------------------------------- Not Independent Director - --------------------------------------------------------------------------------------------------------- Kirk K. Mandy X - --------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------- Meetings held during 7 9 3 nil Fiscal 2008 - ---------------------------------------------------------------------------------------------------------
(1) Mr. Khaykin was appointed to the Board of Directors on November 12, 2007. In Fiscal 2008, all members of the standing committees of the Board of Directors attended all meetings of their respective committees held during the period they served as directors of the Company with the exception of J. Spencer Lanthier, who missed two meetings of the Audit Committee and one meeting of the Nominating and Corporate Governance Committee, Dennis Roberson, who missed one meeting of the Compensation and Human Resources Development Committee, and Andre Borrel, who missed one meeting of the Compensation and Human Resources Development Committee prior to his resignation from the Board of Directors on February 4, 2008. In each case, each of these individuals reviewed the agenda material and gave input to the relevant Chairperson in advance of the meeting. APPOINTMENT OF AUDITORS Deloitte & Touche LLP ("Deloitte") have been acting as auditors of the Corporation since July 24, 2007. -10- The Board of Directors recommends that the Shareholders vote FOR the resolution appointing Deloitte as auditors of the Company, to hold office until the next annual meeting of Shareholders or until their successors are appointed. Except where authority to vote in respect of the appointment of Deloitte as auditors of the Company is withheld by the Shareholder, the appointees named in the accompanying Form of Proxy will vote the Common Shares represented by such proxy FOR the appointment of Deloitte. AMENDMENT OF BY-LAWS General At the Meeting, the Shareholders will be asked to consider and, if deemed appropriate, adopt, with or without amendments, a resolution approving an amendment to By-Law No. 16 of the Company. Background The listing requirements of the New York Stock Exchange ("NYSE") require securities issued by the Company to be eligible for direct registration with the Company effective January 1, 2008. When the Company participates in the direct registration system, an investor will be able to hold a security of the Company in electronic form via a book-entry position on the books of the Company, in addition to holding a security of the Company indirectly through a broker, dealer or other financial intermediary, or in the form of a physical security certificate. Such investors will be treated as registered owners of securities. The Company concluded that for the Common Shares to be eligible for direct registration as required by the NYSE, the Company must amend section 7.03 of its By-Law No. 16 to permit Common Shares to be transferred without the need for a certificate representing the Common Shares. The Board of Directors amended Section 7.03 of By-Law No. 16, effective May 20, 2008, which amendment will cease to be effective unless it is confirmed by Shareholders at the Meeting. In the event that the Shareholders do not vote for the adoption of the proposed amendment, the Company will be in breach of its NYSE listing requirements. Vote Required and Recommendation of Board of Directors The text of the resolution, which shall be submitted to the Shareholders at the Meeting, is set forth on Schedule A, attached hereto. For the reasons indicated above, the Board of Directors believes that the proposed amendment is in the best interests of the Company and its Shareholders and, accordingly, recommends that Shareholders vote FOR the resolution. The resolution must be approved by a majority of the votes cast at the Meeting to be effective. Except where a Shareholder who has given the proxy directs that his or her Common Shares be voted against such resolution, the appointees named in the accompanying Form of Proxy will vote the Common Shares represented by such proxy FOR such resolution. REDUCTION OF STATED CAPITAL General At the Meeting, the Shareholders will be asked to consider and, if deemed appropriate, adopt, with or without amendments, a special resolution to reduce the stated capital of the Company from $479,000,000, as at March 28, 2008, to $149,000,000. The amount of the proposed reduction, being $330,000,000, is equal to the amount of the accumulated deficit of the Company as of March 28, 2008, calculated in accordance with Canadian GAAP. The reduction will not be reflected in the Company's balance sheet, as prepared in accordance with US GAAP. -11- Background and Reasons for the Reduction of Stated Capital Under the Act, a corporation is prohibited from taking certain actions, including purchasing its own shares and declaring or paying dividends on its shares, if, among other things, there are reasonable grounds for believing that the realizable value of the corporation's assets would thereby be less than the aggregate of its liabilities and stated capital of all classes of shares. At a meeting of the Board of Directors held on May 20, 2008, the realizable value of the Company's assets, its liabilities and its stated capital were discussed. In order to give the Board of Directors flexibility in managing the Company's capital structure going forward, the Board of Directors has decided to submit a special resolution to the Shareholders for their approval of the reduction of the stated capital to address limitations under the Act which result from the historically high stated capital amount of the Common Shares. Limitation on Reduction of Stated Capital under the Act The Act provides that a corporation may not reduce its stated capital if there are reasonable grounds for believing that, after giving effect to the reduction in the stated capital accounts for the Common Shares, the corporation will be unable to pay its liabilities as they become due or that the realizable value of the corporation's assets will be less than the aggregate amount of its liabilities. Management of the Company is of the view that the Company does not have reasonable grounds to believe that after giving effect to such reduction, the Company will be unable to pay its liabilities as they become due or that the realizable value of the Company's assets will thereby be less than the aggregate amount of its liabilities. Certain Canadian Federal Income Tax Consideration This summary is of a general nature only. It is based on the current provisions of the Tax Act and Regulations, all amendments thereto proposed by the Minister of Finance (Canada) prior to the date hereof, and the Corporation's counsel's understanding of the current published administrative and assessing practices of the CRA. This summary assumes that any proposed amendments will be enacted as intended, and that legislative, judicial or administrative actions will not modify or change the statements expressed herein. It does not otherwise take into account or anticipate any changes in laws whether by judicial, governmental or legislative decision or action or any changes in administrative practices of the CRA nor does it take into account provincial or foreign income tax legislation or considerations. All references to the Tax Act in this summary are restricted to the scope defined in this paragraph. The reduction of stated capital will not result in a deemed dividend or in a reduction of the adjusted cost base of the Common Shares for Shareholders. Furthermore, the reduction in the stated capital account of the Common Shares will not give rise to immediate tax consequences under the Tax Act for Shareholders. Shareholders may wish to consult with their own tax advisors with respect to the proposed stated capital reduction. This summary is not intended to be, nor should it be construed as, legal or tax advice to Shareholders. Vote Required and Recommendation of the Board of Directors The text of the special resolution, which will be submitted to shareholders at the Meeting, is set forth in Schedule B, attached hereto. For the reasons indicated above, the Board of Directors believe that the proposed reduction of stated capital of the Company is in the best interests of the Company and its Shareholders and, accordingly, recommends that Shareholders vote FOR the special resolution. The special resolution must be approved by not less than two-thirds of the votes cast by the Shareholders -12- present in person or represented by proxy at the Meeting to be effective. Except where a Shareholder who has given the proxy directs that his or her Common Shares be voted against such resolution, the appointees named in the accompanying Form of Proxy will vote the Common Shares represented by such proxy FOR such resolution. EXECUTIVE COMPENSATION Summary Compensation Table The following table sets forth compensation information for Fiscal 2008 and the two fiscal years ended March 30, 2007 ("Fiscal 2007"), and March 31, 2006 ("Fiscal 2006"), respectively, for the Chief Executive Officer (the "CEO"), the Chief Financial Officer (the "CFO"), the three most highly compensated executive officers of the Company, other than the CEO and the CFO, who were serving as executive officers of the Company on March 28, 2008 (collectively, the "Named Executive Officers"). -13-
- ---------------------------------------------------------------------------------------------------------------------------- Annual Compensation Long-Term ------------------------------------ Compensation Bonus Securities (Annual Other Under Name and Incentive Annual Options All Other Principal Fiscal Salary(1) Awards) Compensation(1)(2) Granted Compensation(1)(3) Position Year $ $ $ # $ - ---------------------------------------------------------------------------------------------------------------------------- Kirk K. Mandy 2008 534,894 194,507 19,397 450,000 83,881 President and 2007 484,333 292,000 16,360 450,000 75,952 Chief Executive 2006 459,867 275,920 20,052 450,000 72,115 Officer - ---------------------------------------------------------------------------------------------------------------------------- Scott Milligan 2008 325,799 97,253 17,311 125,000 51,982 Senior Vice 2007 295,003 149,000 16,378 125,000 47,113 President Finance 2006 280,101 140,050 14,709 125,000 44,691 and Chief Financial Officer - ---------------------------------------------------------------------------------------------------------------------------- Donald McIntyre 2008 325,799 97,253 10,678 125,000 51,706 Senior Vice 2007 295,003 149,000 13,973 125,000 47,298 President, HR, 2006 280,101 140,050 14,234 185,000 44,574 General Counsel and Secretary - ---------------------------------------------------------------------------------------------------------------------------- Henry Perret(4) 2008 228,876 100,000 9,264 nil 4,731 Senior Vice 2007 N/A N/A N/A N/A N/A President and 2006 N/A N/A N/A N/A N/A General Manager, Wired Communications - ---------------------------------------------------------------------------------------------------------------------------- Stanley Swirhun 2008 275,000 nil 12,380 125,000 9,433 Senior Vice 2007 233,654 103,000 4,901 125,000 12,016 President and 2006 183,462 78,750 913 125,000 255 General Manager, Optical Communications - ----------------------------------------------------------------------------------------------------------------------------
(1) For Messrs. Mandy, Milligan, and McIntyre, changes in salary from Fiscal 2007 to Fiscal 2008 were due solely to foreign exchange fluctuations. Canadian dollar amounts have been converted to United States dollars using the Fiscal 2008 average exchange rate of $0.972534 (2007 - 0.880605; 2006 - 0.836121). (2) "Other Annual Compensation" includes the following expenses for certain Named Executive Officers as follows: Mr Mandy - Fiscal 2008 includes car allowance/benefits $18,278 (2007 - $15,535; 2006 - $19,441); Mr. Milligan - Fiscal 2008 includes car allowance/benefits amounting to $15,764 (2007 - $15,272; 2006 -$13,891); Mr. McIntyre - Fiscal 2008 includes car allowance/benefits amounting to $9,131 (2007 - $12,867; 2006 - $13,416); Mr. Perret - Fiscal 2008 includes car allowance/benefits amounting to $7,192; Mr. Swirhun - Fiscal 2008 includes car allowance/benefits amounting to $11,000 (2007 - $3,808). (3) "All Other Compensation" includes contributions made and accrued by the Company to a defined contribution pension plan and supplemental executive retirement plan. (4) Mr. Perret was the former president of Legerity, Inc. which the Company acquired August 3, 2007. As at that date, Mr. Perret assumed the position of Senior Vice President, Wired Communications. -14- Employee Share Ownership Plan The Company's Employee Share Ownership Plan was approved by the Board of Directors in May 1997. The purpose of this plan is to enable employees to invest in equity shares of the Company through employee savings. Employees make contributions by means of payroll deductions and Common Shares are purchased twice per month through normal market facilities by Computershare Investor Services Inc., which assumed the administration role for Montreal Trust Company of Canada (the trustee appointed to administer the plan). The Company pays all brokerage commissions, transfer taxes, and other charges and expenses of the purchase and sale of the common shares except for the issuance of a certificate for fewer than 100 shares, in which case the employee is responsible for such costs. In April 2001, the Company implemented a matching contribution in connection with the Employee Share Ownership Plan which provides for a contribution by the Company equal to 15% of each employee's contribution under the plan, subject to a maximum of $486 per employee per year. The maximum contribution by the Company under this plan for the upcoming fiscal year is estimated at $150,000 based on average headcount during Fiscal 2008, assuming that each eligible employee contributes sufficient funds to achieve a matching contribution by the Company equal to the maximum amount permitted under the plan. Director, CEO and Executive Share Ownership The Company's policy for Director, CEO and Executive Share Ownership (the "Policy"), which was approved by the Board of Directors in May 2003 and revised in January 2006, serves to better align the interests of the Company's directors, CEO and those executives, including the CFO, who report directly to the CEO (together with the CEO, the "Executives") with the financial interests of the Shareholders, create ownership focus and build long-term commitment. The Policy requires that the directors and Executives establish and hold specified dollar investment levels in Common Shares within defined periods of time following the implementation of the Policy or from their date of hire or promotion to these roles after the effective date of the Policy, if later. The Chairperson of the Board must invest a total of CDN$100,000 for the purchase of Common Shares within five years after the effective date of the Policy or his/her date of appointment to the role, if later. Each non-executive director who is not Chairperson of the Board of Directors must invest a total of CDN$50,000 for the purchase of Common Shares within five years after the effective date of the Policy or his/her date of appointment to the Board of Directors, if later. The CEO must invest a total dollar amount equal to two times his/her base salary for the purchase of Common Shares by the end of five years from the effective date of the Policy or his/her date of hire or promotion to the role, whichever is later. Each Executive, other than the CEO, must invest a total dollar amount equal to one times his/her base salary for the purchase of Common Shares by the end of five years from the effective date of the Policy or his/her date of hire or promotion to the role, whichever is later. The following guidelines and rules apply for purposes of the Policy: (a) base salary will be the average base salary of the Executive over the three years prior to each measurement date; (b) interim investment thresholds for the Executives will be 25% of target levels after two years; 50% after three years; 75% after four years; and 100% after five years; (c) if any Executive has not met the target -15- investment level at any of the measurement dates but has earned sufficient after-tax incentive plan payments since the effective date of the Policy or his/her date of hire or promotion to the role, he/she will be reported as in default under the Policy; and (d) after the fifth anniversary date, the measurement date will be each subsequent anniversary date. If any Executive misses the target investment level at any of the measurement dates or thereafter, one-half of any incentive payments earned by the Executive after the measurement date will be withheld and not paid to the Executive until his/her dollar investment level has been increased by the lesser of the after tax value of one-half of the incentive payment or the amount required to meet the required target investment level as of the most recent measurement date. As of the most recent measurement date, all directors and the Executives were in compliance with the terms of the Policy except Stephen Swift. If any director misses the target investment level at any of the measurement dates or thereafter, any annual director's fees owing to that director after the measurement date will be withheld and not paid to the director until his/her investment level has been increased to meet the required target investment level of the most recent measurement date. Pursuant to the Policy, until the required ownership levels are met, it is expected that any exercise of outstanding options to purchase Common Shares will be used to increase the individual's required target investment level in Common Shares. All trades (purchases and sales) of Common Shares by the directors and the Executives must be made in strict adherence with the Company's Insider Trading Guidelines and relevant securities laws. 1991 Stock Option Plan for Key Employees and Non-Employee Directors The Option Plan provides for the granting of non-transferable options to purchase Common Shares to certain key employees and non-employee directors of the Company and its subsidiaries as determined from time to time by the Compensation and Human Resources Development Committee (the "Compensation Committee") administering the Option Plan. The Option Plan was approved by the Shareholders at the 1991 annual and special meeting of shareholders and certain amendments were approved by the Shareholders in 1993, 1995, 1998, 2001 and, most recently, at the Company's annual general and special meeting of shareholders held on July 24, 2007. The price at which Common Shares may be purchased upon exercise of an option shall be determined by the Board of Directors, and shall not be less than the average of the market price (as defined in the Option Plan) of the common shares on the Toronto Stock Exchange for the five trading-day period immediately preceding the date of grant. The Option Plan provides that, in the event of the death or permanent disability of an optionholder, the vesting period of any options unexercised at the date of death or permanent disability will be accelerated so that the optionholder's legal personal representative will be permitted to purchase and take delivery of, (i) in the case where the optionholder shall have been in the employment of the Company or any subsidiary for at least five years prior to the date of such employee's death or permanent disability, 50% of all Common Shares under option and not purchased or delivered at the date of death or permanent disability, and (ii) in the case where the optionholder shall have been in the employment of the Company or any subsidiary for at least ten years prior to the date of such employee's death or permanent disability, all Common Shares under option and not purchased or delivered at the date of death or -16- permanent disability, in each such case during the one-year period following such optionholder's death or permanent disability (but in no event after the expiration date of such options). The Option Plan also provides that, in the event of the termination of an employee's employment for any reason other than cause or death or permanent disability, the employee's options may be exercised, to the extent the options are exercisable as of the termination date, within 90 days following the date the employee's employment is terminated (but in no event after the expiration date of such options); provided, however, that the Board of Directors may, in its discretion, amend the terms of any option to permit the employee to exercise such options as if such employee's employment had not been terminated, for up to a maximum of three years following the date of termination of the employee's employment (but in no event after the expiration date of such options). In the event the employee's employment has been terminated for cause, the employee's options shall be immediately cancelled. The optionholder's rights with respect to options granted under the Option Plan are not assignable or transferable by the optionholder other than by will or by the laws of descent and distribution or pursuant to a qualified domestic relations order as defined by the U.S. Internal Revenue Code. The Option Plan further provides that, in the event of a change of control (whether in fact or in law) of the Company which results in a non-employee director being replaced, the vesting period shall be waived with respect to the options then held by such non-employee director in order to permit the full exercise of all outstanding options then held by such person. In the event of a resignation of a non-employee director, all options held by such director, which are then exercisable, may be exercised within 180 days following the announcement of the quarterly results next following the date of resignation of such person (but in no event after the expiration date of such options). The Option Plan also provides that the Compensation Committee may determine that any option granted under the Option Plan shall include provisions which accelerate the date on which an option shall become exercisable upon the happening of such events as the Compensation Committee may determine and as permitted in the Option Plan. On January 11, 2000, the Board of Directors decided that all unvested stock options held by each director, the CEO, the then five Senior Vice Presidents which included the CFO and any other executives of the Company as may be designated by the Board of Directors from time to time would be accelerated and become fully vested and immediately exercisable in the event of (i) the making by any person of a take-over bid (as defined in the Securities Act (Ontario)) for the Common Shares, or (ii) a change of control (whether in fact or in law and as more fully defined in such resolution of the Board of Directors) of the Company. By further action of the Board of Directors, this resolution now applies to each director and ten designated executives including the CEO and the CFO. The Option Plan provides that all options granted under the Option Plan must be exercised within a maximum of six years following the date of grant or within such other shorter time or times as may be determined by the Compensation Committee at the time of grant. In the case of options granted to employees of the Company, other than executive officers and non-employee directors and first-time option grants to new employees, the terms of the Option Plan provide for staggered equal monthly vesting at a rate of 2.08% per month over a period of four years commencing on the date of grant of the options, or at such other time or times as may be determined by the Compensation Committee at the time of grant. In the case of first-time option grants to new employees, up to twenty-five percent of the common shares in respect of each option may be purchased after one year from the date of grant and 2.08% per month for each month thereafter during a three-year period, or at such other time or times as may be determined by the Compensation Committee at the time of grant. In the case of executive officers and non-employee directors, up to twenty-five percent of the common shares in respect of each option may be purchased after one year from the date of grant, up to fifty percent after two years from the date of grant, up to seventy-five percent after three years from the date of grant and up to one hundred percent after four years -17- from the date of grant or at such other time or times as may be determined by the Compensation Committee at the time of grant. The maximum number of Common Shares that may be issued under the Option Plan is 20,227,033 Common Shares, which represents 15.9% of the outstanding Common Shares as of May 30, 2008. The Option Plan provides that the maximum number of Common Shares in respect of which options may be granted under the Option Plan to non-employee directors during any fiscal year of the Company is 20,000 Common Shares per director. Furthermore, the Option Plan limits the number of Common Shares issuable to insiders (as that term is defined in the Securities Act (Ontario) and the rules of the Toronto Stock Exchange (the "TSX"), at any time, or issued to insiders within any one-year period, under the Option Plan or any other securities-based compensation arrangement, to 10% of the outstanding Common Shares. As at May 30, 2008, the number of Common Shares issuable under outstanding options and options available for grant was 14,462,313, which represented 11.4% of the then outstanding Common Shares. Also, as at May 30, 2008, a total of 12,049,292 options were outstanding, which represented 9.5% of the then outstanding Common Shares. Shareholder approval is required to be obtained by the Company for any amendment (i) to increase the total number of Common Shares offered under the Option Plan; (ii) to implement a program to provide for the exchange of any option granted under the Option Plan for other options under the Option Plan; (iii) to reduce the price at which Common Shares may be purchased under the Option Plan (except in connection with an adjustment to the share capital in accordance with the terms of the Option Plan) or to cancel and reissue options; (iv) to extend the original expiry date of an option; (v) to increase the maximum number of Common Shares issuable to insiders of the Company under the Option Plan and any other security-based compensation arrangement; (vi) to increase the maximum number of Common Shares in respect of which options may be granted to non-employee directors during any fiscal year; and (vii) to amend the terms of the Option Plan governing the transfer or assignment of options. The Board of Directors otherwise has discretion to make certain amendments to the Option Plan which it may deem necessary, without having to obtain Shareholder approval if such amendments do not result in significant or unreasonable dilution in the Company's outstanding securities or in any additional benefits to employees, particularly insiders, at the expense of the Company and its other Shareholders. Such amendments may include, for example, (i) amendments to the eligibility for, and limitations and conditions on, participation in the Option Plan, (ii) amendments to any terms relating to the grant or exercise of options (other than a reduction in the price of an option), (iii) amendments to permit the grant of deferred or restricted share units or to add or amend any other provisions which result in employees receiving securities of the Company while no cash consideration is received by the Company, (iv) amendments that are necessary to comply with applicable laws, rules or regulations, (v) corrections or rectifications of any ambiguity, defective provision, error or omission in the Option Plan or in any option, and (vi) amendments to the terms relating to the administration of the Option Plan. Amendments to the Option Plan adopted in 2007 The Option Plan was amended by shareholder resolution adopted at the Company's annual general and special meeting held on July 24, 2007 as follows: (i) the number of Common Shares issuable to insiders at any time, or issued to insiders within any one-year period, under the Option Plan or any other securities-based compensation arrangement, was limited to 10% of the outstanding Common Shares; and (ii) the amending provisions of the Option Plan were changed to state what amendments would require Shareholder approval. -18- Options Granted and Exercised in Fiscal 2008 The following table sets forth the details regarding options granted to the Named Executive Officers under the Option Plan during Fiscal 2008.
Option Grants During Fiscal 2008 - ----------------------------------------------------------------------------------------------------------------------- Market Value % of Total of Securities Securities Options Underlying Under Granted to Exercise or Options on the Options Employees in Base Price(1) Date of Grant(1) Name Granted(#) Fiscal 2008 ($/Security) ($/Security) Expiration Date - ----------------------------------------------------------------------------------------------------------------------- Kirk K. Mandy 450,000 11.87% 0.85 0.85 February 15, 2014 Scott Milligan 125,000 3.30% 0.85 0.85 February 15, 2014 Donald McIntyre 125,000 3.30% 0.85 0.85 February 15, 2014 Henry Perret Nil 0% N/A N/A N/A Stanley Swirhun 125,000 3.30% 0.85 0.85 February 15, 2014 - -----------------------------------------------------------------------------------------------------------------------
(1) In accordance with the terms of the Option Plan, the exercise price of an option is determined by averaging the closing share prices on the Toronto Stock Exchange on the five trading days prior to the date of the grant. Market Value is the closing share price on the Toronto Stock Exchange on the date of grant. Canadian dollar values are converted to United States dollars using the closing foreign exchange rate of the Bank of Canada on the date of each grant. See "Report on Executive Compensation - Long Term Incentive" for an explanation of the Company's new option granting practice. The following table summarizes, for each of the Named Executive Officers (a) the number of options, if any, exercised during Fiscal 2008, (b) the aggregate value realized upon exercise, if applicable, which is the difference between the fair market value of the underlying Common Shares on the exercise date and the exercise or base price of the option, (c) the total number of unexercised options, if any, held on March 28, 2008, and (d) the aggregate value of unexercised in-the-money options at March 28, 2008, which is the difference between the exercise or base price of the options and the closing price of the Common Shares on the TSX on March 28, 2008, which was Cdn$0.78 per Common Share. The aggregate values indicated with respect to unexercised in-the-money options at financial year-end have not been, and may never be, realized. These options have not been, and may not be exercised, and actual gains, if any, on exercise will depend on the value of the Common Shares on the date of exercise. There can be no assurance that these values will be realized. -19- Aggregated Options Exercised During Fiscal 2008 and Fiscal Year-End Option Values
- --------------------------------------------------------------------------------------------------------------------- Value of Unexercised Unexercised Options In-the-Money Options at Securities Aggregate at March 28, 2008(1) March 28, 2008 Acquired On Value (#) ($) Exercise Realized ------------------------------------------------------------------- Name (#) ($) Exercisable Unexercisable Exercisable Unexercisable - --------------------------------------------------------------------------------------------------------------------- Kirk K. Mandy -- -- 1,015,000 1,225,000 -- -- Scott Milligan -- -- 283,750 301,250 -- -- Donald McIntyre -- -- 268,750 331,250 -- -- Henry Perret -- -- -- -- -- -- Stanley Swirhun -- -- 168,750 356,250 -- -- - ---------------------------------------------------------------------------------------------------------------------
(1) See "1991 Stock Option Plan for Key Employees and Non-Employee Directors" for details on vesting periods. REPORT ON EXECUTIVE COMPENSATION Composition of the Compensation Committee The Compensation and Human Resources and Development Committee ("Compensation Committee") is comprised of three independent members of the Board of Directors: Jules M. Meunier, the Chairperson of the Committee, Adam Chowaniec and Dennis Roberson. It is the responsibility of the Compensation Committee to recommend to the Board of Directors compensation policies and levels, compensation plans, stock option/purchase plans, benefit plans and pension plans and CEO and senior management goals and performance objectives and assess their performance against these objectives at each fiscal year end. The Compensation Committee is also responsible for reviewing succession plans developed by management that sustain the long-term viability of the Company. General Principles of Executive Compensation Compensation of executive officers, including the Named Executive Officers, is determined by the Compensation Committee and, upon the recommendation of the Compensation Committee, approved by the Board of Directors. The Company's executive compensation policies and programs are designed to enable the Company to increase its profitability and shareholder value, and attract and retain those key individuals who can realize and ensure the short-term and long-term success of the Company. As such, the policies and programs link rewards to individual contribution, Company success and shareholder financial interests. The Company's executive compensation program, on a total compensation basis, aims to be competitive with other companies who are competing in similar geographical regions for the same qualified executive talent as the Company. Executive positions are benchmarked against those of applicable external comparator groups through the use of third party international compensation consultant services. The prime comparator group is one of similar semiconductor and high-technology companies, with complementary comparator groups of other companies used where appropriate. -20- Accordingly, in Fiscal 2006, the Compensation Committee engaged the Hay Group Consultants (Toronto) to review against a comparator group of semiconductor companies the compensation of directors and executives as well as option grants to directors, executives and employees. In addition, the Hay Group was retained to assist management in the design and operation of a 360(degree) evaluation process for executives. The total compensation program for executive officers is comprised of three components: base salary, an annual incentive and a long-term incentive. Base Salary Base salary recommendations are determined based on market data for positions of similar responsibilities and complexity in the comparator groups, on internal equity comparisons and on the individual's ability, experience and contribution level. Base salaries for the executive group overall are reviewed on an annual basis. Those for individual executive positions may also be reviewed outside of the regular cycle so as to take into consideration market pressures. There were no salary increases for the executive group for Fiscal 2008. Annual Incentive Compensation Arrangements The Company's annual incentive plans are intended to focus and reward executives on the achievement of current year financial targets, key Company and/or business unit objectives and some strategic individual performance objectives. While the financial targets serve to focus on results of current year profitability, the key Company, business and individual objectives focus on activities designed to improve financial results and increase profitability in a two to three-year time frame. Financial threshold targets are approved by the Board of Directors at the commencement of the fiscal year and are required to be met for payments to be made according to plan criteria. As the Company threshold financial performance was not achieved for Fiscal 2008, there were no bonus awards to executives under the annual bonus plan based on the assessment by the Compensation Committee and the Board of the individual performances of the executives against specific objectives. There were ad hoc bonuses paid to Kirk Mandy, Scott Milligan and Donald McIntyre relating to the successful acquisition and integration of Legerity, Inc. during the second quarter of Fiscal 2008. See "Executive Compensation - Summary Compensation Table" for the amounts of the bonuses paid to each of the Named Executive Officers over each of the last three fiscal years. The target incentive levels of the executive group are reviewed at the same time as the base salaries. The target and actual total cash compensation (salaries plus annual incentives) of the Company's executive group are currently competitive with those of the applicable comparator group. The comparator group for short term incentives includes primarily semiconductor businesses. Long-Term Incentive Options to purchase Common Shares are granted to the Named Executive Officers and other key employees to sustain commitment to long-term profitability and maximize shareholder value over the long term. Under the terms and conditions of the Option Plan, participants are granted options which are exercisable for periods of time determined by the Compensation Committee to a maximum of six years following the date of grant at an exercise price equal to the average market price of the Common Shares on the Toronto Stock Exchange during the five trading-day period immediately preceding the date of grant. See "Executive Compensation - 1991 Stock Option Plan for Key Employees and Non-Employee Directors". -21- Beginning in Fiscal 2007, the Company established a new option granting practice. General grants of options are now made by the Company on the eighth business day following the date of release of the Company's Q3 financial results. Accordingly, the Option Plan's pricing formula of the five previous trading days' average used to determine the exercise price of the options will commence after the second clear business day following the release of quarterly results, so that the price will reflect the market share price after the markets have had two days to react to the most recent release of financial information. This is consistent with the Company's Insider Trading Guidelines. The Company and Board of Directors believe that stock options provide strong links between executive and key employee rewards, shareholder interests and the success of the Company. Stock option grants to executives and to other top contributors and critical skilled individuals are generally made on an annual basis. The size of grant for the executive group is determined based on the available option pool, the levels and values of options provided by companies in the external comparator group(s), and the number of options required for motivating and retaining the executives and other top contributors and critical skilled employees. During Fiscal 2008, the Company granted options under a general grant and special grant to executives and employees of newly acquired Legerity, Inc. to purchase up to 3,791,000 Common Shares to a total of 145 employees and seven non-employee directors of the Company at an average exercise price of $1.04 per share; of this total grant, 160,000 were granted to directors, 1,400,000 to executive officers and 2,251,000 to key employees. As options to purchase 1,653,753 Common Shares were forfeited in Fiscal 2008 due to the termination of employment of certain employees and expiry of options in the normal course, the net number of options granted during the year was 1.7% of the total number of outstanding Common Shares on March 28, 2008. On March 28, 2008, the number of outstanding options to purchase Common Shares was 9.7% of outstanding Common Shares on such date. The comparator group for long-term incentives is primarily semiconductor businesses. Compensation of the President and Chief Executive Officer In February 2005, Kirk K. Mandy was appointed President and CEO of the Company. Mr. Mandy's compensation was determined by the Compensation Committee and, upon the recommendation of the Compensation Committee, approved by the Board of Directors. The base salary and long-term incentive components of Mr. Mandy's compensation are determined in accordance with the policies applying to all executive officers of the Company. Mr. Mandy's current base salary is $534,894. Mr. Mandy's annual base salary is determined in Canadian dollars and set at CDN$550,000. Mr. Mandy's annual discretionary incentive payment is determined, at each fiscal year end, based on the Compensation Committee's assessment of Mr. Mandy's performance, particularly in improving the Company's financial condition and long term prospects. In Fiscal 2008, the Company did not achieve the EPS target in the Company's annual bonus plan. It also continued to invest strongly in research and development programs to increase the number of new products in order to fuel an acceleration of growth of Company revenue from new products. See "Employment Agreements - Kirk K. Mandy". As the Company did not achieve target financial performance on an operating basis for Fiscal 2008, the Compensation Committee and Board of Directors assessed Mr. Mandy's specific achievements during the year and awarded him no incentive payment under the annual bonus plan. It did, however, award him an ad hoc bonus of $194,507 for the successful completion of the acquisition and integration of Legerity, Inc. in the second quarter of fiscal 2008. The Compensation Committee of the Board of Directors, whose names are set out below, has approved the issue of this Report on Executive Compensation and its inclusion in this Circular. -22- Jules M. Meunier Dennis Roberson Adam Chowaniec May 30, 2008 PERFORMANCE GRAPH The following graph compares the cumulative total shareholder return on CDN$100 invested in Common Shares with the cumulative total return of the S&P/TSX Composite Index for the five most recently completed fiscal years, assuming reinvestment of all dividends. [The following information was depicted as a line chart in the printed material] TSX TSX Composite ZL Composite ZL Index (Cumulative) Index ---- --------- ------------ --------- March 28, 2003 $100 $100 $100 $100 March 26, 2004 $96 $135 $96 $135 March 25, 2005 $38 $152 $38 $152 March 31, 2006 $65 $193 $65 $193 March 30, 2007 $45 $209 $45 $209 March 28, 2008 $15 $210 $15 $210 EMPLOYMENT AGREEMENTS The Company has entered into employment agreements with the Named Executive Officers on the terms and conditions described below. KIRK K. MANDY Effective January 26, 2005, the Company entered into an employment agreement with Mr. Kirk K. Mandy with respect to his employment as interim President and Chief Executive Officer and, effective February 16, 2005, as full time President and Chief Executive Officer. This employment agreement was revised on May 24, 2007. Pursuant to the agreement, Mr. Mandy is entitled to receive an annual base salary in the amount of 534,894. Mr. Mandy's annual base salary is determined in Canadian dollars and set at CDN$550,000. He is also eligible to receive an annual incentive payment equal to 60% of his annual base salary or, at exceptional performance, 90% of his annual base salary, conditional upon the Board of Directors' assessment of the successful achievement by Mr. Mandy of specific target objectives in each fiscal year. The incentive payment objectives for each fiscal year are reviewed and finalized by the Compensation Committee and the Board of Directors within 60 days following the commencement of each fiscal year. Mr. Mandy's objectives for Fiscal 2009 are as follows: -23- 1. Meet or exceed the Company's Fiscal 2009 earnings targets; 2. Improve the Company's quality of earnings through continued focus on cost containment and margin expansion; and 3. Execute the Company's strategic plan, deriving an increasing proportion of revenue from new product programs, while growing overall revenue. Mr. Mandy is also entitled to customary benefits and currently holds 2,240,000 options for Common Shares at exercise prices determined as follows: 20,000 options (all of which are currently exercisable) may be exercised at the market price (as defined in the Option Plan) of CDN$$5.10 in effect on February 6, 2003; 20,000 options (all of which are currently exercisable) may be exercised at the market price of CDN$5.36 in effect on January 29, 2004; 100,000 options (75,000 of which are currently exercisable) may be exercised at the market price of CDN$2.12 in effect on February 3, 2005; 750,000 options (562,500 of which are currently exercisable) may be exercised at the market price of CDN$2.26 in effect on February 24, 2005; 450,000 options (225,000 of which are currently exercisable) may be exercised at the market price of CDN$2.51 in effect on January 27, 2006; 450,000 options (112,500 of which are currently exercisable) may be exercised at the market price of CDN$2.49 in effect on February 6, 2007; and 450,000 options (none of which are currently exercisable) may be exercised at the market price of CDN$0.86 in effect on February 15, 2008. The options provide for equal annual vesting over a period of four years with first tranche vesting one year following their date of grant, and are otherwise governed by the terms and conditions of the Option Plan. (Canadian dollar amounts have been converted to United States dollars using the closing foreign exchange rate provided by the Bank of Canada on the date of grant). Mr. Mandy's employment agreement provides further that, in the event that the Company terminates his employment without legal grounds for which an employer is entitled to dismiss an employee without notice or compensation in lieu of notice, he will be entitled to the following termination package: (i) a lump sum payment equal to two times his annual base salary, (ii) a lump sum payment in lieu of incentive payment equal to two times his target annual bonus, (iii) a payment of two years' regular annual contributions to an executive pension plan and (iv) continued group life and health benefits coverage until the earlier of two years following the date of termination or 30 days after he secures substantially similar replacement coverage through re-employment. In addition, Mr. Mandy will have a period of six months following the date of termination to exercise all stock options that will have vested up to the end of such exercise period. SCOTT MILLIGAN On May 12, 2003, the Company entered into an employment agreement with Mr. Scott Milligan with respect to his employment as Senior Vice President, Finance and Chief Financial Officer. This employment agreement was revised on May 24, 2007. Pursuant to the agreement, Mr. Milligan is entitled to receive an annual base salary in the amount of 325,799. Mr. Milligan's base salary is determined in Canadian dollars and has been set at CDN$335,000 since Fiscal 2004. The change in the U.S. dollar equivalent of Mr. Milligan's base salary is due solely to foreign exchange fluctuations. He is also eligible to receive an annual incentive payment, conditional upon the successful achievement by Mr. Milligan of specific target objectives in each fiscal year, as follows: (i) if the objectives are achieved in full, the annual incentive payment will be equal to 50% of the annual base salary, and (ii) if the financial component of the objectives is exceeded, Mr. Milligan may earn up to 150% of his target incentive payment. The incentive payment objectives for each fiscal year are reviewed and finalized with the Board of Directors within 45 days following the commencement of each fiscal year. Mr. Milligan is also entitled to customary benefits and received an initial grant of options to purchase 50,000 Common Shares pursuant to the Option Plan. The options -24- provide for equal annual vesting over a period of four years commencing one year following their date of grant, and are otherwise governed by the terms and conditions of the Option Plan. Mr. Milligan's employment agreement provides further that, in the event that the Company terminates his employment without legal grounds for which an employer is entitled to dismiss an employee without notice or compensation in lieu of notice, he will be entitled to the following termination package: (i) a lump sum payment equal to two times his then current annual base salary, (ii) a lump sum payment in lieu of incentive payment equal to two times his target annual incentive payment, (iii) a payment of two years' regular annual contributions to an executive pension plan, and (iv) continued group life and health benefits coverage until the earlier of one year following the date of termination or 30 days after he secures substantially similar replacement coverage through re-employment. In addition, Mr. Milligan will have a period of six months following the date of termination to exercise all stock options that vested up to the end of such exercise period. DONALD MCINTYRE Mr. McIntyre was engaged by the Company, then known as Mitel Corporation, in March 1987 as Vice President, General Counsel and Secretary. His current position is Senior Vice President, Human Resources, General Counsel and Secretary of the Company. Pursuant to his current employment agreement, Mr. McIntyre is entitled to receive an annual base salary of 325,799. His base salary is determined in Canadian dollars and has been set at CDN$335,000 since Fiscal 2004. The change in the U.S. dollar equivalent of Mr. McIntyre's base salary is due solely to foreign exchange fluctuations. Mr. McIntyre is also eligible to receive an annual incentive payment, conditional upon the successful achievement by Mr. McIntyre of specific target objectives in each fiscal year as follows: (i) if the objectives are achieved in full, the annual incentive payment will be equal to 50% of his annual base salary and (ii) if the financial component of the objectives is exceeded, Mr. McIntyre may earn up to 150% of his target incentive payment. The incentive payment objectives for each fiscal year are reviewed and finalized with the Board of Directors of the Company within 45 days following the commencement of each fiscal year. On January 12, 2000, the Board of Directors approved an executive termination agreement for Mr. McIntyre to be effective from that date. The agreement provides that in the event that the Company terminates Mr. McIntyre's employment without legal grounds for which an employer is entitled to dismiss an employee without notice or compensation in lieu of notice, he will be entitled to the following termination package: (i) a lump sum payment equal to two times his then current annual base salary and annual target incentive payment, (ii) a payment of two years' regular annual contributions to an executive pension plan and (iii) continued group life and health benefits coverage during such two-year period. In addition, Mr. McIntyre will have a period of six months following the date of termination to exercise all stock options that will have vested up to the end of such exercise period. HENRY PERRET Mr. Perret was the President and Chief Executive Officer of Legerity, Inc., which was acquired by the Company on August 3, 2007. Mr. Perret agreed to be employed by Zarlink for one year as Senior Vice President, Wired Communications to effect an orderly transition and integration of the business. On July 31, 2007, the Company entered into an employment agreement with Mr. Perret with respect to his employment as Senior Vice President and General Manager, Wired Communications for a term of one year. Pursuant to the agreement, Mr. Perret is entitled to receive a base salary in the amount of $350,000. He is also eligible to receive a bonus of up to 50% of his base salary conditional upon the -25- successful achievement by Mr. Perret of specific target objectives during the term of his agreement. The agreement also provides Mr Perret with the ability to earn a retention bonus of $350,000 as incentive to remain in the employ of the Company, payable after the completion of one year of employment (or earlier if Mr. Perret's employment is terminated by the Company without cause before the expiry of the term). Mr. Perret is also entitled to customary benefits. Mr. Perret's employment agreement provides further that, in the event that the Company terminates his employment without cause, as defined in the agreement, he will be entitled to (i) a lump sum payment equal to the amounts remaining (salary and bonus) for the balance of his one-year employment term, and (ii) a gross amount in cash, less statutory deductions, sufficient to pay for the remaining number of months of the one year employment term of insurance premiums in order to obtain life, health and dental insurance coverage at the same or similar premium basis and level that was available to him at the time of his termination. STANLEY SWIRHUN On May 31, 2005, the Company entered into an employment agreement with Mr. Stanley Swirhun with respect to his employment as Senior Vice President and General Manager, Optical Communications. Pursuant to the agreement, Mr. Swirhun is entitled to receive an annual base salary in the amount of $275,000. He is also eligible to receive an annual incentive payment, conditional upon the successful achievement by Mr. Swirhun of specific target objectives in each fiscal year, as follows: (i) a target annual incentive of 50% of his annual base salary, and (ii) the possibility of earning up to 75% of his annual base salary in the case of exceptional performance. The incentive payment objectives for each fiscal year are reviewed and finalized with the Board of Directors of the Company within 60 days following the commencement of each fiscal year. Mr. Swirhun is also entitled to customary benefits. Mr. Swirhun's employment agreement provides further that, in the event that the Company terminates his employment without legal grounds for which an employer is entitled to dismiss an employee without notice or compensation in lieu of notice, he will be entitled to the following termination package: (i) a lump sum payment equal to one times his then current annual base salary, (ii) a lump sum payment in lieu of incentive payment equal to one times his average earned incentive payment over the previous three years or such shorter period if the period of employment is shorter than three years, and (iii) an amount equivalent to the Company's one-year cost of his current life, health and dental insurance coverage. In addition, Mr. Swirhun will have a period of six months following the date of termination to exercise all stock options that vested up to the end of such exercise period. EQUITY COMPENSATION PLAN INFORMATION The following table provides information as of March 28, 2008 about the Common Shares that may be issued upon exercise of options, warrants and rights under all of the Company's equity compensation plans. -26-
- ------------------------------------------------------------------------------------------------------------- Number of securities remaining Number of securities to Weighted-average available for future issuance be issued upon exercise exercise price of under equity compensation of outstanding options, outstanding options, plans (excluding securities Plan Category warrants and rights warrants and rights reflected in the first column) - ------------------------------------------------------------------------------------------------------------- Equity compensation 12,390,625 $2.30 2,071,688 plans approved by securityholders(1) - ------------------------------------------------------------------------------------------------------------- Equity compensation N/A N/A N/A plans not approved by securityholders - ------------------------------------------------------------------------------------------------------------- Total 12,390,625 $2.30 2,071,688 - -------------------------------------------------------------------------------------------------------------
(1) For more information regarding the Option Plan, please refer to the section "Executive Compensation - 1991 Stock Option Plan for Key Employees and Non-Employee Directors". COMPENSATION OF NON-EMPLOYEE DIRECTORS During the fiscal year ended March 28, 2008, each director who was not a salaried officer of the Company or its subsidiaries received an annual stipend of $9,752 and a director's fee of $1,950 for each meeting of the Board of Directors or any Committee thereof attended in person and for each day spent on the affairs of the Company or $1,219 for each telephone meeting of the Board of Directors and was reimbursed for his expenses. In addition, the Chairperson of each Committee of the Board of Directors received an annual fee of $5,851, with the exception of the Chairperson of the Audit Committee, who received an annual fee of $14,629. The Company pays the Chairperson of the Board of Directors, when such person is not an employee of the Company, an annual stipend of $97,523 (inclusive of Board and Committee meeting fees) and a per diem of $2,438 for attendance to Company business, to an annual maximum of $48,762. The Chairperson did not receive any per diem amount for attendance to Company business, at his request, for the 2nd half of the fiscal year ended March 28, 2008. The per diem portion of the Chairperson's compensation has been suspended indefinitely at the Chairperson's request until the Company returns to an acceptable level of profitability. The compensation of non-employee directors is fixed in Canadian dollars. Changes in compensation for non-employee directors from Fiscal 2007 to Fiscal 2008 were due solely to foreign exchange fluctuations. See note 1 under "Executive Compensation - Summary Compensation Table" for details on the foreign exchange fluctuations. The following table summarizes the aggregate number of unexercised options held by non-employee directors at May 30, 2008. -27- Option Information for Non-Employee Directors
- --------------------------------------------------------------------------------------------------------------------- Unexercised Options at May 30, 2008 -------------------------------------------------------------------------------- Date of Grant Exercise Price Exercisable Unexercisable - --------------------------------------------------------------------------------------------------------------------- July 13, 2002 CDN $7.15 20,000 0 - --------------------------------------------------------------------------------------------------------------------- February 6, 2003(1) CDN $5.10 80,000 0 - --------------------------------------------------------------------------------------------------------------------- May 14, 2003(1) CDN $6.68 20,000 0 - --------------------------------------------------------------------------------------------------------------------- January 29, 2004(1) USD $4.04 100,000 0 - --------------------------------------------------------------------------------------------------------------------- November 26, 2004 USD $2.25 15,000 5,000 - --------------------------------------------------------------------------------------------------------------------- February 24, 2005 USD $1.83 90,000 30,000 - --------------------------------------------------------------------------------------------------------------------- January 27, 2006 USD $2.18 60,000 60,000 - --------------------------------------------------------------------------------------------------------------------- February 6, 2007 USD $2.11 30,000 90,000 - --------------------------------------------------------------------------------------------------------------------- February 19, 2007 USD $2.12 5,000 15,000 - --------------------------------------------------------------------------------------------------------------------- November 12, 2007 USD $1.16 0 20,000 - --------------------------------------------------------------------------------------------------------------------- February 15, 2008 USD $0.85 0 140,000 - ---------------------------------------------------------------------------------------------------------------------
(1) See "Executive Compensation - 1991 Stock Option Plan for Key Employees and Non-Employee Directors" for details on vesting periods. INDEBTEDNESS OF DIRECTORS, EXECUTIVE OFFICERS AND SENIOR OFFICERS As of May 30, 2008, and at no time during Fiscal 2008, was any executive officer, director, employee or former executive officer, director or employee of the Company or any of its subsidiaries indebted to the Company or any of its subsidiaries (other than routine indebtedness). Furthermore, the Company has not provided any guarantee, support agreement, letter of credit or other similar arrangement or understanding in respect of any indebtedness (other than routine indebtedness) of any such person to any other person or entity. DIRECTORS' AND OFFICERS' LIABILITY INSURANCE As at May 30, 2008, the Company had in force Directors' and Officers' Liability Insurance policies in the amount of $30,000,000 for the benefit of the directors and officers of the Company and its subsidiaries. The total amount of the premiums paid by the Company for the policies in effect for the fiscal year ended March 28, 2008 was $681,372. No portion of these premiums was paid by the directors and officers of the Company. The policies do not provide for a deductible for any loss in connection with a claim against a director or an officer. For claims brought against the Company, a deductible of $1,000,000 applies. STATEMENT OF CORPORATE GOVERNANCE PRACTICES The Board of Directors and the Company's management are committed to the highest standard of corporate governance, and the Company has had standards in place for many years. The Nominating and Corporate Governance Committee and the Board of Directors review the Company's governance standards periodically and at least annually and revise them when necessary to respond to changing regulatory requirements and evolving best practices. The Company's principal objective in directing and managing its business and affairs is to enhance shareholder value. The Company believes that effective corporate governance improves corporate performance and benefits all shareholders. The Canadian Securities Administrators ("CSA") published on April 15, 2005 National Policy 58-201 - Corporate Governance Guidelines and National Instrument 58-101 - Disclosure of Corporate -28- Governance Practices which prescribe corporate governance guidelines (the "Governance Guidelines") and related detailed disclosure, which came into force on June 30, 2005. Previously, in March 2004, the CSA rules relating to audit committees and certification of financial disclosure came into force ("CSA Audit Committee Rules"). The Board of Directors of the Company believes that the Company is fully compliant with the Governance Guidelines. The Company's corporate governance practices are compared with the Governance Guidelines in Schedule C hereto. As the Company complies with the NYSE corporate governance rules (the "NYSE Rules") regarding the role and composition of the Audit Committee, the Company is exempt from compliance with the CSA Audit Committee Rules. As the Common Shares are registered in the United States, the Company is subject to certain provisions of the United States Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") and the rules and regulations ("SEC Rules") of the SEC. Moreover, as the Common Shares are listed on the NYSE, it is subject to the NYSE Rules. Although there are certain differences between the corporate governance practices of the Company, which is a foreign private issuer under the SEC Rules, and those required of a domestic company under the NYSE Rules, we do not believe that any of these differences are significant. The differences in corporate governance practices are set forth in Schedule D hereto. The Governance Guidelines, which are not mandatory, define a director as independent if he or she has no direct or indirect material relationship with the Company. The Governance Guidelines recommend and the NYSE Rules require that a majority of the board be "independent". Independence is defined under the Governance Guidelines and the NYSE Rules to mean the board has affirmatively determined that the director has no material relationship with the Company which could be reasonably expected to interfere with the exercise of a member's independent judgment. The Governance Guidelines and the NYSE Rules deem certain relationships to be indicative of non-independence. The NYSE Rules also require that all audit committee members meet additional independence standards, including not accepting, directly or indirectly, any consulting or other compensatory fee and not being an affiliate of the Company. The Board of Directors has reviewed the Governance Guidelines and NYSE Rules and has individually considered their respective interests in and relationships with the Company. As a consequence, the Board of Directors has determined that, on a rigorous application of these definitions, the Board is composed of seven "independent" directors out of eight board members. The CEO of the Company, Kirk K. Mandy, is the only director not considered to be an "independent" director. The NYSE Rules require that all of audit committee members be independent and financially literate, as defined by such rules. The Company is also required, under the Sarbanes-Oxley Act and SEC Rules, to disclose whether it has an audit committee financial expert (within the meaning of such rules) serving on its audit committee. The Board of Directors has reviewed the independence of each member of the Audit Committee, as well as the education and experience of each member of the Audit Committee relevant to the performance of his duties on the Audit Committee and has determined that all Audit Committee members are independent and financially literate and that Hubert T. Lacroix, Chairperson of the Audit Committee, and J. Spencer Lanthier, a member of the Audit Committee, are the audit committee financial experts. The Board of Directors has approved a detailed set of internal corporate governance policies including mandates for the Board of Directors and its committees and a Code of Ethics and Business -29- Conduct. These policies are described in detail in Schedule C hereto and are available in their entirety at the Company's website at www.zarlink.com. The Board of Directors continues to monitor changes to corporate governance rules and best practices and to take appropriate action, including, as appropriate, the adoption of voluntary policies and procedures. A brief summary of the education and/or experience of each member of the Audit Committee that is relevant to the performance of his responsibilities as a member of the Committee is set out below. AUDIT COMMITTEE MEMBERS Relevant Education and Experience Hubert T. Lacroix has a BCL (1976) and a MBA (1981) from McGill University and has been a member of the Quebec Bar since 1977. Mr. Lacroix has been President and Chief Executive Officer of Canadian Broadcasting Corporation / Radio-Canada ("CBC") since January 1, 2008. From February 1, 2000 to May 2, 2003, he served as Executive Chairman of the Board of Telemedia Corporation as well as Executive Chairman of the Board of Directors of its affiliated companies. Mr. Lacroix is Chairman of the Board of SFK Pulp Fund and a member of its audit committee. Mr. Lacroix has acquired a good understanding of the accounting principles used to prepare financial statements, in general, resulting from his legal practice specializing in business law and the positions held with CBC and Telemedia Corporation as well as the experience acquired as a member of audit committees for several public and private corporations over a period of nearly 20 years. This experience allows him to understand the accounting principles used by the Company in preparing its financial statements and to evaluate, in general, the application of accounting principles as they relate to the accounting of the Company's estimates, accounts receivable, accounts payable and reserves. Moreover, he has an excellent understanding of the procedures regarding the disclosure of financial information. J. Spencer Lanthier was the Chairman and Chief Executive Officer of KPMG Canada from 1993 to 1999 and Vice-Chairman from 1989 to 1993. He also served as a member of the KPMG International Executive Committee and Board. Mr. Lanthier was awarded his F.C.A. designation by the Institute of Chartered Accountants of Ontario in 1982 and served as a partner of KPMG Canada from 1972 until his retirement in 1999. He received the Award of Outstanding Merit from the Institute of Chartered Accountants of Ontario in 2001. Mr. Lanthier also serves as a director on the Board of Directors of several public companies. As a result of his accounting background and active practice as a certified public accountant for over 27 years, Mr. Lanthier has developed a high level of financial expertise. Mr. Lanthier has experience in preparing, auditing, analyzing or evaluating financial statements that present a certain breadth and level of complexity of accounting issues and has actively supervised persons engaged in performing similar functions. Jules Meunier has served as President and CEO of Proquent Systems Inc. and President of Nortel Network's Wireless Network division. He is also a director and a member of the audit committee of Spectrum Signal Processing. In such capacities, Mr. Meunier has acquired accounting and related financial management expertise and general financial literacy. Mr. Meunier has also actively supervised persons engaged in preparing, auditing, analyzing or evaluating financial statements. Mr. Meunier holds a Bachelor of Science degree in Mathematics and Computer Science from the University of Ottawa. -30- REPORT OF THE AUDIT COMMITTEE The Audit Committee oversees the Company's financial reporting process on behalf of the Board of Directors. Management has the primary responsibility for the financial statements and the reporting process, including internal control systems. In fulfilling its oversight responsibilities, the Audit Committee reviews the audited financial statements contained in the Annual Report with management. This review involves a discussion of the quality, and not just the acceptability, of the accounting principles, the reasonableness of significant judgments, and the clarity of the disclosure in the financial statements. The Audit Committee also reviews the audited financial statements with the independent auditors, who are responsible for expressing an opinion on the conformity of such financial statements with generally accepted accounting principles, their view as to the quality, and not just the acceptability, of the Company's accounting principles and such other matters as are required to be discussed by Statement on Auditing Standards No. 61, as amended (Communications with Audit Committees) and under generally accepted auditing standards. In addition, the Audit Committee discusses with the independent auditors the auditors' independence from management and the Company, and such other matters contained in the written disclosure required by Independence Standards Board No. 1 (Independence Discussions with Audit Committees) and considers the compatibility of non-audit services with the auditors' independence. The Audit Committee discusses the overall scope and plan for the annual audit with the Company's independent auditors. The Audit Committee meets with the independent auditors, with and without management present, to discuss the results of their examinations, their evaluations of the Company's internal controls and the overall quality of the Company's financial reporting. The Audit Committee has adopted a policy that requires advance approval of all audit, audit-related, tax and other services performed by the independent auditor. The policy provides for pre-approval by the Audit Committee of specifically defined audit and non-audit services. Unless the specific service has been previously pre-approved with respect to that year, the Audit Committee must approve the permitted service before the independent auditor is engaged to perform it. For a full description of the Audit Committee responsibilities, please review Schedule E, the Audit Committee Charter, attached to this Circular. In reliance on the reviews and discussions referred to above, the Audit Committee recommended to the Board of Directors that the audited financial statements be included in the Annual Report on Form 20-F for Fiscal 2008 for filing with the SEC and all other applicable regulatory authorities and the Board of Directors has approved such financial statements. Hubert T. Lacroix J. Spencer Lanthier Jules Meunier June 4th, 2008 AUDIT AND OTHER FEES The fees billed to the Company by its auditors in Fiscal 2008 and Fiscal 2007 are summarized in the table below. -31- - -------------------------------------------------------------------------------- Deloitte & Touche(3) Ernst & Young FEES FISCAL 2008 FISCAL 2007 - -------------------------------------------------------------------------------- Audit services(1) $1,191,000 $750,000 - -------------------------------------------------------------------------------- Audit-related services(2) $78,000 $13,000 - -------------------------------------------------------------------------------- Tax services Nil $185,000 - -------------------------------------------------------------------------------- Non-audit services Nil nil - -------------------------------------------------------------------------------- Total Fees(1): $1,269,000 $948,000 - -------------------------------------------------------------------------------- (1) These fees included fees for the audit of the consolidated financial statements and other services performed such as statutory audits and quarterly reviews. In Fiscal 2008, these fees include incremental costs of approximately $400,000 for audit of internal control over financial reporting (SOX) and approximately $180,000 relating to the acquisition of Legerity, Inc. and the Swindon foundry sale. (2) These fees included fees for the Canadian Public Accountability Board in Fiscal 2008. (3) Deloitte fees were converted to United States dollars from Canadian dollars using the Fiscal 2008 average exchange rate of $0.972534. Based on a review of these services and of the fees billed by Deloitte, the Audit Committee has concluded that Deloitte is independent with respect to the Company. Representatives of Deloitte are expected to be present at the Meeting and will have an opportunity to make a statement if they so desire and will be available to respond to appropriate questions. NORMAL COURSE ISSUER BID On May 22, 2008, the TSX accepted the Company's Notice of Intention (the "Notice") to Make a Normal Course Issuer Bid (the "Bid"). In the Notice, the Corporation stated its intention to repurchase up to 12,272,384 Common Shares, representing approximately 10% of its public float of Common Shares as of May 20, 2008. The Company intends to repurchase Common Shares under the Bid using available cash during a 12-month period from May 26, 2008 to May 25, 2009. The timing and exact number of Common Shares purchased under the bid will be at the Company's discretion, will depend on market conditions, and may be suspended or discontinued at any time. All shares purchased by the Company under the Bid will be cancelled. Purchases under the bid will be made at the prevailing market price through the facilities of the TSX. The average daily trading volume of the Company over the six complete calendar months preceding the filing of the Notice was 411,976 Common Shares (the "ADTV"). Under TSX rules, the Company may purchase up to 25% of the ADTV (or 102,994 Common Shares) per trading day. Once a week, in excess of the daily repurchase limit, the Company may purchase a block of Common Shares not owned by an insider (i) having a purchase price of $200,000 or more, (ii) of at least 5,000 Common Shares with a purchase price of at least $50,000, or (iii) of at least 20 board lots of Common Shares which total 150% or more of the ADTV. To the knowledge of the Company, after reasonable inquiry, no director, senior -32- officer or any of their associates, or any person acting jointly or in concert with the Company, intends to sell Common Shares under the Bid. SHAREHOLDERS' PROPOSALS Proposals of holders of common shares intended to be presented at the next Annual Meeting must be received by the Company, c/o Donald G. McIntyre, Secretary, Zarlink Semiconductor Inc., 400 March Road, Ottawa, Ontario, Canada K2K 3H4, no later than March 6, 2009 for inclusion in the Company's Management Proxy Circular and form of proxy relating to that meeting. It is recommended that proposals be delivered to the Company by registered mail. OTHER MATTERS The information contained herein is given as of May 30, 2008. Management of the Company knows of no amendment of the matters referred to in the Notice of Meeting. However, if any amendment, variation or other business should properly be brought before the Meeting, the accompanying Form of Proxy confers discretionary authority upon the persons named therein to vote upon any amendment or variation of the matters referred to in such notice or on such other business in accordance with their best judgment. ADDITIONAL INFORMATION Financial information is provided in the Company's annual audited financial statements and any interim financial statements submitted subsequent to the filing of the most recent annual financial statements and the Management's Discussion and Analysis ("MD&A") included in those statements. Copies of the Company's financial statements and related MD&A are available upon request from the Company's Corporate Secretary as well as on the Company's website. Additional information relating to the Company is also available on SEDAR at www.sedar.com and on EDGAR at www.sec.gov. DIRECTORS' APPROVAL The contents and sending of this Circular have been approved by the Board of Directors of the Company. Dated this 4th day of June 2008. /s/ Donald G. McIntyre ---------------------- Donald G. McIntyre Corporate Secretary Ottawa, Ontario, Canada -33- SCHEDULE "A" PROPOSED RESOLUTION TO APPROVE THE AMENDMENT TO THE BY-LAWS ZARLINK SEMICONDUCTOR INC. (the "Company") RESOLUTION OF THE SHAREHOLDERS OF THE COMPANY July 23, 2008 ---------- RESOLVED, as an ordinary resolution, that: 1. the amendment to By-Law No. 16 of the Company consisting in the deletion of Section 7.03 thereof and its replacement with the following, be and is hereby confirmed and approved: "7.03 Registration of Transfer. Subject to the provisions of the Act, no transfer of shares shall be registered in a securities register except: (i) upon presentation of the certificate representing such shares with an endorsement which complies with the Act made thereon or delivered therewith duly executed by an appropriate person as provided by the Act, together with such reasonable assurance that the endorsement is genuine and effective, or (ii) if the shares are held through a direct registration system (DRS) that enables persons to hold and transfer shares electronically directly on the books of the Corporation or its registrar and transfer agent, without the need for share certificates representing such shares, upon satisfaction of such conditions applicable to the transfer of shares on such DRS and such other conditions as may be approved by the board from time to time; and 2. any director or officer of the Company be and each of them is hereby authorized, to do such things and to execute and deliver all such documents that such director or officer may, in his discretion, determine to be necessary or useful in order to give full effect to the intent and purpose of this resolution. A-1 SCHEDULE "B" PROPOSED RESOLUTION TO REDUCE THE COMPANY'S STATED CAPITAL ZARLINK SEMICONDUCTOR INC. (the "Company") RESOLUTION OF THE SHAREHOLDERS OF THE COMPANY July 23, 2008 ---------- WHEREAS there are no reasonable grounds for believing that the Company, after the reduction of its stated capital from US$479,000,000 to US$149,000,000, will be unable to pay its liabilities as they become due or that the realizable value of the Company's assets will thereby be less than the aggregate of its liabilities. RESOLVED, as a special resolution, that: 1. the stated capital account maintained in respect of the common shares of the Company is hereby reduced from US$479,000,000 to US$149,000,000; and 2. any director or officer of the Company be and each of them is hereby authorized to do such things and to execute and deliver all such documents that such director or officer may, in his discretion, determine to be necessary or useful in order to give full effect to the intent and purpose of this resolution. B-1 SCHEDULE "C" STATEMENT OF CORPORATE GOVERNANCE PRACTICES
- -------------------------------------------------------------------------------------------------------------------------- Guidelines Compliance Description of Approach - -------------------------------------------------------------------------------------------------------------------------- 1. Board of Directors Yes The Board of Directors is composed of eight directors. The Governance Guidelines recommend and (a) Disclose the identity of directors who are the NYSE Rules require that a majority of the independent. board must be "independent". The Governance Guidelines define a director as independent if he or she has no material relationship with the Company. Independence is defined under the Governance Guidelines and the NYSE Rules to mean the board has affirmatively determined that the director has no material relationship with the Company. The Governance Guidelines and the NYSE Rules deem certain relationships to be indicative of non-independence. The Board of Directors has determined that, on a rigorous application of these definitions, the Board would be composed of seven "independent" directors out of eight board members, namely Henry Simon, Oleg Khaykin, Adam Chowaniec, Hubert T. Lacroix, J. Spencer Lanthier, Jules Meunier and Dennis A. Roberson. (b) Disclose the identity of directors who are The President and Chief Executive Officer of the not independent, and describe the basis for Company, Kirk K. Mandy, is the one director out of that determination. eight on the Board of Directors not considered to be an "independent" director. (c) Disclose whether or not a majority of the In determining whether or not a director is directors are independent. independent, as that term is defined in the Governance Guidelines and the NYSE Rules, the Board of Directors considers all relevant facts applicable to a director. Based on the foregoing and on the information provided by directors as to their individual circumstances (see "Election of Directors"), the Board has determined that seven of the eight Board of Directors members are independent. See Item 1(a) above. (d) Disclose the names of directors who are This information is provided in each director's directors of any other reporting issuer and biography under the heading "Election of the name of the reporting issuer. Directors" of this Circular. (e) Disclose whether or not the independent The independent directors meet at regularly directors hold regularly scheduled meetings scheduled "executive sessions" without management. at which non-independent directors and The Chairperson of the Board of Directors chairs members of management are not in attendance. the executive sessions; however, he may choose to If the independent directors hold such defer to a Committee Chairperson when the subject meetings, disclose the number of meetings matter of the meeting falls within the purview of held since the beginning of the issuer's a Board Committee. The independent directors, led most recently completed financial year. by the Chairperson of the Board of Directors, determine the frequency, length and agenda for executive sessions. An executive session is scheduled immediately before or after a regular Board of Directors meeting at least quarterly each year. At least four executive sessions were held during the course of the last fiscal year.
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(f) Disclose whether or not the chair of the The Chairperson of the Board of Directors, Dr. board is an independent director. If the Henry Simon, is an independent director and board has a chair or lead director who is an ensures that the Board of Directors can function independent director, disclose the identity independently of management. The Chairperson's of the independent chair or lead director, primary role includes ensuring that the Board of and describe his or her role and Directors functions properly, that it meets its responsibilities. obligations and responsibilities, that it fulfills its mandate and that its organization and mechanisms are in place and are working effectively. The Chairperson's responsibilities are to ensure that the Board of Directors meets on a regular basis and at least quarterly without management present; in consultation with the CEO, to establish a calendar for holding meetings of and setting the agendas for the meetings of the Board of Directors and the Shareholders; to coordinate the schedule of meetings of the Board Committees with the Chairpersons of the Board Committees; to act as liaison and to maintain communication with all directors and Board Committee Chairpersons to optimize and co-ordinate input from directors, and to optimize effectiveness of the Board of Directors and Board Committees; to ensure that the Board of Directors receives adequate and regular updates from the President and CEO on all issues important to the welfare and future of the Company; and to meet periodically with the CEO and the Secretary to optimize his liaison function and to ensure efficient communication between management and the Board of Directors. A copy of the role description for the Chairperson of the Board of Directors can be found on the Company's website at www.zarlink.com. (g) Disclose the attendance record of each Each director's attendance at Board of Directors director for all board meetings held since meetings is disclosed under "Election of the beginning of the most recently completed Directors" and each director's attendance at financial year. Committee meetings is disclosed under "Election of Directors - Independence and Board Committees". - -------------------------------------------------------------------------------------------------------------------------- 2. Board Mandate Yes Disclose the text of the board's written The mandate of the Board of Directors is mandate. reproduced under Schedule F to this Circular and can also be found on the Company's website at www.zarlink.com. - -------------------------------------------------------------------------------------------------------------------------- 3. Position Descriptions Yes (a) Disclose whether or not the board has The Board of Directors has developed written developed written position descriptions for position descriptions for the Chairperson of the the chair of the board and the chair of each Board of Directors (see item 1(f) above) as well board committee. as for each Committee Chair. A copy of the role description for the Chairperson of the Board and for the Committee Chairs can be found on the Company's website at www.zarlink.com. (b) Disclose whether or not the board and CEO The Board of Directors has developed a written have developed a written position position description for the CEO under the name description for the CEO. "Terms of Reference for the Chief Executive Officer" and can be found on the Company's website at www.zarlink.com. - --------------------------------------------------------------------------------------------------------------------------
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4. Orientation and Continuing Education Yes (a) Briefly describe what measures the board The Board of Directors considers that orienting takes to orient new members regarding: and educating new directors is an important element of ensuring responsible corporate (i) the role of the board, its committees governance. In addition to having extensive and its directors, and discussions with the Chairperson of the Board of Directors and the President and CEO with respect (ii) the nature and operation of the to the business and operations of the Company, a issuer's business. new director receives a record of public and other information concerning the Company and prior minutes of recent meetings of the Board of Directors and applicable committees. The details of the orientation of each new director are tailored to that director's individual needs and areas of interest. (b) Briefly describe what measures, if any, the The Board of Directors is responsible for ensuring board takes to provide continuing education that an appropriate continuing education program for its directors. is made available to all directors. Educational presentations are provided at the Board of Directors meetings from time to time. In addition, all directors receive from the CEO regular business updates and are provided with a copy of all CEO communications to employees. - -------------------------------------------------------------------------------------------------------------------------- 5. Ethical Business Conduct Yes (a) Disclose whether or not the board has All of the Company's employees (including the adopted a written code for its directors, senior executives) are subject to a Code of Ethics officers and employees. If the board has and Business Conduct, a copy of which is available adopted a written code: on the Company's website at www.zarlink.com. The CEO, the CFO and the Corporate Controller of the (i) disclose how a person or company may Company must, in addition, meet the standards and obtain a copy of the code; requirements of the Supplementary Code of Ethics and Business Conduct, which can be found on the Company's website at www.zarlink.com. (ii) describe how the board monitors Two direct email links posted on Zarlink's website compliance with its code; and to the Audit Committee Chairperson and the Chairperson of the Board of Directors permit employees and third parties to communicate directly with the Board of Directors. The Audit Committee Chairperson is also copied directly on all ad hoc incident and monthly reports sent to the Company by ReportLine, a third party ethics line provider to which employees and third parties may complain or report. (iii) provide a cross-reference to any The Board of Directors has not granted any waiver material change report filed since the to its Code of Ethics and Business Conduct. beginning of the issuer's most recently completed financial year that pertains to any conduct of a director or executive officer that constitutes a departure from the code.
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(b) Describe any other steps the Board takes to No material conflicts of interest were declared by ensure directors exercise independent a director or an officer in Fiscal 2008 except (i) judgment in considering transactions and relating to the discussion and determination of agreements in respect of which a director or compensation matters for the CEO, and (ii) any executive officer has a material interest. discussions relating to ownership of 10,000,000 shares of Mitel Networks Corporation and any amendments relating to put rights, as the CEO was a member of the Board of directors of Mitel Networks Corporation when the decision to sell the Mitel Networks shares was made. When there is a declaration of material conflict of interest, the declarant is asked to immediately leave the Board of Directors or Committee meeting for the duration of the discussion, and not participate in any decision, relating to the transaction or agreement in respect of which he or she has a material interest. (c) Describe any other steps the Board takes to The Board of Directors requires employees to encourage and promote a culture of ethical review annually the Company's Code of Ethics and business conduct. Business Conduct and to sign acknowledgements that the employees have read and understood the Code. The Board also requires the CEO, the CFO and the Corporate Controller of the Company to review annually the Supplementary Code of Ethics and Business Conduct and sign an acknowledgement that they have read and understood the Supplementary Code. The Board also provides direct email links to the Audit Committee Chairperson and Chairperson of the Board of Directors and provides an ethics reporting line hosted by a third party provider, ReportLine to ensure ease of communication directly to the Board of employee or third party complaints or reports relating to ethical business conduct. - -------------------------------------------------------------------------------------------------------------------------- 6. Nomination of Directors Yes (a) Describe the process by which the board The Nominating and Corporate Governance Committee identifies new candidates for board reviews and recommends the slate of directors nomination. nominees to be proposed annually for election by the shareholders, considering the size of the Board of Directors and the competencies and skills of proposed nominees, and annually reviews the composition of the Board of Directors and its committees to determine if the members meet the "independent" director criteria of the Governance Guidelines and the NYSE Rules. When considering a potential candidate, the Nominating and Corporate Governance Committee will take into consideration such factors as it deems appropriate, including the following: o the appropriate size of the Board of Directors; o the needs of the Company with respect to the particular talents and experience of its directors; o the knowledge, skills and experience of nominees, including experience at the policy making level in technology, business, finance, administration or public service, in light of prevailing business conditions, the knowledge, skills and experience already possessed by other members of the Board of Directors and the highest
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professional and personal ethics and values; o minimum individual qualifications, including strength of character, mature judgment, familiarity with the Company's business and industry, independence of thought and an ability to work collegially; o experience with accounting rules and practices; o appreciation of the relationship of our business to the changing needs of society; and o the desire to balance the considerable benefit of continuity with the periodic injection of the fresh perspective provided by new members. The Nominating and Corporate Governance Committee will evaluate director candidates recommended by shareholders in light of the Committee's criteria for the selection of new directors. Any shareholder recommendation of a director candidate should include the candidate's name, biographical data and a detailed description of the candidate's qualifications for membership on the Board of Directors, and should be sent to Zarlink Semiconductor Inc., 400 March Road, Ottawa, Ontario, Canada K2K 3H4, Attention: Company Secretary or can be communicated directly to the Chairperson of the Board of Directors by addressing an e-mail to boardchair@zarlink.com. Any shareholder recommendations must be submitted in sufficient time for an appropriate evaluation by the committee. However, if a shareholder wishes the recommendation of a potential candidate to constitute a proposal intended to be included in the Company's next year circular, it must follow the procedure set forth under the heading "Shareholders' Proposals" of this Circular. The Nominating and Corporate Governance Committee will periodically assess the appropriate size of the Board of Directors, and whether any vacancies on the Board of Directors are expected due to retirement or otherwise. In the event that vacancies are anticipated, or otherwise arise, the Committee will consider potential candidates for director who may come to its attention through current members of the Board of Directors, shareholders or other persons. The Company has in the past engaged search firms to help identify or evaluate or assist in identifying potential nominees. The candidates will be evaluated at meetings of the Nominating and Corporate Governance Committee, and may be considered at any point during the year. (b) Disclose whether or not the board has a The Board of Directors has a nominating committee, nominating committee composed entirely of the Nominating and Corporate Governance Committee, independent directors. composed of three independent directors, namely Dr. Henry Simon (Chairperson), Hubert T. Lacroix and J. Spencer Lanthier.
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(c) If the board has a nominating committee, The mandate of the Nominating and Corporate describe the responsibilities, powers and Governance Committee is (i) to conduct the CEO operation of the nominating committee. candidate identification and appointment process; (ii) to conduct the director identification, evaluation, selection and performance assessment processes; and (iii) to take the leadership role in shaping corporate governance by establishing, amending and monitoring the corporate governance processes and practices of the Company, including an annual review that members of the Board of Directors and its committees meet the "independent" director criteria of the Governance Guidelines and the NYSE Rules. The Committee also has the mandate to review the compensation of directors to ensure that the compensation realistically reflects the responsibilities and risk involved in being an effective director. A copy of the mandate of the Nominating and Corporate Governance Committee can be found on the Company's website at ir.zarlink.com/corp_gov/nominating.htm. - -------------------------------------------------------------------------------------------------------------------------- 7. Compensation Yes (a) Describe the process by which the board The process by which the Board determines the determines the compensation for the issuer's compensation for the Company's directors and directors and officers. officers is outlined under "Report on Executive Compensation" included in this Circular. (b) The process by which the Board determines The Board of Directors has a compensation the compensation for the Company's directors committee, the Compensation and Human Resources and officers is outlined under "Report on Development Committee, composed of three Executive Compensation" included in this independent directors, namely Jules Meunier Circular. Disclose whether or not the board (Chairperson), Adam Chowaniec and Dennis Roberson. has a compensation committee composed entirely of independent directors. (c) Describe the responsibilities, powers and The mandate of the Compensation and Human operation of the compensation committee. Resources Development Committee is outlined under "Report on Executive Compensation" included in this Circular. A copy of the mandate of the Compensation and Human Resources Development Committee can be found on the Company's website at www.zarlink.com. (d) If a compensation consultant or advisor has, In Fiscal 2006, the Compensation Committee engaged at any time since the beginning of the the Hay Group Consultants (Toronto) to review issuer's most recently completed financial against a comparator group of semiconductor year, been retained to assist in determining companies the compensation of directors and compensation for any of the issuer's executives as well as option grants to directors, directors and officers, disclose the executives and employees. In addition, Hay Group identity of the consultant or advisor and was retained to assist management in the design briefly summarize the mandate for which they and operation of a 360(degree) evaluation process have been retained. If the consultant or for executives. advisor has been retained to perform any other work for the company, state that fact and briefly describe the nature of the work. - -------------------------------------------------------------------------------------------------------------------------- 8. Other Board Committees Yes If the board has standing committees other The Board of Directors has one other standing than the audit, compensation and nominating committee, the Executive Committee composed of Dr. committees, identify the committees and Henry Simon (Chairperson), Hubert T. Lacroix, two describe their function. independent directors, and Kirk K. Mandy,
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President and CEO of the Company. The mandate of the Executive Committee is (when the Board of Directorsis not in session) to supervise, control and manage the business and affairs of the Company and exercise all of the powers of the Board of Directors, save and except certain powers which are exclusive to the Board of Directors. A copy of the mandate of the Executive Committee can be found on the Company's website at www.zarlink.com. - -------------------------------------------------------------------------------------------------------------------------- 9. Assessments Yes Disclose whether or not the board, its The Board has implemented and reviews, from time committees and individual directors are to time, a process to annually assess the regularly assessed with respect to their effectiveness of the Board of Directors, the Board effectiveness and contribution. If committees and individual directors. Annually, assessments are regularly conducted, each director completes a questionnaire evaluating describe the process used for the the performance of the Board of Directors assessments. generally. In addition, the Chairperson of the Board of Directors conducts one-on-one interviews with each director in order to obtain information regarding the effectiveness and performance of the Board of Directors, and of each member of the Board of Directors. The members of each committee also complete an evaluation questionnaire for each committee on which they sit, which is then reviewed by the applicable committee and reported to the Board of Directors. The Nominating and Corporate Governance Committee Chairperson also conducts one on one interviews with each member of the Board of Directors in the evaluation of the performance of the Board Chairperson. The results of all assessments are discussed with the Board of Directors and form the basis of recommendations to the Board of Directors for change. The last full Board of Directors and director performance review was completed by the Board of Directors on May 20, 2008. - --------------------------------------------------------------------------------------------------------------------------
C-7 SCHEDULE "D" New York Stock Exchange - Differences in Corporate Governance Practices Compliance with NYSE Standards Zarlink's corporate governance practices differ from those of the NYSE in only one way: the NYSE Standards require that the Compensation Committee determine and approve the Chief Executive Officer's compensation. While the Governance Guidelines require the Compensation Committee to determine the Chief Executive Officer's compensation, his or her compensation is approved by the Board upon the recommendation of the Compensation Committee. Zarlink believes that this variation in its corporate governance practices from those of the NYSE is not significant. D-1 SCHEDULE "E" AUDIT COMMITTEE CHARTER Appointment The Audit Committee (the "Committee") is a standing committee of the Board of Directors (the "Board") hereby constituted with all the powers and duties conferred on it by the laws governing the Company and such powers and duties as may be conferred on it from time to time by resolution of the Board. The Board shall appoint at least three directors to serve on the Committee at the first meeting of the Board following each annual meeting of shareholders of the Company, to hold office, subject to paragraph 5 of the Qualifications, Powers and Procedures section, until the next annual shareholders' meeting. Mandate The Board has given the Committee the following mandate: The Committee shall be directly responsible for the appointment, compensation, retention and oversight of the work of any registered public accounting firm engaged (including resolution of disagreements between management and the auditor regarding financial reporting) for the purpose of preparing or issuing an audit report or related work or performing other audit, review or attest services for the Company. Each such registered public accounting firm shall report directly to the Committee. The Committee shall establish approval guidelines for any non-audit related work to be undertaken by the independent auditors. 1. The Committee's purpose will be to assist the Board oversight of: i. The integrity of the Company's financial statements; ii. The Company's compliance with legal and regulatory requirements; iii. The independent auditors' qualifications and independence; iv. The performance of the Company's internal control self-assessment committee and independent auditors; and v. The process for monitoring compliance with laws and regulations and with the Code of Ethics and Business Conduct. 2. The Committee shall: i. Review the significant accounting principles and management estimation processes incorporated in the Company's financial statements, including any changes in the Company's accounting principles or application thereof; ii. Review the results of assessments of the Company's internal controls including disclosure controls and procedures, and the steps adopted to correct significant internal control deficiencies, if any; E-1 iii. Oversee the work of the independent auditors, including (a) resolving disagreements between management and the independent auditors with respect to financial reporting and (b) reviewing the planned scope and approach of the independent audit and the areas of significant emphasis and the measures taken by management to deal with significant internal control deficiencies, if any. The Committee shall discuss with the independent auditors any difficulties encountered in the course of the audit work and any restrictions on the scope of activities or access to requested information. iv. Review the analyses prepared by management and/or the independent auditors setting forth significant financial reporting issues and judgments made in connection with the preparation of the financial statements, including analyses of the effects of alternative GAAP methods on the financial statements; v. Review the effect of regulatory and accounting initiatives as well as off-balance sheet structures, if any, on the financial statements of the Company; vi. Discuss earnings press releases as well as financial information and earnings guidance provided to analysts and rating agencies; vii. Obtain and review a report by the Company's independent auditors describing: a. The independent auditing firm's internal quality control procedures; any material issues raised by the most recent internal quality-control review, or peer review, of the firm, or by any inquiry or investigation by governmental or professional authorities, within the preceding five years, respecting one or more independent audits carried out by the firm, and any steps taken to deal with any such issues; b. The results of the most recent SEC Peer Review and (when available) the practice inspection assessments conducted on behalf of the Public Accounting Oversight Board, and similar practice inspection assessments conducted on behalf of the Canadian Public Accountability Board; and c. All relationships between the Company and the independent auditor which would permit the Committee to assess the auditor's independence; viii. Discuss the annual audited financial statements and unaudited quarterly financial statements with management and the independent auditors including the Company's disclosures under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and review related press releases, before such information is publicly disclosed; ix. Ensure that adequate procedures are in place for review of the Company's public disclosure of financial information extracted or derived from the Company's financial statements (other than (viii) above) and periodically assess the adequacy of such procedures; x. Discuss policies with respect to risk assessment and risk management; xi. Meet separately, at least quarterly, with management, with the internal control self-assessment committee and with the independent auditors; E-2 xii. Review with the independent auditors any audit problems or difficulties and management's response to them; xiii. Set clear hiring policies for employees, partners or former employees or partners of the independent auditors; xiv. Establish procedures for the receipt, retention, processing and treatment of complaints regarding accounting, internal accounting controls, or auditing matters; xv. Establish procedures for the confidential, anonymous submission by employees and third parties of concerns regarding questionable accounting or auditing practices; xvi. Inquire of the appropriate personnel of the Company and the independent auditors as to any deviation from the established Code of Ethics and Business Conduct and Supplementary Code of Ethics and Business Conduct for Designated Executives and periodically review the policies covering such Codes; xvii. Review and evaluate the qualifications and performance of the lead audit partner and other relevant personnel of the auditors; xviii. Report regularly to the Board any issues that arise with respect to the quality or integrity of the Company's financial statements, the Company's compliance with legal or regulatory requirements, the performance and independence of the Company's independent auditors, or the performance of the internal control self-assessment committee; xix. Review and discuss with management and the independent auditor a) the annual audited financial statements, including disclosures made in management's discussion and analysis, and recommend to the Board whether the audited financial statements should be included in the Company's Form 20-F and b) the Company's quarterly financial statements prior to the filing of its Form 6-K, including the results of the independent auditor's review of the quarterly financial statements; xx. Review and pre-approve all audit services and all permissible non-audit services to be performed by the independent auditors subject to the de minimis exception for non-audit services set forth in Section 10A(i)(1)(B) of the Securities Exchange Act of 1934; xxi. Annually review the status of the Company's environmental compliance program; xxii. Review and discuss with management and the independent auditors any related party transaction (as defined in the rules of the U.S. Securities and Exchange Commission (SEC); xxiii. Prepare the report of the Committee to be included in the annual proxy circular or statement; xxiv. Review, with the Company's General Counsel, any legal matter that could have a significant impact on the Company's financial statements. E-3 Delineation of Responsibilities Management is responsible for preparing the Company's financial statements with all material disclosures such that they are complete, accurate and fairly present the information set forth in conformity with Generally Accepted Accounting Principles (GAAP) and all applicable rules and regulations. The independent auditor is responsible to provide an opinion, based on its audits, that the financial statements fairly present, in all material respects, the financial position of the Company, its results of operations and its cash flows in conformity with GAAP. The independent auditors report directly to the Audit Committee. The Audit Committee's role is one of oversight in line with its mandate. Qualifications, Powers and Procedures 3. All members of the Committee shall be "independent" directors as defined by the listing guidelines of the New York Stock Exchange (NYSE) and applicable Canadian securities legislation, rules and policies. All members shall be financially literate and have relevant and practical business experience and competencies as determined by the Nominating and Corporate Governance Committee from time to time. At least one member shall be determined by the Board to be an audit committee "financial expert" as defined by the SEC. 4. Committee members shall not serve on three or more public company audit committees simultaneously unless the Board determines that such simultaneous service would not impair the ability of such member to effectively serve the shareholders' and Company's best interests. Any such determination shall be disclosed in the Company's annual proxy circular and annual report on Form 20-F. 5. Committee members are barred from accepting any consulting, advisory or other compensatory fee, directly or indirectly, from the Company or an affiliate of the Company, other than in the member's capacity as a member of the Board and any Board committee. This prohibition precludes payments to a spouse, a minor child or stepchild or a child or stepchild sharing the home with the member, as well as payments accepted by an entity in which a Committee member is a partner, member, officer or principal or occupies a similar position and which provides accounting, consulting, legal, investment banking, financial or other advisory services or any similar services to the Company. A Committee member shall not be an affiliated person of the Company or any subsidiary of the Company. 6. The Committee shall elect from its members a Chairperson. The Secretary shall be elected from its members, or shall be the Secretary, or the Assistant or Associate Secretary, of the Company. 7. Any member of the Committee may be removed or replaced at any time by the Board. A member shall cease to be a member of the Committee upon ceasing to be a director of the Company. 8. Meetings of the Committee shall be called by the Chairperson of the Committee and shall be held at least four times a year. 9. The times and places where meetings of the Committee shall be held and the procedures at such meetings shall be as determined, from time to time, by the Committee. 10. Notice of each meeting of the Committee shall be given to each member of the Committee. Subject to the following, notice of a meeting shall be given orally or by letter, telex, telegram, electronic mail, telephone facsimile transmission or telephone not less than 48 hours before the time fixed for the meeting. Notice of regular meetings need state only the day of the week or C-12 month, the place and the hour at which such meetings will be held and need not be given for each meeting. Members may waive notice of any meeting. 11. The Committee may invite from time to time such person as it may see fit to attend its meeting and to take part in discussion and consideration of the affairs of the Committee. However, any such persons invited may not vote at any meeting of the Committee. 12. A meeting of the Committee may be held by means of such telephonic, electronic or other communications facilities as permit all persons participating in the meeting to communicate adequately with each other during the meeting. 13. The majority of the Committee shall constitute a quorum for the purposes of conducting the business of the Committee. Notwithstanding any vacancy on the Committee, a quorum may exercise all of the powers of the Committee. 14. Any decision made by the Committee shall be determined by a majority vote of the Members of the Committee present. A member will be deemed to have consented to any resolution passed or action taken at a meeting of the Committee unless the member dissents. 15. A record of the minutes of, and the attendance at, each meeting of the Committee shall be kept. The approved minutes of the Committee shall be circulated to the Board forthwith. 16. The Committee shall report to the Board on all proceedings and deliberations of the Committee at the first subsequent meeting of the Board, and at such other times and in such manner as the Board or the By-laws of the Company may require or as the Committee in its discretion may consider advisable. 17. The Committee shall review annually its Mandate and all Guidelines, Procedures, Policies or other documents used by it in fulfilling its responsibilities. 18. The Committee shall assess performance of the Committee and each of its members on an annual basis in accordance with performance assessment guidelines provided by the Nominating and Corporate Governance Committee. 19. In the performance of its duties and responsibilities, the Committee shall have access to any and all books and records of the Company necessary for the execution of the Committee's obligations and may discuss with the officers and auditors of the Company such accounts, records, documents and other matters considered appropriate. 20. The Committee may retain, at the Company expense, such outside legal, accounting or other consultants and advisors as it deems necessary from time to time to fulfill its duties and responsibilities. E-5 SCHEDULE "F" BOARD MANDATE Appointment Directors are elected annually by the shareholders of the Company and together with those appointed to fill vacancies or appointed as additional directors throughout the year, collectively constitute the Board of Directors (the "Board") of the Company. Mandate The Board establishes the overall policies for the Company; monitors and evaluates the Company's strategic direction, and retains plenary power for those functions not specifically delegated by it to its Committees or to management. Accordingly, in addition to the duties of directors of a Canadian corporation as prescribed by statute, the mandate of the Board is to supervise the management of the business and affairs of the Company with a view to evaluate, on an ongoing basis, whether the Company's resources are being managed in a manner consistent with enhancing shareholder value, ethical considerations and corporate social responsibility. In order to better fulfill its mandate, the Board is responsible for, among other matters: 1. Selecting the Chairperson for the Board of Directors annually or as otherwise required; 2. Reviewing and approving, prior to the beginning of each fiscal year, the business plan, capital budget and financial goals of the Company as well as longer term strategic plans (taking into account the opportunities and risks of the business) prepared and elaborated by management and, throughout the year, monitoring the achievement of the objectives set; 3. Reviewing and approving all regulatory filings such as the Annual Report, Proxy Circular, Annual Information Form and Reports on Form 10-K, 10-Q and 8-K; 4. Ensuring that it is properly informed, on a timely basis, of all important issues (including environmental, cash management and business development issues) and developments involving the Company and its business environment; 5. Identifying, with management, the principal risks of the Company's business and the systems put in place to manage these risks as well as monitoring, on a regular basis, the adequacy of such systems; 6. Ensuring proper succession planning, including appointing, training and monitoring senior executives; 7. To the extent feasible, satisfying itself as to the integrity of the chief executive officer (the "CEO") and other senior officers and that the CEO and other senior officers create a culture of integrity throughout the organization; 8. Reviewing and ratifying the Compensation and Human Resources Development Committee's assessment of the performance of the senior executives; 9. Adopting and enforcing good corporate governance practices and processes; F-1 10. Ensuring proper communication with shareholders, customers and governments; 11. Monitoring the efficiency and integrity of internal control and management information systems; 12. Assessing annually the performance of the CEO, the Board, its committees and each of its directors; 13. Recommending to shareholders, pursuant to the recommendation of the Audit Committee, the appointment of auditors and approving auditor compensation where authorized by shareholders; 14. Developing, with the CEO, a position description for the CEO and developing and approving the corporate goals and objectives that the CEO must meet; 15. Nominating or appointing directors, as appropriate, based on the advice of the Nominating and Corporate Governance Committee and considering the size of the Board and the competencies and skills of directors and proposed directors; 16. Ensuring the new directors receive comprehensive orientation to the Board and that an appropriate continuing education program is made available to all directors; 17. Ensuring that the compensation of directors realistically reflects the responsibilities and risk involved in being an effective director. and has taken, when necessary, specific measures in respect of these items. Long-term goals and strategies for the Company are developed as part of management's annual strategic planning process with the Board, which also includes the preparation of a detailed one-year operating plan. Through this process, led by the President and Chief Executive Officer and senior management of the Company, the Board adopts the operating plan for the coming financial year and monitors senior management's relative progress through a regular reporting and review process. The Board reviews on a quarterly basis the extent to which the Company has met the current year's operating plan. Consistent with the Board's power to delegate management of the day-to-day operation of the Corporation's business, the Board exercises business judgment in establishing and revising guidelines for authorization of expenditures or other corporate actions, and these have been periodically reviewed with management. The current committee structure of the Corporation includes the following committees: Audit, Nominating and Corporate Governance, Executive and Compensation and Human Resources Development. The mandate of each standing committee is reviewed periodically by the Board with a view to delegating to committees the authority of the Board concerning specified matters appropriate to such committees. Such authorities are set forth in board resolutions or bylaws pertaining to the charters of board committees. The Board has put policies in place to ensure effective, timely and non-selective communications between the Company, its stakeholders and the public. The Board, or the appropriate committee thereof, reviews the content of the Company's major communications to shareholders and the investing public, including the quarterly and annual reports, and approves the proxy circular, the F-2 annual information form and any prospectuses that may be issued. The disclosed information is released through mailings to shareholders, news wire services, the general media and a home page on the internet. Qualifications and Procedures At least twenty-five percent of the directors shall be "resident Canadians" as defined by the Canada Business Corporations Act and a majority of the directors shall be "independent" as defined by the listing guidelines of the New York Stock Exchange (NYSE) and applicable Canadian securities legislation, rules and policies. The Board shall review and affirmatively determine the "independent" status of each director. These percentages also apply to director attendance at any Board meetings. The independent directors shall meet at regularly scheduled executive sessions at least quarterly without management present. If the Chairperson of the Board is an "independent" director, he/she will preside over the executive sessions of the Board. Otherwise, the independent directors shall designate and publicly disclose the name of the independent director who will preside at the executive sessions. The Board may retain such outside consultants and advisors (at Company expense), as it deems necessary from time to time to fulfill its duties and responsibilities. The Board's operational procedures are set out in By-Law No. 16 of the Company as amended from time to time. F-3 -----END PRIVACY-ENHANCED MESSAGE-----