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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year ended December 31, 2003
0-27878
(Commission File Number)
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NORTHGATE INNOVATIONS, INC.
(Exact name of registrant as specified in its charter)
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Delaware 13-3779546
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
801 S. Sentous Street
City of Industry, California 91748
(Address of principal executive offices)
(626) 923-6000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.03 par value
(Title of Class)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K: / /
Indicate by check whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes / / No /X/
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant at June 30, 2003, based on the $0.11 per share
closing price for our common stock on the OTC Bulletin Board, was approximately
$560,000.
The number of shares of the registrant's common stock outstanding as of
February 27, 2004 was 18,942,808.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information from the definitive Proxy Statement for the registrant's
2004 Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission pursuant to Regulation 14A not later than 120 days after the end of
the registrant's fiscal year, is incorporated by reference into Part III of this
Form 10-K.
Table of Contents
Page
----
PART I ................................................................................................1
ITEM 1. BUSINESS........................................................................................1
ITEM 2. PROPERTIES.....................................................................................17
ITEM 3. LEGAL PROCEEDINGS..............................................................................17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................17
PART II ...............................................................................................18
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..........................18
ITEM 6. SELECTED FINANCIAL DATA........................................................................19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..........20
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.....................................29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................................29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...........29
ITEM 9A. CONTROLS AND PROCEDURES........................................................................29
PART III ...............................................................................................30
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.............................................30
ITEM 11. EXECUTIVE COMPENSATION.........................................................................30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.30
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................................30
ITEM 14. PRINCIPAL ACCOUNT FEES AND SERVICES............................................................30
PART IV ...............................................................................................31
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K...............................31
SIGNATURES.....................................................................................34
INDEX TO EXHIBITS..............................................................................35
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS..............................................................F-1
INDEPENDENT AUDITORS' REPORTS...........................................................................F-2
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............................................................F-4
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PART I
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS
This report contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, both as amended. All statements other than statements of
historical fact are "forward-looking statements" for purposes of federal and
state securities laws, including: any projections of earnings, revenues or other
financial items; any statements of the plans, strategies and objectives of
management for future operations; any statements concerning proposed new
products, services or developments; any statements regarding future economic
conditions or performance; any statements of belief; and any statements of
assumptions underlying any of the foregoing. Forward-looking statements may
include the words "may," "will," "estimate," "intend," "continue," "believe,"
"expect," "plan" or "anticipate" and other similar words. Such forward-looking
statements may be contained in the sections "Factors Affecting Operating
Results," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business," among other places in this report.
Although we believe that the expectations reflected in our
forward-looking statements are reasonable, actual results could differ
materially from those projected or assumed. Our future financial condition and
results of operations, as well as any forward-looking statements, are subject to
change and to inherent risks and uncertainties, such as those disclosed in this
report. We do not intend, and undertake no obligation, to update any
forward-looking statement.
ITEM 1. BUSINESS
Overview
Since 1992, when our predecessor was formed, we have primarily offered
consumers personal computers and related products through distribution channels
that include television shopping networks, mail order catalog companies and
large electronic and office supply chain stores. In December 2003, an investor
group acquired a majority of our outstanding common stock and appointed a
majority of the members of our board of directors. In January and February of
2004, our new board of directors employed new members of our management team,
including a new chief executive officer. Under the direction of our restructured
management team, we began implementing a new strategic focus designed to
complement our existing business. We are now developing a business plan to
launch a hardware and software offering targeted at what we believe is an
underserved segment of the personal computer and Internet market.
We were incorporated in Delaware in May 1994. On December 2, 1999, we
completed a merger with Mcglen Micro, Inc. in which the stockholders of Mcglen
Micro acquired a majority of our outstanding shares of common stock. On December
17, 1999, we changed our name to Mcglen Internet Group, Inc.
On March 20, 2002, we completed a merger with Lan Plus Corporation, a
manufacturer of branded turnkey computer products and services. In the merger,
the shareholders of Lan Plus acquired a majority of our outstanding common
stock. In addition, upon the closing of the merger, we completed a one-for-ten
reverse stock split and changed our name to Northgate Innovations, Inc. As a
result of the merger, for financial accounting purposes, we treat the merger as
a purchase of our company by Lan Plus. Therefore, we present the historical
financial statements of Lan Plus, for comparison purposes, for all periods
presented. We have adjusted all share information contained in this report to
reflect the one-for-ten reverse stock split.
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Consumer Personal Computer Business
Our current business model is focused on offering turnkey,
build-to-order, personal computers, notebooks, accessories and software products
through television shopping networks, mail order catalog companies and large
electronic and office supply chain stores, primarily in the United States. Our
build-to-order manufacturing process is designed to enable us to achieve high
inventory turnover rates and reduced inventory levels. We also believe that,
since products are sold closer to the time they are actually manufactured, this
process gives us the ability to more rapidly incorporate new technologies and
components into our products.
Products and Services
Our personal computer business develops, manufactures, markets, sells
and supports a wide range of desktop systems, notebook computers, workstations
and network servers under the Northgate, Protek, and Netway brand names. We also
sell, resell and support a variety of additional peripherals, software and
services. We offer pre-configured computers with various memory and storage
configurations, and various operating systems and application software, as well
as our built-to-order systems. We also offer a variety of hardware components
and peripherals to complement our desktop systems, notebook computers and
network servers, including monitors, modems, graphics cards, accelerators,
CD-ROM and DVD drives, software and services. In addition, we offer numerous
hardware and Internet services, mainly through third party service providers.
Revenue Breakdown by
Product Group Year Ended December 31,
----------------------------------------------------------------------
2003 2002 2001
---------------------- ------------ --------------- ------------------
Systems $ 53,162 $ 41,061 $ 47,063
---------------------- ------------ --------------- ------------------
Barebone/bundles 5,393 3,259 222
---------------------- ------------ --------------- ------------------
Components 18,491 20,856 26,598
---------------------- ------------ --------------- ------------------
Total Revenue $ 77,046 $ 65,176 $ 73,883
---------------------- ------------ --------------- ------------------
Sales and Marketing
Our end-users are comprised primarily of private consumers, with small
and medium-sized businesses and governmental entities making up a much smaller
portion. In general, we use similar sales and marketing approaches across all of
these different customer groups, since we believe that the demand levels of
these various groups respond similarly to changes in market prices and overall
general economic conditions. We market and sell our systems primarily through
high profile distribution channels in retail, catalog, telemarketing and other
industries. We have a direct sales organization focused on selling to these
large distribution channels. We also sell through some of these channels using a
network of field manufacturers representatives. We also sell a limited number of
systems through customer-direct relationships supported by advertising, direct
mail, telephone sales and our www.accessmicro.com web site.
In the second quarter of fiscal 2002, we began marketing and selling
our personal computer products through a network of value-added resellers.
Through this program, we now have relationships with approximately 159
resellers throughout the United States. We have a dedicated sales force, with
experience in selling through resellers, supporting this sales channel. Our
arrangements with value-added
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resellers are non-exclusive, territory specific, generally cover all of our
products and provide for appropriate discounts based on a variety of factors,
including volume purchases. We support this distribution channel with our
www.northgate.com web site, which focuses on information for our reseller
program.
Research and Development
We must continuously evaluate, obtain and incorporate into our
offerings new hardware, software, storage, communications and peripherals
technologies that are developed by third parties to ensure that our products are
compatible with industry standards. Historically, we have not devoted a material
amount of our resources to direct research and development activities with
respect to our existing business. In the past three years, we have had less than
five employees dedicated to this effort. However, we maintain relationships with
many of our suppliers and other technology developers, and believe that we
benefit from the significant research and development activities conducted by
those suppliers and developers.
We believe that these relationships enable us to evaluate the latest
developments in technology, and to quickly introduce new products and new
product features to the market. We believe that our turnkey, build-to-order
manufacturing process allows us to use these relationships to deliver to our
customers these emerging technologies on a timely and more cost-effective basis.
We also believe that our relationships with our customers enable us to obtain
valuable market information, which we use to assist our suppliers in developing
new product offerings.
Manufacturing and Materials
We currently use third parties to manufacture sub-assemblies for our
desktop personal computers and to manufacture our laptop personal computers. We
perform final product assembly and quality testing at our headquarters in City
of Industry, California. Our manufacturing process consists of assembly,
functional testing and quality control of our computer systems. We use
production teams to assemble most of our desktop personal computers. We train
each member of a production team to do several tasks, which we believe increases
flexibility and efficiency. We also apply testing and quality control processes
to components, parts and sub-assemblies that we obtain from suppliers. We ship
each of our computer systems from our manufacturing facilities ready-for-use,
with an operating system and application software installed.
We maintain quality control through testing components, parts and
subassemblies at various stages in the manufacturing process. Our quality
control also includes a burn-in period for completed units after assembly,
on-going production reliability audits, failure tracking for early
identification of production and component problems and information from our
customers obtained through our direct relationships and service and support
programs. Our computer manufacturing operations have been assessed and certified
as meeting the requirements of the International Organization for
Standardization (ISO) 9002, a certification that recognizes compliance with
international standards for quality assurance.
We purchase materials, supplies and product subassemblies from a number
of vendors. Some key components included in our line of products are currently
available only from single or limited sources. In the past, we have experienced
significant price increases and limited availability of certain components that
are not available from multiple sources. We are dependent upon Microsoft
Corporation for various software products.
Like other participants in the computer manufacturing industry, we
ordinarily acquire materials and components through a combination of blanket and
scheduled purchase orders to support our
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requirements for periods averaging 90 to 120 days. At times, we have been
constrained by parts availability in meeting our product orders. From time to
time, we have obtained scarce components for somewhat higher prices on the open
market, which may have an impact on gross margins but does not disrupt
production. On occasion, we have also acquired component inventory in
anticipation of supply constraints.
Competition
The personal computer industry represents a mature segment of the
consumer electronics industry and is highly competitive, especially with respect
to pricing and the introduction of new products and new product features. We
expect competition in the personal computer industry to continue to be intense
for the foreseeable future. We believe that the principal competitive factors in
the market include price, logistics, on-line technical support and services,
call center management, Original Equipment Manufacture (OEM) relationships with
major component manufacturers, new technology, variety of products, software and
features, marketing and sales capability. Although we believe that our products
generally compete favorably with respect to such factors, we cannot guarantee
that we will compete successfully against current and potential competitors,
especially those with greater financial resources or brand name recognition.
We are considered one of the second tier personal computer
manufacturers, which include Systemax, Sys Technologies and Acer, among others.
Although we compete with these manufacturers, we also compete with a number of
large, national brand, personal computer manufacturers, including Dell, Inc.,
Gateway, Inc., Hewlett-Packard Company, Apple Computer, Inc., Sony, e-Machines
and Toshiba. These manufacturers sell their products through different
combinations of national and regional distributors, dealers, value-added
resellers, retail stores and direct sales. Most of our current competitors have
longer operating histories, significantly greater financial, technical,
marketing and other resources, significantly greater name recognition and a
substantially larger installed base of customers than we do. In addition,
because of the high volume of components that many of our competitors purchase
from their suppliers, they are able to keep their costs of supply relatively low
and, as a result, may be able to recognize higher margins on their personal
computer sales than we do. The introduction of lower-priced personal computers
combined with the brand strength, extensive distribution channels and financial
resources of the larger vendors may cause us to lose market share.
Customer Service and Technical Support
Our technical support and customer service representatives respond to a
variety of inquiries from customers, including questions concerning product
offerings, order status and post-installation hardware and software issues. We
resolve many inquiries over the telephone without the need to repair or replace
system components. When repairs are necessary, we may ship a replacement part or
system and advise customers by telephone regarding installation. Alternatively,
customers may elect to ship a system directly to us for repair. We also provide
technical support services through our web sites, www.accessmicro.com and
www.northgate.com. These services enable customers to access system-specific
information and recent software updates for many of the software programs and
drivers included with our computer systems. In addition, many of our systems are
sold with system diagnostic and repair software that has been optimized for our
products.
Significant Customers
For the year ended December 31, 2003, our sales to Staples the Office
Superstore, Inc. represented approximately 36.5% of our total net sales for the
year. We expect that we will continue to be dependent upon Staples for a
significant portion of our revenues in future periods. Our agreement with
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Staples expires at the end of 2004. The agreement is renewable annually upon
mutual agreement between Staples and us.
Management Systems
Our site management, search, customer interaction, transaction
processing and fulfillment systems consist of a combination of our own
proprietary technologies and third-party technologies. We have enhanced the
capability and scalability of our systems through the acquisition of new
third-party technologies and in-house development. In 2002, we implemented new
enterprise software for our procurement, accepting and verifying orders,
managing orders, creating customer interaction instructions, automatically
selecting fulfillment methods, assigning inventory to customer orders, managing
shipment of products to customers, recording tracking numbers and authorizing
and charging customer credit cards, with address verification.
New Product Initiative
Currently, we are developing a business plan to launch a new product
line that is complementary to our current product line, but will include
hardware, software and services designed specifically to be attractive to a
segment of the personal computer and online market that we believe is currently
underserved. In entering this untested and rapidly changing market sector, we
will face a variety of obstacles and challenges.
We believe, but can give no assurance, that there will be a significant
demand for well-designed and attractive consumer electronics products that focus
on satisfying the computing desires of our target market segment. As a result of
this demand, we hope to be able to charge a relatively higher price for our new
line of personal computers and related products, thereby increasing our margins.
We are still in the planning stages of our new growth strategy and can give no
assurance that we will achieve any of our objectives. Currently, we are
developing prototypes and conducting market testing to assess the feasibility of
our new business plan. We have no sales contracts with potential customers for
our anticipated suite of products and services.
At this early stage of our efforts with our new product initiative, and
given the dynamic nature of the market we hope to serve, we cannot be sure as to
the final form that our solutions will take. Our new products, if successfully
developed, will be the first in what we hope will be our continuing line of
business serving our new target market. We can give no assurance that any of
these efforts will be successful.
We plan to market our new product initiative through specific direct
marketing efforts that are focused on the market segment we have targeted. We
intend to expend a large portion of our sales and marketing resources on these
marketing efforts. We cannot give any assurance that any of these efforts will
be successful.
We believe that strong product development capabilities will be
essential to our new product initiative. In early 2004, we began to invest
significant time and resources in creating a structured process for undertaking
all product development projects for this initiative. After implementing our new
product initiative, we actively recruited and hired engineers and software
developers with expertise in the areas of hardware design and software. Although
we have hired some employees to perform this work, we are currently relying on
outside consulting firms to provide the bulk of these resources. We anticipate
hiring additional employees in these specialties as our new product initiative
matures. We have supported this effort with individuals and additional
management with extensive backgrounds in the consumer electronic and enterprise
software industries. We will focus our ongoing research and development efforts
on our
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new suite of consumer electronic products. We intend to expend a large portion
of our resources on these research and development efforts. We cannot give any
assurance that any of these efforts will be successful.
We intend to use third party manufacturers to produce our new line of
consumer products. We believe that it will be essential for us to have
relationships with these manufacturers to assure that we have a stable and
predictable supply of our products. We are actively seeking manufacturers to
supply our products. We have no contracts with potential suppliers for our new
suite of products.
Intellectual Property
We rely, and intend to rely, on a combination of trademark, trade
secret and copyright law and contractual restrictions to protect the proprietary
aspects of our products. We have applied to register, or intend to register,
various trademarks relating to our existing business and our new product
initiative. Although we have yet to file any patent applications for inventions
related to our new line of products, we anticipate filing patent applications
for inventions relating to that product line that we determine will be key to
our new product initiative. We can give no assurance that we will obtain any
such patents, or that any patents we obtain will be useful in our new business.
If we are not successful in obtaining the patent protection we seek, our
competitors may be able to replicate our new products and more effectively
compete with us.
In our existing business, we work closely with component suppliers and
other technology developers to stay abreast of the latest developments in
personal computer technology. We obtain patent licenses for some technologies,
some of which require significant royalty payments, when we believe those
licenses are necessary or advantageous to our business. We have entered into
non-exclusive licensing arrangements with Microsoft and other software suppliers
for various operating systems and application software that we sell with our
personal computers. Our licensing agreement with Microsoft expires on July 31,
2004.
From time to time, third parties assert exclusive patent, copyright,
trademark or other intellectual property rights to technologies or marks that
are important to our business. We evaluate each such claim relating to our
products and, if appropriate, seek a license to use the protected technology.
The licensing agreements with these parties generally do not require the
licensor to assist us in duplicating the protected technology. These agreements
also generally do not protect us or our suppliers from claims by third parties
of trade secret, copyright or other violations involved in developing or selling
these products.
Seasonality
Our operating results have been subject to seasonality and to quarterly
and annual fluctuations. Factors involved in that seasonality include new
product developments or introductions, availability of components, changes in
product mix and pricing and product reviews and other media coverage.
Historically, our sales have increased in the third and fourth calendar quarters
due, in part, to back-to-school and holiday spending, respectively. We expect
that the sales of our new product line will have similar seasonality patterns.
Employees
We had 116 full-time employees and 15 part-time employees as of
February 29, 2004, a substantial majority of whom are non-management personnel.
None of our employees are represented by a labor union. We have not experienced
any work stoppages, and we believe that we have satisfactory employee relations.
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Government Regulation
Our business is subject to regulation by various federal and state
governmental agencies. Such regulation includes the radio frequency emission
regulatory activities of the U.S. Federal Communications Commission, the
anti-trust regulatory activities of the U.S. Federal Trade Commission and
Department of Justice, the consumer protection laws of the Federal Trade
Commission, the import/export regulatory activities of the U.S. Department of
Commerce, the product safety regulatory activities of the U.S. Consumer Products
Safety Commission and environmental regulation by a variety of regulatory
authorities in each of the areas in which we conduct business.
Backlog
We do not believe that our backlog is a meaningful indicator of sales
that we can expect for any period, and there can be no assurance that our
backlog at any point in time will translate into sales in any subsequent
periods. Historically, our levels of unfilled orders for systems fluctuate
depending upon component availability, demand for products, the timing of large
volume customer orders and production schedules. Our customers frequently change
delivery schedules and orders depending on market conditions and other factors.
Factors Affecting Operating Results
There are numerous risks affecting our business, some of which are
beyond our control. An investment in our common stock involves a high degree of
risk and may not be appropriate for investors who cannot afford to lose their
entire investment. In addition to the risks outlined below, risks and
uncertainties not presently known to us or that we currently consider immaterial
may also impair our business operations. Our future operating results and
financial condition are heavily dependent on our ability to successfully
develop, manufacture and market technologically innovative solutions in order to
meet customer demands for personal computers and related products. Inherent in
this process are a number of factors that we must successfully manage if we are
to achieve positive operating results in the future. Potential risks and
uncertainties that could affect our operating results and financial condition
include, without limitation, the following:
We cannot predict our future results because we have recently
implemented a new strategic initiative and have no operating history
with that line of business.
Although we have over ten years of operating history, we have no
history operating our new business model. We began exploring our new product
initiative in December 2003. Our product initiative is still in the early
planning stage and is a new strategic focus for us. There are significant risks
and costs inherent in our efforts to undertake our new product initiative. These
include the risk that we may not be able to develop viable products, achieve
market acceptance for our proposed line of products or earn adequate revenues
from the sale of such products, that our new business model, if started at all,
may not be profitable and other significant risks related to the implementation
of a new business model described below. Our prospects must be considered in
light of the uncertainties and difficulties frequently encountered by companies
in their early stages of development. We will devote a great deal of our
resources to implementing our new product initiative. Therefore, if that
initiative is not successful, we may not be able to continue to operate our
existing business. It is possible that we will exhaust all available funds
before we reach the positive cash flow phase of our proposed business model,
which would hurt our existing business.
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We may have difficulty in raising capital because our common stock is
not traded on a recognized public market.
In order to implement our new product growth strategy, we will need to
raise significant amounts of additional capital. In April 2001, our common stock
was de-listed from trading on the Nasdaq SmallCap Market. Our common stock is
presently traded in the over-the-counter market, which is viewed by most
investors as a less desirable, and less liquid, marketplace. As a result, an
investor may find it more difficult to purchase, dispose of and obtain accurate
quotations as to the value of our common stock.
In addition, since the trading price of our common stock is less than
$5.00 per share, trading in our common stock is also subject to the requirements
of Rule 15g-9 of the Exchange Act. Our common stock is also considered a penny
stock under the Securities Enforcement Remedies and Penny Stock Reform Act of
1990, which defines a penny stock, generally, as any equity security not traded
on an exchange or quoted on the Nasdaq SmallCap Market that has a market price
of less than $5.00 per share. Under Rule 15g-9, brokers who recommend our common
stock to persons who are not established customers and accredited investors, as
defined in the Exchange Act, must satisfy special sales practice requirements,
including requirements that they:
o make an individualized written suitability determination for
the purchaser; and
o receive the purchaser's written consent prior to the
transaction.
The Securities Enforcement Remedies and Penny Stock Reform Act of 1990
also requires additional disclosures in connection with any trades involving a
penny stock, including the delivery, prior to any penny stock transaction, of a
disclosure schedule explaining the penny stock market and the risks associated
with that market. Such requirements may severely limit the market liquidity of
our common stock and the ability of purchasers of our equity securities to sell
their securities in the secondary market. For all of these reasons, an
investment in our equity securities may not be attractive to our potential
investors. Although we intend to apply to have our common stock listed on the
Nasdaq National Market or the Nasdaq SmallCap Market, there is no assurance that
we will be successful in getting such listing in the foreseeable future.
The implementation of our new product initiative is risky and
expensive, and it is possible that we may never become profitable.
Successful implementation of our new product initiative continues to
involve several risks. These risks include:
o reliance upon unproven products;
o our unproven and evolving business model;
o unknown market acceptance of our new product line and any
additional products that we may be able to develop;
o our ability to anticipate and adapt to a rapidly developing
market and to changing technologies;
o the effect of competitive pressures in the marketplace;
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o our need to structure our internal resources to support the
development, marketing and future growth of our existing and
proposed product offerings;
o uncertainties concerning our strategic direction and financial
condition;
o our need to introduce additional reliable products that meet
the demanding needs of our target market; and
o our need to enhance our business development, research and
development, product development and support organizations,
and to expand our distribution channels, to develop our new
product initiative.
In addition, although we believe that the actions that we are taking
will help us become profitable, we cannot assure you that such actions will
succeed in the long or short term.
Internal and external changes resulting from our financial condition
may concern our prospective customers, investors, suppliers and employees, and
produce a prolonged period of uncertainty, which could have a material adverse
affect on our business. Our growth strategy requires substantial changes,
including pursuing new strategic relationships, increasing our research and
development expenditures, adding employees who possess the skills we believe we
will need going forward, establishing leadership positions in what we believe
will be new high-growth markets, establishing distribution channels for our new
products and realigning and enhancing our sales and marketing departments. Many
factors may impact our ability to successfully implement our growth strategy,
including our ability to finalize agreements with other companies, sustain the
productivity of our workforce, introduce innovative new products in a timely
manner, manage operating expenses and quickly respond to, and recover from,
unforeseen events associated with our strategy.
As a result of our new growth strategy, it is extremely difficult to
forecast our future financial performance. We are now in the initial stages of
pursuing our new business plan. Therefore, we do not expect to achieve
profitability, and expect to continue to incur net losses, at least through the
end of 2004. We expect to incur significant product development, administrative
and operating expenses relating to our new product initiative in the future.
Only if we are able to successfully develop our proposed products, bring them to
market before our competitors, and gain the acceptance of our products by our
target market, will we be able to generate any significant revenues from our new
business model. It is possible that we will exhaust all available funds before
we reach the positive cash flow phase of that business model.
If we are unable to develop our new line of products and services, our
business will suffer.
We hope to develop and then deliver to market an offering of hardware,
software and services focused on a segment of the personal computer and online
market that we believe is currently underserved. If we are unsuccessful in
developing these new products, we will have no new products or services to bring
to market and, therefore, will never be able to generate revenues from our new
product initiative, and our business will suffer. Also, if we exhaust all
available funds before we can develop our new line of products and services, our
new business model will fail, and our existing business will suffer.
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The market potential for our new products is unproven, and may not
develop as we hope, which could result in our failure to achieve sales
and profits from our new product initiative.
Our business model involves competing in a dynamic, but mature, market.
Therefore, our financial performance and any future growth will depend, in large
part, upon our ability to obtain market share from existing competitors. We
intend to invest a significant portion of our resources in the market segment we
have targeted, which we anticipate will grow at a significantly higher rate than
the broader consumer electronics industry on average. The markets for consumer
electronics products are highly competitive, and we are not certain that our
target customers will widely adopt our new products. Our target customers may
not choose to use our products for technical, style, cost, support or other
reasons. If we are incorrect in our assumption that our target market is
underserved, and that market does not develop as we hope, or if our new products
and services do not meet the demand in that market, we may never achieve
significant revenues and profits from our new product initiative. We cannot be
certain that a market for our new products or services will ever emerge or be
sustainable if it does emerge. If this market does not develop, or develops more
slowly than we expect, our business, results of operations and financial
condition will be seriously harmed.
If we are unable to develop and introduce our new product line quickly,
our business will suffer.
The market for consumer electronics products is characterized by rapid
technological change, frequent new product introductions and changes in customer
requirements. We believe that we have identified a segment of the personal
computer market that is currently underserved. Therefore, our success will
depend upon our ability to develop and introduce our new products in a timely
manner and to gain market acceptance of any products developed, before a
competitor can introduce products aimed at our target market segment. In
developing our new line of products, we have made, and will continue to make,
assumptions with respect to which features and performance criteria our target
customers will require. If we implement features and performance criteria that
are different from those required by our target customers, market acceptance of
our products may be significantly reduced or delayed and our business would be
seriously harmed.
Competition in the personal computer market may reduce the demand for,
or price of, our products.
We are considered one of the second tier personal computer
manufacturers, which include Systemax, Sys Technologies and Acer, among others.
Although we compete with these manufacturers, we also compete with a number of
large, national brand, personal computer manufacturers, including Dell, Inc.,
Gateway, Inc., Hewlett-Packard Company, Apple Computer, Inc., Sony, e-Machines
and Toshiba. We may also face additional competition from new entrants into the
personal computer market that we have not yet identified. The market for
personal computers and related products is highly competitive, and we expect
competition to intensify in the future. Our competitors may introduce new
competitive products aimed at the same markets targeted by our line of products.
These products may have better performance, lower prices and broader acceptance
than our products. Competition may reduce the overall market for our products.
Most of these current and potential competitors have longer operating
histories, greater name recognition, larger customer bases and significantly
greater financial, technical, sales, marketing and other resources than we do.
In addition, because of the higher volume of components that many of our
competitors purchase from their suppliers, they are able to keep their costs of
supply relatively low and, as a result, may be able to recognize higher margins
on their personal computer sales than we do. Many
10
of our competitors may also have existing relationships with the resellers who
we use to sell our products, or with our potential customers. This competition
may result in reduced prices, reduced margins and longer sales cycles for our
products. The introduction of lower-priced personal computers, combined with the
brand strength, extensive distribution channels and financial resources of the
larger vendors, would cause us to lose market share and would reduce our margins
on those personal computers we sell. If any of our larger competitors were to
commit greater technical, sales, marketing and other resources to our markets,
our ability to compete would be adversely affected.
We are dependent on Staples for a substantial portion of our revenues.
We are dependent upon our relationship with Staples for a substantial
portion of our existing and anticipated revenues. For the year ended December
31, 2003, sales to Staples represented approximately 36.5% of our total net
sales for the year. We expect that we will continue to be dependent upon Staples
for a significant portion of our revenues in future periods. As a result of this
concentration of sales, our business, operating results or financial condition
would suffer as a result of the termination of, or an adverse change in, our
relationship with Staples. In addition, we cannot assure you that our
relationship with Staples will continue, or if continued, will not decrease in
any future period. Staples may also use this concentration of sales to negotiate
lower prices for our products, which would result in lower margins on the
products we sell to Staples. Our agreement with Staples expires at the end of
2004. The agreement is renewable annually upon mutual agreement between Staples
and us. Therefore, we cannot assure you that we will generate significant
revenues in future periods from Staples. The loss of all or any significant part
of our relationship with Staples would seriously harm our business.
We will not be able to develop or continue our business if we fail to
attract and retain key personnel.
Our future success depends on our ability to attract, hire, train and
retain a number of highly skilled employees and on the service and performance
of our senior management and other key personnel. The loss of the services of
our executive officers or other key employees could adversely affect our
business. Competition for qualified personnel possessing the skills necessary
for success in the competitive consumer electronics industry is intense, and we
may fail to attract or retain the employees necessary to execute our business
model successfully. Because we have experienced operating losses, and because
our common stock is not traded on a recognized national market, we may have a
more difficult time in attracting and retaining the employees we need. Our
relationships with most of these key employees are "at will." Moreover, we do
not have "key person" life insurance policies covering any of our employees.
Some members of our management team have joined us only recently. Our
success depends to a significant degree upon the continued contributions of our
key management, business development and marketing, engineering, research and
development and other personnel, many of whom would be difficult to replace. In
particular, we believe that our future success is highly dependent on Kent A.
Savage, our chief executive officer.
The brand for our new product initiative may not achieve the broad
recognition necessary to grow our customer base.
We believe that recognition and a favorable perception of our new
products and services by our target market is essential to the success of our
new product initiative. If we are unsuccessful in establishing or maintaining a
favorable perception of our products and services, we may not be able to grow
our customer base. Our success in promoting and maintaining the brand that we
use in connection with the new business model, will depend largely on:
11
o the success of our brand-enhancement strategy, including
marketing and advertising, promotional programs and public
relations activities;
o the quality and ease-of-use of our products, services and
applications;
o our ability to provide high quality customer service; and
o our ability to enhance and improve the quality and features of
our products and services.
We cannot assure you that we will be able to achieve success in any of
these areas. In addition, in order to attract and retain customers and to
promote and maintain our brands, we will need to substantially increase our
marketing expenditures. If we incur excessive expenses in promoting and
maintaining our brands, our financial results could be seriously harmed.
If we are unable to acquire key components or are unable to acquire
them on favorable terms, our business will suffer.
Some key components included in our line of products are currently
available only from single or limited sources. In addition, some of the
suppliers of these components are also supplying certain of our competitors. We
cannot be certain that our suppliers will be able to meet our demand for
components in a timely and cost-effective manner. We expect to carry little
inventory of some of our products and product components, and we will rely on
our suppliers to deliver necessary components to our contract manufacturers in a
timely manner based upon forecasts we provide. We may not be able to develop an
alternate source of supply in a timely manner, which could hurt our ability to
deliver our products to our customers. If we are unable to buy these components
on a timely and a cost-efficient basis, we may not be able to deliver products
to our customers, or the margins we receive for our products may suffer, which
would negatively impact our future financial performance and, in turn, seriously
harm our business.
We purchase a substantial portion of our products from a single
manufacturer. Purchases from this manufacturer accounted for more than 11% of
our aggregate merchandise purchases for 2003. We have no long-term contracts or
arrangements with this manufacturer, or our other suppliers, that guarantee the
availability of components. If we lose our relationship with this manufacturer,
we may not be able to find an alternate supplier on a timely basis, or on
reasonable terms.
At various times, some of the key components for our products have been
in short supply. Delays in receiving components would harm our ability to
deliver our products on a timely basis. In addition, because we expect to rely
on purchase orders rather than long-term contracts with our suppliers, we cannot
predict with certainty our ability to procure components in the longer term. If
we receive a smaller allocation of components than is necessary to manufacture
products in quantities sufficient to meet our customers' demand, those customers
could choose to purchase competing products.
Our reliance on third parties to manufacture and assemble our products
could cause a delay in our ability to fill orders, which might cause us
to lose sales.
We currently use third parties to manufacture sub-assemblies of our
products and we purchase our components on a purchase order basis. We expect to
continue this method of procurement indefinitely, at least with respect to our
existing business. If we cannot continue our arrangement with our contract
manufacturers, and if we cannot establish an arrangement with at least one
contract manufacturer who agrees to manufacture our sub-assemblies on terms
acceptable to us, we may not be able to produce and ship our products, and our
business will suffer. If we fail to manage our relationships with our contract
manufacturers effectively, or if they experience delays, disruptions or quality
control
12
problems in their manufacturing operations, our ability to ship products to our
customers could be delayed.
The absence of dedicated capacity with our contract manufacturers means
that, with little or no notice, they could refuse to continue manufacturing, or
increase the pricing of, some or all of our products. Qualifying new contract
manufacturers and commencing volume production would be expensive and
time-consuming. If we are required or choose to change contract manufacturers,
we could lose revenues and damage our customer relationships.
Our reliance on third-party manufacturers also exposes us to the
following risks that are outside our control:
o unexpected increases in manufacturing and repair costs;
o interruptions in shipments if one of our manufacturers is
unable to complete production;
o inability to control delivery schedules;
o unpredictability of manufacturing yields; and
o inability of a manufacturer to maintain the financial strength
to meet our procurement and manufacturing needs.
We may not be able to compete effectively if we are not able to protect
our intellectual property.
We rely, and intend to rely, on a combination of trademark, trade
secret and copyright law and contractual restrictions to protect the proprietary
aspects of our products. We have applied to register, or intend to apply to
register, various trademarks relating to our existing business and our new
product initiative. Although we have yet to file any patent applications for
inventions related to our new line of products, we anticipate filing patent
applications for inventions relating to that product line which we determine
will be key to our new product initiative. If we are not successful in obtaining
the patent protection we need, our competitors may be able to replicate our
technology and compete more effectively against us. We also enter, and plan to
continue to enter, into confidentiality or license agreements with our
employees, consultants and other parties with whom we contract, and control
access to and distribution of our software, documentation and other proprietary
information. The legal protections described above would afford only limited
protection. Unauthorized parties may attempt to copy aspects of our products, or
otherwise attempt to obtain and use our intellectual property. Monitoring
unauthorized use of our products will be difficult, and the steps we have taken
may not prevent unauthorized use of our technology, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as in
the United States.
Undetected product errors or defects could result in loss of revenues,
delayed market acceptance and claims against us.
We offer a warranty on all of our products, allowing the end user to
have any defective unit repaired or to receive a replacement product within a
certain period after the date of sale. Our products may contain undetected
errors or defects. If one of our products fails, we may have to replace all
affected products without being able to record any revenue for the replacement
units, or we may have to refund the purchase price for the defective units. Some
errors are discoverable only after a product has been
13
installed and used by end users. Any errors discovered after our products have
been widely used could result in loss of revenues and claims against us.
If we are unable to fix errors or other problems that later are
identified after installation, in addition to the consequences described above,
we could experience:
o failure to achieve market acceptance;
o loss of customers;
o loss of market share;
o diversion of development resources;
o increased service and warranty costs; and
o increased insurance costs.
If we fail to predict our manufacturing requirements accurately, we
could incur additional costs or experience manufacturing delays, which
could reduce our gross margins or cause us to lose sales.
We provide forecasts of our demand to our contract manufacturers prior
to the scheduled delivery of products to our customers. If we overestimate our
requirements, our contract manufacturers may have excess component inventory,
which would increase our costs. If we underestimate our requirements, our
contract manufacturers may have an inadequate component inventory, which could
interrupt the manufacturing of our products and result in delays in shipments
and revenues. In addition, lead times for materials and components that we order
vary significantly and depend on factors such as the specific supplier, contract
terms and demand for each component at a given time. We may also experience
shortages of components from time to time, which also could delay the
manufacturing of our products or increase the costs of our products.
We could become subject to litigation regarding intellectual property
rights that could be costly and result in the loss of significant
rights.
In recent years, there has been a significant increase in litigation in
the United States involving patents and other intellectual property rights. In
the future, we may become a party to litigation to protect our intellectual
property or to defend against an alleged infringement by us of another party's
intellectual property. Claims for alleged infringement and any resulting
lawsuit, if successful, could subject us to significant liability for damages
and invalidation of our intellectual property rights. These lawsuits, regardless
of their success, would likely be time-consuming and expensive to resolve and
would divert management time and attention. Any potential intellectual property
litigation could also force us to do one or more of the following:
o stop or delay selling, integrating or using products that use
the challenged intellectual property;
o obtain from the owner of the infringed intellectual property
right a license to sell or use the relevant technology, which
license might not be available on reasonable terms, or at all;
or
o redesign the products that use that technology.
14
If we are forced to take any of these actions, our business might be
seriously harmed. Our business insurance may not cover potential claims of this
type or may not be adequate to indemnify us for all liability that could be
imposed.
The inability to obtain any third-party license required to develop new
products and product enhancements could seriously harm our business,
financial condition and results of operations.
From time to time, we are required to license technology from third
parties to develop new products or product enhancements. Third-party licenses
may not be available to us on commercially reasonable terms, or at all. Our
inability to obtain any third-party license necessary to develop new products or
product enhancements could require us to obtain substitute technology of lower
quality or performance standards, or at greater cost, which could seriously harm
our business, financial condition and results of operations.
Our officers and directors own a large percentage of our outstanding
stock and could significantly influence the outcome of actions.
Glenbrook Group, LLC, an entity controlled by members of our board of
directors, owned approximately 50.1% of our outstanding stock as of February 29,
2004. Our executive officers, directors and entities affiliated with them,
including Glenbrook Group and our employee stock ownership plan, in the
aggregate, beneficially own approximately 78.0% of our outstanding stock as of
February 29, 2004. These stockholders, if acting together, would be able to
determine all matters requiring approval by our stockholders, including the
election of directors and the approval of mergers or other business combination
transactions.
Shares of common stock eligible for public sale could cause our stock
price to decline.
The market price of our common stock could decline as a result of sales
by our existing stockholders of a large number of shares of our common stock in
the market, or the perception that such sales could occur. This circumstance may
be more significant because of the relatively low volume of our common stock
that is traded on any given day. All of our outstanding common stock that was
issued in private placements prior to December 2003 may currently be resold in
reliance on Rule 144 of the Securities Act. We have the obligation to file a
registration statement registering the resale of the shares of our common stock
issued in our December 2003 private placement, and the shares purchased from our
former majority shareholder, on or before April 7, 2004, and that registration
statement must be declared effective prior to May 22, 2004, or June 21, 2004 if
the registration statement is subject to review by the Securities Exchange
Commission. Such registration may result in additional shares being sold in the
market, which may have a negative impact on the market price of our common
stock.
We may be unable to obtain the additional capital required to grow our
business, which could seriously harm our proposed business. If we raise
additional funds, our current stockholders may suffer substantial
dilution.
As of December 31, 2003, we had approximately $464,000 in cash and cash
equivalents on hand. We currently do not have a traditional line of credit with
a commercial bank. We may need to raise additional funds at any time and, given
our history, we cannot be certain that we will be able to obtain additional
financing on favorable terms, if at all. Due to the recent volatility of the
U.S. equity markets, particularly for smaller technology companies, we may not
have access to new capital investment when we need to raise additional funds.
15
Our future capital requirements will depend upon several factors,
including whether we are successful in developing our products, and our level of
operating expenditures. Our expenditures are likely to rise as we continue our
technology and business development efforts. If our capital requirements vary
materially from those we currently plan, we may require additional financing
sooner than anticipated. If we cannot raise funds on acceptable terms, we may
not be able to develop our new products and services, take advantage of future
opportunities or respond to competitive pressures or unanticipated requirements,
any of which could have a material adverse effect on our ability to develop and
grow our business.
Further, if we issue equity securities, our existing stockholders will
experience dilution of their ownership percentages, and the new equity
securities may have rights, preferences or privileges senior to those of our
common stock. If we do not obtain additional funds when needed, we could quickly
cease to be a viable going concern.
We do not intend to declare dividends and our stock could be subject to
volatility.
We have never declared or paid any cash dividends on our common stock.
We presently intend to retain all future earnings, if any, to finance the
development of our business and do not expect to pay any dividends on our common
stock in the foreseeable future.
The market price of our common stock may fluctuate significantly in
response to a number of factors, some of which are beyond our control,
including:
o variations in the magnitude of our losses from operations from
quarter to quarter;
o changes in market valuations of companies in the consumer
electronics industry;
o changes in the dynamics of the market segment that we are
targeting with our new product initiative;
o announcements by us or our competitors of new technology,
products, services, significant contracts, acquisitions,
strategic relationships, joint ventures, capital commitments
or other material developments that affect our prospects and
our relative competitive position in our prospective markets;
o our inability to locate or maintain suppliers of components of
our line of consumer electronics products at prices that will
allow us to attain profitability;
o product or design flaws, or our inability to bring functional
products to market, product recalls or similar occurrences, or
failure of a substantial market to develop for our planned
products;
o additions or departures of key personnel;
o sales of capital stock in the future;
o stock liquidity or cash flow constraints; and
o fluctuations in stock market prices and volume, which are
particularly common for the securities of highly volatile
technology companies pursuing untested markets and new
technologies.
16
ITEM 2. PROPERTIES
Our principal property consists of our headquarters located in a leased
facility (approximately 78,000 square feet) at 801 S. Sentous Street, City of
Industry, California. We believe that our present facilities are adequate for
our current needs.
ITEM 3. LEGAL PROCEEDINGS
On or about December 16, 2002, the Pension and Welfare Benefits
Administration of the U.S. Department of Labor informed us that they had
selected our employee stock ownership plan for review. The Department of Labor
has raised issues regarding the December 1999 transaction between our former
chief executive officer and majority stockholder and the Lan Plus, Inc. [sic]
Employee Stock Ownership Plan. In the December 1999 transaction, our former
chief executive officer sold shares of our preferred stock to the plan in
connection with the establishment the plan. The Department of Labor has
indicated that this transaction may have been a prohibited transaction because
the purchase price of the shares may have been above fair market value at the
time of the transaction, which would require the unwinding or correction of the
transaction. Although our former chief executive officer is primarily
responsible for remedying any prohibited transaction, we may have some liability
as a co-fiduciary of the plan. However, our former chief executive officer has
agreed to indemnify us against any costs or damages incurred by us in connection
with the Department of Labor investigation. We intend to cooperate with the
Department of Labor in connection with its review of our employee stock
ownership plan, and to bring such review to conclusion as quickly as possible.
At this time, we are not involved in any other legal proceedings that
our management currently believes would be material to our business, financial
condition or results of operations. We could be forced to incur material
expenses with respect to these legal proceedings, and in the event there is an
outcome in any that is adverse to us, our financial position and prospects could
be harmed.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is quoted on the Over-the-Counter Bulletin Board under
the symbol "NGTE". Prior to March 28, 2002, our common stock was quoted on the
Over-the-Counter Bulletin Board under the symbol "MIGS". Effective March 28,
2002, we implemented a one-for-ten reverse stock split in connection with our
merger with Lan Plus Corporation and, on that date, every ten shares of common
stock outstanding were converted into one share of common stock.
The following table shows the high and low daily closing sale prices
per share of our common stock on the Over-the Counter Bulletin Board for each
quarterly period within the two most recent fiscal years. We have adjusted all
of the price information to reflect the one-for-ten reverse stock split as if it
had taken place on December 31, 2001.
Price Range
-----------
Quarter Ending High Low
- -------------- ---- ---
March 31, 2002................................... $2.00 $0.50
June 30, 2002.................................... 1.01 0.17
September 30, 2002............................... 0.90 0.08
December 31, 2002................................ 0.51 0.16
March 31, 2003................................... 0.25 0.11
June 30, 2003.................................... 0.25 0.12
September 30, 2003............................... 0.25 0.07
December 31, 2003................................ 1.35 0.11
As of February 29, 2004, there were approximately 120 holders of record
of our common stock, and the closing price on the OTC Bulletin Board was $0.95.
We have not declared cash dividends on our common stock since our
inception. Our board of directors intends to retain any of our earnings to
support operations and to finance expansion and does not intend to pay cash
dividends on our common stock in the foreseeable future. Any future
determinations as to the payment of dividends will be at the discretion of our
board of directors, and will depend on our financial condition, results of
operations, capital requirements, and such other factors as our board of
directors deems relevant.
Recent Sales of Unregistered Securities
On December 9, 2003, we sold 4,000,000 shares of our common stock to
Glenbrook Group, LLC for $0.25 per share, or a total of $1 million, in cash. In
connection with that offering, we also entered into a consulting agreement with
J&M Interests, LLC, a controlling member of Glenbrook, under which we agreed to
issue to J&M Interests warrants to purchase 2.5 million shares of our common
stock for $0.50 per share. The warrants, which are exercisable over a five-year
period, was consideration for consulting services provided to us by J&M
Interests over the six-month period following the date of issuance. The offering
to Glenbrook and J&M Interests was exempt from registration under the Securities
Act pursuant to Section 4(2) of that act and Regulation D promulgated by the
Securities Exchange Commission.
In March 2002, we entered into a corporate consulting agreement with
Investor Relation Resources. In exchange for various corporate consulting and
public relations services, we agreed to issue 10,000 shares of our common stock.
We valued these shares at the market price on the date of the agreement, $1.00
per share. These shares were not registered under the Securities Act pursuant to
Sectiuon 4(2) of the Securities Act.
18
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our audited financial statements and the notes
thereto included elsewhere in this report. The consolidated balance sheet data
as of December 31, 2003 and 2002 and the consolidated statement of operations
data for the years ended December 31, 2003, 2002 and 2001 set forth below are
derived from, and qualified by reference to, our audited financial statements
appearing elsewhere in this annual report. The consolidated balance sheet data
for the years ended December 31, 2001, 2000 and 1999 and the consolidated
statement of operations data for the years ended December 31, 2000 and 1999 are
derived from audited consolidated financial statements not included herein.
Statements of Operations Data: Years ended December 31,
2003 2002 2001 2000 1999
-------------- ------------- ---------------- --------------- ------------
(in thousands, except per share data)
Net sales........................ $ 77,046 $ 65,176 $ 73,883 $ 69,101 $ 87,158
Cost of sales.................... 72,790 58,650 64,872 60,326 76,845
-------------- ------------- ---------------- --------------- ------------
Gross profit..................... 4,256 6,526 9,011 8,775 10,313
Operating expenses............... 8,724 8,032 7,273 7,700 10,176
-------------- ------------- ---------------- --------------- ------------
Income (loss) from operations.... (4,468) (1,506) 1,738 1,075 137
Other (income) expense........... 330 268 (217) 202 (282)
-------------- ------------- ---------------- --------------- ------------
Income (loss) before income
taxes............................ (4,798) (1,774) 1,955 873 419
Provision (benefit) for income
taxes............................ (79) 489 467 358 173
-------------- ------------- ---------------- --------------- ------------
Net income (loss)................ $ (4,719) $(2,263) $ 1,488 $ 515 $ 246
============== ============= ================ =============== ============
Basic income (loss) per common
share............................ $ (0.31) $ (0.16) $ 0.15 $ 0.05 $ 0.02
Fully-diluted income (loss) per
common share..................... $ (0.31) $ (0.16) $ 0.13 $ 0.05 $ 0.02
As of December 31,
2003 2002 2001 2000 1999
-------------- ------------- ---------------- --------------- ------------
(in thousands, except per share data)
Balance Sheet Data:
Cash and cash equivalents........ $ 464 $ 1,983 $ 8,555 $ 2,884 $ 1,307
Working capital.................. 2,133 3,239 5,245 3,836 5,483
Total assets..................... 15,397 15,183 24,091 13,913 20,775
Long-term debt................... 1,355 9,263 9,263 9,880 11,303
Stockholders' equity (deficit)... 5,061 (966) (3,238) (5,609) (5,412)
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the section "Selected Financial Data" and the financial statements and
related notes included elsewhere in this report.
The information contained below may be subject to risk factors. We urge
you to review carefully the section "Factors Affecting Operating Results" in
this report for a more complete discussion of the risks associated with an
investment in our securities. See "Special Note on Forward-Looking Statements
and Risk Factors" above under Item 1.
Executive Overview
Since 1992, when our predecessor was formed, we have primarily offered
consumers personal computers and related products through distribution channels
that include television shopping networks, mail order catalog companies and
large electronic and office supply chain stores. In December 2003, an investor
group acquired a majority of our outstanding common stock and appointed a
majority of the members of our board of directors. In January and February of
2004, our new board of directors employed new members of our management team,
including a new chief executive officer. Under the direction of our restructured
management team, we began implementing a new strategic focus designed to
compliment our existing business. We are now developing a business plan to
launch a hardware and software offering targeted at what we believe is an
untapped segment of the personal computer and Internet market.
On March 20, 2002, we completed a merger with Lan Plus Corporation, a
manufacturer of both private-label and branded turnkey computer products and
services. In that merger, the shareholders of Lan Plus acquired approximately
75% of our outstanding common stock as of that date. In addition, upon the
closing of the merger, we completed a one-for-ten reverse stock split and
changed our name from Mcglen Internet Group, Inc. to Northgate Innovations, Inc.
As a result of the merger, for financial accounting purposes, we treat the
merger as a purchase of us by Lan Plus. Therefore, we present the historical
financial statements of Lan Plus for comparison purposes for all periods
presented.
In the consumer electronics industry, and particularly with respect to
the distribution of personal computers, financial performance is closely tied to
the ability of the distributor to receive adequate gross profit margins. Since
our operating expenses are relatively non-variable, we must increase our gross
margins in order to generate more income, and cash. Competition has driven down
the selling prices for personal computers. Due primarily to the competitive
pressures on our selling prices, over the last two fiscal years we have
experienced increasing pressure on our gross profit margins, which have dropped
from 12.2% in 2001 to 5.5% in 2003. As a result, we have also experience
operating losses and net losses in each of the past two fiscal years. These
losses have been the primary reason for a decrease in our cash and cash
equivalents from approximately $8.6 million at the end of 2001 to approximately
$464,000 at the end of 2003. We expect that there will be continued pressure on
our margins in the foreseeable future.
In order to improve our gross profit margins, we have adopted our new
product initiative to try to decrease the competitive pressures on our margins.
Our new product initiative is designed to increase demand for our products, so
that we can charge a higher price for, and thereby increase the profit margin
on, those products. If we are unsuccessful in increasing the demand for our new
products, resulting in a higher price for those products, we will probably not
be successful in improving our profit margins. We are also trying to increase
the profit margins on both our new products and our existing product line by
lowering our component costs, which decreases our cost of goods sold. However,
lowering component
20
costs has proven difficult in the past. If we cannot improve our margins through
our new product initiative, or by lowering our component costs, our financial
performance is likely to continue to suffer in 2004 and beyond.
Critical Accounting Policies and Estimates
Management's discussion and analysis of financial condition and results
of operations is based upon our financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States
of America. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities
and expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, we evaluate our estimates, including those related to our
revenue recognition, deferred taxes, impairment of long-lived assets and
inventory. We base our estimates on historical experience and on various other
assumptions that we believe are reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates.
Our critical accounting policies are as follows:
Revenue Recognition. We derive revenue primarily from sales of our
personal computers, and to a lesser extent, from software, peripherals and
accessories. Generally, we will recognize revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable and
collection is probable. We provide for estimated costs of doubtful accounts and
product warranties as a reduction in revenue at the time we recognize revenue.
Our estimate of costs of doubtful accounts is based upon our historical
collection experience. If our collections decrease due to the deterioration of
the financial condition of our customers, or otherwise, we would have to
increase the doubtful account allowance, which would reduce revenues. Securities
and Exchange Commission Staff Accounting Bulletin No. 101 - Revenue Recognition
in Financial Statements requires us to estimate returns and warranty expenses
prior to recognizing revenue. While certain of the products we sell are covered
by third party manufacturer warranties, we may have products returned by
customers the costs of which we may not be able to recover from the
manufacturer. Returns of this nature have been immaterial in the past; however,
should actual product failure rates increase, or if the manufacturers go out of
business or refuse to honor their warranty obligations, we may be forced to
cover these warranty costs and the costs may differ from our estimates. We will
record discounts provided to resellers for achieving purchasing targets as a
reduction of revenue on the date of sale.
Vendor Rebates. We earn rebates from our vendors that are based on
various quantitative contract terms. Amounts we expect to receive from vendors
relating to the purchase of merchandise inventories are recognized as a
reduction of cost of goods sold at the time the merchandise is sold. If the
amounts of those rebates we actually receive are less than we expected, our cost
of sales will be understated for the period covered. We record rebates received
that represent a reimbursement of incremental costs, such as advertising, as a
reduction to the related expense in the period that the related expense is
incurred. We have several controls in place that we believe allow us to ensure
that these amounts are recorded in accordance with the terms of the applicable
contracts. Should the vendors paying the rebates reach different judgments
regarding the terms of these contracts, they may seek to recover all or a
portion of the rebates from us.
Deferred Taxes. As part of the process of preparing our financial
statements, we are required to estimate our income taxes. This process involves
estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which
are included within our
21
balance sheet. We must then assess the likelihood that our deferred tax assets
will be recovered from future taxable income and to the extent we believe that
recovery is not likely, we must establish a valuation allowance. To the extent
we establish a valuation allowance or increase this allowance in a period, we
must include an expense within the tax provision in our statement of operations.
Significant judgment involving multiple variables is required in
determining our deferred tax assets and liabilities and any valuation allowance
recorded against our net deferred tax assets. In assessing the potential
realization of deferred tax assets, we consider whether it is more likely than
not that some portion or all of the deferred tax assets will be realized. The
ultimate realization of deferred tax assets is dependent upon achieving future
taxable income during the period in which our deferred tax assets are
recoverable. If our estimates regarding our future taxable income prove to be
incorrect, we may have to write down the value of the deferred tax assets.
Impairment of Long-Lived Assets. We evaluate the recoverability of our
long-lived assets and review these assets for recoverability when events or
circumstances indicate a potential impairment. Factors we consider important
that could trigger an impairment review include the following:
o significant underperformance relative to historical or
projected operating results;
o significant changes in the manner or use of the assets or the
strategy for our overall business; and
o significant negative industry or economic trends.
When we determine that the carrying value of these assets may not be
recoverable based on the existence of one or more of the above indicators of
impairment, we measure any impairment by estimating the undiscounted cash flows
to be generated from the use and ultimate disposition of these assets. We record
assets to be disposed of at the lower of the carrying amount or fair market
value less anticipated costs of sales.
Impairment of Goodwill and Other Intangible Assets. As a result of our
adoption of Statement of Financial Accounting Standards No. 142 "Goodwill and
Other Intangible Assets", we now annually review goodwill and other intangible
assets that have indefinite lives for impairment and whether events or changes
in circumstances indicate the carrying value of these assets might exceed their
current fair values. These reviews require us to estimate the fair value of our
identified reporting units and compare those estimates against the related
carrying values. For each of the reporting units, the estimated fair value is
determined as compared to our stock price.
Inventory. We adjust our inventory values so that the carrying value
does not exceed net realizable value. We estimate net realizable value based
upon forecasted demand. However, forecasted demand is subject to revisions and
actual demand may differ. This difference may require a write-down of our
inventory, which could have a material effect on our financial condition and
results of operations. From time to time, we maintain at our facilities
component parts inventory that remains the property of our vendors supplying the
inventory until such time as we elect to use the inventory. At the time we elect
to use the inventory, we reflect the cost of that inventory in our inventory
account, and generate a corresponding account payable.
2002 Restatement
In connection with the preparation of our quarterly report for the
six-month period ended June 30, 2003, we became aware of certain differences in
our detailed records and the liabilities included in our
22
financial statements for the year ended December 31, 2002. We conducted an
investigation into those differences. As a result of that investigation, we
concluded that the amount of our accounts payable reported for December 31, 2002
was understated as a result of an incorrect adjustment for consigned inventory.
This understatement of accounts payable in the period resulted in a lower costs
of goods sold and higher net income for the period. The restatement caused our
net loss to be increased for the year ended December 31, 2002. In addition, in
connection with the restatement, we reviewed certain tax assets reflected in the
financial statements as of December 31, 2002 and determined that certain of
those assets may expire before we can utilize them. Therefore, we recorded a
valuation allowance for the deferred tax assets as of December 31, 2002.
Results of Continuing Operations for the Years Ended December 31, 2003 and 2002
Results of Operations
The following table sets forth for the years indicated the percentage
of net sales represented by certain items reflected in our consolidated
statements of operations. There can be no assurance that the trends indicated
will continue in the future.
PERCENTAGE OF NET SALES
Year Ended December 31,
2003 2002 2001
---- ---- ----
STATEMENTS OF OPERATIONS DATA:
Net sales 100.0% 100.0% 100.0%
Cost of sales 94.5% 90.0% 87.8%
Gross profit 5.5% 10.0% 12.2%
Operating expenses 11.3% 12.3% 9.8%
Income (loss) from operations (5.8%) (2.3%) 2.4%
Other (income) expense 0.4% 0.4% (0.2%)
Income (loss) before income taxes (6.2%) (2.7%) 2.6%
(Provision) benefit for income taxes 0.1% (0.8%) (0.6%)
Net income (loss) (6.1%) (3.5%) 2.0%
Net Sales
Our net sales are primarily derived from our sale of personal computer
hardware, software, peripherals and accessories. Our net sales increased by
approximately $11.9 million, or 18.2%, to approximately $77.0 million for the
year ended December 31, 2003, compared to approximately $65.2 million for the
year ended December 31, 2002. The increase in net sales was a result of an
increase in the number of computer systems shipped during the period with the
addition of Staples as our largest customer in late 2002.
Gross Profit
Our gross profit consists of net sales less our product and shipping
costs. Our gross profit decreased by $2.3 million, or 34.8%, to approximately
$4.3 million for the year ended December 31, 2003, compared to $6.5 million for
the year ended December 31, 2002. The decrease in our gross profit
23
was a result of a decrease in the average selling price per system due to lower
component costs and competition in the marketplace. Our gross profit in 2003 was
significantly impacted by price reductions in the marketplace by competitors
such as Dell and Gateway, as well as reduction in consumer demand, each of which
took place in the fourth quarter of 2002. In addition, in the fourth quarter of
2002 our airtime on one of the home shopping networks decreased significantly as
compared to the prior year. Our gross profit margins may continue to be impacted
by competitive pressures in the future. However, our new product initiative is
designed to decrease those competitive pressures and increase our gross profit
margins for our new products.
Operating Expenses
Our operating expenses increased by approximately $692,000, or 8.6%, to
$8.7 million for the year ended December 31, 2003, from $8.0 million for 2002.
The increase in operating expenses was attributable to a $590,000 impairment
loss on goodwill and $625,000 of non-cash stock compensation expense. These
amounts were offset in part by a decrease in salaries of approximately $330,000
and a decrease in costs related to outsourcing assembly of approximately
$180,000. We did not make any discretionary contributions to our employee stock
ownership plan in 2002 or 2003.
Other (Income) Expense
Our net other expense increased by approximately $62,000, or 23.1%, to
$330,000 for the year ended December 31, 2003, from $268,000 for the prior year.
The increase was primarily due to lower interest income in 2003. We expect that
our operating expenses will increase in our current fiscal year and beyond. Our
new product initiative will require significant increases in research and
development expenses and sales and marketing expenses. We will also incur higher
general and administrative expenses related to the expansion of our management
team in early 2004 and related costs.
Income Taxes
Our provision for income taxes for the year ended December 31, 2003 was
a credit of $79,000, versus $489,000 for the year ended December 31, 2002. The
income tax provision for 2003 decreased primarily as a result of our taxable
losses.
Results of Continuing Operations for the Years Ended December 31, 2002 and 2001
Net Sales
Our net sales decreased by $8.7 million, or 11.8%, to $65.2 million for
the year ended December 31, 2002, compared to $73.9 million for the year ended
December 31, 2001. The decrease in net sales was a result of a decrease in the
number of computer systems shipped during the period, as well as a decrease in
the average selling price per system due to lower component costs and
competition in the marketplace. The fourth quarter of 2002 was significantly
impacted by price reductions in the marketplace by our competitors, such as Dell
and Gateway, as well as reduction in consumer demand. In addition, in the fourth
quarter of 2002 our airtime on one of the home shopping networks decreased
significantly as compared to the prior year.
Gross Profit
Our gross profit decreased by $2.5 million, or 27.6%, to $6.5 million
for the year ended December 31, 2002, compared to $9.0 million for the year
ended December 31, 2001. The decrease in gross profit was due to the decrease in
net sales discussed above and the resulting decrease in our gross
24
profit margin. Our gross profit margin, as a percentage of net sales, decreased
to 10.0% for the year ended December 31, 2002 from 12.2% for the year ended
December 31, 2001. The decrease in gross profit margin as a percentage of sales
was due to an increase in labor and applied overhead costs associated with the
integration of Mcglen and Lan Plus following the 2002 merger of those companies,
an increase in costs due to integration of our new enterprise software in 2002
and less units being produced in 2002 as compared to 2001.
Operating Expenses
Our operating expenses increased by $0.7 million, or 9.6%, to $8.0
million for the year ended December 31, 2002, from $7.3 million for 2001. The
increase in operating expenses was attributable to an increase in payroll and
related costs and an increase in advertising costs in 2002. Compensation expense
related to our employee stock ownership plan decreased by $0.3 million for the
year ended December 31, 2002, as we did not make any discretionary contributions
to the plan in 2002. Payroll and related costs increased by approximately $0.9
million, or 19.1%, for the year ended December 31, 2002 compared to 2001. The
increase in payroll and payroll related costs was due to a 15% increase in
insurance costs in 2002 and a 20% increase in average head count for the year
ended December 31, 2002. Advertising expense increased by approximately $250,000
in 2002 as we received less market development funds from our suppliers. We also
increased our print advertising expenditures as we began to advertise the
Northgate brand. We also experienced an increase in labor and applied overhead
costs associated with the integration of two operations following our March 2002
merger with Mcglen Internet Group and an increase in costs due to the
integration of our new enterprise software in 2002.
Other (Income) Expense
Our other income decreased by approximately $485,000, or 223.5%, to a
net other expense of $268,000 for the year ended December 31, 2002, from a net
other income of $217,000 for the prior year. The decrease was partially due to
decreased gains on our marketable securities portfolio and lower interest income
in 2002. We also recorded an $827,000 loss in 2002 on our marketable securities
portfolio as the result of the overall decline in the stock and bond markets
from when we purchased the securities, as well as specific factors affecting
individual investments within the portfolio. As a partial offset to these
decreases, in the fourth quarter of 2002, we reached a settlement with the
lender under our predecessor's line of credit. Under that settlement, we repaid
$40,000 of the $90,000 that was due under the line of credit. The resulting gain
of $50,000 is included in other income for the year ended December 31, 2002.
Also in 2002, we revised our estimate for accruals related to our liability for
certain subscriber fees to an Internet service provider, resulting in
recognition of other income of approximately $1.0 million.
Income Taxes
Our provision for income taxes for the year ended December 31, 2002 was
$489,000, versus $467,000 for the year ended December 31, 2001. The income tax
provision for 2002 increased primarily as a result of a valuation allowance
applied to our tax asset acquired during 2002, offset by certain changes in the
estimates for our past income tax liabilities, and amounts refundable from prior
years' tax payments.
Liquidity and Capital Resources
Historically, our primary financing need has been the funding of
working capital requirements. We financed our operations and met our capital
expenditure requirements primarily from cash provided by operations, borrowings
from private individuals, including our former chief executive officer and
25
majority stockholder, and financial institutions. As of December 31, 2003, we
had approximately $464,000 in cash, cash equivalents and short-term investments,
compared to approximately $2.5 million at December 31, 2002. Our new product
initiative will require significant capital to fund operating expenses,
including research and development expenses and sales and marketing expenses,
capital expenditures and working capital needs until we achieve positive cash
flows from that initiative. We expect to seek between $10.0 million and $15.0
million in external equity financing by the end of our current fiscal year to
fund our new product initiative. We have yet to enter into discussions with
potential investors regarding the terms of any such equity financing. We also
expect to seek a new revolving credit facility of between $5.0 million and $10.0
million with a commercial bank to fund the working capital needs of our current
operations and our new product initiative. We have contacted several commercial
banks regarding a revolving credit facility, but we do not currently have any
binding commitments regarding such a facility. We cannot give any assurance that
any additional financing will be available, that we can ever achieve positive
operating cash flows from our new product initiative or that we will have
sufficient cash from any source to meet our needs. It is possible that we will
exhaust all available funds before we reach positive cash flow from our new
product initiative. If we are not able to raise sufficient external financing,
we will have to curtail our efforts to implement our new product initiative.
During the year ended December 31, 2003, we had a revolving credit
facility with a commercial bank. The line of credit was collateralized by a
first priority lien on substantially all of our assets and the personal
guarantee of our former chief executive officer and majority stockholder. Under
the facility, we could borrow up to $2.3 million for working capital purposes,
subject to availability under a borrowing base. As of December 31, 2003, we had
no borrowings under the facility. The revolving credit facility terminated and
all amounts borrowed thereunder and not previously repaid were due and payable
in full (including any accrued interest) on January 31, 2004. Advances under the
line of credit accrued interest at a rate equal to the bank's prime rate plus
0.75% per annum. The loan agreement relating to the revolving credit facility
contained customary covenants and restrictions on additional indebtedness,
liens, disposition of assets, capital expenditures, investments and the
repayment of indebtedness to third parties. As of December 31, 2003, we were not
in compliance with the financial covenants contained in the loan agreement, but
had obtained a forbearance agreement from the bank. We were also out of
compliance with the restriction on repayment of indebtedness to third parties.
In January 2004 we repaid $500,000 of the approximately $1.0 million in
indebtedness we owed to our former chief executive officer and majority
stockholder in violation of that restriction. In addition, that payment was in
violation of a subordination agreement that our former chief executive officer
and majority stockholder executed for the benefit of the bank. Our former chief
executive officer and majority stockholder repaid the $500,000 to us on February
2, 2004.
On December 9, 2003, we closed a private placement of 4 million shares
of our common stock for a purchase price of $0.25 per share, and realized gross
proceeds of approximately $1 million. The investor in the private placement was
a limited liability company, which is controlled by Samuel J. Furrow, Jr. and
Marc B. Crossman, each of whom joined our board of directors as a result of that
private placement. We used the proceeds of the private placement for working
capital needs.
On or about February 6, 2004, we entered into a purchase and sale
agreement with a financial institution. Under the terms of that agreement, we
may assign certain of our accounts receivable to the financial institution for
immediate cash in the amount of 75% of the assigned receivables. We also receive
a portion of the remaining balance of the assigned accounts receivable,
depending on how soon after assignment the financial institution receives
payment on those accounts. We expect to keep this financing purchase line in
place until we can obtain another revolving credit facility from a commercial
bank.
26
In the year ended December 31, 2003, our cash and cash equivalents
decreased by approximately $1.5 million, to approximately $464,000 from
approximately $2.0 million as of December 31, 2002. During the same period, our
working capital decreased by approximately $1.1 million to approximately $2.1
million from approximately $3.2 million as of December 31, 2002. The decrease in
cash during the year was primarily the result of net cash used in our operating
activities during 2003, which was partially offset by approximately $1 million
in gross proceeds from the sale of our common stock. The decrease in working
capital during the year was primarily due to an increase in our accounts payable
balances and related party borrowings.
Net cash used in operating activities for the year ended December 31,
2003 was approximately $5.5 million, as compared to net cash used in operating
activities of $4.0 million for the year ended December 31, 2002 and net cash
provided by continuing operating activities of approximately $3.5 million for
the year ended December 31, 2001. The decrease in net cash used in continuing
operating activities in the year ended December 31, 2003, as compared with the
year ended December 31, 2002, was primarily the result of an increase in our net
loss and an increase in our accounts receivable of approximately $3.8 million
during fiscal year 2003, as compared to a decrease of approximately $6.8 million
in accounts receivables during fiscal year 2002. The decrease in net cash
provided by operating activities in the year ended December 31, 2002, as
compared with the year ended December 31, 2001, was primarily the result of our
net loss and a reduction of trade accounts payable and accrued liabilities of
approximately $7.5 million during the year, which was partially offset by an
increase of accounts receivable of approximately $6.8 million, as compared to an
increase of trade accounts payable and accrued liabilities of approximately $6.4
million, which was partially offset by a decrease of accounts receivable of
approximately $5.8 million, in 2001.
Net cash provided by investing activities was approximately $1.7
million for the year ended December 31, 2003, compared to net cash used in
investing activities of approximately $1.1 million for the year ended December
31, 2002 and net cash provided by investing activities of approximately $1.5
million for the year ended December 31, 2001. Cash provided by, or used in,
investing activities consists of the net result of the sale and purchase of
property and equipment and the maturity, purchase or sale of certain investment
securities. During the year ended December 31, 2003, our capital expenditures
were approximately $168,000, compared to approximately $337,000 for the same
period in 2002. This decrease was primarily due to expenditures in 2002 for
computer hardware and leasehold improvements incurred in connection with our
facility, which we occupied in September 2002.
Net cash provided by financing activities was approximately $2.3
million for the year ended December 31, 2003, compared to net cash used in
financing activities of approximately $40,000 for the year ended December 31,
2002 and net cash used in financing activities of approximately $713,000 for the
year ended December 31, 2001. This increase in net cash provided by financing
activities for the year ended December 31, 2003, as compared to the year ended
December 31, 2002, was primarily the result of approximately $1 million in gross
proceeds from the sale of our common stock and borrowings from our former
majority stockholder and chief executive officer. In the past, we have invested
excess operating funds in the stock market. From time to time, we invested these
funds in short sales of stock that we typically covered within 60 days after the
date of the short purchase. Short sales typically have a higher degree of risk
than traditional stock purchases. At December 31, 2001, we had approximately
$426,000 invested in short sales of securities, and we recorded an unrealized
loss of $102,000 on these investments. We covered the short sales in January and
April 2002, recording a loss of $60,000. We did not make any more of investments
in short sales after that time, and we do not intend to make any such
investments in the future.
27
At December 31, 2003, our aggregate contractual obligations were as
follows:
Payments Due by Period
----------------------
Less Than 1 1-3 3-5 More Than
Contractual Obligations Total Year Years Years 5 Years
----------------------- ----- ---- ----- ----- -------
Long term debt...................................... $ 1,371 $ 16 $ 1,344 $ 11 $ -
Capital lease obligations........................... - - - - -
Operating leases.................................... 1,462 494 968 - -
Purchase obligations................................ - - - - -
Other long-term liabilities reflected on the
balance sheet under GAAP............................ - - - - -
Recently Issued Accounting Standards
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN
45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN 45 requires that a
liability be recorded in the guarantor's balance sheet upon issuance of certain
guarantees. FIN 45 also requires disclosure about certain guarantees that an
entity has issued. We have implemented the disclosure requirements required by
FIN 45, which were effective for fiscal years ending after December 15, 2002. We
will apply the recognition provisions of FIN 45 prospectively to guarantees
issued after December 31, 2002. Our adoption of FIN 45 did not have a material
effect on our financial position, cash flows or results of operations.
In December 2003, FASB issued Interpretation No. 46R ("FIN 46R") which
replaced Interpretation No. 46, "Consolidation of Variable Interest Entities, an
interpretation of Accounting Research Bulletin No. 51, Consolidated Financial
Statements," to improve financial reporting of special purpose and other
entities. In accordance with the interpretation, business enterprises that
represent the primary beneficiary of another entity by retaining a controlling
financial interest in that entity's assets, liabilities, and results of
operations must consolidate the entity in their financial statements. Prior to
the issuance of FIN 46R, consolidation generally occurred when an enterprise
controlled another entity through voting interests. The disclosure requirements
of FIN 46R are effective for financial statements issued after December 31,
2003. The initial recognition provisions of FIN 46R are to be implemented no
later than the end of the first reporting period that ends after March 15, 2004.
We do not expect FIN 46R to have a material impact on our financial statements.
In November 2002, the FASB's Emerging Issues Task Force ("EITF")
reached a consensus on Issue No. 00-21, "Revenue Arrangements with Multiple
Deliverables." EITF Issue No. 00-21 provides guidance on how to account for
arrangements that involve the delivery or performance of multiple products,
services and/or rights to use assets. The provisions of EITF Issue No. 00-21
will apply to revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. We do not expect EITF Issue No. 00-21 to have a material
effect on our financial position, cash flows or results of operations.
In January 2003, the EITF reached a consensus on Issue No. 02-16,
"Accounting by a Customer (Including a Reseller) for Certain Consideration
Received from a Vendor." EITF Issue No. 02-16 provides guidance regarding how a
reseller of a vendor's products should account for cash consideration received
from a vendor. The provisions of EITF Issue No. 02-16 will apply to vendor
arrangements entered into after December 31, 2002, including modifications of
existing arrangements. Our adoption of EITF 02-16 did not have a material effect
on our financial position, cash flows or results of operations.
28
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not use derivative financial instruments to hedge interest rate
and foreign currency exposure. We do not believe that we have any material
exposure to interest rate risk. We did not experience a material impact from
interest rate risk during fiscal 2003.
Currently, we do not have any significant investments in financial
instruments for trading or other speculative purposes, or to manage our interest
rate exposure.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following table contains our selected unaudited consolidated
quarterly financial data (in thousands, except per share data):
Three Months Ended
===========================================================================================================
December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31,
2003 2003 2003 2003 2002 2002 2002 2002
===========================================================================================================
Statement of Operations
and Other Data:
Net sales................. $ 22,168 $ 17,415 $ 17,398 $ 20,065 $ 11,537 $ 18,562 $ 15,645 $ 19,432
Cost of sales............. 20,677 16,113 16,773 19,227 11,480 16,473 13,005 17,692
Gross profit.............. 1,491 1,302 625 838 57 2,089 2,640 1,740
Net income (loss)......... (1,718) (519) (1,353) (1,129) (2,301) 78 200 (240)
Net income (loss) per
share ............. (0.11) (0.03) (0.09) (0.08) (0.15) 0.01 0.01 (0.01)
Shares used in per share
calculation........ 15,900 14,943 14,943 14,943 14,943 14,943 14,943 10,827
We believe that you should not rely upon period-to-period comparisons
of our financial results as an indication of future performance. Our results of
operations have been subject to significant fluctuations, particularly on a
quarterly basis, and results of operations could fluctuate significantly
quarter-to-quarter and year-to-year.
The financial statements and supplementary data required by this item
are set forth in Item 15(a)(1) and begin at page F-1 of this report.
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The term "disclosure controls and procedures" is defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act. This term refers to the controls
and procedures of a company that are designed to ensure that information
required to be disclosed by a company in the reports it files or submits under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified by the Securities and Exchange Commission. Our management,
including our chief executive officer and chief financial officer, each of whom
joined us after the end of the period covered by this annual report, has
evaluated the effectiveness of our disclosure controls and procedures as of the
end of the period covered by this annual report. Based upon that evaluation, our
chief executive officer and chief financial officer have concluded that our
disclosure controls and procedures were not effective in all material respects
as of the end of the period covered by this annual report.
29
There were no changes to our internal controls over financial reporting
during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal controls over financial reporting.
However, in the first quarter of our current fiscal year we took corrective
actions with regard to significant deficiencies and material weaknesses that our
management discovered in its evaluation of the effectiveness of our disclosure
controls and procedures.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference to our proxy statement for the May 27,
2004 Annual Meeting of Stockholders under the caption "Management- Executive
Officers and Directors."
We have adopted a code of ethics applicable to our chief executive
officer, who is our principal executive officer, and our chief financial
officer, who is our principal financial and accounting officer. We will provide
a copy of the code of ethics to any person, without charge, upon written request
delivered to our offices at 801 S. Sentous Street, City of Industry, California
91748.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference to our proxy statement for the May 27,
2004 Annual Meeting of Stockholders under the caption "Executive Compensation
and Other Information," provided that the Compensation Committee Report on
Executive Compensation, the Report of the Audit Committee and the Comparison of
Stockholder Returns are expressly not incorporated herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Incorporated herein by reference to our proxy statement for the May 27,
2004 Annual Meeting of Stockholders under the caption "Security Ownership of
Certain Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference to our proxy statement for the May 27,
2004 Annual Meeting of Stockholders under the caption "Certain Relationships and
Related Transactions."
ITEM 14. PRINCIPAL ACCOUNT FEES AND SERVICES
Incorporated herein by reference to our proxy statement for the May 27,
2004 Annual Meeting of Stockholders under the caption "Principal Accountant Fees
and Services."
30
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
(1) Financial Statements:
Page
----
Independent Auditors' Reports............................ F-2
Consolidated Balance Sheets as of
December 31, 2003 and December 31, 2002.................. F-4
Consolidated Statements of Operations for the
years ended December 31, 2003, 2002 and 2001 ............ F-5
Consolidated Statements of Stockholders' Equity for
the years ended December 31, 2003, 2002 and 2001......... F-6
Consolidated Statements of Cash Flows for the
years ended December 31, 2003, 2002 and 2001............. F-7
Notes to Consolidated Financial Statements............... F-8
(2) Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts and Reserves
(3) Management Contract or Compensatory Plan:
See Index to Exhibits. Each of the following Exhibits
described on the Index to Exhibits is a management contract or
compensatory plan: Exhibits 10.3 through 10.11.
(b) Reports on Form 8-K:
On December 24, 2003, the registrant filed a report on Form 8-K, under
Item 1, with respect to a change in control of the registrant. No
financial statements were filed with that report.
(c) Exhibits:
See Index to Exhibits.
(d) Schedules:
See financial statements and the accompanying notes.
31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NORTHGATE INNOVATIONS, INC.
By: /s/ KENT A. SAVAGE
----------------------------------
Kent A. Savage
Chief Executive Officer
Date: March 30, 2004
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below hereby constitutes and appoints Kent A. Savage, Theodore B. Muftic
and J. William Wilson, and each of them individually, as his attorney-in-fact,
each with full power of substitution, for him in any and all capacities, to sign
any and all amendments to this Report on Form 10-K, and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
said attorney-in-fact, or his substitutes, may do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
---- ----- ----
/s/ KENT A. SAVAGE Chief Executive Officer and March 30, 2004
- -------------------- Director
Kent A. Savage (Principal Executive Officer)
/s/ THEODORE B. MUFTIC Vice President and March 30, 2004
- ----------------------- Chief Financial Officer
Theodore B. Muftic (Principal Financial Officer)
/s/ RICHARD SHYU President and Director March 30, 2004
- ------------------
Richard Shyu
/s/ TROY CARTER Director March 30, 2004
- -----------------
Troy Carter
/s/ MARC B. CROSSMAN Director March 30, 2004
- ----------------------
Marc B. Crossman
/s/ SAMUEL J. FURROW, JR. Director March 30, 2004
- ---------------------------
Samuel J. Furrow, Jr.
/s/ SUHAIL RIZVI Director March 30, 2004
- ------------------
Suhail Rizvi
32
INDEX TO EXHIBITS
Exhibit
Number Description
- ------ -----------
3.1 Certificate of Incorporation of registrant. (1)
3.2 Certificate of Amendment of Certificate of Incorporation of registrant,
filed with the Delaware Secretary of State on March 15, 2002. (2)
3.3 Certificate of Designation of Preferences of Series A Preferred Stock
of registrant, filed with the Delaware Secretary of State on March 15,
2002. (1)
3.4 Amended and Restated Bylaws of registrant. (1)
4.1 Specimen Certificate for Common Stock. (1)
4.2 Registration Rights Agreement among registrant, Glenbrook Group, LLC
and J&M Interests, LLC, dated December 9, 2003. (3)
10.1 Sublease Agreement by and between registrant and Proview Technology,
Inc., dated July 2, 2002. (1)
10.2* Registrant's 1999 Stock Option Plan. (4)
10.3* Registrant's 2000 Stock Option Plan. (5)
10.4* Registrant's 2004 Stock Incentive Plan. (1)
10.5* Employment Agreement by and between Kent A. Savage and registrant dated
as of January 15, 2004. (1)
10.6* Stock Option Agreement by and between Kent A. Savage and registrant
dated as of January 15, 2004. (1)
10.7* Employment Agreement by and between Theodore B. Muftic and the
registrant dated March 1, 2004. (1)
10.8* Consulting Agreement by and between J&M Interests, LLC and the
registrant dated December 9, 2003. (6)
10.9* Form of Common Stock Purchase Warrant issued by registrant to J&M
Interests, LLC pursuant to Consulting Agreement dated December 9, 2003.
(1)
10.10 Purchase and Sale Agreement by and between the registrant and Prestige
Capital Corporation dated February 6, 2004. (1)
21 Subsidiaries of registrant. (1)
23.1 Consent of Singer Lewak Greenbaum & Goldstein LLP. (1)
33
23.2 Consent of Corbin and Company, LLP. (1)
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer. (1)
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer. (1)
32 Section 1350 Certifications. (1)
- -------------------
* Management contract or compensatory plan, contract or arrangement
required to be filed as an exhibit pursuant to Item 4(c) of Form 10-K
(1) Filed herewith.
(2) Incorporated herein by reference to registrant's Annual Report on Form
10-K filed with the Commission on April 16, 2002.
(3) Incorporated herein by reference to registrant's Current Report on Form
8-K filed with the Commission on December 24, 2003.
(4) Incorporated herein by reference to registrant's Amendment No. 1 to its
Annual Report on Form 10-KSB filed with the Commission on April 17,
2000.
(5) Incorporated herein by reference to registrant's Amendment No. 1 to its
Registration Statement on Form SB-2 filed with the Commission on
September 27, 2000.
(6) Incorporated herein by reference to the Schedule 13D of Glenbrook
Group, LLC filed with the Commission on December 22, 2003.
34
NORTHGATE INNOVATIONS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Independent Auditors' Reports...................................................................................F-2
Consolidated Balance Sheets as of December 31, 2003 and December 31, 2002.......................................F-4
Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001......................F-5
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2003, 2002 and 2001................................................................................F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001......................F-7
Notes to Consolidated Financial Statements......................................................................F-8
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Northgate Innovations, Inc.:
We have audited the accompanying consolidated balance sheets of
Northgate Innovations, Inc. and subsidiaries (the "Company") as of December 31,
2003 and 2002 and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for the years then ended. In
connection with our audits, we have also audited the related consolidated
financial statement schedule for the years ended December 31, 2003 and 2002.
These consolidated financial statements, and the consolidated financial
statement schedule, are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and the consolidated financial statement schedule based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Northgate
Innovations, Inc. as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the related consolidated financial statement schedule, when
considered in relation to the consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein for the years ended December 31, 2003 and 2002.
/s/ CORBIN AND COMPANY LLP
Irvine, California
March 26, 2004
F-2
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Northgate Innovations, Inc.:
We have audited the statements of operation, stockholders' equity and
cash flows of Northgate Innovations, Inc. for the year ended December 31, 2001.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the results of its operations and its cash
flows for the year ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America.
/s/ SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
April 12, 2002
F-3
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
December 31,
-------------------------------------------
ASSETS 2003 2002
------------------- --------------------
Current assets:
Cash and cash equivalents $ 464 $ 1,983
Restricted certificates of deposit - 1,016
Marketable securities - 490
Accounts receivable, net of allowance for doubtful accounts
of $911 and $280 in 2003 and 2002, respectively 6,597 2,898
Inventories, net 3,480 3,178
Prepaid expenses and other current assets 573 560
--------------- ----------------
Total current assets 11,114 10,125
Equipment, net 709 900
Goodwill 3,492 4,082
Other assets 82 76
--------------- ----------------
Total assets $ 15,397 $ 15,183
=============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 5,710 $ 3,987
Accrued expenses 328 440
Accrued royalties 1,431 1,427
Convertible notes payable 100 100
Dividends payable 186 186
Advances from ESOP 210 -
ESOP interest payable - 746
Note payable to related party 1,000 -
Note payable - current portion 16 -
--------------- ----------------
Total current liabilities 8,981 6,886
Note payable, net of current portion 1,355 1,300
Guarantee of ESOP loan payable - 7,963
--------------- ----------------
Total liabilities 10,336 16,149
--------------- ----------------
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock, $0.01 par value; 5,000 shares authorized,
1,350 shares issued and outstanding in 2003 and 2002,
liquidation preference of $1,350 14 14
Common stock, $0.03 par value; 50,000 shares authorized,
18,943 and 14,943 shares issued and outstanding in
2003 and 2002, respectively 568 448
Additional paid-in capital 14,572 3,953
Accumulated other comprehensive loss - (7)
(Accumulated deficit) retained earnings (3,530) 1,189
---------------- ----------------
11,624 5,597
Less: unearned ESOP shares (6,563) (6,563)
--------------- ----------------
Total stockholders' equity (deficit) 5,061 (966)
--------------- ----------------
Total liabilities and stockholders' equity $ 15,397 $ 15,183
=============== ================
See accompanying notes to consolidated financial statements
F-4
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Years Ended December 31,
-------------------------------------------------------------
2003 2002 2001
----------------- ---------------- ------------------
Net sales $ 77,046 $ 65,176 $ 73,883
Cost of sales 72,790 58,650 64,872
-------------- -------------- -------------
Gross profit 4,256 6,526 9,011
Operating expenses (including impairment loss
on goodwill of $590 in 2003) 8,724 8,032 7,273
-------------- -------------- -------------
Operating (loss) profit (4,468) (1,506) 1,738
-------------- -------------- -------------
Other income (expense)
Interest expense (598) (636) (647)
Interest income 19 118 205
Other income, net 249 250 659
-------------- -------------- -------------
Total other income (expense), net (330) (268) 217
-------------- -------------- -------------
(Loss) income before benefit (provision) for
income taxes (4,798) (1,774) 1,955
Benefit (provision) for income taxes 79 (489) (467)
-------------- -------------- -------------
Net (loss) income $ (4,719) $ (2,263) $ 1,488
============== ============== =============
Basic net (loss) income per share $ (0.31) $ (0.16) $ 0.15
============== ============== =============
Diluted net (loss) income per share $ (0.31) $ (0.16) $ 0.13
============== ============== =============
Shares used in computing basic net (loss)
income per share 15,184 13,928 9,854
============== ============== =============
Shares used in computed diluted net (loss)
income per share 15,184 13,928 11,305
============== ============== =============
See accompanying notes to consolidated financial statements
F-5
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
AND COMPREHENSIVE LOSS
(In thousands)
Accumulated Total
Preferred Stock Common Stock Additional Other Unearned Stockholders' Comprehensive
----------------- ----------------- Paid-in Comprehensive ESOP Retained Equity Income
Shares Amount Shares Amount Capital Loss Shares Earnings (Deficit) (Loss)
-------- -------- -------- -------- --------- ------- -------- ---------- --------- --------
Balance at
December 31, 2000 1,350 $ 14 9,854 $ 296 $ 520 $(1,020) $(7,964) $ 2,545 $ (5,609)
Unrealized gain on
marketable securities - - - - - 524 - - 524 $ 524
Dividends declared on
allocated ESOP shares - - - - - - - (285) (285) -
Release of ESOP shares - - - - - - 1,189 - 1,189 -
Decrease in value of
released ESOP shares - - - - (249) - - (296) (545) -
Net income - - - - - - - 1,488 1,488 1,488
-------- -------- -------- -------- --------- ------- -------- ---------- --------- --------
Total comprehensive
income $ 2,012
=======
Balance at
December 31, 2001 1,350 14 9,854 296 271 (496) (6,775) 3,452 (3,238)
Unrealized gain on
marketable securities - - - - - 489 - - 489 $ 489
Shares issued in
recapitalization - - 5,079 152 3,884 - - - 4,036 -
Shares issued to
consultant - - 10 - 10 - - - 10 -
Adjustment to prior
year's decrease in
value of released
ESOP shares - - - - (212) - 212 - - -
Net loss - - - - - - - (2,263) (2,263) (2,263)
-------- -------- -------- -------- --------- ------- -------- ---------- --------- --------
Total comprehensive
loss $(1,774)
=======
Balance at
December 31, 2002 1,350 14 14,943 448 3,953 (7) (6,563) 1,189 (966)
Change in unrealized
gain on marketable
securities - - - - - 7 - - 7 $ 7
Release of guarantee
of ESOP loan payable - - - - 9,114 - - - 9,114 -
Sale of common shares - - 4,000 120 880 - - - 1,000 -
Stock-based compensation-
warrants issued to new
investor group - - - - 625 - - - 625 -
Net loss - - - - - - - (4,719) (4,719) (4,719)
-------- -------- -------- -------- --------- ------- -------- ---------- --------- --------
Total comprehensive
loss $(4,712)
=======
Balance at
December 31, 2003 1,350 $ 14 18,943 $ 568 $ 14,572 $ - $(6,563) $ (3,530) $ 5,061
======== ======== ======== ======== ========= ======== ======== ========== =========
See accompanying notes to consolidated financial statements
F-6
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31,
-------------------------------------------------------------
2003 2002 2001
----------------- ---------------- ------------------
Net (loss) income $ (4,719) $ (2,263) $ 1,488
Cash flows from operating activities:
Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:
Depreciation and amortization 331 282 158
Impairment of goodwill 590 - -
Realized and permanent (gains) losses on
marketable securities (285) 928 -
Gain on debt settlement - (50) -
Stock issued for services 625 10 -
Provision for losses on accounts receivable 631 30 661
Gain on sale of fixed assets (5) - -
Release of shares to ESOP - - 903
Decrease in fair value of released ESOP shares - - (545)
Deferred taxes - 858 15
Changes in operating assets and liabilities:
Accounts receivable (4,330) 6,782 (5,758)
Inventories (302) 1,114 (1,320)
Prepaid expenses and other current assets (13) (350) 216
Other assets (6) (46) 8
Accounts payable 1,723 (6,633) 5,675
Accrued expenses (112) (910) 709
Income taxes payable - (388) 1,053
Dividends payable - - 186
ESOP interest payable 405 468 (536)
Advances to Mcglen - (307) (845)
Accrued royalties 4 (3,572) 1,467
-------------- -------------- -------------
Net cash (used in) provided by operating activities (5,463) (4,047) 3,535
-------------- -------------- -------------
Cash flows from investing activities:
Proceeds from sale of fixed assets 33 - -
Purchase of investment - (200) -
Sale of investment - 200 -
Purchases of equipment (168) (337) (511)
Proceeds from sale of marketable securities and
redemption of certificates of deposit 1,798 3,231 21,188
Purchases of marketable securities and
certificates of deposit - (4,110) (19,205)
Acquisition of Mcglen, net of cash acquired - 108 -
-------------- -------------- -------------
Net cash provided by (used in) investing activities 1,663 (1,108) 1,472
-------------- -------------- -------------
Cash flows from financing activities:
Net payments on line of credit - (40) -
Note payable to bank 71 - -
Borrowings from related party 1,706 - -
Repayment on borrowings from related party (706) - -
Payment on ESOP debt - - (617)
Advances from ESOP 210 - -
Sale of common stock 1,000 - -
Dividends paid on preferred stock - - (96)
-------------- -------------- -------------
Net cash provided by (used in) financing activities 2,281 (40) (713)
-------------- -------------- -------------
Net change in cash and cash equivalents (1,519) (5,195) 4,294
Cash and cash equivalents, beginning of year 1,983 7,178 2,884
-------------- -------------- -------------
Cash and cash equivalents, end of year $ 464 $ 1,983 $ 7,178
============== ============== =============
See accompanying notes to consolidated financial statements
F-7
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
- -----------------------------------------------
The accompanying consolidated financial statements include the accounts of
Northgate Innovations, Inc. (formerly Mcglen Internet Group, Inc.) and its
wholly owned subsidiaries. All significant intercompany transactions have been
eliminated.
We are a Delaware corporation headquartered in the City of Industry, California.
We are a developer, manufacturer and distributor of innovative PCs, peripherals,
software and over 100,000 computer products. We specialize in selling computers
through television shopping networks, mail order catalog companies and large
electronic chain stores as well as targeting specific business-to-business and
business-to-consumer markets through the Internet to customers principally in
the United States. We are organized and operate as one business segment.
In December 2003, an investor group acquired a majority of our outstanding
common stock and appointed a majority of the members of our board of directors.
In connection with this transaction, we sold 4,000,000 shares of our stock to
this investor group at $0.25 per share, or $1,000,000. Also in connection with
this transaction, we agreed to issue warrants to a member of the investor group
to purchase 2,500,000 shares of our stock for certain consulting services to be
provided for six months following the stock purchase. The warrants are to be
issued in three equal installments of 833,333, the first of which occurred on
December 9, 2003. The warrants are exercisable over a five-year period at $0.50
per share (see Note 12). Since the change in control was only 50.5% on a fully
diluted basis, "push-down accounting" treatment does not apply. Therefore we
accounted for the acquisition on a historical basis and did not apply purchase
accounting.
In January and February of 2004, our new board of directors employed new members
of our management team, including a new chief executive officer. Under the
direction of our restructured management team, we began implementing a new
strategic focus designed to complement our existing business. We are now
developing a business plan to launch a hardware and software offering targeted
at what we believe is an underserved segment of the personal computer and
Internet market.
Our new product initiative will require significant capital to fund operating
expenses, including research and development expenses and sales and marketing
expenses, capital expenditures and working capital needs until we achieve
positive cash flows from that initiative. We expect to seek between $10,000,000
and $15,000,000 in external equity financing by the end of our current fiscal
year to fund our new product initiative. We have yet to enter into discussions
with potential investors regarding the terms of any such equity financing. We
also expect to seek a new revolving credit facility of between $5,000,000 and
$10,000,000 with a commercial bank to fund the working capital needs of our
current operations and our new product initiative. We have contacted several
commercial banks regarding a revolving credit facility, but we do not currently
have any binding commitments regarding such a facility. We cannot give any
assurance that any additional financing will be available, that we can ever
achieve positive operating cash flows from our new product initiative or that we
will have sufficient cash from any source to meet our needs. It is possible that
we will exhaust all available funds before we reach positive cash flow from our
new product initiative. If we are not able to raise sufficient external
financing, we will have to curtail our efforts to implement our new product
initiative.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
Use of Estimates
- ----------------
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires us to make estimates and assumptions that
F-8
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements and the recorded amount of revenues and expenses during the reporting
periods. On an on-going basis, we evaluate our estimates including but not
limited to, those related to (i) the allowance for doubtful accounts receivable,
(ii) allowance for inventories, (iii) sales allowances, (iv) useful life or
impairment of intangible assets, (v) deferred tax asset valuation allowances and
(vi) royalty and litigation settlements accrual. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis of
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions, and such differences may be
material to the consolidated financial statements.
Cash and Cash Equivalents
- -------------------------
Cash and cash equivalents consist of cash on hand, cash on deposit and all
highly liquid investments with original maturities at the date of purchase less
than three months. Cash equivalents consist primarily of cash deposited in money
market accounts. While our cash and cash equivalents are on deposit with high
quality FDIC insured financial institutions, at times, deposits exceed insured
limits. We have not experienced any losses in such accounts.
Restricted Certificates of Deposit
- ----------------------------------
At December 31, 2002, certain of our certificates of deposit with a bank were
held as collateral against letters of credit issued by the bank to one of our
primary suppliers. In 2003, we sold the certificates of deposit upon the
expiration of the letter of credit.
Marketable Securities
- ---------------------
Marketable securities are accounted for in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." This standard requires us to
classify and account for investments in equity securities that have readily
determinable fair values and all debt securities as follows: (1) debt securities
that we have the intent and the ability to hold to maturity are classified as
held-to-maturity securities and are reported at amortized cost; (2) debt and
equity securities that are bought and held principally for the purpose of
selling them in the near-term are classified as trading securities and are
reported at fair value, with unrealized gains and losses included in earnings;
and (3) debt and equity securities not classified as held-to-maturity securities
or trading securities are classified as available-for-sale securities and
reported at fair value, with unrealized gains and losses excluded from earnings
and reported as a separate component of stockholders' equity. At December 31,
2002 our marketable securities were classified as available-for-sale.
In the fourth quarter of 2002, we reviewed our marketable securities portfolio
for permanent impairment. Due to the overall decline in the stock and bond
markets from when we purchased the investments, as well as specific factors
affecting individual investments within the portfolio, we recorded an "other
than temporary" loss of $827,000 on our marketable securities portfolio. This
loss is included in other income in the consolidated statement of operations for
the year ended December 31, 2002. In 2003, we sold all of our marketable
securities, generating a realized gain of $285,000.
F-9
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
Fair Value of Financial Instruments
- -----------------------------------
The carrying value of certain of our financial instruments, consisting primarily
of cash equivalents, receivables, accounts payable and accrued expenses,
approximates fair value due to the short-term nature of these agreements. The
fair value of the note payable to related party is not determinable as the
transaction is with a related party. The fair value of the other notes payable
are not determinable because either equivalent instruments are difficult to
locate or the note is in default.
Inventories
- -----------
Inventories are stated at the lower of cost or market. Cost is determined using
average cost. Inventory costs include raw materials, labor and overhead.
Provisions, when required, are made to reduce excess and obsolete inventories to
their estimated net realizable value.
From time to time we also maintain at our facilities consigned inventory that
remains the property of the vendors supplying the inventory ("consigned
inventory") until such time as we elect to use the inventory. At the time that
we elect to use the consigned inventory, the cost of such inventory is reflected
in our inventory accounts and a corresponding account payable to the vendor is
recorded.
Equipment
- ---------
Equipment is stated at cost and depreciated using the straight-line method based
over the estimated useful lives of the respective assets, which range from three
to five years. Leasehold improvements are stated at cost and amortization is
computed using the straight-line method over the shorter of the useful life of
the asset or the term of the lease. Upon retirement or disposition of equipment,
the cost and accumulated depreciation are removed from the accounts and any
resulting gain or loss is reflected in operations.
Goodwill and Other Intangible Assets
- ------------------------------------
We have adopted SFAS No. 142 "Goodwill and Other Intangible Assets." Under SFAS
No. 142, goodwill associated with acquisitions consummated after June 30, 2001
is not to be amortized, and effective January 1, 2002, goodwill and other
intangible assets with indefinite lives are no longer subject to periodic
amortization but are instead reviewed annually for impairment, or more
frequently if impairment indicators arise. We decided to perform an impairment
test on goodwill at December 31, 2003. We determined that $590,000 of the
recorded goodwill balance was impaired and was written down (see Note 5). There
can be no assurance however, that market conditions will not change or demand
for our services will continue, which could result in impairment of goodwill and
other intangible assets in the future.
Identifiable assets and liabilities acquired in connection with business
combinations accounted for under the purchase method are recorded at their
respective fair values. Deferred income taxes have been recorded to the extent
of differences between the fair value and the tax basis of the assets acquired
and liabilities assumed.
F-10
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
Long-Lived Assets
- -----------------
In the event that facts and circumstances indicate that equipment or other
long-lived assets may be impaired, an evaluation of recoverability would be
performed. If an evaluation is required, the estimated future undiscounted cash
flows associated with the asset are compared to the asset's carrying amount to
determine if an impairment charge is necessary. The amount of long-lived asset
impairment, if any, is charged to operations in the period in which long-lived
asset impairment is determined. At December 31, 2003, we believe there is no
impairment of our long-lived assets. There can be no assurance however, that
market conditions will not change or demand for our services will continue,
which could result in impairment of long-lived assets in the future.
Concentrations
- --------------
Financial instruments that potentially subject us to a concentration of credit
risk consist primarily of cash and cash equivalents and accounts receivable.
Sales are primarily concentrated in the United States and we have primarily
offered consumers personal computers and related products through distribution
channels that include large electronic and office supply retailers, television
shopping networks and mail order catalogues. We perform credit evaluations on
our customers and we provide allowances for potential credit losses and product
sales returns. Some key components included in our line of products are
currently available only from single or limited sources. The loss of a major
customer or the inability of one or more of our suppliers to meet our demand for
components in a timely and cost-effective manner could have a material adverse
impact on our financial condition or results of operations.
For the years ended December 31, 2003, 2002 and 2001, three customers accounted
for approximately 48.2%, 54.4% and 66.5%, respectively, of total sales. At
December 31, 2003 and 2002, $4.1 million and $1.5 million, respectively, of
accounts receivable related to these customers. We believe other customers could
be located which would purchase merchandise on comparable terms; however, the
establishment of new customer relationships could take several months.
In addition to the customers mentioned above, sales to Mcglen, with whom the
Company merged in March 2002, were $8.9 million for the year ended December 31,
2001.
For the years ended December 31, 2003, 2002 and 2001, one supplier accounted for
11.2%, 15.6% and 10.2%, respectively, of total purchases. Management believes
that other suppliers could provide similar merchandise on comparable terms.
We had an Internet access and portal co-marketing agreement with Microsoft
Corporation and the Microsoft Network (MSN) to provide Internet access to our
end users, for which we paid MSN a royalty. Under the agreement, MSN also had
the obligation to pay us for our end users that continued as subscribers to MSN.
This agreement was terminated in July 2001. During the fourth quarter of 2002,
we revised our estimate for accruals related to our liability for the royalties
to MSN, resulting in recognition of other income of approximately $1,000,000. We
have maintained an accrual balance of $1,400,000 related to this program pending
final settlement of the matter with Microsoft and MSN.
Revenue Recognition
- -------------------
We derive revenue primarily from sales of our personal computers, and to a
lesser extent, from software, peripherals and accessories. Generally, we will
recognize revenue when persuasive evidence of an arrangement exists, delivery
has occurred, the fee is fixed or determinable and collection is probable. We
record discounts provided to resellers for achieving purchasing targets as a
reduction of revenue on the date of sale.
For sales of merchandise owned and warehoused by us, we recognize revenue when
title to products sold has transferred to the customer in accordance with
shipping terms. We also sell merchandise from suppliers on a "drop-ship" basis.
We take title to this merchandise from the time it is shipped by the supplier
until the time it is received by the customer.
F-11
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
Accounting for Shipping and Handling Revenue, Fees and Costs
- ------------------------------------------------------------
We classify amounts billed for shipping and handling as revenue in accordance
with Emerging Issues Task Force ("EITF") Issue No. 00-10 "Accounting for
Shipping and Handling Fees and Costs." Shipping and handling fees and costs are
included in cost of sales.
Merchandise Return and Warranty Policy
- --------------------------------------
We warranty our products for one year following the sale. The majority of the
products used in the production of our computers are covered by the original
manufacturers warranties, which are generally one to three years. Other products
that we sell are covered by the third-party manufacturer's warranty. We provide
allowances for estimated future returns and product warranty (included in
accrued expenses) to the customer based on historical experience. While certain
of the products we sell are covered by third party manufacturer warranties, we
may have products returned by customers the costs of which we may not be able to
recover from the manufacturer. Returns of this nature have been immaterial in
the past; however, should actual product failure rates increase, or if the
manufacturers go out of business or refuse to honor their warranty obligations,
we may be forced to cover these warranty costs and the costs may differ from our
estimates.
Software Development Costs
- --------------------------
In accordance with Statement of Position ("SOP") 98-1 and EITF No. 00-2,
internal and external costs incurred to develop internal-use computer software
are expensed during the preliminary project stage. Upon reaching technological
feasibility the costs are capitalized. During the three years ended December 31,
2003, $0, $162,000, and $52,000, respectively, was expensed for software
development costs. We capitalized $0, $32,000 and $331,000 for the years ended
December 31, 2003, 2002 and 2001, respectively.
Advertising Revenue and Costs
- -----------------------------
Advertising revenue is recognized upon receipt of income. Advertising costs are
charged to expense as incurred. Net advertising expense (income) was $227,000,
$76,000 and $(178,000) for the years ended December 31, 2003, 2002 and 2001,
respectively, and is included in operating expenses.
Income Taxes
- ------------
We follow the provisions of SFAS No. 109, "Accounting for Income Taxes," which
requires recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been included in the financial
statements and tax returns. Deferred tax assets and liabilities are determined
based upon the difference between the financial statement and tax bases of
assets and liabilities, using the enacted tax rates in effect for the year in
which the differences are expected to reverse. A valuation allowance is provided
when it is more likely than not that deferred tax assets will not be realized.
F-12
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
Stock-Based Compensation
- ------------------------
We have adopted SFAS No. 123, "Accounting for Stock-Based Compensation." SFAS
No. 123 requires disclosure of the compensation cost for stock-based incentives
granted after January 1, 1995 based on the fair value at grant date for awards.
At December 31, 2003, we have two stock-based employee compensation plans, which
are described more fully in Note 10. We account for these plans under the
recognition and measurement principles of Accounting Principles Board Opinion
No. 25 ("APB 25"), "Accounting for Stock Issued to Employees," and related
interpretations. No stock-based employee compensation cost related to these
plans is reflected in the statement of operations, as all options granted under
those plans had exercise prices equal to the market value of the underlying
common stock on the dates of grant. The following table illustrates the effect
on net income and earnings per share if we had applied the minimum value
recognition provisions of SFAS No. 123 to stock-based employee compensation
(amounts in thousands, except per share data):
Years Ended December 31,
-------------------------------------------------------------
2003 2002 2001
----------------- ---------------- ------------------
Net (loss) income, as reported $ (4,719) $ (2,263) $ 1,488
Deduct:
Total stock-based compensation expense under
fair value based method for all awards, net of
related tax effects $ (16) (56) -
-------------- -------------- -------------
Pro form net (loss) income $ (4,735) $ (2,319) $ 1,488
============== ============== =============
Basic EPS - as reported $ (0.31) $ (0.16) $ 0.15
============== ============== =============
Diluted EPS - as reported $ (0.31) $ (0.16) $ 0.13
============== ============== =============
Basic EPS - pro forma $ (0.31) $ (0.17) $ 0.15
============== ============== =============
Diluted EPS - pro forma $ (0.31) $ (0.17) $ 0.13
============== ============== =============
In accordance with SFAS No. 123, during 2003 we recorded approximately
$625,000 in compensation expense related to warrants to purchase 2,500,000
shares of our common stock that we issued to a member of the new invesetor
group. The compensation expense is included in operating expenses in the
accompanying consolidated statement of operations (see Note 12).
F-13
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
401(k) Plan
- -----------
We offer a 401(k) plan that covers all full time employees who are not a covered
by a collective bargaining agreement. Employees are eligible for the plan
following one year of service. We made matching contributions to participants
equal to 50% of the first 6% of the employee's contribution through June 2001.
Expenses relating to the 401(k) plan were approximately $1,800, $8,000 and
$19,000 for the years ended December 31, 2003, 2002, and 2001, respectively.
Net Income (Loss) Per Share
- ---------------------------
Basic net income (loss) per share excludes dilution and is computed by dividing
net income by the weighted average number of common shares outstanding during
the reported periods. Diluted net income (loss) per share reflects the potential
dilution that could occur if other commitments to issue common stock were
exercised. Each share of ESOP preferred stock is convertible into 3.12828 shares
of common stock. Allocated ESOP shares (including shares released for
allocation) are considered dilutive for all periods presented. The computation
of basic and diluted shares outstanding is as follows for the years ended
December 31 (in thousands):
Years Ended December 31,
-------------------------------------------------------------
2003 2002 2001
----------------- ---------------- ------------------
Weighted average shares - basic 15,184 13,928 9,854
Effect of dilutive shares - - 1,451
-------------- -------------- -------------
Weighted average shares - dilutive 15,184 13,928 11,305
============== ============== =============
Since we reported losses for fiscal 2003 and 2002, basic and diluted weighted
average shares are the same for those years, as the effect of stock options and
warrants per share are anti-dilutive and thus not included in the diluted loss
per share calculation. Additional potential dilutive shares are 1,849,759 and
1,451,000 at December 31, 2003 and 2002, respectively.
Product Licenses
- ----------------
From time to time, we receive notices from companies and individuals asserting
exclusive patent, copyright, trademark or other intellectual property rights to
technologies or marks that are important to the technology industry and/or our
business. We evaluate each claim relating to its products and, if appropriate,
seek a license to use the protected technology. The licensing agreements
generally do not require the licensor to assist us in duplicating its patented
technology nor do these agreements protect us from trade secret, copyright or
other violations by us, or our suppliers in developing or selling these
products. We record liabilities when claims asserted are probable and such costs
to us can be estimated. No such costs have been recorded at December 31, 2003 or
2002.
Comprehensive Income
- --------------------
We have adopted SFAS No. 130, "Reporting Comprehensive Income." This statement
established standards for the reporting of comprehensive income and its
components. Comprehensive income, as defined, includes all changes in equity
(net assets) during a period from non-owner sources. For the years ended
December 31, 2003, 2002 and 2001, the difference between net income (loss) and
comprehensive net income (loss) relates to unrealized gains on
available-for-sale securities of $7,000, $489,000 and $524,000, respectively.
F-14
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
New Accounting Pronouncements
- -----------------------------
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN 45 elaborates on the disclosures to
be made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and initial measurement provisions of FIN 45
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements in FIN 45 are effective for
financial statements of interim or annual periods ending after December 15,
2002. Our adoption of FIN 45 in fiscal 2003 did not have a material impact on
our financial position, cash flows or results of operations (see Note 15).
In December 2003, FASB issued Interpretation No. 46R ("FIN 46R") which replaced
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
interpretation of Accounting Research Bulletin No. 51, Consolidated Financial
Statements," to improve financial reporting of special purpose and other
entities. In accordance with the interpretation, business enterprises that
represent the primary beneficiary of another entity by retaining a controlling
financial interest in that entity's assets, liabilities, and results of
operations must consolidate the entity in their financial statements. Prior to
the issuance of FIN 46R, consolidation generally occurred when an enterprise
controlled another entity through voting interests. The disclosure requirements
of FIN 46R are effective for financial statements issued after December 31,
2003. The initial recognition provisions of FIN 46R are to be implemented no
later than the end of the first reporting period that ends after March 15, 2004.
We do not expect FIN 46R to have a material impact on our financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
require that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS No. 150 is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. It is to be implemented by reporting the cumulative effect
of a change in an accounting principle for financial instruments created before
the issuance date of the statement and still existing at the beginning of the
interim period of adoption. Restatement is not permitted. Our adoption of SFAS
No. 150 in 2003 did not have a material impact on our financial position, cash
flows or results of operations.
In November 2002, the EITF reached a consensus on Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables." EITF Issue No. 00-21 provides guidance
on how to account for arrangements that involve the delivery or performance of
multiple products, services and/or rights to use assets. The provisions of EITF
Issue No. 00-21 will apply to revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. We do not expect EITF Issue No. 00-21 to
have a material effect on our financial position, cash flows or results of
operations.
In January 2003, the EITF reached a consensus on Issue No. 02-16, "Accounting by
a Customer (Including a Reseller) for Certain Consideration Received from a
Vendor." EITF Issue No. 02-16 provides guidance regarding how a reseller of a
vendor's products should account for cash consideration received from a vendor.
The provisions of EITF Issue No. 02-16 will apply to vendor arrangements entered
into after December 31, 2002, including modifications of existing arrangements.
Our adoption of EITF 02-16 did not have a material effect on our financial
position, cash flows or results of operations.
F-15
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued
- --------------------------------------------------------------
Reclassifications
- -----------------
Certain reclassifications have been made to the December 31, 2002 and 2001
financial statements to conform to the December 31, 2003 presentation. These
reclassifications had no effect on previously reported net income (loss) for
2002 or 2001.
NOTE 3 - DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
- -------------------------------------------------
Inventories, net consists of the following at December 31 (in thousands):
2003 2002
------------------- --------------------
Raw material $ 2,995 $ 2,564
WIP and finished goods 485 614
--------------- ----------------
$ 3,480 $ 3,178
=============== ================
Cost and fair market value for available-for-sale securities were as follows at
December 31 (in thousands):
2003 2002
------------------- --------------------
Adjusted cost $ - $ 497
Unrealized losses - (7)
--------------- ----------------
Fair value $ - $ 490
=============== ================
Equipment consists of the following at December 31 (in thousands):
2003 2002
------------------- --------------------
Machinery and equipment $ 748 $ 708
Software 360 353
Leasehold improvements 373 349
Vehicles 97 71
Furniture and fixtures 80 80
--------------- ---------------
1,658 1,561
Less accumulated depreciation
and amortization (949) (661)
--------------- ---------------
$ 709 $ 900
=============== ===============
Depreciation and amortization expense on equipment was approximately
$331,000, $282,000 and $158,000 for the years ended December 31, 2003, 2002 and
2001, respectively.
F-16
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 4 - MERGER WITH MCGLEN INTERNET GROUP, INC.
- ------------------------------------------------
On October 11, 2000, we entered into a definitive merger agreement and plan of
merger with Lan Plus Corporation. Lan Plus manufactures branded turnkey computer
products and services, with over ten years of operating history. On March 21,
2001, the companies entered into an amended and restated merger agreement that,
among other things, eliminated certain conditions to closing contained in the
original merger agreement. The amended and restated merger agreement was
subsequently amended several times, ending on March 14, 2002. Upon the close of
the merger on March 20, 2002, Lan Plus shareholders received approximately 3.128
shares of our common stock for each Lan Plus share they owned, totaling
9,854,000 shares, and owned approximately seventy-five percent (75%), on a fully
diluted basis, of our outstanding stock (after taking into account a 10:1
reverse split that took place immediately prior to the close of the merger).
Pursuant to the merger agreement, upon close of the merger, our accounts payable
to, and advances from, Lan Plus totaling approximately $2.3 million were
converted to common stock and the stock was then retired to treasury and
cancelled.
Although Lan Plus was merged into our subsidiary , the merger was
accounted for as a reverse acquisition since Lan Plus shareholders controlled
the combined entity after the merger. As a result, for financial accounting
purposes, the merger is treated as a purchase of us by Lan Plus.
Therefore, the historical financial statements of Lan Plus are presented for
comparison purposes for all periods presented.
After the 10:1 reverse stock split, Mcglen stockholders held 5,079,000 shares of
our $0.03 par value common stock. For accounting purposes, the shares retained
by Mcglen stockholders in the merger were valued on Lan Plus' books as an
issuance of new shares at $0.788 per share (after the 10:1 reverse stock split
and based on the weighted average closing price of the shares just prior to and
after the merger date), totaling $4,002,000. In addition, Lan Plus assumed
previously issued options and warrants resulting in additional fair value of
$34,000.
The following represents the estimated fair value of net assets acquired by Lan
Plus in the reverse acquisition at March 14, 2002 (in thousands):
Cash $ 108
Other current assets 539
Fixed assets 95
Deferred income taxes 1,400
Goodwill 4,082
Accounts payable and accrued expenses (846)
Inter-company payables (1,152)
Notes payable (190)
----------------
$ 4,036
================
Deferred income taxes represent our estimate at the time of the merger of
Mcglen's net operating loss carryforwards (NOLs) that were expected to be used
to offset our future taxable income, after considering limitations imposed on
NOLs upon a change in control. As a result of losses generated subsequent to the
merger, we recorded a valuation allowance equal to the entire deferred tax
balance at December 31, 2003 (see Note 8).
Goodwill represents the excess of the purchase price of Mcglen over the
estimated fair value of the tangible assets acquired. We identified no material
identifiable intangibles to be recorded related to this purchase in accordance
with SFAS No. 141, "Business Combinations."
F-17
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 4 - MERGER WITH MCGLEN INTERNET GROUP, INC., continued
- -----------------------------------------------------------
On a pro forma basis, the statements of operations would have been as follows
for the year ended December 31 2002, if the acquisition had occurred on January
1, 2002 (in thousands, except per share data) (unaudited):
Net sales $ 69,615
Gross profit 7,030
Loss before taxes 1,832
Net loss $ (2,321)
=============
Net loss per share $ (0.16)
=============
NOTE 5 - GOODWILL IMPAIRMENT
- ----------------------------
In response to uncertain macroeconomic conditions, deteriorating margins and
significant operating losses in 2003 and in connection with the employment of
the new management team and the addition of new members to our board of
directors (see Note 1), we initiated a strategic review of our core business and
began to develop a new business plan to launch a hardware and software offering
targeted at what we believe is an untapped segment of the personal computer and
Internet market. The strategic review triggered an impairment evaluation of the
intangible assets related to the Mcglen acquisition. Based on a valuation
prepared by an independent third party appraisal company, we recorded a
write-down of these intangible assets totaling $590,000.
The following represents the changes in the goodwill balance for the three years
ended December 31, 2003 (in thousands):
Goodwill, January 1, 2001 and 2002 $ -
Goodwill recorded from Mcglen transaction
(see Note 4) 4,082
------
Balance, December 31, 2002 4,082
Impairment of goodwill (590)
------
Balance, December 31, 2003 $ 3,492
===========
NOTE 6 - LINE OF CREDIT
- -----------------------
At December 31, 2003, we had a $2,500,000 line of credit with a bank. The line
of credit, provided for borrowings secured by substantially all of our assets
and was guaranteed by our former chief executive officer. Borrowings under the
line were advanced based upon 70% of eligible accounts receivable, as defined,
less any letters of credit issued on our behalf, and a $200,000 holdback for
potential chargebacks on credit cards processed. Advances under the line bore
interest at the bank's prime rate (4.0%) plus 0.75% (a total of 4.75% at
December 31, 2003). The line contained certain restrictive covenants (as
defined) that required us to maintain profitability in the third and fourth
quarter of 2002, a minimum of $4.25 million of tangible net worth, a current
ratio of at least 1.2:1, working capital of at least $2.5 million, and limits
the capital expenditures we could make in any one year to $750,000. As of
December 31, 2003 the Company was not in compliance with the financial covenants
contained in the loan agreement, but had obtained a forbearance agreement from
the bank. At December 31, 2003, we had no balance outstanding under this line.
F-18
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 6 - LINE OF CREDIT, continued
- ----------------------------------
The line expired in January 2004. In February 2004 we entered into a purchase
and sale agreement with a financial institution. Under the terms of that
agreement, we may assign certain of our accounts receivable to the financial
institution for immediate cash in the amount of 75% of the assigned receivables.
We also receive a portion of the remaining balance of the assigned accounts
receivable, depending on how soon after assignment the financial institution
receives payment on those accounts. We expect to keep this financing purchase
line in place until we can obtain another revolving credit facility of between
$5 million and $10 million with a commercial bank to fund the working capital
needs of our current operations and any new product initiatives. We have
contacted several commercial banks regarding a revolving credit facility, but we
do not currently have any binding commitments regarding such a facility.
In September 2002, we reached a settlement with the holder of the Mcglen line of
credit whereby we repaid $40,000 of the $90,000 due under the line. The
resulting gain of $50,000 is included in other income for the year ended
December 31, 2002.
NOTE 7 - NOTES PAYABLE
- ----------------------
At December 31, 2003, we had a $1,300,000 note payable to an individual.
Interest on the note is payable monthly at 9% and the note is due January 1,
2005. Accrued but unpaid interest of approximately $185,000 and $58,000 is
included in accrued expenses at December 31, 2003 and 2002, respectively.
Two installment loans totaling approximately $71,000 were also outstanding at
December 31, 2003, collateralized by company-owned vehicles.
Maturities of long-term debt are as follows (in thousands):
Years Ending October
31,
------------------------
2004 $ 16
2005 1,316
2006 17
2007 18
2008 4
----------------
$ 1,371
================
At December 31, 2003, we also had $100,000 of convertible notes payable to an
individual, dated June 18, 1999. Interest was payable at 10% per annum through
December 18, 2000 and is payable at 12% thereafter. The note and accrued
interest were due December 18, 2000. The note is convertible at $20.00 per share
and is currently in default. Management has held settlement discussions with the
note holder but has been unable to reach a settlement for payment.
F-19
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 8 - INCOME TAXES
- ---------------------
The components of the income tax provision (benefit) were as follows (in
thousands):
Years Ended December 31,
-----------------------------------------------------------
2003 2002 2001
----------------- ---------------- ----------------
Current $ (79) $ (369) $ 452
Deferred - 858 15
-------------- -------------- -------------
$ (79) $ 489 $ 467
============== ============== =============
For the years ended December 31, 2003, 2002 and 2001, income tax
expense differed from the amounts computed applying the federal statutory rate
of 34% to pre-tax income (loss) as follows (in thousands):
Years Ended December 31,
-------------------------------------------------------------
2003 2002 2001
----------------- ---------------- ------------------
Computed "expected" tax expense (benefit) $ (1,631) $ (603) $ 665
(Decrease) increase in income taxes resulting
from expenses not deductible for tax purposes 55 47 (267)
Release of accrual for change in estimate - (637) -
State and local income taxes, net of federal
effect (275) (104) 69
Increase in valuation allowance 1,772 1,786 -
-------------- -------------- -------------
$ (79) $ 489 $ 467
============== ============== =============
Deferred taxes consist of the following at December 31 (in thousands):
-------------------------------------
2003 2002
------------------- ----------------
Deferred tax assets:
Net operating loss carryforward $ 3,061 $ 1,443
Reserves and allowances 554 120
Marketable securities - 197
Other 56 58
Less valuation allowance (3,558) (1,786)
------------ ----------
Total deferred tax assets 113 32
------------ ----------
Deferred tax liabilities:
Fixed assets (16) (12)
State tax (97) (20)
------------ ----------
Total deferred tax liabilities (113) (32)
------------ ----------
$ - $ -
============ ==========
F-20
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 8 - INCOME TAXES, continued
- --------------------------------
We have federal and state net operating loss carryforwards of approximately $19
million and $13 million. Utilization of the net operating loss carryforwards is
subject to a substantial annual limitation due to the ownership change
limitations provided by the Internal Revenue Code of 1986, as amended, and
similar state provisions. The annual limitation will result in our being able to
only utilize $8.6 million and $5.3 million to offset federal and state income,
respectively, as of December 31, 2003. The remaining net operating loss
carryforwards will go unused. The net operating loss carryforwards will expire
at various dates beginning in 2012 through 2023 for federal purposes and 2004
through 2013 for state purposes, if not utilized. As of December 31, 2003 all
such loss carryforwards have been reserved, due to the likelihood that such
amounts will not be utilized before expiration.
We have an income tax receivable of $464,000 for overpayment on 2002 taxes. This
amount is included in prepaid expenses and other assets. During 2002, we revised
our estimate for tax accruals related to its 1997 and 1998 tax years, resulting
in a tax benefit of $637,000.
NOTE 9 - RELATED PARTY TRANSACTIONS
- -----------------------------------
We leased our office/manufacturing facility under a non-cancelable operating
lease with our former chief executive officer. The lease was terminated in
September 2002. The lease provided for minimum annual rentals and escalations
based on increases in real estate taxes and other operating expenses. Rent
expense was approximately $445,000, $421,000 and $345,000 for the years ended
December 31, 2003, 2002, and 2001 respectively. The amounts for 2002 and 2001
included payments of $258,000 and $345,000, respectively, to our former chief
executive officer.
During 2003, our former chief executive officer advanced approximately
$1,706,000 to us. We repaid approximately $706,000 during 2003. During January
2004, we repaid $500,000 of the amount owed to our former chief executive
officer. These payments were in violation of certain restrictions in connection
with our line of credit. In addition, the payments were in violation of a
subordination agreement that our former chief executive officer executed for the
benefit of the bank. Our former chief executive officer repaid us $500,000 on
February 2, 2004. We paid interest on the outstanding advances during the year
at the rate of 3.5% per annum. Total interest expense related to these advances
was approximately $18,000 for 2003. The outstanding advances of $1,000,000 are
due on demand.
NOTE 10 - STOCKHOLDERS' EQUITY
- ------------------------------
Private Placement
- -----------------
On December 9, 2003, we closed a private placement of 4,000,000 shares of our
common stock for a purchase price of $0.25 per share, and realized gross
proceeds of approximately $1,000,000. The investor in the private placement was
a limited liability company, which is controlled by Samuel J. Furrow, Jr. and
Marc B. Crossman, each of whom joined our board of directors as a result of that
private placement. We used the proceeds of the private placement for working
capital needs.
Stock Split
- -----------
In connection with the merger with Mcglen in March 2002, we effected a 3.12828
split of our ommon stock and changed our par value to $0.03 per share. All
common shares and per share data have been retroactively adjusted to reflect the
stock split and par value change.
Dividends
- ---------
In December 2001, our board of directors approved a dividend of $1.00 per share
for all of our outstanding preferred stock, of which $96,000 was paid in 2001
and was used to service the ESOP debt (see Note 11).
F-21
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 10 - STOCKHOLDERS' EQUITY, continued
- -----------------------------------------
Employee Stock Option Plans
- ---------------------------
Terms and conditions of our option plans, including exercise price and the
period in which options are exercisable, generally are at the discretion of our
board of directors; however, no options may be exercisable for more than five
years after date of grant.
In February 2000, our board of directors approved the Mcglen Micro, Inc. 1999
Stock Option Plan for issuance of common stock to eligible participants. On
February 28, 2002, our stockholders approved the Mcglen Internet Group, Inc.
2000 Stock Option Plan for issuance of common stock to eligible participants.
The 1999 Plan and the 2000 Plan each provides for the granting of incentive
stock options and non-qualified stock options.
Prior to the merger in March 2002 (see Note 4), we had no stock options. The
following table summarizes employee stock option activity:
Weighted Average
Number of Options Price Per Share
------------------ -------------------
Options issued in reverse acquisition 102,000 $ 6.70
Granted 518,000 0.43
Exercised - -
Canceled (38,000) (2.80)
------------- ----------
Outstanding at December 31, 2002 582,000 1.37
Granted - -
Exercised - -
Canceled (370,000) 1.05
------------- ----------
Outstanding at December 31, 2003 212,000 $ 2.50
============== ==========
Exercisable at December 31, 2003 95,000 $ 5.15
============== ==========
Weighted average fair value of options
granted in 2002 $ 0.32
==========
The following table summarizes information about our stock options
outstanding at December 31, 2003:
Options Outstanding Options Exercisable
------------------------------------------------------------- ---------------------------------------
Number Weighted Average Number
Outstanding at Remaining Exercisable at
Range of December 31, Contractual Life Weighted Average December 31, Weighted Average
Exercise Prices 2002 (Years) Exercise Price 2002 Exercise Price
- -------------------- ----------------- ------------------ ------------------ ----------------- ------------------
$0.35 155,000 2.1 $ 0.35 45,000 $ 0.35
$0.50 9,000 3.4 0.50 2,000 0.50
$1.00 8,000 0.2 1.00 8,000 1.00
$9.40 to 15.90 40,000 0.5 11.67 40,000 11.67
-------------- ------- --- ----- ------------- -------------
$0.35 to $15.90 212,000 1.8 $ 2.50 95,000 $ 5.15
=============== ======= === ===== ============= =============
F-22
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 10 - STOCKHOLDERS' EQUITY, continued
- -----------------------------------------
Pro forma information (see Note 1) regarding net (loss) income and net (loss)
income per share is required by SFAS No. 123, and has been determined as if we
had accounted for our employee stock purchase plan and employee stock options
granted under the fair value method of SFAS No. 123. The fair value for these
options was estimated at the date of grant using a Black-Scholes option pricing
model on the date of grant in 2003 and 2002 using the following assumptions: (i)
no dividend yield, (ii) average volatility of 333% and 212%, respectively, (iii)
weighted average risk-free interest rate of approximately 2.11% and 3%,
respectively, and (iv) average expected life of the options of 3 years and 5
years, respectively.
NOTE 11 - EMPLOYEE STOCK OWNERSHIP PLAN
- ---------------------------------------
On December 1, 1999, we established a leveraged employee stock ownership plan
(ESOP) that covers all of our employees who complete 1,000 or more hours of
service in a plan year. To establish the plan, the ESOP borrowed approximately
$10,000,000 from Andy Teng, our then chief executive officer and majority
shareholder, which the plan then used to purchase all of our outstanding
preferred stock (a total of 1,350,000 shares) from Mr. Teng at the then market
price, $7.41 per share.
The preferred stock is convertible into common stock at an exchange rate of one
share of preferred to 3.12828 shares of common, has a liquidation preference of
$1.00 per share, and has certain protective provisions that allow the preferred
stockholders to vote on matters that would alter the preferred stockholders
rights, privileges, powers or restrictions from those currently granted to the
preferred stockholders. We received no funds from this transaction; however, we
were required to record the liability on our books as we had guaranteed the ESOP
debt, in accordance with the American Institute of Certified Public Accountants
Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership
Plans" (SOP 93-6). Under SOP 93-6, the loan obligation is considered unearned
employee benefit expense and, as such, we record it as a reduction to
stockholders' equity, "Unearned ESOP shares."
We made annual contributions to the ESOP equal to a minimum of the ESOP's
required debt service less dividends received by the ESOP. The ESOP shares
initially were pledged as collateral for its debt. As the debt is repaid, shares
are released from collateral and allocated to active employees, based on the
proportion of debt service paid in the year. As shares are released from
collateral, we report compensation expense equal to the current market price of
the shares and the released shares become outstanding for earnings-per-share
computations. We recognized compensation expense of $0, $0, and $322,000 for the
years ended December 31, 2003, 2002, and 2001, respectively. Dividends on
released ESOP shares are recorded as a reduction of retained earnings; dividends
on unreleased ESOP shares are recorded as a reduction of debt and accrued
interest when paid. ESOP interest expense related to the ESOP note was $405,000,
$468,000, and $502,000 for the years ended December 31, 2003, 2002, and 2001,
respectively.
The ESOP note payable required monthly principal payments of $119,000 commencing
January 1, 2000 plus interest at 8% for the first two years. In January 2001,
the ESOP renegotiated its note with Mr. Teng, reducing the interest rate from 8%
to 6% and lowering the required monthly principal payments from $119,000 to
$25,000. The note's maturity date was also extended to December 2009 from
January 2006.
F-23
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 11 - EMPLOYEE STOCK OWNERSHIP PLAN, continued
- --------------------------------------------------
In December 2003, in connection with our change in control (see Note 1), Mr.
Teng agreed to release the ESOP from its obligations under the promissory note,
thereby releasing us from our guarantee of the ESOP debt. Since the ESOP is
under investigation by the United States Department of Labor (DOL) (see Note
14), Mr. Teng has not been able to foreclose on the unreleased shares, as is his
right under the ESOP agreement. In addition, Mr. Teng has agreed to indemnify us
against any damages, claims, etc. relating to the establishment, operation or
termination of the ESOP, including any liability relating to the pending DOL
investigation.
In connection with Mr. Teng's release of the ESOP from its obligations under the
promissory note, we eliminated the guarantee of ESOP loan payable and ESOP
interest payable balances against additional paid-in capital, totaling
$9,114,000, as this debt release is considered a contribution of capital to us
by Mr. Teng. We anticipate that Mr. Teng will foreclose on the unreleased shares
in 2004 when the DOL investigation is completed. At that time, the value of the
unearned ESOP shares will also be eliminated against additional paid-in capital.
Preferred shares held by the ESOP at December 31 are as follows (in thousands):
2003 2002
------------------- --------------------
Allocated shares 464 464
Shares released for allocation - -
Unreleased (unearned) shares 886 886
--------------- ---------------
Total ESOP shares 1,350 1,350
=============== ===============
Fair value of unreleased
(unearned shares) $ 2,494 $ 554
=============== ===============
In the event a terminated ESOP participant desires to sell his or her shares of
preferred stock, or for certain employees who elect to diversify their account
balances, we may be required to purchase the shares from the participant at
their fair market value. During the years ended December 31, 2003, 2002 and
2001, we did not purchase any stock from ESOP participants. In addition, at
December 31, 2003, approximately 275,000 shares of preferred stock, with an
aggregate fair market value of approximately $774,000, are held by ESOP
participants who are eligible to elect their diversification privileges under
the ESOP.
At December 31, 2003, we have received advances from the ESOP of $210,000 that
are non-interest bearing and due on demand and are reflected as a current
liability in the accompanying consolidated balance sheet.
F-24
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 12 - WARRANTS
- ------------------
The following table summarizes our warrant activity:
Number of Warrants Weighted Average
Exercise Price
-------------------- --------------------
Outstanding at January 1, 2002 237,000 $ 12.50
Granted 100,000 1.50
Exercised - -
Canceled (106,000) (12.50)
--------- ----------
Outstanding and exercisable at December 31, 2002 231,000 5.61
Granted 2,500,000 0.50
Exercised - -
Canceled - -
----------- ----------
Outstanding and exercisable at December 31, 2003 2,731,000 $ 0.93
=========== =========
Weighted average fair value of warrants granted 2002 $ 0.59
=========
2003 $ 0.25
=========
The following table summarizes information about our warrants
outstanding at December 31, 2003:
Weighted Average
Number of Remaining
Outstanding Contractual Life
Exercise Price and Exercisable (Years)
--------------------- ------------------------ --------------------
$0.50 2,500,000 5.0
$1.50 100,000 2.3
$2.50 12,000 2.5
$5.00 15,000 1.2
$10.00 104,000 1.2
----------------
$0.50 - $10.00 2,731,000 4.05
================
In December 2003, we committed to issue 2,500,000 warrants at $0.25 per share
(exercisable through December 2008) to a consultant pursuant to a six-month
consulting agreement. As these shares were fully vested and nonforfeitable at
the date of the agreement, we measured the value of the entire warrant issuance
at December 31, 2003 in accordance with EITF 96-18, "Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction With Selling, Goods or Services." As we anticipate receiving no
additional benefit from this contract beyond the benefits we received in
December 31, 2003, we have determined to record the entire value of the warrants
in December 2003. The value was determined in accordance with the Black-Scholes
formula under SFAS No. 123, and totaled $625,000. As we have committed to issue
all the warrants, we have reflected them as if all warrants were issued in
December 2003. Pursuant to the terms of the consulting agreement, 1,666,667
warrants will be issued in 2004.
F-25
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 13 - SEGMENT INFORMATION
- -----------------------------
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information," requires companies to report financial and descriptive information
about its reportable operating segments, including segment profit or loss,
certain specific revenue and expense items, and segment assets, as well as
information about the revenues derived from our products or services, the
countries in which we earn revenues and holds assets, and major customers. SFAS
No. 131 also requires companies that have a single reportable segment to
disclose information about products and services, information about geographic
areas, and information about major customers. SFAS No. 131 requires the use of
the management approach to determine the information to be reported. The
management approach is based on the way management organizes the enterprise to
assess performance and make operating decisions regarding the allocation of
resources. It is management's opinion that we have only one reportable segment,
and has no concentration of customers in one specific geographic area within the
United States. Major customers, as defined, have been discussed in Note 1 above.
NOTE 14 - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
- -----------------------------------------------------------
Years Ended December 31,
-------------------------------------------------------------
2003 2002 2001
----------------- ---------------- ------------------
(In thousands)
Cash paid during year ended:
Interest $ 168 $ 126 $ 1,076
Income taxes $ - $ 417 $ 178
Non-cash investing and financing activities:
Release of guarantee of ESOP loan payable $ 9,114 - -
Purchase of Mcglen with our
common stock $ - $ 4,036 $ -
NOTE 15 - COMMITMENTS AND CONTINGENCIES
- ---------------------------------------
We lease certain office space and equipment under long term operating lease
agreements that expire on various dates through 2006. Minimum annual operating
lease commitments at December 31, 2003 are as follows:
Year Amount
---- ------
2004 $494,000
2005 485,000
2006 483,000
---- -------
Total $1,462,000
----------
From time to time, other companies and individuals assert exclusive patent,
copyright, trademark or other intellectual property rights to technologies or
marks that are important to the technology industry or our business. Certain
companies have asserted such rights related to products that we manufacture. We
evaluate each claim relating to our products and, if appropriate, seek a license
to use the protected technology. The licensing agreements generally do not
require the licensor to assist us in duplicating its patented technology nor do
these agreements protect us from trade secret, copyright or other violations by
us or our suppliers in developing or selling these products. We also may be
responsible for any product liability issues that may arise from the sale of its
products.
F-26
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 15 - COMMITMENTS AND CONTINGENCIES, continued
- --------------------------------------------------
We have made certain indemnities and guarantees under which it may be required
to make payments to a guaranteed or indemnified party in relation to certain
transactions. We have indemnified our directors, officers, employees and agents
to the maximum extent permitted under the laws of the State of Delaware. In
connection with our facility leases, we have indemnified our lessors for certain
claims arising from the use of the facilities. In connection with certain of our
debt, management and stock purchase agreements, we have indemnified lenders,
buyers and others for certain claims arising from our breach of representations
and warranties contained in the corresponding agreements. The duration of the
guarantees and indemnities varies, and in many cases is indefinite. These
guarantees and indemnities do not provide for any limitation of the maximum
potential future payments we could be obligated to make. Historically, we have
not been obligated to make any payments for these obligations and no liabilities
have been recorded for these indemnities and guarantees in the accompanying
consolidated balance sheet.
On or about December 16, 2002, we were informed that the Pension and Welfare
Benefits Administration of the DOL had selected our ESOP for review. The DOL has
raised issues regarding the December 1999 transaction between Mr. Teng and the
ESOP. In the December 1999 transaction, Mr. Teng sold shares of our common stock
to the ESOP in connection with the establishment of the plan. The DOL has
indicated that this transaction may have been a prohibited transaction because
the purchase price of the shares may have been above fair market value at the
time of the transaction, which would require the unwinding or correction of the
transaction. Although Mr. Teng is primarily responsible for remedying any
prohibited transaction, we may have some liability as a co-fiduciary of the
ESOP. However, Mr. Teng has agreed to indemnify us against any costs or damages
incurred by us in connection with the DOL investigation. We intend to cooperate
with the DOL in connection with its review of our ESOP, and to bring such review
to conclusion as quickly as possible.
At this time, we are not involved in any other legal proceedings that our
management currently believes would be material to our business, financial
condition or results of operations. We could be forced to incur material
expenses with respect to these legal proceedings, and in the event there is an
outcome in any that is adverse to us, our financial position and prospects could
be harmed.
NOTE 16 - SUBSEQUENT EVENTS
- ---------------------------
On January 15, 2004 we entered into an employment agreement with our chief
executive officer for period of two years. In connection with this employment
agreement, we granted our chief executive officer an option to purchase
3,309,587 shares of our common stock at $1.01 per share. The term of the option
is seven years and the options will vest over a 24-month period starting from
the grant date. We did not record any expense as the exercise price was equal to
the fair market value of the common stock on the date of grant.
On March 23, 2004, our board of directors adopted the Northgate Innovations,
Inc. 2004 Incentive Stock Option Plan, subject to approval by our stockholders
within 12 months after adoption. Under the 2004 Plan, we granted options to
employees to purchase a total of 2,090,317 shares of common stock. Such options
have a term of seven to ten years vesting in 24 monthly installments or four
annual installments through February 2006. We did not record any expense as the
exercise price was no less than the fair market value of the common stock on the
date of grant. However, we may be required to record expense at the time of
stockholder approval if the fair market value of the stock on the date of that
approval is greater than the exercise prices of the options. The options granted
under the 2004 Plan will terminate if our stockholders do not approve the 2004
Plan.
F-27
NORTHGATE INNOVATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 16 - SUBSEQUENT EVENTS, continued
- --------------------------------------
On March 24, 2004, we granted to employees options to purchase a total of
294,500 shares of common stock, at prices ranging from $0.12 to $0.45 per share,
under the 2004 Plan. Such options are vested in varying installments. We will
recognize approximately $30,000 of compensation expense under APB 25 in 2004
relating to these options.
NOTE 17 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
- -------------------------------------------------------
The following tables contain selected unaudited consolidated quarterly financial
data (in thousands, except per share data):
Quarters Ended
----------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
2003 2003 2003 2003 2003
--------------- -------------- ----------------- ----------------- --------------
Net sales $ 20,065 $ 17,398 $ 17,415 $ 22,168 $ 77,046
Cost of sales 19,227 16,773 16,113 20,677 72,790
---------- ------------ ------------ ------------ ------------
Gross profit 838 625 1,302 1,491 4,256
Operating expenses 1,879 1,876 1,696 3,273 8,724
---------- ------------ ------------ ------------ ------------
Operating (loss) income (1,041) (1,251) (394) (1,782) (4,468)
Other income (expense) (167) (102) (125) 64 (330)
----------- ------------- ------------- ------------ -------------
Loss before income taxes (1,208) (1,353) (519) (1,718) (4,798)
Benefit (provision)
for income taxes 79 - - - 79
---------- ------------- ------------ ------------ ------------
Net loss $ (1,129) $ (1,353) $ (519) $ (1,718) $ (4,719)
=========== ============ ============ ============ ============
Basic loss per share $ (0.08) $ (0.09) $ (0.03) $ (0.11) $ (0.31)
=========== ============ ============ ============== ============
Diluted loss per share $ (0.08) $ (0.09) $ (0.03) $ (0.11) $ (0.31)
=========== ============ ============ ============== ============
Weighted average shares of
common stock outstanding
Basic 14,943 14,943 14,943 15,900 15,184
=========== ============ ============ ============ ============
Diluted 14,943 14,943 14,943 15,900 15,184
=========== ============ ============ ============ ============
Quarters Ended
----------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
2002 2002 2002 2002 2002
--------------- -------------- ----------------- ----------------- --------------
Net sales $ 19,432 $ 15,645 $ 18,562 $ 11,537 $ 65,176
Cost of sales 17,692 13,005 16,473 11,480 58,650
---------- ------------ ------------ ------------ ------------
Gross profit 1,740 2,640 2,089 57 6,526
Operating expense 2,145 1,941 2,002 1,944 8,032
---------- ------------ ------------ ------------ ------------
Operating (loss) income (405) 699 87 (1,887) (1,506)
Other income (expense) 5 (372) 36 63 (268)
---------- ------------- ------------ ------------ -------------
(Loss) income before
income taxes (400) 327 123 (1,824) (1,774)
Benefit (provision)
for income taxes 160 (127) (45) (477) (489)
---------- ------------- ------------- ------------- -------------
Net income (loss) $ (240) $ 200 $ 78 $ (2,301) $ (2,263)
=========== ============ ============ ============= ============
Basic income (loss)
per share $ (0.02) $ 0.01 $ 0.01 $ (0.15) $ (0.16)
=========== ============= ============= ============== ============
Diluted income (loss)
per share $ (0.02) $ 0.01 $ 0.00 $ (0.15) $ (0.16)
=========== ============= ============= ============== ============
Weighted average shares of
common stock outstanding
Basic 10,827 14,943 14,943 14,943 13,928
=========== ============ ============ ============ ============
Diluted 10,827 17,133 17,133 14,943 13,928
=========== ============ ============ ============ ============
F-28
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)
Column A Column B Column C Column D Column E
----------- ------- -------- --------- -------
Balance at Balance
Beginning at End
Description of year Additions Deductions of Year
----------- ------- -------- --------- -------
2003
- ----
Allowance for doubtful accounts
deducted from accounts receivable
in the balance sheet $ 280 $ 631 $ - $ 911
Reserve for obsolescence deducted
from inventories on the balance sheet 193 1,457 1,282 368
------- -------- --------- -------
$ 473 $ 2,088 $ 1,282 $1,279
======= ======== ========= =======
2002
- ----
Allowance for doubtful accounts
deducted from accounts receivable
in the balance sheet $ 254 $ 30 $ 4 $ 280
Reserve for obsolescence deducted
from inventories on the balance sheet 305 1,322 1,434 193
------- -------- --------- -------
$ 559 $ 1,352 $ 1,438 $ 473
======= ======== ========= =======
2001
- ----
Allowance for doubtful accounts
deducted from accounts receivable
in the balance sheet $ 559 $ 661 $ 966 $ 254
Reserve for obsolescence deducted
from inventories on the balance sheet 292 3,689 3,676 305
------- -------- --------- -------
$ 851 $ 4,350 $ 4,642 $ 559
======= ======== ========= =======
F-29