SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 6-K
REPORT OF FOREIGN ISSUER
PURSUANT TO RULE 13a-16 OR 15d-16 OF THE
SECURITIES EXCHANGE ACT OF 1934
For the period ended June 30, 2001
MADGE NETWORKS N.V.
Transpolis Schiphol Airport
Polaris Avenue 23
2132 JH Hoofddorp
The Netherlands
(Address of principal executive offices)
Indicate by check mark whether the registrant files or will file annual reports
under cover Form 20-F or Form 40-F
Form 20-F X Form 40-F
---------------- ---------------
Indicate by check mark whether the registrant by furnishing the information
contained in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934
Yes No X
---------------- ---------------
If "Yes" is marked, indicate below the file number assigned to the registrant in
connection with Rule 12g3-2(b):
82- N.A.
----------------
Page 1 of 50 Pages
Exhibit Index Appears on Page 44.
1
MADGE NETWORKS N.V.
Form 6-K
TABLE OF CONTENTS
Page
----
Financial Information:* 3
Condensed Consolidated Balance Sheets as of June 30, 2001 (unaudited), March 31, 2001
(unaudited) and December 31, 2000 3
Condensed Consolidated Statements of Operations for the three months
ended March 31, 2001 and 2000 (unaudited) and June 30, 2001 and 2000
(unaudited) and the six months ended June 30, 2001 and 2000 (unaudited) 5
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 2001 and the six months ended June 30, 2001 and 2000
(unaudited) 7
Notes to Condensed Consolidated Financial Statements (unaudited) 9
Forward Looking Statements 21
Operating and Financial Review and Prospects 21
Legal Proceedings 30
Risk Factors 31
Signatures 43
Exhibit Index 44
Exhibit A--First Half 2001 Press Release 45
--------------------
* The Company's fiscal year ends on December 31 of each year. For the
purposes of presentation, the Company has indicated its fiscal quarters
within the year as ending on a calendar month end, whereas, in fact, the
Company operates on the basis of thirteen week financial quarters.
2
MADGE NETWORKS N.V.
Condensed Consolidated Balance Sheets
(in thousands)
June 30, March 31, December 31,
2001 2001 2000
----------- ---------- -----------
(Unaudited) (Unaudited) Note 3
ASSETS
Current assets:
Cash and cash equivalents $ 5,863 $ 7,972 $ 18,405
Restricted cash 3,181 3,433 3,686
Accounts receivable, net of allowance for doubtful
accounts of $721, $828 and $1,330 at June 30, 2001, March
31, 2001 and December 31, 2000, respectively 9,595 10,397 12,220
Inventories:
Raw materials 1,249 2,780 2,329
Finished goods 7,110 5,428 5,242
----------- ---------- ----------
8,359 8,208 7,571
Current deferred tax assets -- -- 39
Other receivable -- -- 6,290
Receivable due from Administration and
Interim Judicial Management processes 4,030 -- --
Prepayments and other current assets 5,342 6,852 8,880
Current assets of discontinued operations 490 661 13,276
----------- ---------- ----------
Total current assets 36,860 37,523 70,367
Property and equipment, net 10,211 11,339 12,167
Property and equipment related to discontinued operations net of
accumulated depreciation and allowances for losses on disposition 2,208 2,208 2,208
Intangible assets, net of accumulated amortization 7,079 9,108 11,343
Investments of discontinued operations 2,000 2,000 2,000
Restricted cash 5,694 5,585 6,254
----------- ---------- ----------
Total assets $ 64,052 $ 67,763 $ 104,339
=========== ========== ==========
3
June 30, March 31, December 31,
2001 2001 2000
----------- ----------- -----------
(Unaudited) (Unaudited) Note 3
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Short-term borrowing $ 4,247 $ -- $ --
Accounts payable 7,552 10,660 10,588
Deferred consideration 4,193 4,193 4,890
Accrued wages and related liabilities 1,398 2,153 2,851
Other accrued liabilities 22,213 26,332 30,548
Income taxes payable 11,568 11,592 11,593
Current portions of lease obligations 650 637 629
Current liabilities of discontinued operations 25,145 32,531 64,900
----------- ----------- -----------
Total current liabilities 76,966 88,098 125,999
Long-term liabilities and lease obligations 383 563 752
Deposit payable 921 948 948
----------- ----------- -----------
Total liabilities 78,270 89,609 127,699
COMMITMENTS
Shareholders' equity (deficit):
Common shares 29,245 29,245 29,146
Additional paid-in capital 170,305 170,305 169,694
Treasury stock (404) (404) (404)
Retained earnings (deficit) (197,122) (206,110) (208,486)
Accumulated other comprehensive loss (16,242) (14,882) (13,310)
----------- ----------- -----------
Total shareholders' deficit (14,218) (21,846) (23,360)
----------- ----------- -----------
Total liabilities and shareholders' equity (deficit) $ 64,052 $ 67,763 $ 104,339
=========== =========== ===========
See accompanying notes
4
Madge Networks N.V.
Condensed Consolidated Statements of Operations
(Unaudited) (in thousands, except per share amounts)
Three Months Ended Three Months Ended Six Months Ended
March 31, March 31, June 30, June 30, June 30, June 30,
2001 2000 2001 2000 2001 2000
-------- -------- -------- -------- -------- --------
Net sales $ 23,365 $ 44,611 $ 20,812 $ 25,743 $ 44,177 $ 70,354
Cost of sales: 11,521 22,212 9,445 14,897 20,966 37,109
-------- -------- -------- -------- -------- --------
Gross profit 11,844 22,399 11,367 10,846 23,211 33,245
Operating expenses:
Sales and marketing 6,808 13,128 3,839 10,091 10,647 23,219
Research and development 2,835 5,130 197 4,410 3,032 9,540
General and administrative 1,212 1,999 3,016 2,431 4,228 4,430
Special gain -- -- (1,349) -- (1,349) --
-------- -------- -------- -------- -------- --------
Total operating expenses 10,855 20,257 5,703 16,932 16,558 37,189
-------- -------- -------- -------- -------- --------
Operating income (loss) from
Continuing operations 989 2,142 5,664 (6,086) 6,653 (3,944)
Net interest income (expense) 1,459 (115) 157 (366) 1,616 (481)
Gain on sale of investment in Red-M -- -- 7,997 -- 7,997 --
-------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations before income taxes and share
of losses of associate Red-M 2,448 2,027 13,818 (6,452) 16,266 (4,425)
Provision for income taxes 72 240 823 125 895 365
-------- -------- -------- -------- -------- --------
Income (loss) from continuing operations
before share of losses of associate Red-M 2,376 1,787 12,995 (6,577) 15,371 (4,790)
Red-M and discontinued operations
Share of losses of associate Red-M -- -- (1,499) -- (1,499) --
-------- -------- -------- -------- -------- --------
Income (loss) from continuing operations 2,376 1,787 11,496 (6,577) 13,872 (4,790)
Discontinued operations:
Loss from operations of discontinued
Business -- (16,879) -- (16,378) -- (33,257)
Loss from discontinued business
including provision for operating losses -- -- (2,508) -- (2,508) --
-------- -------- -------- -------- -------- --------
Net income (loss) $ 2,376 $(15,092) $ 8,988 $(22,955) $ 11,364 $(38,047)
======== ======== ======== ======== ======== ========
5
Three Months Ended Three Months Ended Six Months Ended
March 31, March 31, June 30, June 30, June 30, June 30,
2001 2000 2001 2000 2001 2000
-------- --------- --------- -------- -------- --------
Net income (loss) per share from
Continuing operations
Basic and diluted $ 0.04 $ 0.04 $ 0.21 $ (0.15) $ 0.26 $ (0.11)
Net (loss) per share from
Discontinued operations
Basic and diluted $ -- $ (0.40) $ (0.04) $ (0.37) $ (0.05) $ (0.77)
Net income (loss) per share
Basic and diluted $ 0.04 $ (0.36) $ 0.17 $ (0.52) $ 0.21 $ (0.88)
Weighted average shares used in
computing net income (loss) per share
Basic and diluted 53,962 41,993 54,038 44,066 54,000 43,029
See accompanying notes
6
Madge Networks N.V.
Condensed Consolidated Statements of Cash Flows
(Unaudited) (in thousands)
Three Months Ended Six Months Ended
March March June June
31, 31, 30, 30,
-------- -------- -------- --------
2001 2000 2001 2000
-------- -------- -------- --------
Cash flows from operating activities:
Net income (loss) from continuing operations $ 2,376 $ 1,787 $ 13,872 $ (4,790)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
Activities:
Depreciation 885 1,553 1,622 3,352
Amortization of intangibles 2,235 2,609 4,264 3,323
Loss on disposal of fixed assets 220 724 196 3,297
Losses from associate Red-M -- -- 1,499 --
Profit on sale of investment in Red-M -- -- (7,997) --
Changes in assets and liabilities net of effect of sale of Red-M:
Accounts receivable 1,823 (4,891) 2,616 10,643
Restricted cash 922 1,276 1,065 (874)
Net inventories (637) 2,825 (1,220) 3,654
Other receivable 6,290 (1,616) 6,290 (1,976)
Prepaid expenses and other current assets 2,028 (4,929) 3,380 (3,007)
Receivable due from Administration and
Interim Judicial Management processes -- -- (4,030) --
Accounts payable 72 5,304 (2,579) 1,108
Other accrued liabilities (4,914) (9,765) (8,420) (14,834)
Related party payable -- -- (2,806) --
Income taxes payable (1) (949) (25) (1,406)
Deferred tax 39 2 39 3
Deferred revenue -- 277 -- (139)
Deferred consideration (697) (1,276) (697) (2,353)
Deposit payable -- -- (27) --
-------- -------- -------- --------
Net cash from (used in) operating
Activities of continuing operations 10,641 (7,069) 7,042 (3,999)
Net cash used in operating activities of
discontinued operations (19,754) (20,239) (29,477) (27,977)
-------- -------- -------- --------
Net cash used in operating activities (9,113) (27,308) (22,435) (31,976)
Cash flows from investing activities:
Additions to property and equipment (277) (520) (515) (1,295)
Purchase of Olicom -- (29) -- (2,038)
Proceeds from sale of investment in Red-M -- -- 8,731 --
-------- -------- -------- --------
Net cash from (used in) investing
Activities of continuing operations (277) (549) 8,216 (3,333)
Net cash used in investing activities of
Discontinued operations -- (3,870) -- (9,726)
-------- -------- -------- --------
Net cash used in investing activities (277) (4,419) 8,216 (13,060)
7
Three Months Ended Six Months Ended
March March June June
31, 31, 30, 30,
-------- -------- -------- --------
2001 2000 2001 2000
-------- -------- -------- --------
Cash flows from financing activities:
Repayments of mortgage and capital
lease obligations (181) (692) (348) (1,435)
Proceeds from (repayments of) short-term loan, net -- (3,104) 4,247 (3,380)
Proceeds from issue of common shares 710 35,109 710 35,138
-------- -------- -------- --------
Net cash from financing
Activities of continuing operations 529 31,313 4,609 30,323
Net cash from financing
Activities of discontinued operations -- 134 -- 7,902
-------- -------- -------- --------
Net cash from financing activities 529 31,447 4,609 38,225
Net decrease in cash and cash equivalents $ (8,861) $ (280) $ (9,610) $ (6,811)
======== ======== ======== ========
Cash and cash equivalents at the beginning of
the period $ 18,405 $ 18,417 $ 18,405 $ 18,417
Effect of exchange rate changes on cash (1,572) (1,591) (2,932) (4,523)
-------- -------- -------- --------
Cash and cash equivalents at the beginning of
the period (at period-end exchange rates) 16,883 16,826 15,473 13,894
Cash and cash equivalents at the end of the
period 7,972 16,546 5,863 7,083
-------- -------- -------- --------
Net decrease in cash and cash equivalents $ (8,861) $ (280) $ (9,610) $ (6,811)
======== ======== ======== ========
See accompanying notes
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1. PREPARATION OF FINANCIAL STATEMENTS - GOING CONCERN
Madge Networks N.V. ("Madge" or the "Company") is a global provider of
advanced networking product solutions to large enterprises and is the market
leader in Token Ring. Until April 2001 the Company operated through three
subsidiary groups: Madge.connect, Red-M and Madge.web. Madge.connect is a global
supplier of Token Ring LAN product solutions for mission-critical enterprise
networks. Red-M is a pioneering developer and leading supplier of wireless
networking product solutions that enable access to a range of voice, video and
data from a range of mobile devices. Madge.web was a global provider of rich
content applications, content distribution and managed network services.
Until October 2000, Red-M was within the Madge.connect legal structure. As
at December 31, 2000 it was owned directly by Madge Networks N.V. as a separate
subsidiary and operating division. As described in Note 6, during April 2001,
the Company sold a portion of its shareholding in Red-M for a total of $8.6
million. As a result of this sale and the issue of new shares in Red-M to the
purchasers and Red-M employees, the Company's shareholding in Red-M has fallen
to less than 50%. Red-M is now an associated company and Madge no longer has any
funding commitment to it.
On April 27, 2001 the Company publicly announced that the Board of Madge
Networks decided not to provide further operational funding for Madge.web and
that it was searching for a purchaser of the Madge.web business. Madge.web
Limited in the United Kingdom and Madge SE Asia Pte Ltd in Singapore were put
into Administration and Interim Judicial Management, respectively, on April 27,
2001 and May 15, 2001, respectively, in accordance with their local laws in
processes broadly similar to Chapter 11 in the United States. The Company
provided an aggregate of $6.3 million of funding to the respective
Administration and Interim Judicial Management processes for these two entities.
On July 19, 2001 the Company announced that the Administrators had entered into
an agreement with Tullett & Tokyo Liberty Plc. ("Tullett & Tokyo") for the sale
of certain assets relating to the Trader Voice business of Madge.web in Asia and
Europe. The sale provided continuity of employment for a number of Madge.web
employees and provided a release for Madge Networks of significant guarantee
obligations relating to the Trader Voice business. The employment of a majority
of the other Madge.web employees was subsequently terminated. As of August 17,
2001 and September 14, 2001, Madge.web Limited and Madge SE Asia Pte Ltd,
respectively, were put into insolvent liquidation. The Liquidators of Madge.web
Limited are continuing to seek purchasers for Madge.web Limited's other
remaining assets. Madge Networks currently only has funding obligations to
Madge.web Inc. in the United States as obligations of Madge.web and Madge
Networks are being settled.
As described in more detail in Note 2, in accordance with Accounting
Principles Board Opinion ("APB") No. 30 and Emerging Issues Task Force ("EITF")
Issue No. 95-18, Madge.web is presented as a discontinued operation within the
accompanying condensed financial statements. The Company has provided guarantees
on behalf of Madge.web in relation to certain property leases, equipment leases
and loans. In determining the loss on disposal, the Company made an estimate of
the amount of the obligations that would not be assumed by Tullett & Tokyo. in
relation to the sale of the Trader Voice business in Asia and Europe and
purchasers of other assets and, therefore, will have to be discharged by the
Company. The Company expects approximately half of the $6.3 million
administrative funding provided to be returned to Madge Networks. The timing and
the amount of the repayment of the funding provided for the Administration and
Interim Judicial Management process is uncertain, but is expected to be in the
first half of 2002. Failure to receive these funds or the Company's inability to
further mitigate its exposure to the Madge.web liabilities could materially
impact its liquidity position and the Company's ability to continue as a going
concern.
9
The Company had a net working capital deficit (excluding restricted cash)
of $43.3 million and a shareholders' deficit of $14.2 million as of June 30,
2001 and has incurred recurring losses from operations. Restricted cash as of
June 30, 2001 was $8.9 million.
The Company will be undertaking further reductions in the Madge.connect
business and corporate overheads in order to maintain the profitability of its
continuing business going forward and intends to seek further revenue generating
activities over which to spread this cost base. The Company believes that
Madge.connect and the corporate function, following these restructuring
activities, will maintain positive cashflow from continuing operations
throughout 2001. During the first six months of 2001 there was an initial
reduction of headcount. The Company is also in the process of changing the key
supplier of product to Madge.connect, Celestica, and is currently negotiating an
exit plan to end all production by Celestica. It is important for the future
success of the business that the transition to its new supplier takes place
smoothly. The Company also believes that Madge.connect's funding facilities will
remain available on acceptable terms. These terms currently provide for either
party to terminate on giving three months notice in writing. If there is a
material adverse change in the Company's business, as determined by the lender,
the funding facility can be terminated immediately. There has been no indication
from the lender that it intends to terminate the facility.
Based on the repayment of a portion of the $6.3 million provided to the
Administrators and Interim Judicial Management, expected future operating
results of the Madge.connect business and continuation of Madge.connect's
funding facilities and assuming the Company can effectively discontinue the
Madge.web business including the successful mitigation of amounts payable for
guarantees and other obligations, the Company believes that its current
liquidity levels and committed financial resources are sufficient to meet the
needs of its ongoing operations for at least 12 months following the furnishing
of this Form 6-K to the Securities and Exchange Commission. Consequently, the
Company is of the opinion that it is appropriate to prepare the condensed
consolidated financial statements on a going concern basis. The condensed
consolidated financial statements do not include any adjustment that would
result if the Company were to cease being a going concern.
There does, however, exist doubt about the Company's ability to continue as
a going concern as there can be no assurance that its assumptions and estimates
will prove correct or that its currently available sources of funding will
remain available. To the extent that the Company's guarantees on behalf of
Madge.web and other obligations cannot be mitigated as planned and have to be
discharged by the Company, the Company's future cash flow and liquidity will be
materially adversely affected. Furthermore, it may be necessary to place the
remaining Madge.web entities (Madge.web Inc. and Madge.web N.V.) into
liquidation. The funds provided to the Administrators and Interim Judicial
Managers may also not be returned to the Company.
The Company is attempting to raise additional funds through working capital
financing and other sources of finance such as bank credit, a further sale or
pledge of its shares in Red-M, or, if achievable, a private placement of shares
in Madge Networks to continue to fund operations of Madge Networks and, if
required, fund obligations of Madge.web in excess of current expectations. If
Madge Networks N.V. shares were to be delisted from The Nasdaq National Market
and listed on either The Nasdaq SmallCap Market or the
Over-The-Counter-Bulletin-Board, the Company would find it more difficult to
raise funds through an equity offering of its shares. Madge's ability to sell
its shares in Red-M and the price that could be obtained for the Red-M shares
are subject to certain restrictions based on the investment agreement between
Madge and the recent purchasers of Red-M shares.
10
2. DISCONTINUED OPERATIONS
In accordance with APB 30 and EITF Issue No. 95-18, Madge.web has been
presented as a discontinued business as at December 31, 2000.
Accordingly, the operating losses for the period January 1, 2001 to April
27, 2001, the date the decision was made to discontinue the Madge.web business,
was accrued as at December 31, 2000. In addition, the loss from the decision to
discontinue the business was also accrued as at December 31, 2000. This was
determined based on our estimate of (i) the amount receivable from the
Administrators of Madge.web Limited related to amounts due to Madge Networks
N.V., (ii) operating losses of the companies not in liquidation or bankruptcy
from April 27, 2001 to the estimated date of liquidation, (iii) the net
realizable value from the sale or liquidation of such companies, (iv) additional
liabilities resulting from guarantees provided by Madge Networks N.V. and
contracts entered into by other Madge Networks companies and (v) obligations
related to companies not in liquidation or bankruptcy including amounts payable
for claims that may be made by former employees of Madge.web. During the six
months ended June 30, 2001 our estimate of the operating losses for the period
January 1, 2001 to April 27, 2001 was revised, which had the effect of
increasing the loss by $784,000. In addition, our estimate of the loss on
disposition was also increased by $1,724,000. The revisions to the estimated
loss on disposition was due to our re-estimation of the portion of the $6.3
million funding provided to the Administrators of Madge.web Limited and the
Interim Judicial Management of Madge SE Asia Pte Ltd which we expect to recover
and to other adjustment to estimates related to the discontinued business. The
sale of the remaining assets of the Madge.web business in all locations
worldwide, except the United States, is expected to be completed by the middle
of the fourth quarter of 2001; however it is expected that it will take until
the end of 2003 to settle all claims and liabilities that relates to the
liquidation of the Madge.web business and until the first half of 2002 before
any portion of the $6.3 million funding provided is returned by the
Administrators.
11
Assets, liabilities and losses of discontinued operations (in thousands)
are as follows:
June 30, March 31, December 31,
2001 2001 2000
------- --------- -----------
Current assets of discontinued operations:
Cash and cash equivalents $ -- $ -- $ 9,431
Accounts receivable -- 171 3,355
Receivable due from Administration and Interim
Judicial Management Processes 4,030 -- --
Amounts due from Madge.web discontinued
operations 490 490 490
------- --------- -----------
Total $ 4,520 $ 661 $ 13,276
======= ========= ===========
Property and equipment of discontinued operations:
Leasehold improvements $ 2,208 $ 2,208 $ 2,208
------- --------- -----------
Investment in Magnifi $ 2,000 $ 2,000 $ 2,000
------- --------- -----------
Current liabilities of discontinued operations:
Accounts payable $ -- $ -- $ 10,647
Provision for liabilities/losses of discontinued
operations including amounts payable under
guarantees 25,145 32,531 54,253
------- --------- -----------
Total $25,145 $ 32,531 $ 64,900
======= ========= ===========
During 2000 Madge.web invested $2.0 million in Magnifi, a California-based,
privately owned developer and operator of business-to-business extranet services
targeted at the marketing and brand management requirements of large
international organizations. Madge.web acquired 623,053 Series E Preferred Stock
of Magnifi, equal to 8.1% of the fully diluted Series E stock or approximately a
1.3% holding of Magnifi's total fully diluted equity as at December 31, 2000. We
expect to sell or pledge Madge.web's interest in Magnifi.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Preparation
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with U.S. Generally Accepted Accounting Principles
("GAPP") for interim financial information and the requirements of Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by U.S. GAAP for complete financial statements. In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three-month period ended March 31, 2001 and the three- and
six-month periods ended June 30, 2001 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2001.
12
The balance sheet at December 31, 2000 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by U.S. GAAP for complete financial statements.
For further information, refer to the consolidated financial statements and
footnotes thereto included in our Annual Report on Form 20-F for the year ended
December 31, 2000.
Consolidation
The consolidated financial statements include the accounts of Madge and its
subsidiaries. All material intercompany balances and transactions have been
eliminated in consolidation.
Discontinued Operations
The operating results, financial position and cash flows of the Madge.web
business have been disclosed within the condensed consolidated financial
statements as a discontinued business, in accordance with APB No. 30 and EITF
Issue No. 95-18. As such, the operations, assets and liabilities of Madge.web
have been shown separately from the continuing operations of Madge Networks.
Revenue recognition
We recognize revenue from product sales upon shipment of product. Net sales
from non-recurring technology licensing or engineering is recognized on customer
acceptance. Software license royalty revenue is recognized upon notification by
the licensee that products incorporating our software have been shipped by the
licensee. Subject to certain limitations, we permit some distributors to
exchange products or to return products in exchange for credits against future
purchases. In addition, in the event we reduce our selling prices, we credit our
distributors for the difference between the purchase price of products remaining
in the distributors' inventories and our reduced price for such products,
subject to certain limitations. An allowance for sales returns and price
reduction adjustments, based on historical experience, is accrued concurrently
with the recognition of revenue.
Inventories
Inventories are stated at the lower of cost or market value, determined on
a weighted average cost method.
Property and equipment
Property and equipment are stated at cost. Depreciation and amortization of
property and equipment are calculated using the straight-line method over the
lesser of the estimated useful lives or period of lease of the assets as
follows:
Furniture and fixtures 4 years Manufacturing equipment 1-3 years
Computer and network equipment 3-5 years Electronic office equipment 3 years
Motor vehicles 3 years Leasehold improvements Shorter of the estimated
useful life of the asset or
the period of the lease.
13
Depreciation for the three months ended March 31, 2001 and 2000 was
$885,000 and $3,707,000, respectively. For the three months ended June 30, 2001
and 2000, depreciation was $737,000 and $3,966,000, respectively. Depreciation
for the six months ended June 30, 2001 and 2000 was $1,622,000 and $7,673,000,
respectively. Assets in the course of construction are not depreciated.
Goodwill and other intangible assets
We amortize goodwill and other intangible assets on a systematic basis over
their estimated useful lives, which range from three to ten years. Goodwill has
been calculated as the excess of the purchase consideration paid over fair value
of the net assets acquired. The basis for other intangible assets has been
calculated through cash flow analysis to determine the fair value of the
specific intangible assets. The carrying amount of goodwill is reviewed on a
regular basis for indicators of impairment. Indicators of impairment include an
adverse change in the opportunities or business climate in which we operate.
Should indicators of impairment exist, such impairment will be reviewed through
the examination of discounted cash flows.
Following a re-evaluation of the value of the Gains business and the
related period over which the value is to be recognized to the Madge.web
business, we determined the estimated useful life of the goodwill arising from
the acquisition of Gains to be 10 years as opposed to the original estimate of
20 years. This took effect from the second quarter of 2000. Following the
announcement of our intention to sell the Madge.web business, the remaining
carrying value of the goodwill to the Gains business was written-off.
Investments
Investments in companies in which we hold less than a 20% interest are
carried at cost or estimated realizable value, if less.
Capital leases
Assets held under capital leases are capitalized in the balance sheet and
are depreciated over their useful lives. Amortization of these assets is
included in the statement of operations with depreciation and amortization of
purchased assets.
Research and development
All research and development expenses are charged to operations as
incurred. Statement of Financial Accounting Standard ("SFAS") No. 86, Accounting
for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,
requires capitalization of certain software development costs subsequent to the
establishment of technological feasibility.
Based on our product development process, technological feasibility is
established on completion of a working model. Costs incurred by Madge between
completion of the working model and the point at which the product is ready for
release have been insignificant. All research and development costs have been
expensed as incurred.
14
Accrued warranty costs
We provide limited warranties on our software and hardware products.
Warranty periods range from 90 days for some software products to one year
warranties for some hardware products. We have the option to either repair or
replace defective products or return the price paid. We accrue for expected
future warranty costs.
Cash equivalents and short-term investments
We include in cash equivalents all highly liquid investments with maturity
dates of three months or less at the purchase date. Short-term investments
consist of highly liquid investments that generally mature within two years from
acquisition. The fair value of investments is based on quoted market prices. We
determine the appropriate classification of debt securities at the time of
purchase and re-evaluate such designation as of each balance sheet date.
Securities classified as available-for-sale are reported at fair market value
with the related unrealized gains and losses included in retained earnings.
Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities are included in general
and administrative expenses. The cost of securities sold is based on the
specific identification method.
Foreign currency translation
We account for foreign currency in accordance with SFAS No. 52, Foreign
Currency Translation. Under this Statement, assets and liabilities of our
non-U.S. dollar subsidiaries are translated into U.S. dollars at exchange rates
in effect at the close of the period. The resulting translation adjustments are
excluded from net earnings, and accumulated as a separate component of
shareholders' equity. The income and expenses of these operations are translated
at monthly market exchange rates.
Foreign currency transaction gains and losses are included in results of
operations in the periods in which they occur. The total amount of currency
transaction gain recognized in the three months ended March 31, 2001 was
$1,386,000 and for the three months ended March 31, 2000 was $420,000. The total
amount of currency transaction gain recognized in the three months ended June
30, 2001 was $1,008,000 and for the three months ended June 30, 2000 was
$861,000. The total amount of currency transaction gain recognized in the six
months ended June 30, 2001 was $2,394,000 and for the six months ended June 30,
2000 was $1,281,000.
Advertising costs
We account for advertising costs as an expense in the period in which they
are incurred. Advertising expenses for the three months ended March 31, 2001
were $46,000 and for the three months ended March 31, 2000 were approximately
$51,000. Advertising expenses for the three months ended June 30, 2001 were
$61,000 and for the three months ended June 30, 2000 were $183,000. Advertising
expenses for the six months ended June 30, 2001 were approximately $107,000 and
for the six months ended June 30, 2000 were $234,000.
Per share data
Basic earnings per share is calculated using the weighted average number of
common shares outstanding. The diluted EPS is calculated based on the weighted
average number of common shares plus the dilutive common shares from the
exercise of employee share options. In periods when we
15
report a net loss, basic and diluted EPS are the same because the effect of
potential common shares is anti-dilutive.
In thousands Three months ended Three months ended Six months ended
(except shares) March 31, June 30, June 30,
2001 2000 2001 2000 2001 2000
-------- -------- -------- -------- -------- --------
Numerator for the basic and
diluted earnings per share:
Net income (loss) from
continuing operations $ 2,376 $ 1,787 $ 11,496 $ (6,577) $ 13,872 $ (4,790)
======== ======== ======== ======== ======== ========
Net income (loss) from
discontinued operations $ -- $(16,879) $ (2,508) $(16,378) $ (2,508) $(33,257)
======== ======== ======== ======== ======== ========
Denominator for the basic and
diluted earnings per share:
Weighted average common
shares outstanding: 53,962 41,993 54,038 44,066 54,000 43,029
======== ======== ======== ======== ======== ========
Net income (loss) from
continuing operations per share:
Basic and diluted $ 0.04 $ 0.04 $ 0.21 $ (0.15) $ 0.26 $ (0.11)
======== ======== ======== ======== ======== ========
Net income (loss) from
discontinued operations per share:
Basic and diluted $ -- $ (0.40) $ (0.04) $ (0.37) $ (0.05) $ (0.77)
======== ======== ======== ======== ======== ========
4. SEGMENTAL INFORMATION
Our businesses are organized, managed and internally reported as separate
products and services segments which are reportable under SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information. The
Madge.connect and Red-M business segments develop, manufacture and market
networking products. The discontinued segment (Madge.web) supplied networking
services to businesses, with expertise in IP-enabled networks.
We are an integrated enterprise characterized by substantial
inter-segmental co-operation, cost allocation and inventory transfers.
Therefore, management does not represent that these segments, if operated
independently, would have reported the operating results and other financial
information shown. Going forward there will be only one segment for us to
report.
16
Business Segment Information
(In thousands)
(Unaudited) Three months ended Three months ended Six months ended
March 31, March 31, June 30,
2001 2000 2001 2000 2001 2000
-------- -------- -------- -------- -------- --------
NET SALES
Madge.connect $ 23,210 $ 44,611 $ 20,812 $ 25,743 $ 44,022 $ 70,354
Red-M 155 -- -- -- -- --
-------- -------- -------- -------- -------- --------
Total $ 23,365 $ 44,611 $ 20,812 $ 25,743 $ 44,022 $ 70,354
======== ======== ======== ======== ======== ========
OPERATING INCOME
Madge.connect 4,399 3,333 5,554 (3,172) 9,893 161
Red-M (5,312) (1,635) (1,499) (2,428) (6,811) (4,063)
Corporate and other 1,962 444 8,107 (486) 10,069 (42)
-------- -------- -------- -------- -------- --------
Total $ 989 $ 2,142 $ 12,162 $ (6,086) $ 13,151 $ (3,944)
======== ======== ======== ======== ======== ========
As discussed in Note 6, Red-M is not a subsidiary with effect from April
12, 2001 and, therefore, the operations of Red-M are not included in operating
income (loss) for the period after April 12, 2001.
The above tables are based on management estimates and may include
differences from U.S. GAAP, including estimates of costs and allocation of
overheads between divisions.
5. COMPREHENSIVE INCOME (LOSS)
Under SFAS No. 130, Reporting Comprehensive Income, foreign currency
translation adjustments are included in other comprehensive income (loss). No
income tax effect has been recorded related to the foreign translation
adjustment. The following are the components of comprehensive income (loss):
17
Continuing operations
(in thousands) Three months ended Three months ended Six months ended
March 31, March 31, June 30,
2001 2000 2001 2000 2001 2000
-------- -------- -------- -------- -------- --------
Net income (loss) $ 2,376 $ 1,787 $ 11,496 $ (6,577) $ 13,872 $ (4,790)
Foreign currency translation
Adjustments (1,572) (1,870) (1,361) (2,653) (2,933) (4,523)
-------- -------- -------- -------- -------- --------
Comprehensive income
(loss) from continuing
Operations $ 804 $ (83) $ 10,135 $ (9,230) $ 10,939 $ (9,313)
======== ======== ======== ======== ======== ========
Discontinued operations
Net (loss) $ -- $(16,879) $ (2,508) $(16,378) $ (2,508) $(33,257)
Foreign currency
Translation adjustments -- -- -- -- -- --
-------- -------- -------- -------- -------- --------
Comprehensive income
(loss) from discontinued
Operations $ -- $(16,879) $ (2,508) $(16,378) $ (2,508) $(33,257)
======== ======== ======== ======== ======== ========
Comprehensive income (loss) $ 804 $(16,962) $ 7,627 $ 25,608 $ 8,431 $(42,570)
======== ======== ======== ======== ======== ========
6. SALE OF RED-M SHARES
On April 12, 2001, we secured additional funding for Red-M from Apax
Partners Funds and Amadeus Capital Partners the ("Red-M Investors"). On
September 10, 2001 a further investment in Red-M was received from Intel Capital
Corporation ("Intel). Red-M has called in a further US$3.1 million of funds from
the Red-M Investors and Intel in return for additional shares being issued. The
effect of these investments will be that we will hold 37.2% of the voting rights
and 29.7% of the equity in Red-M. The Red-M Investors and Intel together will
hold 62.1% and 49.5% of the voting and equity rights, respectively, and the
management and employees of Red-M will hold the balance. These investments,
together with the fact that all shares issued have certain tag-along, rights of
first refusal and pre-emptive rights attached to them and that Red-M is seeking
additional funding from further strategic trade investors, mean that our
shareholding in Red-M will likely be further diluted over time. There are also
certain events, such as the liquidation of Madge Networks N.V., in which we
would be required to sell our shares in Red-M to the Red-M Investors and Intel,
under certain circumstances at a discount to the value at the time.
We do not have control of the Red-M board or its operations. Of the seven
members of the new Red-M board of directors, we have designated two, the Red-M
Investors have also designated two, the chairman is an independent non-executive
nominated by all parties, a second non-executive director is to be appointed by
agreement by the board and the chief executive officer of Red-M is the remaining
director. It is possible that additional investors in Red-M may also require
board
18
representation or an observer seat (as Intel has required). In addition,
although certain of the officers of Red-M were employed by Madge, their
employment arrangements with Madge have terminated as their employment was
transferred to Red-M.
Since April 12, 2001, Red-M is no longer a subsidiary of the Madge group
but is classified as an associated company, and we will no longer consolidate
the results of Red-M in the accounts of Madge Networks. Therefore, in accordance
with U.S. GAAP, we now account for Red-M under the equity method and recognize
our allocable percentage of Red-M's net income or loss on our income statement
based upon our equity holding in Red-M. The carrying value of our investment has
been reduced to zero and we will recognize no further operating losses. We will
recognize our share of profits as, when and if Red-M becomes profitable on a
cumulative basis. In addition, we recognised a gain of $8.0 million on the sale
of a portion of our shares for $8.65 million cash.
7. SPECIAL CHARGES
During June 2001, we released a $1.3 million provision that we had made to
cover the real estate-related claim by Terastor in California on our U.S.
subsidiary, Madge Networks Inc. because Terastor withdrew the court action.
8. NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and SFAS
No. 142, Goodwill and Other Intangible Assets, effective for fiscal years
beginning after December 15, 2001. Under the new rules, goodwill will no longer
be amortized but will be subject to annual impairment tests in accordance with
the Statements. Other intangible assets will continue to be amortized over their
useful lives.
We will apply the new rules on accounting for goodwill and other intangible
assets beginning in the first quarter of 2002. We will perform the first of the
required impairment tests of intangible assets as of January 1, 2002. We have
determined that these tests should not have any effect as annual impairment
tests were already performed.
In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No.
144 is first applicable to our financial statements for the year ending December
31, 2002, though earlier application is encouraged. SFAS No. 144 supersedes SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, and provides a single accounting model for long-lived
assets to be disposed of. Although SFAS No. 144 retains many of the recognition
and measurement provisions of SFAS No. 121, it significantly changes the
criteria that have to be met in order to classify long-lived assets as
held-for-sale and excludes goodwill and intangible assets not being amortized
from its impairment provisions.
SFAS No. 144 also supersedes the provisions of APB No. 30 with regard to
reporting the effects of a disposal of a segment of a business and requires
expected future operating losses from discontinued operations to be displayed in
discontinued operations in the periods in which the losses are incurred rather
than as of the measurement date as currently. In addition, more dispositions
will qualify for discontinued operations treatment in the income statement.
19
As the provisions of SFAS No. 144 are to be applied prospectively, they
will not affect these condensed financial statements. The impact, if any, upon
adoption will depend upon the circumstances existing at that time.
9. RECEIVABLE DUE FROM ADMINISTRATION AND INTERIM JUDICIAL MANAGEMENT
PROCESSES
On April 27, 2001, we publicly announced that, after 16 months of seeking
additional financing for Madge.web, the Board of Madge Networks decided not to
further fund the operations of Madge.web and that we were searching for a
purchaser of Madge.web. In order to provide for orderly administration of
Madge.web and to further the ability to sell it as a going concern, Madge.web
Limited in the United Kingdom and Madge SE Asia Pte Ltd in Singapore were put
into Administration and Interim Judicial Management, respectively, in accordance
with their local laws in processes broadly similar to Chapter 11 in the United
States. In June 2001, Madge Networks provided $3.7 million of funding to the
Administration of Madge.web Limited and a further $0.3 million to the Interim
Judicial Management of Madge SE Asia Pte Ltd in Singapore. This funding has been
reported separately in the condensed consolidated financial statements and forms
part of the $6.3 million total provided to the Administrators and Interim
Judicial Management.
10. SUBSEQUENT EVENT
The shareholders meeting held on October 10, 2001 approved an amendment to
the Articles of Association for Madge Networks N.V. to convert our share capital
from Dutch guilders to Euros to reflect the fact that the Dutch guilder will be
replaced by the Euro as the official currency of the Netherlands on January 1,
2002. With effect from October 10, 2001 the nominal value of each share is EUR
0.45.
20
FORWARD LOOKING STATEMENTS
Our operating results have in the past and may be in the future affected by
various risk factors, many of which are beyond our control. Certain of the
statements included in this Form 6-K express our "anticipation," "belief,"
"commitment," "expectation," "intention," "goals," "plans" or similar terms,
regarding
o our ability to complete the planned sale of Madge.web's assets and to
mitigate Madge Networks liabilities for the discontinued Madge.web business
o the adequacy of our financial resources and our ability to raise additional
financing
o events that could reduce the value of our Red-M shareholding or further
dilute our holding in Red-M
o the success of cost reduction plans in Madge.connect and our corporate
functions
o the size of markets for our products and services
Such statements as well as other statements that are not historical fact, are
forward-looking statements within the meaning of the United States Private
Securities Litigation Reform Act of 1995 and involve risks and uncertainties
referred to in this Form 6-K and in our Annual Report on Form 20-F for the year
ended December 31, 2000 (the "Form 20-F") under "Description of Business - Risk
Factors." Actual results, actions or events could differ materially.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
Madge Networks N.V. ("Madge") is a global provider of advanced networking
product solutions to large enterprises. Until April 2001, we operated through
three subsidiary groups; Madge.connect, Red-M and Madge.web. Madge.connect is a
global supplier of Token Ring LAN product solutions for mission-critical
enterprise networks and is the market leader in Token Ring. Red-M is a
pioneering developer and leading supplier of wireless networking product
solutions that enable access to a range of voice, video and data from a range of
mobile devices. As of April 2001 we no longer own a majority of the voting or
equity interests of Red-M. Madge.web was a global provider of rich content
applications, content distribution and managed network services. We have
discontinued all activities of Madge.web except for its limited business
activities in the United States and are seeking purchasers for the Madge.web
assets that remain. Madge.connect is, therefore, our only continuing operating
business and we will need to make further cuts in our Madge.connect and
corporate cost base to maintain the profitability of our business as the
revenues reduce over time and to add further revenue generating activities over
which to spread the cost base. In addition to our Madge.connect business we also
have a corporate function that provides services to our Madge.connect business,
to Red-M and to the remaining operations of Madge.web. We are reimbursed for
these services through a quarterly fee that is charged to Red-M. Red-M has
indicated that it intends to seek alternative methods of receiving a number of
the services that our corporate team currently provide to them and accordingly
as their demand upon us for these services reduce, we will make further
headcount reductions to take this into account.
In April 2001, we secured additional funding for Red-M. We received $8.65
million in exchange for some of our shares in Red-M and the Red-M Investors also
invested a further $21.3 million directly into the Red-M business in exchange
for additional shares being issued. In addition, on September 10, 2001, Intel
invested approximately $2.9 million and were issued shares in Red-M. Red-M has
called in a further $3.1 million of funds committed from the Red-M Investors and
Intel. The Red-M Investors and Intel also agreed to invest a further $7.5
million between January 2002 and April 2002, subject to certain conditions being
met. From April 12, 2001 Red-M is classified as an associate company and we no
longer have any funding commitment to it. The carrying value of our
21
investment has been reduced to zero and we will recognize no further operating
losses. We will recognize our share of profits as, when and if Red-M becomes
profitable on a cumulative basis.
As at September 30, 2001 we held 39.4% of the voting rights and 31.0% of
the equity in Red-M. The Red-M Investors and Intel held 59.8% and 47.2% of the
voting and equity rights respectively, and the management and employees of Red-M
held the balance. Once the further $3.1 million has been received from the Red-M
Investors and Intel, our percentage will decrease to 37.2% of voting rights and
29.7% of equity rights.
On April 27, 2001, we publicly announced that, after 16 months of seeking
additional financing for Madge.web, the Board of Madge Networks decided not to
further fund the operations of Madge.web and that we were searching for a
purchaser of Madge.web. In order to provide for orderly administration of
Madge.web and to further the ability to sell it as a going concern, Madge.web
Limited in the United Kingdom and Madge SE Asia Pte Ltd in Singapore were put
into Administration and Interim Judicial Management, respectively, in accordance
with their local laws in processes broadly similar to Chapter 11 in the United
States. Madge Networks provided $6.3 million of funding to the respective
Administration and Interim Judicial Management processes for these two
entities.. Following the failure to secure a purchaser for the whole Madge.web
business, on June 12, 2001 we received permission from the Dutch courts for an
Insolvent Liquidation of Madge.web B.V., the Dutch registered European sales
subsidiary of Madge.web with branches in France, Germany, Italy, Spain and
Sweden.
On July 19, 2001 we announced that that the Administrators had entered into
an agreement with Tullett & Tokyo for the sale of certain assets relating to
Madge.web's Trader Voice business in Asia and Europe. The sale provided
continuity of employment for a number of Madge.web employees and provided a
release for Madge Networks of significant guarantee obligations relating to the
Madge.web Trader Voice business. The sale proceeds, together with the
receivables from the Madge.web business since the Administration process began
on April 27, 2001, are being used by the Administrators of Madge.web to repay a
proportion of the debts due to Madge.web's creditors and of the funds supplied
by Madge Networks for the Administration process.
Madge Networks did not conclude an agreement from the Letter of Intent
previously announced, and this sale to Tullett and Tokyo is on different terms
to those envisaged. Accordingly, Madge Networks do not expect at this stage that
the funds realized by the Administration process in total will be sufficient to
repay the full US$6.3 million funding provided by it to the Administrators, as
had been anticipated. Madge Networks hopes the funds will be received in the
first half of 2002.
The majority of the other Madge.web employees were subsequently terminated.
As of August 17, 2001 and September 14, 2001, Madge.web Limited and Madge SE
Asia Pte Ltd, respectively, were put into insolvent liquidation. The Liquidators
of Madge.web Limited are continuing to seek purchasers for Madge.web's other
remaining assets. Madge Networks currently only has funding obligations to
Madge.web Inc. in the United States as obligations of Madge.web and Madge
Networks are being settled.
In accordance with U.S. GAAP, Madge.web is presented as a discontinued
business within this report and the results for 2000 have been reclassified
accordingly. In addition, the assets and liabilities of Madge.web at December
31, 2000 were re-valued in light of these events and presented at the value
expected to be realized on the sale of the global Trader Voice business as a
going concern and on the sale of other assets of Madge.web. We also made a
provision of $41.7 million against the
22
future expected losses of the business from December 31, 2000 to the expected
date of sale of the global Trader Voice business and against liabilities which
would crystallize on our exit of the Madge.web business, which includes
operational guarantees given by Madge Networks on behalf of Madge.web that we
may be unable to mitigate. As at June 30, 2001 this provision was $25.1 million.
See Note 2 to the condensed consolidated financial statements for additional
information with respect to the discontinuance of Madge.web.
To optimize the current and future business of Madge Networks, a new
management team has been appointed through internal promotion. Martin Malina,
previously Senior VP Lines of Business, Madge.web, was appointed as our Chief
Executive Officer on July 19, 2001 taking the place of Robert Madge who
continued as Chairman and President of the Management Board. On October 10, 2001
Martin Malina was elected to the Management Board by the shareholders, Robert
Madge was appointed to the Supervisory Board and the articles of Madge Networks
N.V. were amended to allow for our Supervisory Board to appoint a Designated
Supervisory Board Member who would have additional responsibilities including
working more closely with the Management Board. The Supervisory Board has
appointed Robert Madge to this role.
The Supervisory Board have reached agreement in principle with Robert Madge
to terminate his employment by mutual consent following the replacement of Mr
Madge as Chief Executive Officer and the relinquishing of his responsibilities
as Managing Director. The agreement will require a settlement payment to be made
to Robert Madge as compensation for loss of office. The agreement is being
finalized by the parties' legal advisors. We expect the settlement payment,
which will be made with reference to Dutch employment law practices, to be
substantial. Robert Madge has agreed in principle to the settlement payment
being paid over an extended period in order to accommodate our cash flow
position. We will disclose the terms of the settlement agreement once it has
been signed by the parties.
We also intend to enter into a consultancy arrangement with Mr Madge that
will provide for consulting services to Madge Networks and our affiliates for a
period of 24 months in relation to past activities of these companies and the
strategic development of our businesses. The terms of this agreement are also
being finalised.
Mr Madge is entitled to receive a bonus of $100,000 under his previous
employment arrangements for the year ended December 31, 2000. Such bonus payment
will be made during the fourth quarter of 2001.
Mr. Madge will receive compensation in his new roles of Supervisory
Director and Designated Supervisory Director as approved by our shareholders at
the shareholders' meeting on October 10, 2001. As Supervisory Director, Robert
Madge will receive an annual fee of $32,500 (plus meeting attendance fees) and
received options for 100,000 shares upon his election. In addition, as the
Designated Supervisory Director, he will receive an additional annual fee of
$65,000 as well as options to receive an additional 400,000 shares.
Chris Bradley, Chief Financial Officer has announced his intention to leave
Madge Networks at the end of the year in order to pursue other opportunities.
Chris will continue as Chief Financial Officer and be a committed member of the
senior management team until his departure. Chris Semprini, previously Director,
Finance, Madge.web is now acting in the capacity of Deputy Chief Financial
Officer with the intention of moving into the role of Chief Financial Officer in
the new year.
23
As announced in June 2001, our Management Board is developing a
strategy and a number of actions to refocus Madge moving forward. These actions
include maintaining profitability in our remaining operating subsidiary,
Madge.connect, through close management of pricing, product costs and overheads;
further streamlining our corporate organization; benefiting from any increase in
the value of Red-M, which could include selling or pledging some of our shares
in Red-M; exploring new business opportunities that can leverage our assets and
core competencies without significant use of resources; and seeking additional
equity funding at an appropriate time when we have made progress in developing
our value-generation strategy. There can be no assurance that this strategy
will be successful.
OPERATING RESULTS
The following table shows the percentage of net sales represented by
certain items in our statements of operations for continuing operations:
(Unaudited ) (in thousands) Three months ended Three months ended Six months ended
March 31, June 30, June 30,
------------------ ------------------ ----------------
2001 2000 2001 2000 2001 2000
---- ---- ---- ---- ---- ----
Net sales 100% 100% 100% 100% 100% 100%
Cost of sales 49 50 45 58 48 53
---- ---- ---- ---- ---- ----
Gross profit 51 50 55 42 52 47
Operating expenses:
Sales and marketing expenses 30 30 18 39 24 33
Research and development expenses 12 11 1 17 7 13
General and administrative expenses 5 4 14 10 9 6
Special (gain) - - (6) - (3) -
---- ---- ---- ---- ---- ----
Total operating expenses 47 45 27 66 37 52
---- ---- ---- ---- ---- ----
Income (loss) from operations 4 5 28 (24) 15 (5)
Net interest (income) loss 6 - - (1) 3 (1)
Gain on sale of investment in Red-M - - 38 - 18 -
---- ---- ---- ---- ---- ----
Income (loss) before income taxes 10 5 66 (25) 36 (6)
Provision for income taxes - (1) (4) - (2) (1)
---- ---- ---- ---- ---- ----
Net income (loss) 10% 4% 62% (25)% 34% (7)%
==== ==== ==== ==== ==== ====
Net Sales
Total net sales for the three months ended March 31, 2001 were $23.4
million compared to $44.6 million for the three months ended March 31, 2000.
Total net sales for the three months ended June 30, 2001 were $20.8 million
compared to $25.7 million for the three months ended June 30, 2000. Total net
sales for the six months ended June 30, 2001 were $44.2 million compared to
$70.4 million for the six months end June 30, 2000. The decrease in net sales in
2001 compared to 2000 reflects the reduced demand for our products.
In addition net sales in 2000 included video networking products up to the
end of September 2000, when the business was sold. Because the market for our
Token Ring products (principally adapter cards) continues to decline as
companies turn to other technologies, we have been and are continuing to take
steps to reduce overheads and streamline the Madge.connect business.
24
Gross Profit
Gross profit was 51% for the three months ended March 31, 2001 compared to
50% for the three months ended March 31, 2000. Gross profit from continuing
operations was 55% for the three months ended June 30, 2001 compared to 42% for
the three months ended June 30, 2000. Gross profit from continuing operations
was 52% for the six months ended June 30, 2001 compared to 47% for the six
months ended June 30, 2000. We employ special pricing deals when appropriate but
do not expect them to have a negative effect on gross margin performance.
Sales and Marketing
Sales and marketing expenses were $6.8 million and $13.1 million for the
three months ended March 31, 2001 and 2000, respectively. For both periods these
expenses represented 30% of sales. For the three months ended June 30, 2001 and
2000 sales and marketing expenses from continuing operations were $3.8 million
and $10.1 million, respectively. These expenses represented 18% and 39% of
sales, respectively. Sales and marketing expenses from continuing operations
were $10.6 million for the six months ended June 30, 2001 compared to $23.2
million for the six months ended June 30, 2000. These expenses represented 24%
and 33% of sales, respectively. During 2000, we reduced the size of our sales
and marketing activities in Madge.connect, resulting in the substantial
reduction in our expenses between the first six months of 2000 and of 2001.
Further headcount reduction in Madge.connect as well as in our corporate
functions may be required in the future as sales for Madge.connect decline
further.
Research and Development
Research and development expenses were $2.8 million and $5.1 million for
the three months ended March 31, 2001 and 2000, respectively. These expenses
represented 12% and 11% of sales, respectively. For the three months ended June
30, 2001 and 2000 research and development expenses from continuing operations
were $0.2 million and $4.4 million, respectively. These expenses represented 1%
and 17% of sales, respectively. Research and development expenses from
continuing operations were $3.0 million for the six months ended June 30, 2001
compared to $9.5 million for the six months ended June 30, 2000. These expenses
represented 7% and 13% of sales, respectively. The decline in expenditure
reflected our strategy to reduce research and development headcount focussed on
the mature Token Ring market and video networking. All of our research and
development costs have been expensed as incurred. We anticipate that we will
increase our research and development expenditure in the future if we have
sufficient funds available to do so.
General and Administrative
General and administrative expenses were $1.2 million and $2.0 million for
the three months ended March 31, 2001 and 2000, respectively. These expenses
represented 5% and 4% of sales, respectively. For the three months ended June
30, 2001 and 2000 general and administrative expenses from continuing operations
were $3.0 million and $2.4 million, respectively. These expenses represented 14%
and 10% of sales, respectively. General and administrative expenses from
continuing operations were $4.2 million for the six months ended June 30, 2001
compared to $4.4 million for the six months ended June 30, 2000. These expenses
represented 9% and 6% of sales, respectively. General and administrative
expenses for the three months ended June 30, 2001 included professional fees and
the general and administrative expenses for the three months ended March 31,
2001 included release of payroll and travel accruals and payment from our
director and officers insurers of a portion of the legal fees we incurred in our
class action.
25
As a result of the dissolution of Madge.web and the sale of our majority
stake in Red-M, we have already and expect to make further headcount reductions
in our corporate function to enhance the profitability and cash generation of
Madge.connect as the remaining operation of Madge.
Special Charges
During June 2001, we released a $1.3 million provision that we had made to
cover the real estate-related claim by Terastor in California on our U.S.
subsidiary, Madge Networks Inc. because Terastor withdrew the court action.
Gain on Sale of Investment in Red-M
In the second quarter of 2001 we recognized a special gain of $8.0 million
relating to the sale of shares in Red-M (Communications) Limited.
Earnings before interest, tax, depreciation and amortization
Earnings before interest, tax, depreciation and amortization ("EBITDA") is
not a measurement in accordance with U.S. GAAP. EBITDA is presented as a
management tool and is not necessarily comparable to similar measures used by
other companies. EBITDA for continuing operations (which includes Madge.connect
and corporate) for the three months ended March 31, 2001 was $4.1 million
compared to $6.4 million for the three months ended March 31, 2000. EBITDA for
continuing operations for the three months ended June 30, 2001 was $5.6 million
compared to a loss of $1.8 million for the three months ended June 30, 2000.
EBITDA for continuing operations for the six months ended June 30, 2001 was $9.7
million compared to $4.6 million for the six months ended June 30, 2000.
Income Taxes
Our provision for income taxes as a percentage of pre-tax income from
continuing operations for the six months ended June 30, 2001, was 6% compared to
8% for the six months ended June 30, 2000.
The tax expense for the three months ended March 31, 2001 and 2000 was $0.1
million and $0.2 million, respectively. The tax expense for the three months
ended June 30, 2001 and 2000 was $0.8 million and $0.2 million, respectively.
The tax expense for the six months ended June 30, 2001 and 2000 was $0.9 million
and $0.4 million, respectively. The tax expenses were principally the result of
profits in certain entities against which we were unable to offset losses. We
recognized approximately $44,000 current deferred tax assets at both June 30,
2001 and 2000.
Sale of Video Networking
In September 2000 Madge.connect sold its video networking business to
Initia Inc. a provider of scalable, multi-service network solutions for
videoconferencing and distance learning applications based in New Jersey. As
part of this agreement, key staff transferred to Initia and Initia agreed to
acquire inventory we own to support this business over the following twelve
months. The sale of this business gave rise to a special charge of $0.9 million,
comprised of a $2.0 million provision to cover the restructuring program, offset
by income and various assets/liabilities relating to the Video Networking
business.
26
At the same time, the manufacturing function of the video networking
business was sold separately to Freedom and our support staff within this
business were transferred to them. In order that Freedom can continue to
manufacture the video networking products for Initia, we agreed with Freedom
that for a period we would continue our direct relationship with Kbyte Hibbing
Manufacturing (Hibbings), one of the main component suppliers of the Video
Networking business. The components purchased by Madge from Hibbings under this
direct relationship were delivered to Freedom and are placed with all the other
Madge inventory which had been consigned to Freedom. Initia is obliged to pay
Madge for all inventory it uses from this consigned inventory during its
operation of the video networking business. We have indicated to Freedom, that
we have met all of our existing purchase obligations for long lead time items
and that we will not be entering into any new purchase orders once the existing
ones in place have been used up and Freedom should enter into a direct
relationship with Hibbings which we estimate will be by the end of the fourth
quarter 2001.
Alliance with Magnifi
In October 2000 Madge.web entered a strategic alliance with Magnifi, a Los
Gatos, California-based developer and operator of business-to-business extranet
services targeted at the marketing services industry.
During the fourth quarter of 2000, Madge.web also acquired $2.0 million
worth of Series E preferred stock of Magnifi, giving us 623,053 or 8.1% of the
fully diluted Series E stock or approximately 1.3% holding of Magnifi's total
fully diluted equity as at December 31, 2000. As a result of the joint venture
between Proctor and Gamble and Magnifi the investment stock will be converted
into a right to receive the same number of shares in the joint venture company,
Emmperative. The shares are transferable subject to compliance with the Investor
Rights Agreement which is intended to ensure compliance with the Securities
Acts. We intend to sell or pledge these shares.
Foreign Currency Exchange Rates
The functional currency of Madge Networks N.V. is the U.S. dollar and a
significant portion of net sales are collected in U.S. dollars. A substantial
portion of our net sales are also collected in currencies other than the U.S.
dollar, principally the British pound and the Euro. Because we have a
substantial portion of our operations located outside the United States,
principally in the United Kingdom, a significant portion of our manufacturing,
logistics, research and development expenses, and general administrative
expenses are incurred in British pounds rather than U.S. dollars. Although it is
impossible to predict future exchange rate fluctuations between the U.S. dollar
and other currencies, it can be anticipated that to the extent the U.S. dollar
strengthens or weakens against the British pound, or to a lesser extent other
currencies, a substantial portion of our reported net sales, cost of goods sold
and operating expenses will be commensurately lower or higher than they would
have been with a stable foreign currency relationship. A portion of our
operations are effectively hedged by the distributed nature of our world-wide
sales and expenses. To the extent that we do not have balanced assets and
liabilities in one or more currencies, we can attempt to estimate the exposure.
At certain points throughout 2000 we hedged this exposure by purchasing or
selling foreign currencies one month forward. These transactions do not
eliminate our foreign currency risks as they involve estimates based on
incomplete information. The use of forward contracts was actively reviewed
throughout 2000 and the six months ended June 30, 2001 and the decision to hedge
using these instruments depended upon our view of the foreign exchange market at
the time the decision whether or not to hedge was taken. We did not hedge any of
this exposure during the six months to June 30, 2001.
27
Foreign currency gains or losses are charged to, or offset against, general
and administrative expenses. Madge and our subsidiaries periodically record
gains and losses from transactions in, and re-measurements of foreign currency
balances and accounts denominated in, currencies other than their respective
functional currencies. This permits Madge and our subsidiaries to present our
financial statements in their respective functional currencies. As a result of
these foreign currency translations and re-measurements, we booked net gains of
approximately $2,394,000 for the six months ended June 30, 2001.
Madge accounts for foreign currency in accordance with SFAS No. 52, Foreign
Currency Translation. Under this Statement, assets and liabilities of our
non-U.S. dollar subsidiaries are translated into U.S. dollars at exchange rates
in effect at the close of the period. The resulting translation adjustments are
excluded from net earnings, and accumulated as a separate component of
shareholders' equity. The income and expenses of these operations are translated
at monthly market exchange rates. As of June 30, 2001, cumulative translation
adjustments decreased shareholders' equity by approximately $16,243,000.
LIQUIDITY AND CAPITAL RESOURCES
As at June 30, 2001, we had cash and cash equivalents of $5.9 million and
an additional $8.9 million of cash that was restricted. In addition, under our
Madge.connect working capital financing arrangement, secured by Madge.connect
accounts receivable (for further details see below), we had approximately $3.7
million headroom available as at June 30, 2001.
During April 2001, we transferred to Red-M cash of $2.7 million to settle
inter-company accounts and received $8.65 million from the sale of our Red-M
shares.
From March 31, 2001 until Madge.web Limited entered Administration on April
27, 2001, we had utilized approximately $3.5 million of cash in Madge.web.
We provided an aggregate of $6.3 million to the Administrators of Madge.web
Limited in the United Kingdom and the Interim Judicial Management in Singapore
to operate their respective Madge.web operations while attempts to secure a
buyer for the Madge.web business and assets were made. We have and continue to
provide funds to Madge.web Inc. in the United States as obligations of Madge.web
and Madge Networks are being settled. Madge Networks currently has no funding
obligations to any other Madge.web subsidiary.
We believe that our current liquidity levels and committed financial
resources are sufficient to meet the needs of our ongoing operations for at
least 12 months following the furnishing of this Form 6-K to the Securities and
Exchange Commission. However, our belief is based on the following assumptions,
some or all of which may not prove accurate, in which case, we would need to
raise money sooner and there would be substantial uncertainty about our ability
to continue as a going concern:
o that approximately half of the funds provided to the Administrators and
Interim Judicial Management will be returned to us during the first half of
2002;
o that we meet our planned revenue targets going forward;
o that we will be able to mitigate substantial liabilities under the
operational guarantees that we made on behalf of Madge.web, the maximum
value of which we estimate to be approximately $15.5 million as at
September 30, 2001 for equipment leases and loans, leasehold improvements
and property leases;
28
o that our currently available sources of funding will remain available to
us;
o that the further cuts in our overhead and headcount we must make, will be
sufficient to cause Madge.connect together with our corporate function to
maintain positive cashflow in 2001; and
o that we will be able to sell the remaining assets of Madge.web and not have
to put Madge.web Inc. into liquidation.
As further liquidity is required, we are attempting to raise additional
funds through working capital financing and other sources of finance such as
bank credit, or a further sale or charge of our shares in Red-M, though our
ability to sell our shares in Red-M are subject to certain contractual
restrictions that could affect our ability to sell and the price that could be
obtained for our Red-M shares. We may also attempt to raise additional funds
through an equity offering of our shares, but if our common shares were to be
delisted from the NASDAQ National Market and listed on either The Nasdaq
SmallCap Market or the Over-The-Counter-Bulletin-Board, we would find it more
difficult to raise fund through an equity offering of our shares. See "Risk
Factors" below for further details.
If we are unable to raise additional funds as outlined above or our
assumptions above prove incorrect, there would be substantial uncertainty about
our ability to continue as a going concern. The condensed consolidated financial
statements do not include any adjustment that may result from the outcome of
that uncertainty.
As outlined above, we had cash and cash equivalents from continuing
operations of $5.9 million as at June 30, 2001 and an additional $8.9 million of
cash was restricted. Of this restricted cash $4.2 million was held in the escrow
established pursuant to an agreement with Olicom whereby we placed $8.5 million
in escrow relating to further minimum guaranteed payments to be made over three
years from 1999 based on a percentage of our Token Ring revenues and $4.7
million is held on deposit against leased assets for the Madge.web data center
in New York City. We paid $0.7 million from the Olicom escrow during 2001 which
related to royalty payments due on our sales. The remaining $4.2 million held in
escrow is a minimum payment due on current and future Token Ring sales.
Our Madge.connect working capital financing arrangement is for a maximum of
$30 million, secured by accounts receivable generated by U.K. and U.S.
Madge.connect entities. Availability of financing under this facility depends
upon the level of receivables for these entities. The arrangement runs for an
initial two year period to September 30, 2001 and continues thereafter until
terminated by either party giving three months notice. We currently have no
intention of giving notice to terminate this agreement. The finance company is
able to terminate this agreement immediately if it considers there to have been
a material adverse change in our business. We have no indication from it that it
intends to terminate this arrangement. There was no balance outstanding under
the arrangement as at December 31, 2000. At September 30, 2001, availability
under this facility was $4.5 million of which we had utilized $4.3 million. The
amount available to us under this agreement in the future is dependant upon our
receivables and indirectly upon Madge.connect future revenue.
Net cash provided by operating activities for continuing operations for the
six months ended June 30, 2001 was $7.1 million. The net cash inflow was
attributable to the net profit for the period excluding non-cash transactions
(such as depreciation and amortization) of $13.5 million, offset by a $6.4
million net decrease in cash from the change in levels of working capital and
gain on the sale of Red-M. Net cash used in operating activities for
discontinued operations for the six months ended June 30, 2001 was $29.5
million. This was due to the net loss for the period excluding non-cash
transactions (such as depreciation, amortization and impairment) of $2.5 million
offset by a net increase in cash from working capital of $27.0 million.
29
Net cash provided by investing activities for continuing operations for the
six months ended June 30, 2001 was $8.2 million of which $0.5 million related to
purchases of property and equipment and offset by $8.7 million relating to the
sale of our investment in Red-M.
Net cash provided by financing activities for continuing operations for the
six months ended June 30, 2001 was $4.6 million. Cash inflow was attributable to
the issue of common shares of $0.7 million and short-term loans (from our
working capital financing arrangement mentioned above) of $4.2 million. This was
offset by outflows of $0.3 million for repayment of capital leases.
Although we did generate cash flow from continuing operations, we did not
generate cash from total operations in either the six months ended June 30, 2001
or the year ended December 31, 2000. We funded the investments we made in
Madge.web and Red-M in 2000 through various sources of financing including $29.2
million in net proceeds from a public offering and $29.7 million in net proceeds
from the private sale to Volendam of common shares. A further $29.8 million was
raised from the issue of Class B Preferred shares of Madge.web N.V. to Volendam.
These were issued on January 26, 2001 and Volendam effectively waived the
repayment of the principal amount of the loan we had to draw down at the time
($28.0 million) and paid the final $2.0 million due. Volendam were entitled to
offset these sums under the loan agreement. In February 2001, we received $7.0
million (plus $1.2 million interest) from Celestica, as performance-related
consideration from the sale of our Irish manufacturing plant to Celestica in
February 1998. During April 2001, we successfully secured additional funding for
Red-M. We received a total of $8.6 million from the Red-M Investors in exchange
for 2,763,578 shares we held in Red-M.
On August 10, 2000 we signed an agreement with Inktomi Corporation whereby
they are committed to invest in Madge.web shares, subject to certain conditions,
at the next round of financing, which was expected to be completed by end of
March, 2001. As we failed to secure this financing by the required deadline this
agreement lapsed. However, in March 2001 Inktomi agreed to purchase $5.0 million
worth of shares in Madge Networks N.V. instead. These shares were to have been
purchased by Inktomi following the filing of the Form 20-F at the closing price
one day after the Form 20-F was filed (with a provision for us to require a
resetting of the price if it is less than $1.00, to the price on the fifth day
after such filing). This agreement is subject to there being no "material
adverse change" in our business. Inktomi have not purchased these shares and may
argue that the current position regarding the future of the Madge.web is
regarded as a "material adverse change" in our business and refuse to make the
investment.
LEGAL PROCEEDINGS
From time to time Madge and our subsidiaries are involved in disputes
relating to claims arising out of our operations in the normal course of
business, which disputes have increased substantially as a result of the
financial difficulties and liquidation of Madge.web. Among other things, such
claims may relate to allegations of patent infringement, employment-related
claims, product warranty claims and service claims. Specific claims relating to
the Madge.web discontinuation include claims from equipment leasing companies
and claims from landlords for unpaid rent. If the judgment in the class action
litigation filed in the United States District for the Northern District of
California in August 1996 were to be successfully appealed by the plaintiffs our
results of operations and financial position would be materially adversely
affected. For more details of the class action see Form 20-F. Since the Form
20-F was filed we have received a date of December 4, 2001, for the Court of
Appeals hearing.
30
RISK FACTORS
From time to time, in connection with the United States Private Securities
Litigation Reform Act 1995, reference may be made to risks addressed in our
public filings with the Securities and Exchange Commission. All the following
factors should be considered carefully before making an investment decision. If
any of the following risks actually occur, our business, financial condition or
results of operations could be materially adversely affected. In that event, the
trading price of our shares could decline, and you could lose part or all of
your investment.
RISKS RELATED TO OUR FINANCIAL CONDITION AND OUR BUSINESS
Our inability to realize sufficient funds from the sale of Madge.web's remaining
assets, to mitigate the remaining Madge.web and Madge Networks liabilities in
relation to the Madge.web business or to be repaid approximately half of the
funds paid in relation to the liquidation of Madge.web Limited will have an
adverse affect on our entire business and could affect our ability to operate as
a going concern.
We believe that our current liquidity levels and committed financial
resources are sufficient to meet the needs of our ongoing operations for at
least 12 months following the furnishing of this Form 6-K to the Securities and
Exchange Commission. However, our belief is based on the following assumptions,
some or all of which may not prove accurate, in which case, we would need to
raise money sooner and there would be substantial uncertainty about our ability
to continue as a going concern:
o that approximately half of the funds provided to the Administrators and
Interim Judicial Management will be returned to us during the first half of
2002;
o that we meet our planned revenue targets going forward;
o that we will be able to mitigate substantial liabilities under the
operational guarantees that we made on behalf of Madge.web, the maximum
value of which we estimate to be approximately $15.5 million as at
September 30, 2001 for equipment leases and loans, leasehold improvements
and property leases;
o that our currently available sources of funding will remain available to
us;
o that the further cuts in our overhead and headcount we must make, will be
sufficient to cause Madge.connect together with our corporate function to
maintain positive cashflow in 2001; and
o that we will be able to sell the remaining assets of Madge.web and not have
to put Madge.web Inc. into liquidation.
As further liquidity is required, we are attempting to raise additional
funds through working capital financing and other sources of finance such as
bank credit, or a further sale or charge of our shares in Red-M, though our
ability to sell our shares in Red-M are subject to certain contractual
restrictions that could affect our ability to sell and the price that could be
obtained for our Red-M shares. We may also attempt to raise additional funds
through an equity offering of our shares, but if our common shares were to be
delisted from the NASDAQ National Market and listed on either The Nasdaq
SmallCap Market or the Over-The-Counter-Bulletin-Board, we would find it more
difficult to raise fund through an equity offering of our shares.
31
Claims by suppliers or customers of Madge.web have been made against Madge
Networks.
As Madge.web Limited and Madge SE Asia Pte Ltd have both been placed into
Insolvent Liquidation and Madge.web B.V. has been declared bankrupt, these legal
entities cannot pay any debts due to their suppliers and customers. Madge.web
has also ceased to support substantially all of its operations, the only
exception to this being the limited business operated by Madge.web Inc. in the
United States which will be funded as obligations of Madge.web and Madge
Networks are being settled. As a result, claims have been made, and may be made
in the future, against Madge Networks under the terms of operational guarantees
given by or contracts entered into by Madge Networks and otherwise. If one or
more significant claims are successful, our business and resources will be
materially adversely affected. Customers, suppliers or former employees of
Madge.web could also attempt to bring claims against Madge Networks' group of
companies.
We are expending a lot of time and resources on Madge.web matters and need to be
in a position where we can focus more on forward looking matters.
Many of our employees are involved in the winding up of the Madge.web
business, the sale of assets, the restructuring of the company and the
mitigation of the remaining liabilities that related to the Madge.web business.
This work needs to be done but is not allowing a number of key individuals to
focus on existing or possible new lines of Madge business in order to generate
further revenue.
We will be wholly dependent upon revenue generated by our Token Ring business
for the foreseeable future.
Our revenue has increasingly been derived from the sale and licensing of
Token Ring products and technology. We depend upon the continued market
acceptance of Token Ring and related technologies. Our total sales of Token Ring
adapter cards have declined over the last five years and have declined steadily
from $26.5 million to $23.0 million and $21.0 million in the fourth quarter of
2000 and the first and second quarters of 2001, respectively. We expect Token
Ring sales to continue to decline as companies turn to other technologies.
Following the sale or liquidation of Madge.web and because since April 2001 we
hold only an equity investment in Red-M, we are totally dependent on sales and
licensing of Token Ring products and technology for revenues and we expect that
our net sales will continue to decrease.
Our inability to change our main subcontract manufacturer successfully would
cause our business to suffer.
We are currently trying to secure alternative sources of supply for our
products, moving away from Celestica as our sole subcontract manufacturer. There
is a risk that these attempts may not be successful and our business would
suffer as a result if there were any disruption in supply of our products or
problems with the quality of the products received from our new supplier. Our
continued reliance upon third-party manufacturers and suppliers involves several
potential risks, including the absence of adequate capacity, manufacturing
yields and costs. In the event that a significant subcontract manufacturer or a
significant supplier were to become unable or unwilling to continue to
manufacture our key products in required volumes, we would be required to
identify and qualify acceptable additional sources for our products or to
manufacture the products ourselves. The identification and qualification process
could lead to further delays and additional costs and no assurance can be given
that additional sources would become available to us on a timely basis or that
we could manufacture such products ourselves on a timely or cost-effective
basis. In addition, if any
32
other significant suppliers were to establish a strategic working relationship
with one or more of our competitors or were to enter into direct competition
with us, our business could be materially adversely affected.
Loss or modification of Madge.connect relationships with third-party
distributors and resellers would harm our operations and sales.
Substantially all of our Madge.connect sales are fulfilled and distributed
world-wide through a network comprised of distributors, value-added resellers
and original equipment manufacturers. Our Madge.connect indirect distribution
channels vary from country to country. In the United States, the majority of our
products are sold through two major national distributors, Ingram Micro, Inc.
and Tech Data Corporation, Inc. In Europe, Asia and other markets, we sell our
Madge.connect products predominantly through marketing representatives,
distributors and resellers. We have undertaken a restructuring of our channel
relationships world-wide and substantially reduced the number of channel
partners and third party sales agents we deal with directly in order to
streamline our business to reflect the declining Token Ring market. Any
contracts we have with our channel partners and third party sales agents are
typically not long-term. The loss of a distributor or reseller or a sales agent
in a particular region could impair our operations in that region. Any resulting
declines in sales could decrease revenue. Until alternative distribution
channels could be established, if at all, our business would suffer. The loss of
a significant number of key sales personnel including sales agents would also
affect our ability to manage our distributors and resellers and continue to
secure revenue from them, particularly during this period when we are trying to
reduce the number of channel partners we deal through.
If we fail to establish or maintain relationships with parties that agree to
resell our Madge.connect products on an original equipment manufacturer basis,
our revenue will decrease.
We anticipate that a portion of our future Madge.connect revenue will be
derived from sales to customers that integrate our products into their own or
resell our products under their own brand names. Therefore, our revenue will be
increasingly dependent upon the ability and willingness of these original
equipment manufacturers ("OEMs") to promote products that incorporate our
products and technology. The ability and willingness by OEMs to do so is based
upon a number of factors, including:
o our timely supply of products with the required reliability, functionality,
speed and performance at acceptable prices;
o the compatibility of our technology with emerging and changing industry
standards and with the products being developed by the potential OEM
partners;
o general industry competition; and
o overall economic conditions.
Many of these factors are beyond our control. Additionally, these customers
may have profitability or other incentives to promote internal solutions or
competing products in lieu of products incorporating our technology. Sales by
these customers also could compete with our products, possibly impacting our
sales, reducing margins and adversely affecting the marketability of our
products. Our inability to promote sales through these manufacturers and provide
ongoing support to existing OEM partners could decrease our revenues.
We may also enter into agreements to obtain products from another
manufacturer or manufacturers for resale on a Madge labelled or OEM basis. We
are dependent in any such arrangement upon the manufacturer of products to
provide us with timely shipments of quality
33
products on a cost-effective basis, and may also depend upon our OEM supplier
for technology, intellectual property indemnification, support and other
assistance. There is no guarantee that an OEM supplier can or will continue to
provide such things on a cost-effective basis or that such relationships will
last if our product strategy changes.
We are dependent upon a limited number of product suppliers.
The chipsets and components used in certain of our Token Ring products are
currently available only from a single source or limited sources. For example,
the ASIC we have designed that are used in certain of our Token Ring adapter
card products are currently available only from NEC Corporation. The nature of
the high technology components business is such that the vendors supplying such
chips and components are few and it takes time and effort to identify and
qualify alternative sources for such components. While our operating results
have not, to date, been materially adversely affected by any shortages, we have
experienced delays in the receipt of certain of our key components and this may
be exacerbated by moving to a new subcontract manufacturer. The inability to
obtain sufficient key components as required, or to develop alternative sources
as we anticipate could be required in the future, could result in increased
costs and delays or reductions in product shipments, which, in turn, could have
a material adverse effect on our results of operations. Texas Instruments
withdrew its Token Ring components from the market in June 2000. We used a
number of the Texas Instruments components and purchased a volume of these
components to meet our sales projections through 2001 when these customers will
be transitioned to products not using these components from Texas Instruments.
Our strategy is also to migrate our customers to the latest Madge technologies
(e.g. Smart PCI MK4 adapter and Smart DeskStream switch) reducing our exposure
to other component manufacturers, thereby lessening our dependence on certain
suppliers.
Our products or services may contain defects that may cause us to incur
significant costs, divert our attention from our core Madge.connect business
and/or result in the loss of customers.
Information Technology products frequently contain undetected software and
hardware defects when first introduced or as new versions are released. Our
Madge.connect products are complex and defects may occasionally be found. In
addition, such products are often embedded in or deployed in conjunction with
customers' products, which incorporate a variety of components produced by third
parties. We may on occasion sell products that are manufactured wholly or partly
by others and for which we lack resources and familiarity to trouble-shoot
effectively. As a result, when problems occur, it may be difficult to identify
the source of the problem. If problems are found in our Madge.connect products,
we may divert resources to address the problem and may incur significant damages
or warranty and repair costs. We may divert the attention of our engineering
personnel from product and/or services development and we could face significant
market acceptance or customer relation problems or the loss of customers.
Although the Madge.connect product range is mature, customers report
defects from time to time. Because of a loss of research and development staff
with the necessary Token Ring product expertise caused by customary attrition,
restructuring and personnel movements to Red-M, we may encounter technical
issues that we are unable to remedy in a timely fashion. Although Red-M has
retained some of our Token Ring Research and Development skills that could be
temporarily re-deployed into Madge.connect in order to resolve any technical
problems with Madge.connect products, we cannot be assured that any such
re-deployment will be possible, timely or effective. This loss of research and
development staff within Madge.connect will also affect our ability to develop
new product lines or expand existing ones for Madge.connect.
34
Our Token Ring sales, could be adversely affected because we have outsourced our
technical support function for Madge.connect and our customers are now required
to pay for support.
In April 2000, we began outsourcing our technical support function for our
Token Ring products to Vital Networks LLC ("Vital"). Vital agreed to provide our
Madge.connect customers with certain measurable levels of support until at least
April 2005. We believe that Vital has delivered a reasonable service to our
customers, who are being moved to a market whereby they will ultimately be
required to pay for the limited range of technical support services that we had
provided ourselves free of charge. This may reduce customer satisfaction and
could have an adverse impact on our future product revenues. However, as Vital
are able to offer a more comprehensive range of services, we believe that
customers will, on balance, receive an improved service. Although many customers
would prefer to continue with Madge.connect's free service, the chargeable
nature of Vital's support services will help to maintain the viability of
support for Madge's Token Ring products in the long term, thus helping customers
to retain and build upon their investment of Madge Token Ring products. There is
a possibility that some customers may decline to pay for support services from
Vital, which could have an adverse effect on Token Ring sales, although we do
not believe any decline in our Token Ring sales is currently attributable
directly to our agreement with Vital. If Vital were to cease business or to
withdraw its support for Token Ring, sales of our Token Ring products would be
adversely affected.
Returns or warranty costs from our Madge.connect business in excess of our
budgeted amounts could harm our results of operations.
The terms of our Madge.connect reseller and distributor relationships
subject us to certain risks. we grant some resellers and distributors limited
rights to exchange unsold products for new purchases. Although we allow for
projected returns, these allowances may not be sufficient in the future to
offset future Madge.connect product returns. In addition, we provide price
protection to certain of our distributors. a significant decrease in the price
of our Madge.connect products, which exceeds the amounts that we have reserved,
could have an adverse effect on our operating results. Moreover, we generally
provide a limited warranty to users for our adapter cards and a one year
warranty on our Token Ring hubs and switches. There can be no assurance that our
warranty reserves will be adequate to cover future warranty costs. if any one of
these allowances is inadequate, our business could be materially adversely
affected.
Our ability to maintain our revenues and continue as a going concern depends on
overall demand for computer hardware, which, in turn, has been affected by the
overall slowdown in general economic conditions.
The nature and extent of the effect of the current economic climate on our
ability to sell Token Ring products is uncertain. A softening of demand for
computer hardware caused by weakening of the economy could further accelerate
the decline in our revenues and could also affect our ability to continue as a
going concern.
Terrorist attacks and the military and other responses to them have and may
continue to adversely affect all aspects of our operations, revenues, and share
price.
On September 11, 2001, unprecedented acts of terrorism occurred in New
York City, Washington, D.C. and Pennsyslvania. On October 7, 2001, the United
States and its allies launched military attacks on Afghanistan in response to
those acts. These events, as well as the possibility that future related events
could occur, including additional terrorist attacks on the United States, the
United Kingdom or other targets, escalation or broadening of the current
military response, and military or trade disruptions affecting our suppliers,
third party distributors or resellers, have and may continue to adversely affect
our operations, including, among other things, causing delays or losses in the
delivery of supplies and products to us and decreased sales of the products we
carry. More generally, any of these events could cause business and consumer
confidence and spending to decrease further, result in
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increased volatility in the United States and worldwide financial markets and
economy and result in economic recession in the United States and
internationally. Any of these occurrences would likely have a significant
adverse effect on our operations, costs and revenues and could increase the
volatility and decrease the market price of our common shares.
Our difficulty in managing our changing operations and acquisitions has harmed
and may continue to harm our business.
In recent years, we have reorganized our operational and internal reporting
structures more than once, including establishing Madge.web in 1999 and Red-M in
May 2000, each of which will no longer be a part of the future of Madge, and
reducing headcount on several occasions at Madge.connect to better align it with
the declining market for Token Ring products. These ongoing restructurings have
placed great strain on our operational, management, financial and other
resources as well as weakened our ability to retain employees. The current
winding up of all Madge.web operations (except the limited business operating in
the United States), will also result in further job cuts in our corporate
function, putting increased strain on those individuals who remain.
We are continually working towards restructuring our Madge.connect group to
create a more simplified business model. As a result, a number of sales and
corporate offices world-wide have been or will be closed or substantially
downsized as we have moved to a model of using independent sales agents in
countries where it is cost-effective to do so either in addition to, or more
often, instead of our own employees. Although we believe the use of sales agents
will have a lower commercial risk than retaining a direct Madge presence, there
can be no assurance that sales will not suffer. The challenge of managing
expenses to changing sources of revenue may lead us to adjust further our
business priorities and resource allocation.
We depend upon our international operations, which subject us to currency
exchange rate fluctuations and other additional risks.
We are a global company, with our headquarters and most of our operations
based outside the United States. We derived approximately $145.0 million, $114.8
million and $27.8 million, or 74%, 73% and 63% of our total net sales from
operations outside of the Americas in the years ended December 31, 1999 and 2000
and the six months ended June 30, 2001, respectively. We expect that
international sales will continue to represent a majority of our net sales. A
significant portion of our transactions are in currencies other than the U.S.
dollar, principally the British pound. As a result, we are subject to currency
exchange rate fluctuations and the associated difficulty of administering
business globally. Fluctuations in the value of foreign currencies cause revenue
or other numbers tied to the U.S. dollar to change in comparison with similar
numbers in previous periods. Due to the number of currencies involved, the
constantly changing currency exposures, and the substantial volatility of
currency exchange rates, we cannot predict the effect of exchange rate
fluctuations upon future operating results. These exchange rate fluctuations
have in the past and could in the future, distort the results of our operations.
As well as exposure to currency fluctuations, we as a multinational business,
are subject to the risks associated with the greater difficulty of administering
business globally, regulatory requirements and other risks, such as import and
export licenses, political and economic instability, overlapping of differing
tax structures, trade restrictions and changes in tariff and freight rates.
At certain points throughout the year we hedge our currency exchange rate
exposure by purchasing or selling foreign currencies one month forward. These
transactions do not eliminate our foreign currency risks as they involve
estimates based on incomplete information. The use of forward contracts is
actively reviewed throughout the year and the decision to hedge using these
instruments
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depends upon our view of the foreign exchange market at the time the decision
whether or not to hedge was taken. At June 30, 2000, there were no outstanding
foreign exchange contracts.
We have experienced fluctuations in operating results and anticipate that these
fluctuations will continue.
We have experienced fluctuations in operating results and anticipate that
these fluctuations will continue. Various factors contribute to this
uncertainty, including:
o the timing of our operating expenditures;
o the size and timing of customer orders;
o the mix of Madge.connect products sold;
o the mix of distribution channels through which our products and services
are sold;
o the pattern of end-user purchasing cycles;
o availability of product supply;
o the introduction of new products and services by us and our competitors;
and
o general economic conditions.
Madge.connect ships products to order and generally operates with little
backlog, although we experienced some product supply issues that caused a
backlog until March 31, 2001. In the six months ended June 30, 2001, we did not
have product supply issues because we had built up an inventory of products in
anticipation of potential supply problems with the transfer to a new subcontract
manufacturer. There can be no guarantee we will not face such shortages in the
future. A significant portion of our operating expenses are fixed expenditures,
based primarily on sales forecasts determined months or years in advance. If net
sales do not meet our expectations in any period, our operating results will be
adversely affected. Moreover, restructuring expenses have strained and will
continue to strain our cash resources.
If we lose the services of our management and other key employees and are unable
to recruit high caliber new employees, our results of operations will be harmed
and our growth inhibited.
We depend upon a limited number of members of senior management and other
key employees. Loss of the services of key personnel in previous restructurings
compromised the efficiency of our operations and there is no assurance that our
future restructurings would not have the same effect. Due to the level of
technical and management expertise necessary to our industry, we must recruit
and retain highly qualified and well-trained personnel. Competition for these
employees is intense. If we cannot attract, hire and retain qualified personnel,
our business and prospects will suffer.
As is common in the computer networking industry, we are subject to the risk of
litigation alleging infringement of third party intellectual property rights.
We have received letters alleging or implying that our Madge.connect
products infringe certain patents of third parties, including a letter from each
of Lucent Technologies, Nortel and Hitachi and may receive similar claims in the
future. In 1999 we entered into a three year license with IBM whereby we
licensed a number of its patents and IBM licensed a number of our Madge.connect
patents. There can be no assurance that we will obtain a future license from IBM
when this license expires or from any other third party, if required in the
future, on commercially acceptable terms. We
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can similarly give no assurances that third parties will not assert
infringement claims against us in the future with respect to current or future
Madge.connect products. Any such assertion could require expending significant
sums on external advisors fees whether or not the case goes to court, could
require the payment of damages, and could require the use of other, more
expensive and/or less suitable technology, the development of non-infringing
technology or the acquisition of licenses to the technology that is the subject
of asserted infringement.
We may not adequately protect our intellectual property, which could increase
our costs of sales.
Our ability to compete successfully depends, in part, on our ability to
protect the proprietary technology contained in our products and services. We
currently rely on a combination of patent, trademark, copyright and trade secret
laws and contractual provisions to establish and protect the proprietary rights
in Madge.connect products. We generally enter into confidentiality and/or
license agreements with our employees, distributors, customers, suppliers and
fellow developers that limit access to and distribution of our proprietary
information. Olicom, which sold us its Token Ring business in 1999, has
warranted that the intellectual property we acquired from it does not infringe
third party rights and has provided us with an indemnity to this effect. We also
rely upon a number of third party licenses that Olicom had in order to continue
to produce their products. All material licenses have been assigned; however, we
have only oral agreements regarding a number of licenses of lesser importance.
There can be no assurance that these protections will be adequate to deter
misappropriation of our technology or independent third-party development of
similar technologies.
We do not control Red-M and future events will further reduce our holding.
As of September 10, 2001, we held 39.4% of the voting rights and 31.0% of
the equity in Red-M, the Red-M Investors and Intel together held 59.8% and 47.2%
of the voting and equity rights, respectively, and the management and employees
of Red-M held the balance. Red-M has called in further committed funds from the
Red-M Investors and Intel. As a result, when these funds are paid our
shareholding will decrease further to 37.2% of the voting and 29.7% of the
equity rights. Our shareholding in Red-M will likely be further diluted over
time. There are also certain events, such as the liquidation of Madge Networks
N.V., in which we would be required to sell our shares in Red-M to the Red-M
Investors and Intel, under certain circumstances at a discount to the value at
the time.
We do not have control of the Red-M board or its operations. Of the seven
members of the new Red-M board of directors, we have designated two, the Red-M
Investors have also designated two, the chairman is an independent non-executive
nominated by all parties, a second non-executive director is to be appointed by
agreement and the chief executive officer of Red-M is the remaining director. It
is possible that additional investors in Red-M may also require board
representation or an observer seat (as Intel has required). In addition,
although certain of the officers of Red-M were employed by Madge, their
employment arrangements with Madge have terminated as their employment was
transferred to Red-M.
Since April 12, 2001, Red-M is no longer a subsidiary of the Madge group
but is classified as an associated company, and we will no longer consolidate
the results of Red-M in the accounts of Madge Networks. Therefore, in accordance
with U.S. GAAP, we now account for Red-M under the equity method and recognize
our allocable percentage of Red-M's net income or loss on our income statement
based upon our equity holding in Red-M. The carrying value of our investment has
been reduced to zero and we will recognize no further operating losses. We will
recognize our share of profits as, when and if Red-M becomes profitable on a
cumulative basis.
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The value of our shareholding in Red-M will fluctuate and will affect our
ability to realize value from our Red-M shares.
Red-M operates in the largely unproven mobile-Internet marketplace and the
success of this business is dependant upon numerous factors including:-
o Bluetooth may not be accepted as the ubiquitous technology for devices
communicating over a local wireless connection or may not develop as
projected;
o Red-M's decision to also move into the 802.11b marketplace will mean it is
spreading its limited resources thinner and the business may suffer as a
result;
o Red-M may not develop revenue generating products from its research and
development efforts;
o Red-M may not secure development partners, manufacturing subcontractors,
key component suppliers and reseller relationships it will need if it is to
become successful;
o Red-M may require additional funding if it does not meet its cash flow
projections;
o Red-M's ability to protect its intellectual property and not infringe on
the rights of others;
o Red-M's ability to develop products that meet the regulatory and product
certification requirements to sell its products, which will be especially
complex if Red-M moves into the consumer market, as planned;
o Red-M's ability to agree with original equipment manufacturers to promote
products that incorporate Red-M's products and technology;
o Red-M's ability to ensure compatibility and operability of Red-M products
with products of other leading vendors, as well as with various personal
computer architectures and network operating systems; and
o Competition in this marketplace.
If Red-M fails to generate significant revenues, or to become profitable,
for the reasons listed above, or any other reason, the fair market value of our
shareholding will decline and we may never be able to realize any value from our
Red-M shareholding. Our agreement with the Red-M Investors and Intel restricts
our ability to sell our Red-M shares and may well reduce the value we could
realize in any sale or pledge of some or all of our interest.
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RISKS RELATED TO OUR CAPITAL STRUCTURE
Our common shares may be delisted from the Nasdaq National Market.
Our common shares trade on the Nasdaq National Market ("Nasdaq"), which has
certain compliance requirements for continued listing. We did not satisfy
several of these listing criteria and had been in the process of appealing the
decision of the Nasdaq to delist us from the National Market. On October 1, 2001
we received notification from the Nasdaq that they have suspended our listing
requirements and that we can remain listed on the Nasdaq National Market until
January 1, 2002 when they will again review our position to see whether we then
comply with the listing requirements applicable at that time. Should we be
delisted at any time after the January 1, 2002 extension, we believe that we may
be able to move to trade on the Nasdaq SmallCaps Market and if that fails, onto
the Over-the-Counter-Bulletin-Board. If we are delisted from the Nasdaq National
Market, there would likely be a reduction in the liquidity of our common shares
and a further adverse effect on their trading price. Lack of liquidity would
also make it more difficult for us to raise capital in the future.
Our common share price has been, and is likely to continue to be, volatile and
could drop unexpectedly.
The trading price of our common shares has been volatile and may continue
to be volatile in response to the following factors:
o our inability to sell Madge.web and mitigate related guarantees;
o the perception of the value of our Red-M share holding;
o a continuing decline in sales of Token Ring products of Madge.connect;
o quarterly variations in our operating results and our financing efforts;
o announcements of technical innovations, new products or services by us or
our competitors;
o investor perception of us, the markets we operate in or the high tech
section in general;
o changes in financial estimates by securities analysts; and
o general economic and market conditions.
Declines in the market price of our common shares could also materially
adversely affect employee morale and retention, our access to capital and other
aspects of our business.
If our share price remains volatile, we may become subject to securities
litigation, which is expensive and could divert our resources.
In the past, following periods of market volatility in the price of a
company's securities, security holders have instituted class action litigation.
Many Internet-related companies have been subject to this type of litigation. If
the market value of our common shares experiences adverse fluctuations, and we
become involved in this type of litigation, regardless of the outcome, we could
incur substantial legal costs and our management's attention could be diverted,
causing our business to suffer.
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Our founder continues to exercise control over us and could have interests that
differ from shareholders' interests.
Various trusts established by Robert Madge, our founder and chief executive
officer, indirectly owned approximately 53.49% of the outstanding common shares
as of September 30, 2001. Therefore, the various trustees, as a group, have the
power to control matters submitted for shareholder approval, including the
election of directors, proxy contests, acquisitions, tender offers, open market
purchase programs or other purchases of common shares that could give our
shareholders the opportunity to realize a premium over the then-prevailing
market price for their shares. In addition, Mr. Madge personally holds options
to purchase common shares, of which options with respect to 1.55% of our
outstanding common shares have vested or will vest within 60 days from September
30, 2001. At our shareholders' meeting held on October 10, 2001, the
shareholders acknowledged Robert Madge's resignation from the Management Board
and appointed him to the Supervisory Board of the Company. The Supervisory Board
have also appointed Mr. Madge Designated Supervisory Director. For both these
roles Mr. Madge will receive compensation as approved by our shareholders at the
shareholders' meeting. For details of Mr. Madge's proposed severance, see
"Operating and Financial Review and Prospects" above.
The pledgee could foreclose upon Madge Networks shares that have been pledged by
certain of the trusts established by Robert Madge.
Of the 28,494,763 shares owned directly or indirectly by trusts established
by Mr. Madge, 17,378,000 shares have been pledged to J P Morgan H&Q pursuant to
a margin loan agreement by Hartland Holdings Ltd., the registered holder
thereof, in respect of an $8 million loan. Under that agreement, as revised, it
is an event of default allowing foreclosure on the shares or if the closing
price per common share on the Nasdaq is less than $1.00 per share, as it has
been recently. We have been advised by Hartland Holdings that JP Morgan H&Q has
not indicated that it intends to foreclose on the shares. However, under
applicable federal securities laws, JP Morgan H&Q could currently be deemed a
beneficial holder of those 17,378,000 shares either separately or together with
Hartland Holdings. If JP Morgan H&Q were to foreclose on all of the pledged
shares for that or any other event of default, the number and percentage
ownership of shares as at September 30, 2001 would be 12,050,013 and 21.90%,
respectively, for Mr. Madge, and 17,378,000 and 32.08%, respectively, for JP
Morgan H&Q. The interests of J P Morgan H&Q could differ from the interests of
our general shareholders.
Our charter documents and the laws of The Netherlands could make it more
difficult for a third party to acquire us.
The shareholders have authorised our Management Board to issue preferential
shares and common shares for a fixed period of time without further shareholder
approval. The issuance of such preferred shares and common shares, while
providing flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from acquiring, a
majority of the outstanding voting shares of Madge Networks N.V.
It may be difficult to enforce a U.S. judgement against us and our executive
officers and directors or to serve process on a substantial majority of our
executive officers and directors.
Because substantially all of our assets and the assets of our executive officers
and directors are located outside the United States, a judgment obtained in the
United States against us or any of these individuals may not be collectible
within the United States. Furthermore, service of process upon these
individuals, most of whom reside outside the United States, may be difficult to
obtain. In
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addition, judgments of U.S. courts, including judgments against us or
our executive officers and directors based upon allegations of violations of
U.S. federal or state securities laws, may not be enforceable in The Netherlands
or elsewhere outside the United States.
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SIGNATURES
Pursuant to the requirements 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.
Madge Networks N.V.
By: /s/ Martin Malina
------------------------------------
Martin Malina
Managing Director
Date: October 30, 2001
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EXHIBIT INDEX
Page
Exhibit A First half 2001 Press Release 45
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