<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended December 28, 1996 Commission file number 0-12643
------------------ -------
GANDALF TECHNOLOGIES INC.
- ----------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
ONTARIO, CANADA NOT APPLICABLE
- ---------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
130 COLONNADE ROAD SOUTH, NEPEAN, ONTARIO K2E 7M4
- ----------------------------------------- ----------------
(Address of principal executive offices) (Postal Code)
Registrant's telephone number, including area code (613) 274-6500
--------------
NOT APPLICABLE
- ----------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last
report.
*Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
The number of shares outstanding as at January 31, 1997 was 43,397,862.
<PAGE>
GANDALF TECHNOLOGIES INC.
INDEX
Page No.
--------
PART I FINANCIAL INFORMATION
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Changes in
Financial Position 5
Consolidated Statements of Shareholders' Equity 6
Notes to Consolidated Financial Statements 7
Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
PART II OTHER INFORMATION 21
SIGNATURE PAGE 21
<PAGE>
GANDALF TECHNOLOGIES INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Thousands of US dollars)
December 28 March 31
1996 1996
----------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 7,213 $ 13,602
Accounts receivable 15,064 28,694
Inventories (note 2) 14,064 13,491
Other 1,315 1,867
-------- --------
Total current assets 37,656 57,654
Fixed assets (note 3) 14,150 16,253
Goodwill, net of amortization of $3,332
(March 31, 1996: $3,172) 3,082 3,242
Other assets 2,145 2,226
-------- --------
Total assets $ 57,033 $ 79,375
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank operating lines (note 4) $ 7,522 $ -
Accounts payable and accrued liabilities (note 5) 18,074 21,755
Deferred revenue 5,120 6,178
Current portion of long-term debt 552 360
-------- --------
Total current liabilities 31,268 28,293
Long-term debt 2,562 2,496
Shareholders' equity:
Capital stock:
Common shares, 43,397,862 issued and
outstanding (March 31, 1996: 42,939,523) (note 6) 55,733 54,198
Retained earnings (deficit) (note 6) (27,233) 260
Cumulative translation adjustment (5,297) (5,872)
-------- --------
Total shareholders' equity 23,203 48,586
-------- --------
Total liabilities and shareholders' equity $ 57,033 $ 79,375
======== ========
(See accompanying notes to consolidated financial statements)
<PAGE>
<TABLE>
<CAPTION>
GANDALF TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Thousands of US dollars except per share amounts)
13 Weeks Ended 39 Weeks Ended
December 28 December 28
-------------------- --------------------
1996 1995 1996 1995
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Product $ 10,029 $ 19,326 $ 29,028 $ 57,141
Service 6,593 8,845 21,158 27,037
-------- -------- -------- --------
16,622 28,171 50,186 84,178
Operating expenses:
Cost of product sales 6,833 9,179 19,137 27,414
Service expenses 5,186 6,096 15,435 17,875
Sales and marketing 8,372 7,892 23,406 23,749
Administration and general 2,367 2,102 6,848 6,315
Research and development 3,517 2,895 9,631 8,329
Restructuring costs (note 7) - - 3,010 -
-------- -------- -------- --------
Income (loss) from operations (9,653) 7 (27,281) 496
Interest expense (156) (108) (242) (450)
Interest income and foreign exchange (41) 193 30 147
-------- -------- -------- --------
Net income (loss) for the period $ (9,850) $ 92 $(27,493) $ 193
======== ======== ======== ========
Basic earnings (loss) per share (note 8) $ (0.23) $ - $ (0.64) $ -
======== ======== ======== ========
Weighted average number of
shares outstanding (thousands) 43,373 41,358 43,259 39,520
======== ======== ======== ========
(See accompanying notes to consolidated financial statements)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
GANDALF TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION
(Unaudited)
(Thousands of US dollars)
13 Weeks Ended 39 Weeks Ended
December 28 December 28
--------------------- --------------------
1996 1995 1996 1995
-------- --------- -------- --------
<S> <C> <C> <C> <C>
Operating activities:
Cash provided by (applied to)
operations (note 9) $ (8,812) $ 1,489 $(22,878) $ 4,234
Decrease (increase) in operating
working capital (note 10) 3,825 (866) 8,942 (1,193)
-------- --------- -------- --------
Cash provided by (applied to)
operating activities (4,987) 623 (13,936) 3,041
-------- --------- -------- --------
Financing activities:
Issue of capital stock 96 6,543 1,535 14,844
Conversion of debentures (note 11) - (2,337) - (10,336)
Other (115) 30 270 481
-------- --------- -------- --------
Cash provided by (applied to)
financing activities (19) 4,236 1,805 4,989
-------- --------- -------- --------
Investing activities:
Purchase of fixed assets (605) (782) (1,912) (1,940)
Other 13 22 6 (15)
-------- --------- -------- --------
Cash applied to investing activities (592) (760) (1,906) (1,955)
-------- --------- -------- --------
Effect of exchange rate changes on
cash balances 130 (47) 126 (213)
-------- --------- -------- --------
Increase (decrease) in cash position
in the period (5,468) 4,052 (13,911) 5,862
Cash position at beginning of period 5,159 7,773 13,602 5,963
-------- --------- -------- --------
Cash position at end of period $ (309) $ 11,825 $ (309) $ 11,825
======== ========= ======== ========
Cash position is comprised of:
Cash and cash equivalents $ 7,213 $ 14,611 $ 7,213 $ 14,611
Bank operating lines (7,522) (2,786) (7,522) (2,786)
-------- --------- -------- --------
$ (309) $ 11,825 $ (309) $ 11,825
======== ========= ======== ========
(See accompanying notes to consolidated financial statements)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
GANDALF TECHNOLOGIES INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Unaudited)
(Thousands of US dollars)
13 Weeks Ended 39 Weeks Ended
December 28 December 28
-------------------------------------------- --------------------------------------------
1996 1995 1996 1995
--------------------- --------------------- --------------------- ---------------------
Shares Dollars Shares Dollars Shares Dollars Shares Dollars
---------- --------- ---------- --------- ---------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Capital Stock:
Consisting of an unlimited
number of common shares
authorized, without par value
Balance at beginning of period (note 6) 43,349,604 $ 55,637 40,056,196 $ 47,220 42,939,523 $ 54,198 35,238,064 $ 91,644
Issued:
On exercise of stock options 39,333 65 1,221,834 2,859 410,683 1,312 1,399,996 3,160
On conversion of debentures (note 11) - - 1,343,402 2,200 - - 5,983,372 9,839
Other 8,925 31 128,398 1,404 47,656 223 128,398 1,404
Reduction in stated capital (note 6) - - - - - - - (52,364)
---------- --------- ---------- --------- ---------- --------- ---------- ---------
Balance at end of period 43,397,862 $ 55,733 42,749,830 $ 53,683 43,397,862 $ 55,733 42,749,830 $ 53,683
========== ========= ========== ========= ========== ========= ========== =========
Retained Earnings (Deficit):
Balance at beginning of period $ (17,383) $ 101 $ 260 $ (52,364)
Net income (loss) (9,850) 92 (27,493) 193
Reduction in stated capital (note 6) - - - 52,364
--------- -------- -------- ---------
Balance at end of period $ (27,233) $ 193 $ (27,233) $ 193
========= ========= ========= =========
Cumulative Translation Adjustment:
Balance at beginning of period $ (5,835) $ (4,760) $ (5,872) $ (4,838)
Adjustment arising on translation of
foreign subsidiaries' financial
statements to US dollars (423) (850) (495) 675
Adjustment relating to subsidiary loans
designated as long-term investments 961 333 1,070 (1,114)
--------- --------- --------- ---------
Balance at end of period $ (5,297) $ (5,277) $ (5,297) $ (5,277)
========= ========= ========= =========
(See accompanying notes to consolidated financial statements)
</TABLE>
<PAGE>
GANDALF TECHNOLOGIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
All amounts are stated in US dollars unless otherwise indicated. C$ refers to
Canadian dollars. Tabular amounts are in thousands. References to years are to
fiscal years ending March 31.
1. INTERIM FINANCIAL STATEMENTS
The consolidated financial statements at December 28, 1996 and for the thirteen
and thirty-nine week periods then ended are unaudited and reflect all
adjustments which are, in the opinion of management, necessary for a fair
presentation of the financial position and operating results for the interim
periods.
2. INVENTORIES
December 28 March 31
1996 1996
----------- --------
Raw materials $ 3,603 $ 2,905
Work-in-process 4,195 3,821
Finished goods 6,266 6,765
-------- --------
$ 14,064 $ 13,491
======== ========
3. FIXED ASSETS
December 28 March 31
1996 1996
----------- --------
Cost:
Land $ 242 $ 218
Buildings 3,526 4,627
Equipment 61,254 58,336
Leasehold improvements 1,919 1,966
-------- --------
66,941 65,147
Accumulated depreciation 52,791 48,894
-------- --------
Net book value $ 14,150 $ 16,253
======== ========
<PAGE>
4. BANK OPERATING LINES
At December 28, 1996, the Company's authorized bank lines totaled $21.3 million
under two committed credit facilities provided by a Canadian chartered bank
which bear interest at the bank's prime rate plus 1.75% or equivalent. The
authorized credit lines are secured by certain of the accounts receivable,
inventories and other assets of the Company. The amount available for borrowing
at any time is based on margin formulas relating to levels of accounts
receivable, inventories and other bank covenants. Based on the margin formulas,
$10.8 million was available to the Company at December 28, 1996 and $7.5 million
was being utilized. Cash and cash equivalents held as of that date represented a
further $7.2 million of cash resources available to the Company. Cash and cash
equivalents and unused credit lines totaled $10.5 million at December 28, 1996.
In view of the Company's current bank borrowing levels and anticipated
additional demands on cash and credit resources relating to short-term operating
requirements, the Company believes that it is necessary to seek and complete
arrangements for additional sources of equity and or debt financing during the
fourth quarter of 1997. The Company has recently selected certain investment
banking firms to assist in pursuing strategic initiatives including raising
additional financing. There can be no assurance at this time that the Company
will be successful in arranging such additional financing in a sufficient amount
or within the time frame which may be required to meet operating cash
requirements and considering any constraints that may be imposed on the
utilization of the bank operating lines.
Financial covenants contained in one of the bank credit agreements measure on a
quarterly basis, among other things, the tangible net worth, the ratio of
liabilities to tangible net worth and the current ratio of the Company. As a
result of the net loss for the third quarter of 1997 and the associated impact
on the consolidated balance sheet, the Company was not in compliance with these
financial covenants at December 28, 1996. The breach of these financial
covenants constitutes an event of default under the terms of the agreements for
which the Company has obtained a waiver from the bank. This waiver is
conditional upon the Company not borrowing an amount in excess of the amount
determined by margin formulas during the period up to March 31, 1997 and
progress on the part of the Company, to the satisfaction of the bank, in its
efforts to raise additional financing. At March 31, 1997 the Company expects
that it will again not be in compliance with these quarterly financial covenants
and will have to seek a further waiver from the bank. While to date the Company
has been successful in obtaining a waiver or amendment from the bank under such
circumstances, there can be no assurance that the Company will continue to be
successful in this regard. If the current waiver ceased to be effective for
reasons of noncompliance by the Company or, following March 31, 1997, the
Company was unable to obtain a further waiver from the bank this would give the
bank the right to terminate the facilities and require repayment of the
outstanding borrowings on demand. While the Company currently anticipates that
the credit facilities will remain available to the Company it believes that the
bank's future course of action will be dependent, among other things, on the
outcome of the Company's efforts to raise additional financing.
The Company anticipates taking actions during the fourth quarter of 1997 which
would reduce operating costs in future periods in order to reduce the Company's
break even level for revenues with the intention of reducing cash applied to
operations after the end of 1997. These actions would result in the Company
recording a charge for restructuring in the final quarter of 1997 and would
likely further increase pressure in the short-term, on cash and credit resources
due to the timing of payments for certain downsizing actions.
<PAGE>
5. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
December 28 March 31
1996 1996
----------- --------
Trade accounts payable $ 6,163 $ 7,376
Payroll, commissions and related taxes 2,855 3,873
Accrued restructuring charges 2,481 2,747
Other payables 5,026 6,434
Income and other taxes payable 1,549 1,325
-------- --------
$ 18,074 $ 21,755
======== ========
6. REDUCTION IN STATED CAPITAL
On August 10, 1995, during the second fiscal quarter of 1996, the shareholders
of the Company passed a special resolution authorizing a reduction in statutory
stated capital in respect of the common shares by $52,364,000. This resulted in
a corresponding reduction in the accumulated deficit as shown on the
consolidated balance sheets and the consolidated statements of shareholders'
equity.
7. RESTRUCTURING COSTS
Over the past several years the Company has undertaken significant restructuring
activities in order to reposition the Company in line with its strategy, reduce
costs and improve competitiveness. The size of the Company's workforce is
currently less than 700 employees, approximately one-third the level of five
years ago.
Restructuring charges of $3.0 million recorded in the first quarter of 1997
included a write down following a review of the net carrying amount of the
Company's manufacturing facilities in which it was determined, in conjunction
with the decision to enter into an agreement with a third party to provide the
Company with a high-volume manufacturing capability, that the net carrying
amount exceeded the estimated net recoverable amount. Restructuring charges also
included provisions for future lease costs on sales offices made redundant in
connection with changing the Company's sales distribution model from direct
sales to multiple channels of distribution including: national resellers,
operating telephone companies, Internet service providers, OEM's system partners
and corporate accounts.
8. EARNINGS PER SHARE
Basic earnings (loss) per share figures are presented on the consolidated
statements of income. These figures are calculated using the monthly weighted
average number of common shares outstanding during the period. Fully diluted
earnings per share information has not been presented in those periods where
potential conversions are anti-dilutive.
<PAGE>
9. CASH PROVIDED BY (APPLIED TO) OPERATIONS
Cash provided by (applied to) operations is computed as follows:
<TABLE>
<CAPTION>
13 Weeks Ended 39 Weeks Ended
December 28 December 28
-------------------- --------------------
1996 1995 1996 1995
-------- ------- -------- --------
<S> <C> <C> <C> <C>
Income (loss) from operations $ (9,653) $ 7 $(27,281) $ 496
Depreciation and amortization 1,038 1,396 3,245 4,022
Writedowns not involving
an outlay of cash - - 1,370 -
Interest paid (156) (107) (242) (431)
Interest income and foreign
exchange (41) 193 30 147
-------- -------- -------- --------
$ (8,812) $ 1,489 $(22,878) $ 4,234
======== ======== ======== ========
</TABLE>
10. DECREASE (INCREASE) IN OPERATING WORKING CAPITAL
The decrease (increase) in operating working capital is computed as follows:
<TABLE>
<CAPTION>
13 Weeks Ended 39 Weeks Ended
December 28 December 28
-------------------- --------------------
1996 1995 1996 1995
-------- ------- -------- --------
<S> <C> <C> <C> <C>
Accounts receivable $ 2,402 $ 691 $ 13,630 $ 1,353
Inventories 1,571 1,236 (573) 1,712
Prepaid expenses (195) (23) 552 895
Accounts payable and accrued
liabilities 499 (1,367) (3,905) (3,185)
Income taxes payable 1 (23) 224 (301)
Deferred revenue (540) (1,130) (1,058) (1,886)
Foreign currency equity adjustment 87 (250) 72 219
-------- ------- -------- --------
$ 3,825 $ (866) $ 8,942 $ (1,193)
======== ======== ======== ========
</TABLE>
<PAGE>
11. CONVERTIBLE DEBENTURES
<TABLE>
<CAPTION>
Shares Issued
Aggregate Principal Amount % Upon Conversion
- ---------------------------------------------------------------------- ---------------
<S> <C> <C> <C> <C>
Balance at March 31, 1994 C$ 30,000 $ 21,681 100%
Converted during the year (15,939) (11,533) (53%) 6,782,519
Impact of foreign exchange - (97) -
- ----------------------------------------------------------------------
Balance at March 31, 1995 14,061 10,051 47%
Converted during the period (14,061) (10,336) (47%) 5,983,372
Impact of foreign exchange - 285 -
- ----------------------------------------------------------------------
Balance at March 31, 1996 C$ - $ - -
======================================================================
</TABLE>
In November 1992 the Company issued 8.5% convertible debentures with an
aggregate principal amount of C$30.0 million which were due to mature in
November 2002. At any time prior to maturity they were convertible into common
shares of the Company at the option of the holder at a conversion price of
C$2.35 (approximately $1.72) which would yield 425.53 common shares for each
C$1,000 (approximately $732) of principal amount of debentures held. During 1995
debentures with an aggregate principal amount of $11,533,000 were converted into
6,782,519 common shares.
During the first three quarters of 1996 all remaining debentures were converted
into 5,983,372 common shares in accordance with the terms of the debentures. The
resulting increase in capital stock of $9,839,000 was determined as the sum of
the principal amount of the debentures converted ($10,336,000) plus interest
accrued to the date of conversion ($135,000), net of the pro rata share of the
associated unamortized deferred financing costs ($632,000).
12. UNITED STATES ACCOUNTING PRINCIPLES
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in Canada ("Canadian GAAP") which in
the case of the Company differ in the following material respects from those
generally accepted in the United States ("US GAAP").
(a) Under US GAAP, financing and investing activities not involving a
receipt or outlay of cash are excluded from the consolidated statement
of changes in financial position. Accordingly, the following financing
activities would not be presented in the consolidated statements of
changes in financial position for the thirteen and thirty-nine week
periods ended December 28, 1995 but would be shown supplementally.
<TABLE>
<CAPTION>
13 Weeks Ended 39 Weeks Ended
December 28, 1995 December 28, 1995
--------------------- -------------------
<S> <C> <C>
Conversion of debentures $ (2,337) $ (10,336)
Issue of capital stock on
conversion of debentures $ 2,337 $ 10,336
</TABLE>
<PAGE>
(b) Under US GAAP, bank operating lines would not be included as a
component of the cash position presented in the consolidated statements
of changes in financial position. The change in bank operating lines
would be presented as a financing activity and would therefore be
included in the determination of the increase or decrease in cash
position in the period.
(c) Reductions in stated capital and deficit, as described under note 6 do
not fall within the definition of a quasi-reorganization under US GAAP
and, accordingly, under US GAAP, capital stock and retained earnings
(deficit) would not each be reduced by $52,364,000.
(d) US GAAP requires the calculation of primary earnings per share. This
figure is not materially different from the basic earnings per share
figure calculated under Canadian GAAP.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
- ------------
The consolidated financial statements for the third quarter ended December 28,
1996, together with accompanying notes, should be read as an integral part of
this review. These financial statements have been prepared by management in
accordance with accounting principles generally accepted in Canada. Note 12 to
the consolidated financial statements describes the impact, in the case of the
Company, of differences between accounting principles generally accepted in
Canada and the United States. All amounts are stated in US dollars unless
otherwise indicated. C$ refers to Canadian dollars. References to years are to
fiscal years ended March 31.
Factors That May Affect Future Financial Performance
- ----------------------------------------------------
The Company's quarterly and annual operating results are affected by various
trends and factors including, but not limited to, competition, the Company's
success in developing, introducing and gaining market acceptance for new
products, its ability to obtain sufficient and timely additional sources of
financing, the timing of orders from customers, the levels of inventory held by
resellers and distributors, as well as factors such as changes in general
economic conditions or conditions in the specific markets for the Company's
products, government regulation, tariffing of carrier services, and industry
consolidation.
The networking industry is intensely competitive and subject to rapid change. As
the market for the Company's products continues to develop, additional
competitors are expected to enter the market and competition is anticipated to
intensify. This may result in price reductions and margin erosion. Many of the
Company's current and potential competitors have larger technical staffs, more
established and larger marketing and sales organizations, and significantly
greater financial resources than does the Company. The Company also competes
with other data networking vendors for access to distribution channels.
The Company's success is substantially dependent upon its ability to manage
changes in its operations. Over the past several years the Company has
undertaken significant restructuring activities in order to reposition the
Company in line with its strategy, reduce costs and improve competitiveness.
During the past year, examples of such changes included the establishment of new
marketing and distribution channels, the restructuring of international
operations and the outsourcing of the delivery of field service maintenance. In
addition, the successful establishment and implementation of relationships with
strategic partners and distributors is critical to the future success of the
Company. During the past year, the Company has changed the way it distributes
its products by establishing multi-tiered distribution channels and entering
into agreements with several large resellers and distributors in North America,
Europe and the Asia Pacific region. These new distribution channels, while
viewed by the Company as critical to its future success, also bring additional
new risks. These include less predictability regarding product demand and
ordering patterns, reduced gross margins on sales to indirect channels and the
time associated with reseller training and increasing awareness for the
Company's products.
<PAGE>
The Company's quarterly operating results fluctuate as a result of a number of
factors including pricing, distributor ordering patterns, product returns and
reserves, product mix, as well as the timing of new product announcements and
introductions by the Company and its competitors. The Company's revenues are
difficult to predict due to shipment patterns. A substantial portion of the
Company's expenses are fixed, and consequently any significant fluctuations in
revenue will impact earnings. Products are generally shipped as orders are
received, and accordingly, the Company operates with a relatively small backlog.
As a result, sales in any quarter are dependent on orders booked and shipped in
that quarter. A high percentage of the Company's revenues are typically earned
in the third month of each fiscal quarter and tend to be concentrated in the
latter half of that month. Accordingly, quarterly financial results will be
difficult to predict prior to the end of the quarter and a shortfall in
shipments at the end of any particular quarter may cause the results of that
quarter to fall significantly short of anticipated levels.
At the end of each quarter, the Company's distributors typically hold
significant inventories of the Company's products. The Company has established
reserves for returns based on experience. New channel relationships introduce
additional uncertainty in this area. Setting reserves involves making judgments
about future competitive conditions, product acceptance and other factors which
by their nature involve uncertainties at the time the reserves are established.
Statements included in this Quarterly Report on Form 10-Q which are not
historical facts, including statements about the Company's beliefs and
strategies, are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 that involve risks and uncertainties
and are not guarantees of future performance. The risks described herein and in
the Company's other filings with the Securities and Exchange Commission could
affect the Company's future results and could cause such results to differ
materially from estimates expressed in any forward-looking statement included
herein.
Results of Operations - Third Quarter Ended December 28, 1996
- ---------------------------------------------------------------
The Company has been working through a period of transition for two years which
has included implementing changes in product development, services,
manufacturing and marketing and during the current fiscal year the Company has
been transforming its sales distribution model to one driven by indirect channel
sales from a primarily direct model. Difficulties experienced in the
implementation of the new sales distribution model have resulted in a
significant decrease in product revenues during the current fiscal year. While
the Company believes that the right actions have been taken to address the
problems encountered in the implementation of the sales distribution model, it
is taking longer than anticipated for the Company to realize the associated
benefits. Service revenues have also declined in the first three quarters of
1997, representing a continuation of a trend in recent quarters. This decline
has occurred as a result of lower revenues on products which the Company has
traditionally derived the majority of its service revenues.
The following table sets forth items derived from the quarterly consolidated
statements of income as a percentage of revenues for the quarter ended December
28, 1996 and for each of the preceding four quarters. The column in the table
entitled "Percentage Change Quarter 3, 1997 vs 1996" represents the percentage
change, either favourable or (unfavourable), in the dollar amount of such items
for the third quarter of 1997 compared with the third quarter of 1996.
<PAGE>
<TABLE>
<CAPTION>
Percentage
Fiscal 1996 Fiscal 1997 Change
--------------------- ------------------------------- Quarter 3
Quarter 3 Quarter 4 Quarter 1 Quarter 2 Quarter 3 1997 vs. 1996
---------- --------- --------- --------- --------- ------------
(Thousands of dollars)
<S> <C> <C> <C> <C> <C> <C>
Revenues $28,171 $32,355 $18,337 $15,227 $16,622 (41.0)%
======= ======= ======= ======= ======= =======
(Percentage of Revenues)
Revenues:
Product 68.6% 74.0% 59.5% 53.1% 60.3% (48.1)%
Service 31.4 26.0 40.5 46.9 39.7 (25.5)
------- ------- ------- ------- -------
100.0% 100.0% 100.0% 100.0% 100.0% (41.0)
======= ======= ======= ======= =======
Gross Margin:
Product 52.5% 51.8% 41.1% 27.3% 31.9% (68.5)
Service 31.1 26.6 28.5 30.8 21.3 (48.8)
Combined 45.8 45.3 36.0 29.0 27.7 (64.3)
Expenses:
Sales & marketing 28.0 25.3 39.8 50.8 50.4 (6.1)
Administration & general 7.5 5.4 12.4 14.5 14.2 (12.6)
Research & development 10.3 9.9 16.4 20.4 21.2 (21.5)
Restructuring costs - 4.7 16.4 - -
------- -------- ------- ------- -------
Income (loss) from
operations - - (49.0) (56.7) (58.1)
Interest expense (0.4) (0.1) (0.3) (0.3) (0.9)
Interest income and
foreign exchange 0.7 0.3 0.3 0.1 (0.3)
------- ------- ------- ------- -------
Net income (loss) 0.3% 0.2% (49.0)% (56.9)% (59.3)%
======= ======= ======= ======= =======
</TABLE>
<PAGE>
Revenues
- --------
The following table sets forth product and service revenues by geographic
segment for the quarter ended December 28, 1996 and for each of the preceding
four quarters. The table also includes the change in revenues, expressed as a
percentage, in the third quarter of 1997 compared to the corresponding period of
1996.
<TABLE>
<CAPTION>
Percentage
Fiscal 1996 Fiscal 1997 Change
--------------------- --------------------------------- Quarter 3
Quarter 3 Quarter 4 Quarter 1 Quarter 2 Quarter 3 1997 vs. 1996
----------- --------- --------- --------- --------- -------------
(Thousands of dollars)
<S> <C> <C> <C> <C> <C> <C>
Product Revenues:
United States $ 6,361 $ 6,432 $ 2,669 $ 2,930 $ 3,267 (48.6)%
Canada 3,474 4,479 1,408 709 1,251 (64.0)
United Kingdom 4,361 5,491 2,676 1,869 1,941 (55.5)
Holland/France 3,428 3,791 2,516 1,522 2,004 (41.5)
Other 1,702 3,742 1,648 1,052 1,566 (8.0)
------- ------- ------- ------- -------
$19,326 $23,935 $10,917 $ 8,082 $10,029 (48.1)%
======= ======= ======= ======= =======
Service Revenues:
United States $ 1,962 $ 1,790 $ 1,526 $ 1,416 $ 1,085 (44.7)%
Canada 1,690 1,607 1,316 1,454 1,315 (22.2)
United Kingdom 3,074 3,083 2,810 2,727 2,798 (9.0)
Holland/France 2,119 1,940 1,768 1,548 1,395 (34.2)
------- ------- ------- ------- -------
$ 8,845 $ 8,420 $ 7,420 $ 7,145 $ 6,593 (25.5)%
======= ======= ======= ======= =======
</TABLE>
The following table sets forth, for the thirty-nine weeks ended December 28,
1996 and for each of the two preceding full fiscal years, product revenues by
geographic segment and product group expressed as a percentage of total product
revenues. These amounts have been calculated assuming constant rates of exchange
in the translation of foreign currency amounts to US dollars. Remote access
products primarily include internetworking products sold under the names Gandalf
Xpressway (TM), XpressStack (TM) and XpressConnnect (TM). Remote access products
represent a subset of the Company's total LAN internetworking product line. The
other three product groups shown below represent traditional product areas for
the Company which include wide area networking (WAN) backbone products; modems,
multiplexers and local connectivity products; and other products which primarily
represent third party products.
<PAGE>
Modems/
Multiplexers/
Remote WAN Local
Years ending March 31 Access Backbone Connectivity Other Total
- --------------------- ------- --------- ------------- ------- -------
1997: (Quarter 1,2 and 3)
United States 23% 3% 4% 1% 31%
Canada 7 1 4 - 12
United Kingdom 14 1 5 2 22
Holland/France 15 1 4 - 20
Other 8 3 3 1 15
--- --- --- --- ---
67% 9% 20% 4% 100%
=== === === === ===
Modems/
Multiplexers/
Remote WAN Local
Access Backbone Connectivity Other Total
------- --------- ------------- ------- -------
1996:
United States 25% 1% 5% 1% 32%
Canada 12 1 4 1 18
United Kingdom 11 2 7 3 23
Holland/France 9 1 2 2 14
Other 8 3 2 - 13
--- --- --- --- ---
65% 8% 20% 7% 100%
=== === === === ===
Modems/
Multiplexers/
Remote WAN Local
Access Backbone Connectivity Other Total
------- --------- ------------- ------- -------
1995:
United States 15% 1% 8% 4% 28%
Canada 9 2 7 1 19
United Kingdom 12 3 9 4 28
Holland/France 6 1 3 1 11
Other 7 3 2 2 14
--- --- --- --- ---
49% 10% 29% 12% 100%
=== === === === ===
Gross Margin
- ------------
The gross margin on product revenues (product revenues minus the cost of product
sales expressed as a percentage of product revenues) was 32% in the third
quarter of 1997 compared with 52% in the third quarter of 1996 and 27% in the
second quarter of 1997. During the first three quarters of 1997 the gross margin
on product revenues was adversely impacted by lower sales volumes during the
period, resulting in fixed manufacturing costs representing a larger percentage
of product revenues. The gross margin in the second and third quarters of 1997
was also adversely impacted by higher adverse manufacturing volume variances as
a result of lower production levels in order to reduce inventories from the end
of the first quarter of 1997. The significant impact in the current fiscal year
on the reported product gross margin resulting from lower sales and production
volumes reduces the comparability of gross margins between fiscal periods. The
Company does not believe that the increase in the product gross margin for the
third quarter of 1997 compared to the second quarter is indicative of a trend in
the underlying margins absent volume considerations.
<PAGE>
The gross margin on service revenues (service revenues less service expenses
expressed as a percentage of service revenues) was 21% during the quarter ended
December 28, 1996 compared to 31% during the same period a year ago. The
decrease in service margin has occurred as a result of the continuing decline in
service revenues which has more than offset the decrease in service expenses.
Service revenues declined more sharply in the third quarter of 1997 as a result
of a number of service contracts on some of the Company's traditional products
not being renewed upon expiry. Service expenses declined 15% in the third
quarter of 1997 compared with the third quarter of 1996, as a result of the
outsourcing to partners for the delivery of field service maintenance, which
occurred following the end of the third quarter of 1996.
Operating Expenses
- ------------------
Sales and marketing, and administration and general expenses were $10.7 million
in the third quarter of 1997, compared to $10.0 million in the third quarter a
year ago. The increase in these expenses has primarily occurred as a result of
the decision by the Company to increase its investment in the sales and
marketing area, as part of the continuing implementation of the Company's
indirect sales distribution model. This increased spending was partially offset
by reduced variable sales expenses in the third quarter of 1997 compared to the
third quarter a year ago, due to lower product revenues.
Research and development expenses increased by 21.5% from the third quarter of
1996 to the third quarter of 1997. The Company has increased spending on
research and development in order to accelerate the completion of certain
projects.
Since 1991, the Company has received funding of approximately $1.4 million and
$2.6 million respectively under two projects approved through the Canadian
federal government's Microelectronics and Systems Development Program ("MSDP").
While the repayment terms of the two projects differ slightly, both are tied to
future sales, with the liability to repay the funding arising from product
revenues earned following both the commercialization of the resulting technology
and completion of the MSDP project. The amount that is potentially repayable is
calculated without interest as a royalty on revenues earned in the ten years
following the project completion date and is limited to the amount of funding
received.
The Company commenced accruing royalties during 1996 upon completion of each
project. To date, royalties of approximately $1.1 million have been accrued
related to these projects. Of this amount, $0.5 million was due for payment
under the funding contracts on or before December 28, 1996. The Company intends
to initiate discussions with the Canadian federal government during the fourth
quarter of 1997 in order to seek ways to restructure the royalty payments under
the agreement. There can be no assurance at this time as to the extent to which
the Company might be successful in this regard.
Loss from Operations
- --------------------
The Company reported a loss from operations of $9.7 million on revenues of $16.6
million for the third quarter of 1997. For the third quarter of 1996 the Company
reported income from operations of $7,000 on revenues of $28.2 million.
Net Loss
- --------
The net loss for the third quarter of 1997 was $9.9 million or $0.23 per share.
Net income for the third quarter of 1996 was $92,000, or break-even on a per
share basis. The net loss for the thirty-nine weeks ended December 28, 1996 was
$27.5 million or $0.64 per share on revenues of $50.2 million. For the first
three quarters of 1996 the Company reported income of $193,000, or break-even on
a per share basis, on revenues of $84.2 million.
<PAGE>
Liquidity and Capital Resources
- -------------------------------
The Company recorded negative cash flow of $5.5 million during the third quarter
of 1997. At December 28, 1996, net bank borrowings (bank operating lines net of
cash and cash equivalents) were $0.3 million compared to a net cash position
(cash and cash equivalents net of bank operating lines) of $5.2 million at
September 28, 1996 and $13.6 million at March 31, 1996. Operating losses during
the first three quarters of 1997 have resulted in the Company experiencing
negative cash flow from operations (cash applied to operations) of $13.9
million. Cash applied to operations for the thirty-nine weeks ended December 28,
1996 represents a lower amount than the loss from operations reported on the
consolidated statement of income during the same period as a result of
reductions in working capital levels and in particular accounts receivable. The
Company's ability to mitigate the cash impact of an operating loss in any future
quarter in this way is dependent on its ability to further reduce working
capital levels beyond those that existed at December 28, 1996. The Company
anticipates that it will report negative cash flow from operations for the
fourth quarter of 1997.
At December 28, 1996, the Company's authorized bank lines totaled $21.3 million
under two committed credit facilities provided by a Canadian chartered bank
which bear interest at the bank's prime rate plus 1.75% or equivalent. The
authorized credit lines are secured by certain of the accounts receivable,
inventories and other assets of the Company. The amount available for borrowing
at any time is based on margin formulas relating to levels of accounts
receivable, inventories and other bank covenants. Based on the margin formulas,
$10.8 million was available to the Company at December 28, 1996 and $7.5 million
was being utilized. Cash and cash equivalents held as of that date represented a
further $7.2 million of cash resources available to the Company. Cash and cash
equivalents and unused credit lines totaled $10.5 million at December 28, 1996.
In view of the Company's current bank borrowing levels and anticipated
additional demands on cash and credit resources relating to short-term operating
requirements, the Company believes that it is necessary to seek and complete
arrangements for additional sources of equity and or debt financing during the
fourth quarter of 1997. The Company has recently selected certain investment
banking firms to assist in pursuing strategic initiatives including raising
additional financing. There can be no assurance at this time that the Company
will be successful in arranging such additional financing in a sufficient amount
or within the time frame which may be required to meet operating cash
requirements and considering any constraints that may be imposed on the
utilization of the bank operating lines.
<PAGE>
Financial covenants contained in one of the bank credit agreements measure on a
quarterly basis, among other things, the tangible net worth, the ratio of
liabilities to tangible net worth and the current ratio of the Company. As a
result of the net loss for the third quarter of 1997 and the associated impact
on the consolidated balance sheet, the Company was not in compliance with these
financial covenants at December 28, 1996. The breach of these financial
covenants constitutes an event of default under the terms of the agreements for
which the Company has obtained a waiver from the bank. This waiver is
conditional upon the Company not borrowing an amount in excess of the amount
determined by margin formulas during the period up to March 31, 1997 and
progress on the part of the Company, to the satisfaction of the bank, in its
efforts to raise additional financing. At March 31, 1997 the Company expects
that it will again not be in compliance with these quarterly financial covenants
and will have to seek a further waiver from the bank. While to date the Company
has been successful in obtaining a waiver or amendment from the bank under such
circumstances, there can be no assurance that the Company will continue to be
successful in this regard. If the current waiver ceased to be effective for
reasons of noncompliance by the Company or, following March 31, 1997, the
Company was unable to obtain a further waiver from the bank this would give the
bank the right to terminate the facilities and require repayment of the
outstanding borrowings on demand. While the Company currently anticipates that
the credit facilities will remain available to the Company it believes that the
bank's future course of action will be dependent, among other things, on the
outcome of the Company's efforts to raise additional financing.
The Company anticipates taking actions during the fourth quarter of 1997 which
would reduce operating costs in future periods in order to reduce the Company's
break even level for revenues with the intention of reducing cash applied to
operations after the end of 1997. These actions would result in the Company
recording a charge for restructuring in the final quarter of 1997 and would
likely further increase pressure in the short-term, on cash and credit resources
due to the timing of payments for certain downsizing actions.
The Company's current ratio was 1.2:1 at December 28, 1996 compared to 2.0:1 at
March 31, 1996. Accounts receivable were $15.1 million at December 28, 1996
compared to $28.7 million at March 31, 1996. The decline in accounts receivable
primarily occurred as a result of lower revenues in the third quarter of 1997
compared to the fourth quarter of 1996. Inventories were $14.1 million at
December 28, 1996 compared to $13.5 million at March 31, 1996. Lower than
anticipated product revenues in the first quarter of 1997 resulted in an
increase in inventory levels. The Company adjusted manufacturing production
levels in the second and third quarters and inventory levels have declined each
quarter since the first quarter.
<PAGE>
II - OTHER INFORMATION
- ----------------------
Item 1 - see Form 10-Q for the quarter ended September 28, 1996.
Item 6(a) - Exhibits
- --------------------
10.12 Amendment dated November 18, 1996 to Credit Agreement dated June 11, 1996
between the Royal Bank of Canada and the Company.
Item 6(b) - Report on Form 8-K
- ------------------------------
There were no reports on Form 8-K filed for the quarter ended December 28, 1996.
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.
GANDALF TECHNOLOGIES INC.
February 6, 1997 BY: s/RICHARD D. BUSTO
- ------------------------- ----------------------------
Date Richard D. Busto
Director, President, and
Chief Executive Officer
(Principal Executive Officer)
February 6, 1997 BY: s/WALTER R. MACDONALD
- -------------------------- ---------------------------
Date Walter R. MacDonald
Vice President, Finance and
Chief Financial Officer
November 18, 1996
Private & Confidential
Gandalf Technologies Inc.
130 Colonnade Road South
Nepean, Ontario
K2E 7M4
Attention: Mr. Walter R. MacDonald
Vice-President, Finance & CFO
-----------------------------
Dear Sirs:
We refer to the letter agreement dated June 11, 1996 detailing a Credit Facility
made available to Gandalf Technologies Inc. by Royal Bank of Canada (the
"Agreement"). All capitalized terms and references herein have the same meaning
as those in the Agreement.
The Bank hereby acknowledges the breach by the Borrower of Sections 23(a) and
24(h) of the agreement for the reporting period ended September 28, 1996. The
Bank hereby waives its rights in respect of the breach of Section 24(h) and
amends Section 23(a) to an amount of US $34,5000,000 for the reporting period
ended September 28, 1996.
The Bank also acknowledges receipt from the Borrower of a letter dated November
11, 1996 attaching a revised plan of operations for the fiscal quarters ending
December 28, 1996, March 31, 1997 and June 28, 1997 (the "Bank Plan").
The Bank hereby amends the Agreement has follows:
(i) Section 23(a) To maintain Tangible Net Worth on a
consolidated basis in amounts not less than those
stated in the Bank Plan for the respective fiscal
quarters ending December 28, 1996, March 31, 1997
and June 28, 1997.
(ii) Section 23(b) Not to permit its Current Ratio on
a consolidated basis to be less than that stated
in the Bank Plan for the respective fiscal
quarters ending December 28, 1996, March 31, 1997
and June 28, 1997.
(iii) Section 23(c) Not to permit its Total Liabilities
to Tangible Net Worth Ratio on a consolidated
basis to be greater than that stated in the Bank
Plan for the respective fiscal quarters ending
December 28, 1996; March 31, 1997 and June 28,
1997.
This waiver and amendment is conditional upon the following:
(i) The Borrower will provide the Bank, within 15 calendars days of
each month end with:
(a) evidence of compliance with the Margin Requirement, together
with supporting lists of accounts receivable and other
information as appropriate;
(b) consolidated, rolling sales forecast for the current fiscal
quarter;
(c) interim consolidated financial statements with
comparisons to the previous fiscal quarter.
(ii) The Borrower will pay to the Bank a risk premium equal to 1% per
annum, calculated and payable monthly in arrears, of the amount
committed under Segment 2(a) of the Credit Facility, until the
earlier of Tangible Net Worth exceeding US $40,000,000 or the
company recording net after tax profit of $1,000,000 or more in
any fiscal quarter.
(iii) Written agreement to similar terms and conditions by GDCL with
respect to a credit facility extended to GDCL by the Bank's
subsidiary in London, England.
(iv) Suspension of Segment (1) of the Credit Facility dealing with FEF
Contracts.
This letter supersedes and cancels our waiver and amendment letter dated
November 6, 1996.
All other terms and conditions of the Agreement remain unchanged.
Please confirm your acceptance by signing and returning the enclosed copy of
this letter.
Yours truly,
BY: s/L. J. (JIM) BLATTMAN
- ---------------------------
Jim Blattman
Senior Manager
Technology Banking Group
