<PAGE> 1
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 quarterly period ended June 30, 2000
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 47 Pages
Exhibit Index Appears on Page 31.
<PAGE> 2
MADGE NETWORKS N.V.
Form 6-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Financial Information:*
Condensed Consolidated Balance Sheets as of June 30, 2000 (unaudited) and
December 31, 1999 3
Condensed Consolidated Statements of Operations for the six months ended June 30,
2000 and 1999 (unaudited) and the three months ended June 30, 2000 and 1999
(unaudited) 4
Condensed Consolidated Statements of Cash Flows for the six months ended June 30,
2000 and 1999 (unaudited) 5
Notes to Condensed Consolidated Financial Statements 6
Forward Looking Statements 10
Management's Discussion and Analysis of Financial Condition and Results of Operations 10
Legal Proceedings 16
Risk Factors 17
Signatures 30
Exhibit Index 31
Exhibit A--Second Quarter Press Release 32
Exhibit B--Directors Stock Option Plan 40
</TABLE>
--------------------
* 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
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Madge Networks N.V.
Condensed Consolidated Balance Sheets
(in thousands)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
--------- -----------
Unaudited
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 8,674 $ 19,471
Restricted cash 11,374 10,500
Accounts receivable, net of allowance for doubtful
accounts of $3,436 and $4,152 at June 30, 2000 and
December 31, 1999, respectively 26,633 38,655
Inventories
Raw materials 204 833
Finished goods 12,302 15,327
--------- ---------
12,506 16,160
Current deferred tax assets 41 44
Prepayments and other current assets 14,111 10,758
--------- ---------
Total current assets 73,339 95,588
Property and equipment, net 47,956 44,834
Goodwill, net of accumulated amortization 31,205 32,528
Intangible assets, net of accumulated amortization 16,476 19,548
--------- ---------
Total assets $ 168,976 $ 192,498
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term borrowing $ 4,189 $ 7,107
Accounts payable 16,649 13,514
Deferred consideration 6,147 8,500
Accrued wages and related liabilities 4,470 5,196
Other accrued liabilities 47,588 65,429
Income taxes payable 15,322 16,715
Current portions of lease obligations 3,988 3,298
--------- ---------
Total current liabilities 98,353 119,759
Long-term liabilities and lease obligations 8,879 3,563
--------- ---------
Total liabilities 107,232 123,322
Shareholders' equity:
Common shares 25,087 23,340
Additional paid-in capital 143,400 110,009
Treasury stock (404) (404)
Retained earnings (94,984) (56,937)
Accumulated other comprehensive income (11,355) (6,832)
--------- ---------
Total shareholders' equity 61,744 69,176
--------- ---------
Total liabilities and shareholders' equity $ 168,976 $ 192,498
========= =========
</TABLE>
See accompanying notes
3
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Madge Networks N.V.
Condensed Consolidated Statements of Operations (Unaudited)
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------ ------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Madge.web sales $ 8,405 $ 8,657 $ 15,305 $ 13,290
Madge.connect sales 25,746 44,685 70,356 88,866
--------- --------- --------- ---------
Net sales 34,151 53,342 85,661 102,156
Cost of sales: 28,313 30,018 64,376 57,918
--------- --------- --------- ---------
Gross profit 5,838 23,324 21,285 44,238
Operating expenses:
Sales and marketing 16,487 18,320 35,590 35,530
Research and development 5,637 8,995 11,319 18,370
General and administrative 6,178 6,316 11,577 10,184
Special charge -- 25 -- 25
--------- --------- --------- ---------
Total operating expenses 28,302 33,656 58,486 64,109
--------- --------- --------- ---------
Loss from operations (22,464) (10,332) (37,201) (19,871)
Net interest income (expense) (366) 596 (481) 1,658
--------- --------- --------- ---------
Loss before income taxes (22,830) (9,736) (37,682) (18,213)
Provision for income taxes 125 402 365 402
--------- --------- --------- ---------
Net loss $ (22,955) $ (10,138) $ (38,047) $ (18,615)
========= ========= ========= =========
Net loss per share
Basic $ (0.52) $ (0.25) $ (0.88) $ (0.44)
Diluted $ (0.52) $ (0.25) $ (0.88) $ (0.44)
Shares used in computing net
Loss per share
Basic 44,066 40,535 43,029 41,863
Diluted 44,066 40,535 43,029 41,863
</TABLE>
See accompanying notes
4
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Madge Networks N.V.
Condensed Consolidated Statements of Cash Flows
(Unaudited) (in thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------------
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (38,047) $ (18,615)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation 7,673 5,256
Amortization of goodwill 6,433 565
Loss on disposal of fixed assets 226 287
Changes in assets and liabilities:
Accounts receivable 12,022 (2,897)
Restricted cash (874) --
Net inventories 3,654 3,702
Prepaid expenses and other current assets (3,350) 2,836
Accounts payable 3,135 1,861
Other accrued liabilities (18,567) (4,788)
Income taxes payable (1,393) 3,413
Deferred consideration (2,353) --
--------- ---------
Net cash used in operating activities (31,441) (8,380)
--------- ---------
Cash flows from investing activities:
Additions to property and equipment (15,499) (13,027)
Payment of contingent consideration - Olicom (2,038) --
Purchase of subsidiary - Gains -- (37,743)
Proceeds from sale of property and equipment -- 21
--------- ---------
Net cash used in investing activities (17,537) (50,749)
--------- ---------
Cash flows from financing activities:
Proceeds from (repayments of) mortgage and lease obligations, net 6,006 3,400
Proceeds from (repayments of) short-term loan, net (2,918) (907)
Repurchase of common shares -- (3,453)
Proceeds from issue of common shares 35,138 803
--------- ---------
Net cash provided by (used in) financing activities 38,226 (157)
Net decrease in cash and cash equivalents $ (10,752) $ (59,286)
========= =========
Cash and cash equivalents at the beginning of the period $ 19,471 $ 130,494
Effect of exchange rate changes on cash (45) 121
--------- ---------
Cash and cash equivalents at the beginning of the period
(at period end exchange rates) 19,426 130,615
Cash and cash equivalents at the end of the period 8,674 71,329
========= =========
Net decrease in cash and cash equivalents $ (10,752) $ (59,286)
========= =========
</TABLE>
See accompanying notes
5
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MADGE NETWORKS N.V.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The condensed consolidated financial statements include the accounts of
Madge Networks N.V., a company incorporated in The Netherlands, and its wholly
owned subsidiaries. All significant intercompany accounts and transactions have
been eliminated. The condensed consolidated financial statements have been
prepared by us without audit. In the opinion of management, all adjustments
(which include only normal recurring adjustments) necessary for a fair
presentation have been made. The condensed consolidated balance sheet at
December 31, 1999 has been derived from the audited consolidated financial
statements at that date.
Our fiscal year ends on December 31 of each year. For the purposes of
presentation, we have indicated our fiscal quarters within the year as ending on
a calendar month end, whereas, in fact, we operate on the basis of thirteen week
financial quarters.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission. These condensed consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and notes thereto for the year ended December 31, 1999
included in our 1999 Annual Report on Form 20-F.
Revenue recognition
Madge.web - Our net revenues are comprised of a mix of recurring
contractual, usage-based and event based revenues. Contractual service revenue
is recognized ratably over the life of the contract. Contract revenues invoiced
in advance of revenues earned are recorded as deferred revenue. Usage-based and
event based revenues are recognized when services are rendered in accordance
with customer usage over the contract period.
Madge.connect - 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 customers' inventories and our
reduced price for such products, subject to certain limitations. An allowance
for sales returns and price reduction adjustments 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.
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<PAGE> 7
Goodwill and other intangible assets
We amortize goodwill and other intangible assets on a systematic basis
over the 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, as well as an examination of market practice, 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 resulted in an
increase in the total net loss of $0.5 million, or $0.01 per share, for the
three months ended June 30, 2000.
Accrued warranty costs
We provide limited warranties on our software and hardware products.
Warranty periods range from 90 days for some software products to lifetime
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.
Foreign currency translation
We account for foreign currency in accordance with Statement of
Financial Accounting Standard ("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 average 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/(loss) recognized in the three months ended June 30, 2000 was
$862,000 and for the three months ended June 30, 1999 was $(302,000). The total
amount of currency transaction gain/(loss) recognized in the six months ended
June 30, 2000 was $1,281,000 and for the six months ended June 30, 1999 was
($160,000).
Per share data
Basic earnings per share ("EPS") is calculated using the weighted
average number of common shares outstanding. Diluted EPS is calculated based on
the weighted average number of common shares plus the dilutive common shares
from the potential exercise of employee share options. In periods when the
Company reports a net loss, diluted EPS is not reported because the effect of
potential common shares is anti-dilutive.
7
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<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
----------------------- -----------------------
2000 1999 2000 1999
--------- -------- --------- --------
<S> <C> <C> <C> <C>
Net income (loss) $ (22,955) $(10,138) $ (38,047) $(18,615)
========= ======== ========= ========
Weighted average common
shares outstanding: 44,066 40,535 43,029 41,863
--------- -------- --------- --------
Total common shares and
common equivalents for
calculation of net loss per share:
Basic 44,066 40,535 43,029 41,863
========= ======== ========= ========
Diluted 44,066 40,535 43,029 41,863
========= ======== ========= ========
Net loss per share:
Basic $ (0.52) $ (0.25) $ (0.88) $ (0.44)
========= ======== ========= ========
Diluted $ (0.52) $ (0.25) $ (0.88) $ (0.44)
========= ======== ========= ========
</TABLE>
2. SEGMENTAL INFORMATION
Our businesses are organized, managed and internally reported as
separate services and products segments which are reportable under SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." The
service segment of Madge (Madge.web) supplies networking services to businesses,
with expertise in IP-enabled networks. The product business segment
(Madge.connect and Red-M) develops, manufactures and markets networking
products. Our services segment established its business in the second half of
1998, and generated its first revenue in the first quarter of 1999. During 1998,
the services segment incurred immaterial costs and as a result this segment is
included within the "Corporate and Other" results in the table below.
We are an integrated enterprise characterized by substantial
intersegmental co-operation, cost allocation and inventory transfers. Therefore,
management does not represent that these segments, if operated independently,
would report the operating results and other financial information shown.
8
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BUSINESS SEGMENT INFORMATION
<TABLE>
<CAPTION>
(In thousands) Three months ended Six months ended
(Unaudited) June 30, June 30,
------------------------ ------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
NET SALES
Madge.web 8,405 8,657 15,305 13,290
Madge.connect $ 25,746 $ 44,685 $ 70,356 $ 88,866
Corporate and other -- -- -- --
--------- --------- --------- ---------
Total company 34,151 53,342 85,661 102,156
OPERATING INCOME
Madge.web (16,377) (5,909) (33,257) (11,021)
Madge.connect (5,602) (1,019) (3,904) (4,589)
Corporate & other (485) (3,404) (40) (4,261)
--------- --------- --------- ---------
Total company (22,464) (10,332) (37,201) (19,871)
Net interest income (expense) (366) 596 (481) 1,658
--------- --------- --------- ---------
Loss before income taxes $ (22,830) $ (9,736) $ (37,682) $ (18,213)
========= ========= ========= =========
</TABLE>
The above table is based on management estimates and may include
differences from U.S. generally accepted accounting principles, including
estimates of costs and allocation of overheads between divisions.
3. COMPREHENSIVE INCOME (LOSS)
Under SFAS No. 130, "Reporting Comprehensive Income," foreign currency
translation adjustments are included in other comprehensive income (loss).
The following are the components of comprehensive income (loss):
<TABLE>
<CAPTION>
(Unaudited) (in thousands) Three months ended Six months ended
June 30, June 30,
---------------------- ----------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net loss $(22,955) $(10,138) $(38,047) $(18,615)
Foreign currency translation adjustments (2,934) (1,519) (4,523) (1,537)
-------- -------- -------- --------
Other comprehensive (loss) income (2,934) (1,519) (4,523) (1,537)
-------- -------- -------- --------
Total comprehensive (loss) income $(25,889) $(11,657) $(42,570) $(20,152)
======== ======== ======== ========
</TABLE>
The components of accumulated other comprehensive loss are as follows:
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
----------- ------------
<S> <C> <C>
Cumulative translation adjustments $ (11,355) $(6,832)
--------- -------
Total accumulated other comprehensive loss $ (11,355) $(6,832)
========= =======
</TABLE>
FORWARD LOOKING STATEMENTS
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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, the success and growth of Madge.web and Red-M, economies of scale
being achieved by Madge.web, expected dates for the launch of our products and
services, the adequacy of our financial resources and our ability to raise
additional financing.
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, 1999 under "Description of Business--Risk
Factors." Actual results, actions or events could differ materially.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Madge Networks N.V. ("Madge") is a global provider of advanced
Internet-centric network services, and mission-critical enterprise solutions. We
operate through two subsidiary groups, Madge.web and Madge.connect. Madge.web is
a global provider of rich content applications and managed network services.
Madge.connect is a global supplier of product solutions including Token Ring,
ISDN switching and IP based video networking for mission critical enterprise
networks. We market our Madge.web services primarily directly to business
customers and serve our customer base for Madge.connect products through a
global network of distributors and resellers.
In May 2000, we announced the formation of Red-M, a subsidiary company
that develops wireless Internet server products that provide Internet and
Intranet access from a wide range of mobile devices in the workplace. At the
Bluetooth Congress in Monte Carlo in June, 2000 Red-M demonstrated its new
technology and won the Bluetooth Innovation Award, the only award given at this
annual meeting. The first products from Red-M are expected to be available by
the end of this year.
Special Charges, Gains and Merger-Related Expenses
In the fourth quarter of 1999, Madge.connect created two separate
groups, one focusing on enterprise products (Token Ring and ISDN) and the other
on new Internet related access products (now called Red-M). The sales and
marketing and research and development functions within Madge.connect were also
re-organized along these lines and the related costs were reduced, including
reductions in the headcount in Madge.connect. A special charge of $6.2 million
was taken in the fourth quarter relating to this restructuring. Headcount in
Madge.connect, including the headcount reduction related to this restructuring
has fallen by 34% since the beginning of the fourth quarter 1999.
Offset against the charge of $6.2 million described above was a release
of $15 million of reserves relating to the sale of Lannet in the third quarter
of 1998. The release was a special credit to operating expenses in the fourth
quarter of 1999 and was related to original estimates for reimbursement
obligations that did not occur. In addition, in June 1999, as part
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of our regular review of the provisions originally created as a special charge
on the sale of Lannet in the third quarter of 1998, we reversed $4.1 million of
the special charge. The reversal related to forecast product returns and
professional fees estimated at the time of sale we did not incur.
During the third quarter of 1999, we incurred special charges of $1.2
million in connection with the acquisition of the Token Ring business of Olicom
A/S. The charges consisted of integration costs, legal fees and financing
charges relating to the acquisition.
Special charges incurred in the second quarter of 1999 related to the
reorganization of operating activities connected with the establishment of the
Enterprise Network Products Division (now Madge.connect). The charges consisted
of costs relating to facilities of $3.0 million, leasehold costs relating to
buildings of $0.6 million and provisions for writing off fixed assets of $0.5
million. Facilities and leasehold costs are expected to be realized through cash
payments whereas fixed assets costs are expected to be non-cash transactions.
Alliance with Inktomi Corporation
In August 2000, we announced a strategic technology and marketing
alliance with Inktomi Corporation, a developer of scalable Internet
infrastructure software. Under the agreement Madge.web will use Inktomi's
technology to upgrade our Overnet, our private overlay network which by-passes
the public Internet, and it will allow Madge.web to offer global content
distribution services specifically for content-intensive industries such as
financial services and media. As part of this agreement Inktomi has committed to
make an equity investment in Madge.web. More details of this appear in the
"Liquidity and Capital Resources" section below.
Acquisition of Olicom A/S Token Ring Business
On August 31, 1999, we completed an agreement with Olicom A/S, under
which we purchased the intellectual property and the rights to manufacture, sell
and develop Olicom's Token Ring product portfolio. The transaction also included
Olicom's Token Ring customer base and we hired 55 Olicom employees. (Although
see above reference to Madge.connect headcount reduction). The purchase price
for the acquisition was $21.5 million, which included an initial payment of
$12.3 million, $8.5 million placed in escrow relating to future minimum
guaranteed payments to be made over three years based on a percentage of our
Token Ring revenues and $0.7 million related to the assumption of a warranty
liability. In the quarter ended June 30, 2000 we paid $3.0 million from the
escrow, of which $2.0 million was paid to Olicom upon attaining the required
technical support milestones obligations and $1.0 million related to the royalty
payments due on our sales. We were also committed to purchase certain Olicom
Token Ring inventory in the six months following the sale. The agreement,
inclusive of $1.2 million of acquisition related expenses, resulted in $24.5
million of specific intangible assets, which are being amortized utilizing a
reducing percentage method, which approximates the forecast reduction in Token
Ring sales over a three year period. Accumulated amortization as of June 30,
2000 was $8.0 million.
Acquisition of Gains
On February 5, 1999, we acquired all the outstanding shares of Gains
International (C.I.) Limited, Gains Hong Kong Limited and Gains Japan Co.
Limited, private companies incorporated in Guernsey, Channel Islands, Hong Kong
and Japan, respectively (collectively, "Gains"). Gains is an international
carrier supplying the financial sector. The purchase
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consideration was $46.0 million in cash. After taking into account the cash
balances of Gains and capitalized acquisition costs, the net cash outflow was
$37.7 million. The acquisition was accounted for under the purchase method,
resulting in goodwill of $33.9 million, which was being amortized on a
straight-line basis over 20 years. After further review and consideration, we
have amended the amortization schedule of the asset to 10 years and the
remaining asset is being amortized on a straight line basis over this period.
Accumulated amortization as of June 30, 2000 was $2.7 million. 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 as well as an
examination of market practice, 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 resulted in an increase in the total net
loss of $0.5 million, or $0.01 per share, for the three months ended June 30,
2000.
RESULTS OF OPERATIONS
Net Sales
Total sales were $34.2 million in the three months ended June 30, 2000,
a decrease of 36%, compared to $53.3 million for the same period in 1999. For
the six months ended June 30, 2000, total sales were $85.7 million, a decrease
of 16% compared to $102.2 million for the same period in 1999.
Net sales from Madge.connect, which consist of Token Ring and video
networking products, were $25.7 million for the three months ended June 30,
2000, a decline of 42% from $44.7 million for the same period in 1999. Sales of
these products represented approximately 75% and 84% of our net sales in the
three months ended June 30, 2000 and 1999, respectively. Net sales for the six
months ended June 30, 2000 were $70.4 million, a decrease of 21% compared to
$88.9 million for the same period in 1999. The Token Ring market has declined
much more quickly than we expected and despite our strategy of gaining market
share, by such things as the acquisition of the Olicom A/S, the quarter's
results reflect the declining nature of the market for Token Ring products. We
expect this market decline to continue and we are taking steps to further
streamline our Token Ring business accordingly, including steps to reduce fixed
overheads.
Net sales of Madge.web, which includes the trader voice connectivity
service acquired with Gains, were $8.4 million, or 25% of net sales, for the
second quarter of 2000, a decrease of 2%, compared to $8.6 million, or 16% of
net sales for the second quarter of 1999. This downturn reflected
discontinuation of the public switched telephone network service we acquired
from Gains which for the second quarter of 1999 had provided $0.7 million of net
sales. Net sales for the six months ended June 30, 2000 were $15.3 million, an
increase of 15% compared to $13.3 million for the same period in 1999. We
anticipate sales growth from Madge.web during the balance of 2000.
Gross Profit
Gross profit from operations was $5.8 million, or 17% of net sales, for
the three months ended June 30, 2000, a decrease of 75%, compared to $23.3
million, or 44% of net sales, for the same period in 1999. Gross profit from
operations for the six months ended June 30, 2000 was $21.3 million, or 25% of
net sales, a decrease of 52% compared to $44.2 million, or 43% of net sales, for
the same period in 1999.
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Gross profit for Madge.connect was $10.8 million and $22.9 million for
the three months ended June 30, 2000 and 1999, respectively. Gross profit for
the six months ended June 30, 2000 and 1999 was $33.2 million and $44.3 million,
respectively. Madge.connect experienced significant market weakness for its
Token Ring products in the quarter. In response to the market turndown
Madge.connect reduced channel inventory by $7.5 million in the quarter.
Gross loss for Madge.web for the three months ended June 30, 2000 was
$5.0 million compared to a gross profit of $0.4 million for the three months
ended June 30, 1999 due to significant continuing investment in bandwidth
network operations and infrastructure in Madge.web. Madge.web continued its
aggressive investment plans to develop the business and enhance its global
Overnet, our private overlay network that by-passes the public Internet,
including the addition of new data centers in Frankfurt and Amsterdam. Economies
of scale in relation to revenue have not yet been realized in the Madge.web
business and are reflected in the negative gross profit. Gross loss for the six
months ended June 30, 2000 was $11.9 million compared to gross loss of $0.1
million for the same period in 1999.
We believe that gross profit for Madge.connect will continue to decline
primarily due to the rapidly declining market for Token Ring products. Long-term
gross margins in Madge.web are expected to remain lower than margins achieved by
Madge.connect, and in the near-term to remain substantially lower until expected
economies of scale can be realized for Madge.web.
Sales and Marketing
Sales and marketing expenses were $16.5 million, or 48% of net sales,
for the three months ended June 30, 2000, a decrease of 10%, compared to $18.3
million, or 34% of net sales, for the same period of 1999. Sales and marketing
expenses were $35.6 million, or 42% of net sales, for the six months ended June
30, 2000, remaining flat compared to $35.5 million, or 35% of net sales, for the
same period of 1999. We expect that our sales and marketing expenses will
continue to be a significant percentage of net sales in the future.
Madge.connect sales and marketing expenses have declined and will decline
further during the balance of 2000 as we take steps to further streamline this
business and reduce headcount. Madge.web sales and marketing expenses will
increase over the balance of 2000 as we further invest in our operations,
particularly in Europe.
Research and Development
Research and development expenses were $5.6 million, or 17% of net
sales, for the three months ended June 30, 2000, a decrease of 37%, compared to
$9.0 million, or 17% of net sales, for the same period in 1999. Research and
development expenses were $11.3 million, or 13% of net sales, for the six months
ended June 30, 2000, a decrease of 38%, compared to $18.4 million, or 18% of net
sales, for the same period in 1999. The majority of research and development
expenses were incurred by Madge.connect, which includes the newly formed Red-M.
The strategy is to continue to reduce research and development expenditure on
Token Ring and ISDN product ranges and to increase research and development
expenditure on Red-M products and, to a lesser extent on Madge.web services.
Research and development in Madge.web has increased as we have invested in
additional network personnel responsible for the design and integration of the
Overnet and system architecture. We expect that group wide research and
development expenditure will remain constant for the rest of 2000. All of our
research and development costs have been expensed as incurred.
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General and Administrative
General and administrative expenses were $6.2 million, or 18% of net
sales, for the three months ended June 30, 2000, a decrease of 2%, compared to
$6.3 million, or 12% of net sales, for the same period in 1999. General and
administrative expenses were $11.6 million, or 14% of net sales, for the six
months ended June 30, 2000, an increase of 14%, compared to $10.2 million, or
10% of net sales, for the same period in 1999.
Earnings before interest, tax, depreciation and amortization
Earnings before interest, tax, depreciation and amortization ("EBITDA")
for Madge.connect for the three months ended June 30, 2000 was a loss of $2.0
million compared to a profit of $0.4 million for the three months ended June 30,
1999. The high initial expenses in the newly formed Red-M business contributed a
$2.4 million loss to the Madge.connect EBITDA in the second quarter of 2000.
EBITDA for Madge.connect for the six months ended June 30, 2000 was a profit of
$3.0 million compared to a loss of $1.8 million for the six months ended June
30, 1999.
EBITDA for the three months ended June 30, 2000 for Madge.web was a
loss of $13.3 million, compared to a loss of $4.3 million for the three months
ended June 30, 1999. EBITDA for the six months ended June 30, 2000 for Madge.web
was a loss of $27.7 million, compared to a loss of $9.3 million for the six
months ended June 30, 1999.
Income Tax
We recorded a provision for income taxes of $0.1 million in the three
months ended June 30, 2000. Although on a consolidated basis Madge was in a net
loss position, certain of our entities had net income for the period.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2000, we had cash and cash equivalents of $8.7 million. An
additional $11.4 million of cash was restricted of which $6.2 million is held in
the Olicom escrow discussed above, and $5.2 million is held on deposit against
leased assets for the Madge.web datacenter in New York City. In the quarter, we
made payments to Olicom totalling $3.0 million from the escrow account, of which
$2.0 million was due to Olicom attaining the required technical support
milestones and $1.0 million related to royalty payments due on our sales. The
$6.2 million held in escrow is a minimum payment due on current and future Token
Ring sales. We finance working capital in part through a $30 million two-year
financing arrangement secured by accounts receivable generated by U.K. and U.S.
Madge.connect entities. The arrangement expires in September 2001 and the amount
outstanding under the arrangement as at June 30, 2000 was $3.7 million.
Net cash used in operating activities for the six months ended June 30,
2000 was $31.4 million. The net cash outflow was attributable to the net loss
for the period of $38.0 million and the net increase in working capital of $7.7
million mainly due to movements in accounts receivable, prepayments and other
accrued liabilities.
Net cash used in investing activities for the six months ended June 30,
2000 was $17.5 million due to additions to property and equipment. Purchases of
property and equipment were primarily for the build-out of the Madge.web
infrastructure.
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Net cash provided by financing activities for the six months ended June
30, 2000 was $38.2 million. The net cash inflow was attributable to the issue of
common shares of $35.1 million and to sale-lease back transactions of $6.0
million off-set by outflows on short-term loans of $2.9 million. During January
and February 2000, we sold 2,663,900 common shares in a public offering at per
share prices ranging from $10.50 to $13.63. The gross proceeds of the offering
were approximately $29.9 million, expenses were approximately $0.7 million and
our net proceeds were approximately $29.2 million.
We did not generate cash from operations in either the year ended
December 31, 1999 or the six months ended June 30, 2000. We have funded our
investments in Madge.web and Red-M through various sources of financing
including $29.2 million in net proceeds we received from our public offering of
common shares as mentioned above. We plan to fund our future investment in
Madge.web and Red-M through lease funding and other sources of financing
including through our financing agreement, announced on July 26, 2000 with
Volendam Investeringen N.V., a private investment company sponsored by our
Chairman and Chief Executive Officer, Robert Madge, that provides for $60.0
million funding for the Madge group by the end of 2000. Volendam has invested
$30.0 million in common shares of Madge Networks N.V. at a price of $3.1875 per
share (all of which had been received by September 30, 2000) and agreed to
invest $30.0 million in the equity of Madge.web N.V. The latter is exercisable
during November and December 2000 at our option however on September 26, 2000
Volendam loaned us US$20 million on the basis that we could repay these monies
by calling in their option to invest in Madge.web N.V. shares as per our
original agreement with them. On August 10, 2000 we also signed an agreement
with Inktomi Corporation whereby they committed to invest in Madge.web shares,
subject to certain conditions, at the next round of financing, which is expected
to be completed by the end of 2000. In addition to a private offering of a
portion of the shares of Madge.web, we are exploring options available to meet
our additional investment requirements including a public offering of shares of
Madge.web or of Madge Networks as well as bank credit or capital lease
facilities. In February 2001, we expect to receive $7.0 million from Celestica,
subject to us making quarterly overhead payments to them at an agreed level, as
deferred consideration for the sale of our Irish manufacturing plant to
Celestica in February 1998. There can be no assurance at this time that our
currently projected requirements will be sufficient or that our requirements
will remain the same given the fact our business is changing and we actively
review business priorities, resource allocation and new business opportunities.
We believe our current liquidity levels and committed financial resources are
sufficient to satisfy our operating and investment needs into the first quarter
of 2001. Our business, results of operations and financial condition will be
materially adversely affected if we are not successful in closing our proposed
financings, including raising the additional capital described above, in
sufficient amounts and on acceptable terms. If we raise additional funds through
the issuance of equity or convertible debt securities of the parent company or
any subsidiary, the percentage ownership of our shareholders will likely be
reduced.
LEGAL PROCEEDINGS
In August 1996, a class action lawsuit was filed in the U.S. District
Court for the Northern District of California, San Jose Division, naming Madge,
Madge Networks, Inc. and certain of our former and current executive officers as
defendants. The complaint alleged that the defendants misrepresented or failed
to disclose material facts about our operations, anticipated financial results
and the anticipated success of our products, in violation of the U.S. federal
securities laws. The suit was brought by two individuals, purportedly as
representatives of a class of purchasers of our stock during the period from
October 12, 1995 to June 13, 1996. In November 1996 and August 1997, the
plaintiffs filed amended
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complaints, each of which the Court dismissed without prejudice. On February 6,
1998, the plaintiffs filed another amended complaint. On April 3, 1998, we and
the individual defendants moved to dismiss that complaint. A hearing on that
motion was held on July 17, 1998. Before the Court ruled on that motion to
dismiss, plaintiffs sought permission from the Court to file another amended
complaint. The Court granted plaintiffs' request and on February 4, 2000 the
plaintiffs filed a fifth amended complaint. On March 3, 2000, we moved to
dismiss the most recent complaint. By Order dated May 25, 2000, the Court
granted our motion. On May 31, 2000, the Court entered judgment for us and the
other defendants. The plaintiffs have filed a notice of appeal against this
ruling. Although the Ninth Circuit Court of Appeals has issued a briefing
schedule calling for briefing to occur in October and November, 2000, it has not
yet announced a date for its hearing of the appeal. We believe the allegations
in the complaints to be without merit and intend to continue to defend the trial
court's dismissal of the claims vigorously.
In addition, from time to time, Madge and our subsidiaries are involved
in disputes relating to claims arising out of its operations in the normal
course of business. Among other things, such claims may relate to allegations of
patent infringement, employment-related claims, product warranty claims and
service claims. If the judgment in the class action litigation described above
were to be successfully appealed by the plaintiffs, our results of operations
and financial position could be adversely affected. In spite of this claim, as
of the date of this report, we are not a party to any legal proceedings the
adverse outcome of which, in management's opinion, individually or in the
aggregate, would have a material adverse effect on our financial position.
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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 securities could decline, and you may lose
part or all of your investment.
RISKS RELATED TO OUR FINANCIAL CONDITION AND OUR BUSINESS
We need significant additional capital and if we cannot obtain this funding on
commercially reasonable terms, our business will suffer.
We did not generate cash from operations in either the year ended
December 31, 1999 or the six months ended June 30, 2000. We have funded our
investments in Madge.web and Red-M through various sources of financing
including $29.2 million in net proceeds we received from our public offering of
common shares as mentioned above. We plan to fund our future investment in
Madge.web and Red-M through lease funding and other sources of financing
including through our financing agreement, announced on July 26, 2000 with
Volendam Investeringen N.V., a private investment company sponsored by our
Chairman and Chief Executive Officer, Robert Madge, that provides for $60.0
million funding for the Madge group by the end of 2000. Volendam has invested
$30.0 million in common shares of Madge Networks N.V. at a price of $3.1875 per
share (all of which had been received by September 30, 2000) and agreed to
invest $30.0 million in the equity of Madge.web N.V. The latter is exercisable
during November and December 2000 at our option however on September 26, 2000
Volendam loaned us US$20 million on the basis that we could repay these monies
by calling in their option to invest in Madge.web N.V. shares as per our
original agreement with them. On August 10, 2000 we also signed an agreement
with Inktomi Corporation whereby they committed to invest in Madge.web shares,
subject to certain conditions, at the next round of financing, which is expected
to be completed by the end of 2000. In addition to a private offering of a
portion of the shares of Madge.web, we are exploring options available to meet
our additional investment requirements including a public offering of shares of
Madge.web or of Madge Networks as well as bank credit or capital lease
facilities. In February 2001, we expect to receive $7.0 million from Celestica,
subject to us making quarterly overhead payments to them at an agreed level, as
deferred consideration for the sale of our Irish manufacturing plant to
Celestica in February 1998. There can be no assurance at this time that our
currently projected requirements will be sufficient or that our requirements
will remain the same given the fact our business is changing and we actively
review business priorities, resource allocation and new business opportunities.
We believe our current liquidity levels and committed financial resources are
sufficient to satisfy our operating and investment needs into the first quarter
of 2001. Our business, results of operations and financial condition will be
materially adversely affected if we are not successful in closing our proposed
financings, including raising the additional capital described above, in
sufficient amounts and on acceptable terms. If we raise additional funds through
the issuance of equity or convertible debt securities of the parent company or
any subsidiary, the percentage ownership of our shareholders will likely be
reduced.
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If our Madge.web services are not effective or of high quality or if our market
does not grow as we expect, our Madge.web revenues will not increase and our
business and financial results will suffer.
We believe that establishing and maintaining high quality service is
critical for attracting and expanding our targeted Madge.web customer base. If
our Madge.web services are not effective or of high quality, our revenues will
suffer.
Although we have, through the acquisition of Gains, gained a customer
base and services geared toward the financial services industry, our business
plan contemplates rapid expansion into new markets with newly developed
services. Both the markets and our Madge.web services are new and unproven. If
our customer base does not expand or if our services are not accepted in the
marketplace, our business and prospects will be harmed. The market for our new
Madge.web services depends on several uncertain events and factors, including:
o the effectiveness of our marketing strategy and efforts;
o our ability to demonstrate the value and quality of our Madge.web
services;
o the extent of our network and data center coverage;
o our ability to provide timely, effective customer support;
o our distribution and pricing strategies as compared to those of our
competitors;
o our industry reputation; and
o general economic conditions such as downturns in the rich content and
Internet service markets.
If the market for our Madge.web services fails to develop, or develops more
slowly than expected, our business will be adversely affected.
European use of the Internet and Internet applications that require high-speed
Internet access may not increase as we expect.
Our Madge.web business plan assumes that use of the Internet and Internet
applications will increase substantially in Europe over the next few years, in a
manner similar to the increased use in the United States in the past few years.
We may not grow as planned or achieve profitability if those assumptions do not
materialize.
Our Madge.web data centers, points of presence and the networks we rely on are
sensitive to harm from human actions and natural disasters. Any resulting
disruption could significantly damage our business and reputation.
Madge.web's reputation for providing reliable service largely depends
on the performance and security of our Overnet, our private overlay network
which by-passes the public Internet, including our data centers, points of
presence and equipment, and the network infrastructure of our bandwidth
providers. In addition, our customers may store confidential information on our
servers. However, our data centers, points of presence and equipment, the
networks we use, and our customers' information are subject to damage and
unauthorized access from human error, breaches of security, natural disasters,
power loss, capacity limitations, software defects, telecommunications failures,
intentional acts of vandalism, including computer viruses, and other events and
factors that can cause interruptions in service or reduced capacity for our
customers, and could potentially jeopardize the security of
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our customers' confidential information. Despite precautions we have taken
and may take in the future, the occurrence of a security breach, a
natural disaster, interruption in service or other unanticipated
problems could seriously damage our business and reputation and cause
us to lose customers. Additionally, the time and expense required to
eliminate computer viruses and alleviate other security problems could
be significant and could impair our service quality.
We also typically provide our Madge.web customers with service level
agreements. If we do not meet the required service levels, we may have to
provide credits to our customers and could lose repeat business from them, which
could significantly reduce our revenues. In addition, although these agreements
disclaim our liability for any lost profits or other consequential damages, a
customer could still bring a lawsuit against us claiming such damages as the
result of a problem that the customer may ascribe to us. There can be no
assurance a court would enforce any limitations on our liability, and the
outcome of any lawsuit would depend on the specific facts of the case and legal
and policy considerations beyond our control. If we do not prevail in any such
claim, we could be liable for substantial damage awards. Such damage awards
might not be covered by our insurance policy or exceed our liability insurance
by significant amounts, both of which would seriously harm our business.
We may be unable to achieve our Madge.web operating and financial objectives due
to significant competition in our sector of Internet applications and
infrastructure services and this may harm our business.
The market for Internet applications and infrastructure services is
highly competitive with few substantial barriers to entry. Many competitors to
Madge.web, particularly the large telecommunications companies, such as ATT,
Cable & Wireless, BT and MCI WorldCom, have substantially greater financial,
technical and marketing resources, larger customer bases, more points of
presence, longer operating histories, greater name recognition and more
established relationships in the industry than we possess.
In addition, the current and potential competitors of Madge.web include
web hosting service providers, Internet service providers, telecommunications
and large information technology outsourcing firms. Madge.web competitors may
operate in one or more of these areas and include companies such as Loudeye
Technologies, Akamai, Digex, Digital Island, DoubleClick, Equant, iBEAM, Intel,
IBM, Navisite and PSINet. In the specific area of trader voice connectivity
services, the primary competitor of Madge.web is IXnet (now part of Global
Crossing).
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Competitors of Madge.web may be able to expand their network
infrastructures and service offerings more quickly than we can. They may also
have a lower cost base, may bundle other services that could allow them to
reduce the relative prices of their services below levels that we could compete
with, may price their services based on the success of the event or offering
that the service is provided to support rather than charging a flat fee, which
could make their service more attractive for potential customers, or may
generally adopt more aggressive pricing policies. In addition, some competitors
have entered and will likely continue to enter into joint ventures or alliances
to provide additional services that may be competitive with those Madge.web
provide. We also believe the markets in which Madge.web competes are likely to
experience consolidation in the near future, which could result in increased
price and other competition that would make it more difficult for us to compete.
We cannot predict the outcome of our Madge.web development efforts with
RealNetworks, Engage Technologies and Inktomi, and if we fail to maintain these
strategic alliances or build new alliances, our ability to generate revenues
would suffer.
Madge.web currently has strategic alliances with RealNetworks, Engage
Technologies and Inktomi. We depend on these relationships to:
o increase usage of our Madge.web services;
o generate revenues from shared service offerings; and
o expand our customer base.
In order to benefit from these strategic alliances, we have invested,
and expect to continue to invest, significant resources to upgrade our network
and increase Madge.web's service offerings. Because these alliances are at their
early stages, we cannot assure you that the ventures will be successful or that
we will see a return on our investment. If RealNetworks, Engage Technologies or
Inktomi terminate their agreements with us, we will cease to receive revenues
from these alliances.
In addition, part of our strategy is, and our success depends in part
on, our ability to continue to develop and maintain strategic alliances with
leading Internet companies and rich content providers that wish to enter the
European market or, alternatively, will give us access to new markets. If we are
not able to develop these alliances, sales of our services and our ability to
maintain or increase our Madge.web customer base may be substantially
diminished.
The market for Internet advertising is uncertain and we may fail to generate the
advertising revenues that we expect.
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Through agreements with Engage Technologies, Madge.web expects to
derive revenues from advertising. The demand and continued market acceptance for
Internet advertising is uncertain, however, and our advertising revenues may not
materialize. Additionally, there are currently no broadly accepted standards for
the measurement of the effectiveness of Internet advertising, and the industry
may need to develop standard measurements to support and promote Internet
advertising as a significant advertising medium. If these standards do not
develop, existing advertisers may not continue their levels of Internet
advertising and advertisers that have traditionally relied upon other
advertising media may be reluctant to advertise on the Internet, which will
effect our ability to generate advertising revenue.
We rely on a limited number of third parties for key components of our Overnet,
the loss of which could harm our operations.
We are dependent on a limited number of third party providers, such as
Nortel, Cisco, Hewlett Packard and Newbridge, to supply key components of
Madge.web's Overnet, including networking and other equipment and facilities for
operating data centers. We also lease all our bandwidth capacity. While we have
entered into agreements for networking equipment, for operating data centers and
for leasing bandwidth capacity and facilities, these are short term agreements
or, in some cases, provided on purchase order only. Any failure to obtain
networking and other equipment, facilities and bandwidth capacity in the amounts
or, in the case of facilities for operating data centers, in the locations, we
require could impede our growth and cause our financial results to suffer.
We rely on a limited number of third parties to supply Madge.web with software
and technology, the loss of which could force us to use inferior substitute
technology or to cease offering our Madge.web services.
We license, and expect to continue to license or otherwise obtain
access to, the intellectual property of third parties. In addition, we use, and
will use in the future, third party software that may not continue to be
available to us on commercially reasonable terms or at all. Our loss of, or
inability to maintain or obtain, any required intellectual property could
require us to use substitute technology, which could be more expensive or of
lower quality or performance, or could force us to cease offering some or all of
our Madge.web services. Moreover, our license agreements are non-exclusive. Our
competitors may have access to the same technology that we license, which would
allow them to offer similar services in direct competition to us.
Regulatory uncertainties could restrict our ability to generate Madge.web
revenues.
We face regulatory and market access barriers for our Madge.web
services in various countries resulting from restrictive laws, policies and
licensing requirements, in particular with respect to our trader voice
connectivity services. Even though all the major markets for our Madge.web
services are now open to competition and the regulatory regimes have been
streamlined significantly, in some countries, voice services still remain
heavily regulated and licenses are still required. It is unclear whether our
other Madge.web services will require a license in the countries in which we
currently operate or intend to operate. Some restrictive telecommunications laws
and practices give rise to, and may in future give rise to, residual
constraints, risks and uncertainties that could affect our ability to fully
develop and market our Madge.web services.
In countries where some or all telecommunications services are subject
to a monopoly or provided by a few suppliers only, we may be required to enter
into an
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arrangement with the incumbent public telecommunications organization
before providing our Madge.web services. Compliance issues may exist for certain
services in a number of countries. There can be no assurance that we will be
able to either enter into or maintain the requisite commercial agreements in the
countries in which we currently or in the future intend to offer our Madge.web
services or will be able to comply with local regulatory requirements at a
reasonable cost or at all.
Privacy and security concerns, particularly related to the use of our software
on the Internet, may limit the effectiveness of and reduce the demand for our
Madge.web services.
The effectiveness of our Madge.web services relies in part on the use
of end user registrations, purchase transactions and surveys which are provided
to us through our agreement with Engage Technologies. Our collection and use of
this data for end-user profiling of customers may raise privacy and security
concerns and we may in the near future be regulated by online privacy
legislation. Our Madge.web customers generally have implemented security
measures to protect their end-user data from disclosure or interception by third
parties. However, the security measures may not be effective against all
potential security threats. If a well publicized breach of data security were to
occur, our Madge.web services may be perceived as less desirable, adversely
affecting our future revenues and profitability.
In addition, due to privacy concerns, some Internet commentators,
consumer advocates, and governmental or legislative bodies have suggested
legislation to limit the use of end user profiling data. In addition, Internet
users can, if they choose, configure their browsers to limit the collection of
data for end user profiling. If many Internet users choose to limit the use of
end user profiling technologies, or if major countries or regions adopt
legislation or other restrictions on the use of end user profiling data, our
Madge.web services would be less useful to our customers, and our sales and
profits could decrease.
We continue to be dependent upon revenue generated by our token ring business.
Our revenue has largely been derived from the sale and licensing of
Token Ring products and technology. We derived approximately 72%, 74% and 71% of
our net sales from our Token Ring products for the years ended December 31,
1998, 1999 and the six months ended June 30, 2000, respectively. Thus, we depend
upon the continued market acceptance of Token Ring and related technologies. Our
total sales of Token Ring adapter cards have declined over for the last three
years, with a dramatic decline this quarter, and we believe they will continue
to decline rapidly. As the Token Ring market declines further, our net sales and
profitability will further decrease unless we are successful in our strategy of
generating revenue from Madge.web and Red-M in order to counteract the declining
Token Ring market. In April 2000, we outsourced our technical support function
to Vital Networks LLC ("Vital") and although Vital agreed to provide our
Madge.connect customers with certain measurable levels of support, this
relationship, and Vital's ability to deliver the kind of service Madge.connect
had previously been providing directly to its customers, is untested. Our
Madge.connect customers will ultimately all be required to pay for 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 revenues.
We are dependent upon a limited number of product suppliers and subcontractors.
The chipsets and components used in certain of our products are
currently available only from a single source or limited sources, for example,
chipsets used in certain of our Token Ring adapter card products that are
currently available only from Texas Instruments or
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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. 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.
Our continued reliance upon third-party manufacturers and suppliers
involves several potential risks, including the absence of adequate capacity,
the unavailability of or interruptions in access to certain process technologies
and reduced control over delivery schedules, manufacturing yields and costs. In
the event that a significant subcontract manufacturer or 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 delays and additional
costs and no assurances can be given that additional sources will 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 other
significant source partner 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.
If we do not develop revenue-generating products from our Madge.connect research
and development group, our business will be harmed.
To the extent that the level of our research and development
expenditures do not result in revenue-generating products or services,
particularly for our Red-M group, our results of operations could be adversely
affected. We focus a significant portion of our resources on the development of
products and services for unproven or developing technology markets, such as the
mobile internet marketplace that Red-M is aimed at. We will face risks to our
business in the event that the markets and industry standards for these new
Red-M products and services do not develop as expected. We will also need to
invest in making our existing and future products easier to understand, install
and use and in educating our Madge.connect sales force and other personnel on
changing technology, evolving industry standards and new product and service
offerings some of which we anticipate will be sold to markets in which we have
little or no experience of operating. For example, it is envisaged that Red-M
products will be sold to the consumer market, a market we have little experience
of and which has a set of regulatory requirements that we have never had to
address before. There can be no assurance that we will be able to respond
effectively to technological changes, or new industry standards or will be
successful in our current or future product and/or service development efforts.
From time to time we may announce plans to develop new products, new product
features and services. Although we have announced and may in the future announce
expected shipment dates for certain products and features, or dates for
launching new services, schedules for high technology products and services are
difficult to predict, and there can be no assurance that we will achieve our
expected shipment dates or launch dates for new services. Our business could be
adversely affected if we were to incur significant delays, if any of our
development projects were to be unsuccessful or were not to gain market
acceptance. Our Madge.connect products may also be subject to safety and Federal
Communications Commission standards in the United States and other regulatory
approvals. Failure to meet these standards or to obtain those approvals/licenses
could have an adverse impact on our business. Another key element to our success
will be our ability to ensure continued compatibility and operability of our
Madge.connect products with products from other leading networking vendors, as
well as with various personal computer
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architectures and network operating systems. To this end we test our
Madge.connect products for operability with the products of other leading
vendors and also performance benchmark testing. There can be no guarantee we
will be able to maintain this compatibility.
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 product sales are fulfilled and
distributed world wide through a network of distributors, value-added resellers
and original equipment manufacturers. Our Madge.connect indirect distribution
channels vary by division and from country to country. In the United States, the
distribution channels include major national distributors, such as Ingram Micro,
Inc. and Tech Data Corporation, Inc. In Europe, Asia and other markets, we sell
our Madge.connect products predominantly through distributors and resellers, but
also in certain circumstances, directly to end-users. We generally do not have
long-term contracts with these distributors and resellers and we are
increasingly selling our Madge.connect products through third party sales
commission agents who are not our employees. We now also depend on distributors
of the former Olicom product line, many of which do not have an established
relationship with us. The loss of a distributor or reseller or a sales
commission 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 commission agents would also affect our ability to manage our distributors
and resellers and continue to secure revenue from them. Red-M is in the process
of setting up a network of third-party distributors and resellers which will be
key to its success. The different type of products Red-M will be marketing, to a
different type of purchaser will require a different type of reseller than we
have previously dealt with. Finding and building a relationship with such
resellers may prove difficult and if this is the case, our business would fail
to develop as projected.
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
(including Red-M) will be derived from sales to customers that integrate our
existing and new 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 to promote
products that incorporate our products and technology. Their ability and
willingness to do so is based upon a number of factors, including:
o our timely development of new products with increased reliability,
functionality, speed and performance at acceptable prices to end users;
o the compatibility of our technology with emerging and changing industry
standards;
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 Madge.connect sales, reducing our margins and adversely
affecting the marketability of our products. Our inability to promote sales
through these manufacturers could decrease our revenue.
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We may also enter into agreements to obtain products from another
manufacturer or manufacturers for resale on a Madge-labeled or OEM basis. We are
dependent in any such arrangement upon the manufacturer of products to provide
us with timely shipments of quality 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.
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 and to date have been fairly accurate with these predictions,
these allowances may not be sufficient in the future to offset Madge.connect
product returns in the future. In addition, we provide price protection to
certain distributors. a significant decrease in the price of our Madge.connect
products, which exceed the amounts that we have reserved, could have an adverse
effect on our operating results. Moreover, the warranty reserves may not cover
actual costs. if any one of these allowances is inadequate, our profitability
could decrease.
We have had difficulty managing our changing operations and acquisitions, which
has harmed and may continue to harm our business.
We reorganized our operational and internal reporting structure in 1999
into two products and services subsidiary groups, Madge.web and Madge.connect,
which became separate legal entities at the end of 1999. We also launched a
third division, Red-M in May 2000. Madge.web is a global provider of rich
content applications and managed networks services. Madge.connect is a global
supplier of product solutions, including Token Ring, ISDN switching and IP based
video networking, for mission critical enterprise networks. Red-M is a developer
of wireless Internet server products that provide Internet and Intranet access
from a wide range of mobile devices in the workplace. Our ability to operate
within this corporate structure, which includes our acquisition of Gains within
the Madge.web group, is untested and our Madge.web and Red-M businesses are
largely unproven. Because the Token Ring industry serviced by Madge.connect
continues to decline rapidly, if we are unsuccessful in developing the Madge.web
and Red-M businesses, our business and results of operations will suffer
significantly.
The ongoing restructuring within the Madge.connect group to create a
more simplified business model is anticipated to be completed by end of 2000 and
will mean Madge.connect will have a significantly reduced headcount from the
fourth quarter of 1999. As a result, a number of sales offices world-wide have
been or will be closed or substantially downsized as we plan to move to a model
of using independent sales agents in most countries either in addition to, or
more often, instead of our own employees. The challenge of managing expenses to
changing sources of revenue may lead us to adjust further our business
priorities and resource allocation.
As a result of our reorganization, the ongoing restructuring and
downsizing and certain acquisitions that we made over the last five years that
we were not completely successful in integrating into our operations, our
management personnel have had increased responsibilities, which has strained and
continues to strain operational, management, financial and other resources and
weaken our ability to retain employees. In addition, there can be no assurance
that we will successfully integrate any future acquisitions into our operations.
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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.
Our success depends significantly on the contributions of Robert H.
Madge, our principal founder and chief executive officer. The loss of Mr.
Madge's services could harm our results of operations and competitive position.
We also 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
current or future restructurings would not have the same effect. In addition,
our acquisitions and subsequent restructurings strained and may continue to
strain operational, financial and other resources and may weaken our ability to
attract and retain employees. Due to the level of technical and management
expertise necessary to our industry, we must recruit and retain highly qualified
and well-trained personnel for our Madge.web and Red-M divisions in particular.
Competition for these employees is intense. If we cannot attract and retain
qualified personnel, our business and prospects will suffer.
Our products or services may contain defects that may cause us to incur
significant costs, divert our attention from product development, expansion of
our Madge.web and Red-M businesses and/or result in the loss of customers.
I.T. products frequently contain undetected software and hardware
defects when first introduced or as new versions are released. Our Madge.connect
products and planned new products are complex and defects may occasionally be
found. In addition, our products are often embedded in or deployed in
conjunction with our customers' products, which incorporate a variety of
components produced by third parties. We may on occasion sell products which are
manufactured 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. Our Madge.web services rely upon an often
complex series of network, connections and transmissions, some of which are, or
will be brand new and as yet untested. If problems are found, in either our
Madge.connect products or Madge.web services, 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. These problems may then adversely
impact our business.
Our revenue, expenses, liquidity and operating results are subject to
significant fluctuation, which could contribute to disparate quarterly results,
resulting in fluctuation in the price of our common shares.
We have experienced quarterly fluctuations in operating results and
anticipate that these fluctuations will continue. Various factors contribute to
this uncertainty, including:
o the timing of operating expenditures;
o the size and timing of customer orders;
o the mix of products sold by Madge.connect;
o the mix between Madge.web services and Madge.connect products sold;
o the mix of distribution channels through which our products and
services are sold;
o economic conditions specific to the personal computer and computer
networking industries;
o the pattern of end-user purchasing cycles;
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o the introduction of new products and services by us and our
competitors; and
o general economic conditions which may effect such things or the price
we can charge for our products and services.
Madge.web enters into customer contracts, typically for one year or more, that
provide for either monthly or quarterly payments, and as such Madge.web revenue
is also subject to fluctuations as customer contracts end, tariff rates change
and new contracts are signed. Madge.connect ships products to order and
generally operates with little backlog, although we sometimes receive
end-of-quarter orders that are not shipped until the following quarter.
Additionally, 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 may continue to strain our cash resources. In the year ended
December 31, 1999 and the six months ended June 30, 2000, we did not generate
cash from operations. If actual expenditures exceed estimates or if the timing
of the restructuring charges changes,we will need to expense additional amounts
in future quarters. Any one or combination of these factors and our failure to
adequately anticipate their effect could contribute to wide period-to-period
fluctuations and could materially and adversely affect our business.
We may not have adequately protected our intellectual property.
Our ability to compete successfully depends, in part, on our ability to
protect the proprietary technology contained in our products, services and
Overnet. We currently rely on a combination of patent, trademark, copyright and
trade secret laws and contractual provisions to establish and protect
proprietary rights in our Madge.connect products and Madge.web services. 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 has warranted
that the intellectual property we acquired from it does not infringe third party
rights. 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 reached only oral agreements regarding a number of
licenses of lesser importance. In addition, the products Red-M is developing may
well be jointly developed with our competitors in this developing market. Our
ability to protect our intellectual property and get rights from others to use
their intellectual property will be key to our success in this market.
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 from them a number of their patents and they licensed from us 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 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 or Madge.web services. Any such assertion could require expending
significant sums in litigation, 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 depend upon our international operations, which subject us to currency
exchange rate fluctuations.
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We are a global company, with our headquarters and most of our operations based
outside the United States. We derived approximately $252.6 million, $199.7
million and $145.0 million, or 66%, 66% and 74%, of our total net sales from
operations outside of the Americas in the years ended December 31, 1997, 1998
and 1999, respectively. We expect that international sales will continue to
represent a majority of our net revenues. 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 could distort the results of our
operations.
RISKS RELATED TO OUR CAPITAL STRUCTURE
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 quarterly variations in our operating results;
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 Internet in
general;
o changes in financial estimates by securities analysts; and
o general economic and market conditions.
The stocks of many technology companies have experienced significant
fluctuations in trading price and volume. Often these fluctuations have been
unrelated to operating performance. 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.
Our founder continues to exercise control over us and could have interests that
differ from shareholders' interests.
Various trusts established by Robert Madge, our principal founder and
chief executive officer indirectly owned approximately 43.36% of the outstanding
common shares as of June 30, 2000. This amount has increased since the purchase
by Volendam
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Investeringen N.V. of $12.0 million of common shares in Madge Networks N.V., as
described in "Management's Discussion & Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources" above. As of August 31,
2000 this percentage had increased to 47.52%. Therefore, the various trustees,
as a group, have the power to control or influence matters submitted for
shareholder approval, including the election of directors. Certain transactions,
which also require shareholder approval, will be more difficult to consummate
without the support of the trusts. Such transactions include 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 1.34% of our outstanding common shares have vested or will vest
within 60 days from June 30, 2000.
Our charter documents and the laws of The Netherlands could make it more
difficult for a third party to acquire us.
The shareholders have authorized 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.
It may be difficult to enforce a U.S. judgment 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 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/ ROBERT MADGE_
-----------------
Robert H. Madge
Managing Director
Date: October 4, 2000
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EXHIBIT INDEX
<TABLE>
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<S> <C> <C>
Exhibit A Second Quarter Press Release 32
Exhibit B Directors Stock Option Plan 40
(marked to show changes from
previous filed version)
</TABLE>
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