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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
Commission File No.: 0-27878
NORTHGATE INNOVATIONS, INC.
(FORMERLY MCGLEN INTERNET GROUP, INC.)
(Name of registrant as specified in its charter)
Delaware 13-3779546
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
16700 Gale Avenue, City of Industry, California 91745
(Address of principal executive offices) (Zip code)
Issuer's telephone number: (626) 923-6000
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: None
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
TITLE OF CLASS
--------------
Common Stock, $.03 par value
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-K contained in this form, and no disclosure will 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. [ ]
The aggregate market value of shares of Common Stock held by
non-affiliates of the registrant on April 12, 2002 was approximately $5,125,814
(computed on the basis of $0.60 per share, the last reported sale price for
shares of the Company's Common Stock on the OTC Bulletin Board as of such date).
As of April 12, 2002, the registrant had outstanding 18,961,162 shares
of Common Stock.
TABLE OF CONTENTS
PAGE
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PART I.
ITEM 1. BUSINESS OF NORTHGATE.......................................1
ITEM 2. DESCRIPTION OF PROPERTY....................................22
ITEM 3. LEGAL PROCEEDINGS..........................................23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........23
PART II.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...23
ITEM 6. SELECTED FINANCIAL DATA....................................24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS..................................25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.31
ITEM 8. FINANCIAL STATEMENTS.......................................31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................31
PART III.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.31
ITEM 11. EXECUTIVE COMPENSATION.....................................32
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................35
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............36
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K...................................................38
SIGNATURES.
Financial Statements and Supplementary Data.
-i-
PART I
ITEM 1. BUSINESS OF NORTHGATE
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K and the documents incorporated herein by
reference contain forward-looking statements based on current expectations,
estimates and projections about our industry, management's beliefs and certain
assumptions made by management. When used in this report and elsewhere by
management, from time to time, the words "believes," "plans," "estimates,"
"intends," "anticipates," "seeks," and "expects" and similar expressions are
intended to identify forward-looking statements. These forward-looking
statements are not guarantees of future performance and are subject to certain
risks and uncertainties that are difficult to predict. Accordingly, actual
results may differ materially from those anticipated or expressed in such
statements. Potential risks and uncertainties include, among others, those set
forth herein under "Additional Factors That May Affect Future Results."
Particular attention should be paid to the cautionary statements involving our
limited operating history, anticipated losses, unpredictability of future
revenues, potential fluctuations in operating results, systems failures,
business interruptions, capacity constraints, systems development, management of
growth, the intensely competitive nature of the electronic commerce industry and
reliance on third parties, manufacturers, distributors and suppliers. Readers
are cautioned not to place undue reliance on the forward-looking statements,
which speak only as of the date made. Except as required by law, we undertake no
obligation to update any forward-looking statement, whether as a result of new
information, future events or otherwise. Readers, however, should carefully
review the factors set forth in other reports or documents that we file from
time to time with the Securities and Exchange Commission ("SEC").
GENERAL
As used in the following section, "Northgate," "Mcglen," "we," "the Company" and
"our" refer to Northgate Innovations, Inc. (formerly known as Mcglen Internet
Group, Inc.) and our subsidiaries including Western Technologies, Inc., Mcglen
Micro, Inc. and AMT Components, Inc. unless the context requires otherwise. We
were incorporated in Delaware in May 1994. In March 1995, we changed our name to
Wanderlust Interactive, Inc., and in May 1998, we changed our name to Adrenalin
Interactive, Inc. On December 2, 1999, we completed a reverse acquisition with
Mcglen Micro, Inc. in which the stockholders of Mcglen Micro, Inc. acquired
control of the Company. As a result of the acquisition, each share of Mcglen
Micro, Inc. was converted into 0.0988961 shares of our common stock, with
2,548,553 shares being issued. On December 17, 1999, we changed our name to
Mcglen Internet Group, Inc. On March 15, 2002, we changed our name to Northgate
Innovations, Inc.
On March 20, 2002, Lan Plus Corporation ("Lan Plus") completed a reverse
acquisition with Mcglen in which the stockholders of Lan Plus acquired control
of Mcglen. As a result of the acquisition, each share of Lan Plus was converted
into approximately 3.128 shares of our common stock, with approximately
14,113,000 shares being issued (after consideration of the reverse split). In
addition, immediately prior to the close of the merger, the Company also
instituted a 10:1 reverse stock split and the Company's accounts payable to, and
advances from Lan Plus, in the amount of approximately $2.3 million were
converted to common stock eliminating the debt; the stock was then retired to
Treasury and cancelled. The Company will report combined operations with Lan
Plus beginning with its 10-Q for the period ended March 31, 2002.
On March 28, 2002, we changed our ticker symbol on the OTC Bulletin Board to
"NGTE." Our executive offices are located at 16700 Gale Avenue, City of
Industry, California 91745. Our Internet address is http://www.Mcglen.com.
Information contained on our web site is not, and should not be considered, part
of this filing.
BUSINESS
The Company is a brick and mortar developer, manufacturer and distributor of
innovative PCs, peripherals, software, and over 100,000 computer products. The
Company specializes in selling its computers through Television Shopping
Networks, Mail Order Catalog Companies and large Electronic Chain Stores as well
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as targeting specific business-to-business and business-to-consumer markets
through the Internet. Our operations division, which includes a call center,
sourcing, warehousing, fulfillment, accounting, business development and
information technology, supports order processing, logistics, customer service,
financial transactions and core technology for our business divisions located in
the City of Industry, California. Our business divisions include sales,
marketing, content management, product management and service management teams
focused on building unique customer experiences for each business division.
We currently offer more than 100,000 computer products on our two operating
on-line retail web sites: Mcglen.com and AccessMicro.com. We offer different
mixtures of computing technology, entertainment and communications products on
these web sites based on the different target market segments' buying patterns.
Mcglen.com, launched in May 1996, and AccessMicro.com, launched in June 1996,
have both achieved Customer Certified Gold Merchant status on BizRate.com, an
independent on-line retail rating guide. Moreover, Gomez Advisor, an independent
business rating guide, consistently ranks Mcglen.com and AccessMicro.com among
the top 31 sites to purchase computing products on the Web in their Internet
Computer Store Scorecard.
RECENT DEVELOPMENTS
On October 11, 2000, we entered into an agreement and plan of merger with Lan
Plus Corporation. Lan Plus is a manufacturer of both private-label and branded
turnkey computer products and services, with over ten years of operating
history. On March 21, 2001, we 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 Mcglen common stock for each Lan Plus share they
owned, and owned approximately seventy-five (75%) of the outstanding stock of
Mcglen (after taking into account a 10:1 reverse split that took place
immediately prior to the close of the merger). In addition, the Company changed
its name to Northgate Innovations, Inc. Pursuant to the merger agreement, upon
close of merger, the Company's accounts payable to, and advances from Lan Plus,
in the amount of approximately $2.3 million was converted to common stock
eliminating the debt; the stock was then retired to Treasury and cancelled. The
Company will report combined operations with Lan Plus beginning with its 10-Q
for the period ended March 31, 2002.
Andy Teng, founder, Chairman and Chief Executive Officer of Lan Plus, became the
Chief Executive Officer and Chairman of the Board of the combined company and
Richard Shyu, previously Vice President of Lan Plus became President of the
combined company. Grant Trexler, previously Mcglen's Chief Financial Officer,
became Chief Financial Officer of the combined company. Two of Mcglen's
founders, Mike Chen and Alex Chen, assumed management positions within the new
company. Mike Chen also remained on the Company's Board of Directors.
DISCONTINUED OPERATIONS
In connection with the reverse acquisition of Adrenalin Interactive, Inc. in
December 1999, our board of directors voted to discontinue the operations of
Western Technologies, Inc., Adrenalin's operating subsidiary. Western
principally developed video games for use with Sony, Nintendo and Sega video
game consoles pursuant to funded contracts with video game developers,
entertainment titles for PCs and electronic toys including interactive,
Web-powered toys that are refreshed from a PC via the Internet. Western also
created interactive television games for digital set-top boxes and published or
licensed PC games in 24 countries and 15 languages. We completed two of the
software development contract obligations conducted by Western during the second
quarter of 2000. Two other contracts were terminated. An additional contract was
assigned to Western's former Vice President of Operations for completion,
releasing Mcglen from any further contractual liability. However, we are still
responsible for any product liability issues that may arise from the two
completed contracts.
INTERNET INDUSTRY BACKGROUND
The Internet allows millions of consumers and businesses to share information
and conduct business electronically. International Data Corporation ("IDC")
estimates that the worldwide Internet economy will reach $2.8 trillion by 2003.
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The growth of the Internet is dependent upon a number of factors, including:
o Increased installed-base and usage of personal computers and
Internet devices;
o Widely available and affordable access to the Internet;
o Awareness and acceptance of Internet among consumers and
businesses; and
o Increase in the capability and availability of network
infrastructure.
INTERNET STRATEGY
Our goal is to create and operate market-focused on-line, retail and wholesale
businesses. We will continue to expand our existing operating business divisions
by enhancing brand recognition, building awareness to our web sites, and
increasing the products and services offerings provided on the web sites. We
intend to capitalize on our existing technology backbone and operations
infrastructure by promoting our web sites to new customers while developing and
implementing programs to retain our current customers. We intend to create
synergy among our operating businesses, and with Lan Plus, to maximize return on
investment.
WEB SITES
We believe our market-focused web sites provide unique on-line experiences to
different target market segments. Based on the target market segment's
expectations and requirements, each of our web sites' content design and product
mixture maximizes the perceived value of our offerings. Mcglen.com offers
computing technology products, targeting information technology professionals.
AccessMicro.com offers computing technology products, targeting small
businesses. We believe ease of use is essential in any successful web site. To
provide a simple and convenient purchasing experience, we developed key features
for our operating web sites. The key features of our web sites include:
o BROWSING - We have categorized our current offering of more
than 100,000 products into product groups, categories and
subcategories. Links to product groups and categories are
placed on each page for convenient "one-click" access. Special
sections are created for special offers and promotional
products to enhance exposure for hot selling, high margin
products that we update daily.
o SPECIALIZED BROWSING - Conventional categorization systems
assign one department, category and subcategory to each
product. For certain product groups, finding the desired
product under this categorization system is difficult. We have
developed a specialized categorization system for certain
product groups to minimize the search effort.
o SEARCHING - We have developed general keyword search, specific
product identification number search and interactive guided
criteria search to facilitate precise product selection with
minimal effort.
o PRODUCT INFORMATION - We provide detailed technical
information for many of the products we offer. Manufacturer
technical support and contact information is also provided.
o CUSTOM CONFIGURATION - We have developed a configuration
engine that allows our customers to interactively configure a
personal computer based on the customer's specification.
o CUSTOMIZABLE DISPLAY FORMAT - To facilitate the purchasing
decision process, visitors can customize the display format,
sorting order and selection criteria for product listings.
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o RELATED PRODUCTS LINKS - At each product detail page, links to
related categories are conveniently placed for one-click
access to relevant products. Links to selected products'
options and accessories are placed on the same page for easy
access.
o ON-LINE ACCOUNT AND ORDERING SYSTEM - Our on-line ordering
engine is designed for intuitive usage and minimal data entry
for first-time and repeat customers. Customers can create an
on-line account as they make a purchase for the first time. On
each subsequent visit the customer will be able to check order
status, review past orders, and place new orders without
entering shipping, billing and credit card information again.
INTERNET MARKETING
Our Internet marketing strategy is to promote and increase brand awareness of
our current storefronts, including AccessMicro.com (a marketplace for small
business) and Mcglen.com (a marketplace for IT professionals). Through various
incentive programs and customer care and support, we also intend to build
customer loyalty and encourage repeat purchases.
We are executing this strategy through the following channels:
o forming alliances with various shopping portals;
o actively maintaining opt-in customer mailing lists;
o broadening product offerings;
o creating repeat buyer incentive programs; and
o building partnerships with manufacturers and vendors.
We believe that the use of multiple marketing channels reduces reliance on any
one source of customers, lowers customer acquisition costs and maximizes brand
awareness.
ON-LINE AND TRADITIONAL ADVERTISING
We have implemented a broad-based, multi-media advertising campaign that
includes both on-line and traditional advertising, designed to drive high-value
traffic to our web sites. Our current on-line advertising focuses on a variety
of web sites that have a proven ability to drive buyers to our sites. These
partners have typically included PriceWatch, Ziff Davis, CNET and various
smaller partner sites. Additionally, efforts in direct marketing in resulted in
high levels of success through e-mail marketing as well as a weekly promotional
newsletter. We believe our newsletter to be very effective in informing
subscribers of the latest and the best products available today.
Clicktrade.com, a site of Link-Exchange, is our primary outsource partner to
support our affiliate program. We pay Link-Exchange on a per-click basis to
affiliate partners. Our affiliate program has been in place since early 1998,
and we increased our exposure in the Link-Exchange network aligning ourselves
with additional affiliate partners in 2000 and 2001.
MERCHANDISING
We currently host two sites with product compositions including computing,
entertainment and communication products. By utilizing these sites
(www.Mcglen.com and www.AccessMicro.com), we have the ability to gear our
marketing campaigns to different segments of the market-- the small office/home
office market and the IT professionals market. The merger with Lan Plus will
allow us to expand our marketing reach through their web sites, Lan-plus.com,
epcdirect.com and myshoppingclub.com.
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Our approach to merchandising allows Mcglen to offer each segment of our target
audience a unique shopping experience, giving Mcglen the advantage of pricing
flexibility, the ability to offer our customers only what is relevant to their
needs, focused cross-selling and up-selling of products, and the potential of
expanding our products and services to each one of these markets.
By utilizing distinct web sites, we are also able to tailor a unique shopping
experience for each segment of our target audience. For example, targeting IT
professionals, our Mcglen.com site offers a clean design and easy access,
together with a no-nonsense functionality, that allows these customers to find
their desired products and purchase them in the shortest amount of time
possible.
Because each web site is targeted to a specific audience, we are able to
cross-sell and up-sell our products more effectively than our competitors. For
example, knowing that the customers from our AccessMicro.Com site are of the
small office/home office market segment, we may "up-sell" a customer who is
purchasing an ink-jet printer an entry-level laser printer because speed of
print jobs would be a major concern of these customers.
Since Mcglen already has concentrated customer bases, we are able to expand our
services to best benefit each individual market. Mcglen will continue to add
products and services that will enhance, rather than fragment, the shopping
experience of each individual market segment. These advantages are in addition
to the advantages Mcglen and other e-tailers already enjoy over traditional
retailers, such as: the ability to instantly change prices when our costs
change, a virtually unlimited amount of display and shelf space, and the ability
to offer our customers much greater access to product information.
CUSTOMER SERVICE
We believe that our ability to establish and maintain long-term relationships
with our customers, and to encourage repeat visits and purchases, depends, in
part, on the strength of our customer support and service operations as well as
our staff. We seek to achieve frequent automated e-mail communication with our
customers to continually improve customer service for our stores and services.
We offer toll-free phone numbers and e-mail addresses for sales, technical
support, return merchandise and general customer service. Many of our
competitors only offer e-mail support. We will continue to acquire new tools and
technology to improve customer satisfaction.
WAREHOUSING, FULFILLMENT AND DISTRIBUTION
We obtain our products from a network of distributors, wholesalers,
manufacturers and software publishers. In 2001, more than 50% of our products
were purchased through Lan Plus. A substantial amount of products that we carry
in inventory is purchased and shipped "on demand" (that is, after we receive
orders, we purchase products required to fill orders received). We "cross dock"
on a daily basis (that is, receive products from vendors and ship those same
products to customers the same day). We carry approximately seven days' worth of
inventory in house. We also rely on our distributors and wholesalers to ship
products directly to our customers. Our distribution partners, such as Ingram
Micro, Battery-Biz, Viking Components, and Transcend Information Systems, have
distribution centers throughout the United States and can fulfill a majority of
in-stock products within 24 hours. We have established strategic partnerships
with manufacturers to custom-configure personal computers based on our
customer's requirement and ship the configured system directly to our customers.
TECHNOLOGY
Our site management, search, customer interaction, transaction processing and
fulfillment systems consist of a combination of our own proprietary technologies
and third-party technology. We may enhance the capability and scalability of our
systems through acquisition of new third-party technologies and in-house
development. The software applications we use have the capability for 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.
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The hosting of our Web servers is subcontracted to an Internet data center
specialist, Exodus Communications, Inc. Exodus has an extensive national network
backbone with redundant Internet connections to multiple Internet access points,
a secure physical environment, climate control and redundant power supply.
Exodus provides Mcglen access to the facility 24 hours a day, seven days a week.
Exodus also monitors our Web servers continuously.
COMPETITION
Although the electronic commerce industry is still in its infancy, it has
matured substantially in recent years as witnessed by the consolidation of its
major players. Many of our competitors have either gone out of business or been
acquired by other firms through bankruptcy. Furthermore, we have seen
competition arise from manufacturers and suppliers who have not traditionally
sold their products through the Internet.
We currently compete with a variety of companies that sell computer, electronics
and communication products to consumers and businesses through a variety of
media. These companies are larger and have more financial resources than we do
and include:
o Traditional catalog-based merchants that have developed a
significant electronic commerce offering, such as CDW
Computers Centers, Inc., Micro Warehouse, Inc., Insight
Enterprises, Inc., Multiple Zones International, Inc. and
PCMall, Inc.;
o Companies with electronic commerce sites such as, Buy.com
Inc., Dell Computer Corporation and NECX Office;
o Companies offering Internet auctions, such as uBid, Inc.,
Amazon.com, Inc., Yahoo! Inc., and eBay Inc.;
o Companies whose primary business is not on-line retailing but
who derive significant revenue from electronic commerce,
including America Online, Inc., Yahoo! Inc. and QVC, Inc.;
o Traditional retailers of personal computer products such as
CompUSA, Inc.;
o Manufacturers such as Dell Computer Corporation and Gateway,
Inc. who sell directly to the consumer via the Internet;
o Mass merchandisers such as Wal-Mart Stores, Inc., Costco
Wholesale Corporation and Best Buy Co., Inc. that primarily
sell through traditional retail channels but have also
developed an Internet presence; and
o Office product retailers such as Office Depot Inc. and
Staples, Inc. that primarily sell through traditional retail
channels but also sell over the Internet.
We believe the principal competitive factors affecting our market are
competitive pricing, quality of customer service, accuracy of technical product
information, quality and ease of use of web sites, breadth of product offerings,
brand recognition and cost of customer acquisition. We believe we compete
adequately in all these areas with the exception of brand recognition, where
companies with much greater financial and marketing resources have made the
establishment of a strong brand name much more costly and difficult. To maintain
and improve our competitive position, we must continue to be competitive in all
the areas mentioned above, while boosting our brand recognition without
significantly increasing our cost of customer acquisition.
SALES TAX
We currently collect sales tax on sales of products delivered to residents in
the state of California and dropped shipped from Ingram Micro to residents of
Massachusetts. Various states have tried to impose on direct marketers the
burden of collecting sales taxes on the sale of products shipped to state
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residents. The United States Supreme Court affirmed its position that it is
unlawful for a state to impose sales tax collection obligations on an
out-of-state mail order company whose only contacts with the state are the
distribution of catalogs and other advertising materials through the mail and
subsequent delivery of purchased goods from out of state locations by parcel
post and interstate common carriers. It is possible that legislation may be
passed to supersede the Supreme Court's decision, or that the Court may change
its position. Additionally, it is uncertain whether any new rules and
regulations may be adopted, in terms of sales tax collection obligations, to
govern electronic commerce companies as the industry continues its growth. The
imposition of new sales tax collection obligations on Mcglen in states to which
we ship products would result in additional administrative expenses to Mcglen.
More importantly, though, we may lose one of our most competitive advantages in
terms of a higher total price of products for our customers.
GOVERNMENT REGULATION
We are subject, both directly and indirectly, to various laws and governmental
regulations relating to our business. There are currently few laws or
regulations directly applicable to commercial on-line services or the Internet.
However, due to the increasing popularity and use of commercial on-line services
and the Internet, it is possible that a number of laws and regulations may be
adopted. These laws and regulations may cover issues including, for example,
user privacy, pricing and characteristics and quality of products and services.
Moreover, the applicability to commercial on-line services and the Internet of
existing laws governing issues including, for example, property ownership, libel
and personal privacy is uncertain and could expose Mcglen to substantial
liability. Any new legislation or regulation or the application of existing laws
and regulations to the Internet could have a material and adverse effect on our
business.
In addition, because our services and products are available over the Internet
anywhere in the world, multiple jurisdictions may claim that we are required to
qualify to do business as a foreign corporation in each of those jurisdictions.
Our failure to qualify as a foreign corporation in a jurisdiction where we are
required to do so could subject Mcglen to taxes and penalties for the failure to
qualify. It is possible that state and foreign governments might also attempt to
regulate our transmissions of content on our web site or prosecute Mcglen for
violations of their laws. There can be no assurance that violations of local
laws will not be alleged or charged by state or foreign governments, that we
might not unintentionally violate these laws or that these laws will not be
modified, or new laws enacted, in the future.
The Internet Tax Freedom Act (ITFA) currently bars state or local governments
from imposing taxes that would subject on-line commerce transactions to taxation
in multiple states. The ITFA does not prohibit state or local taxation of
on-line commerce products or services that would otherwise be taxed, such as in
states where a company has a physical presence. The ITFA also provides for the
establishment of a commission to study on-line commerce and to recommend a fair
method of taxing Internet transactions. We cannot be certain that upon
expiration of the ITFA, we will not be subject to further taxation by state or
local governments on the sale of merchandise.
EMPLOYEES
As of April 12, 2002, all of our employees had been transferred to Northgate
Innovations, Inc. Approximately 25 full-time employees and 1 part-time employee
are employed by Northgate and directly contributed to the fulfillment of orders
for Mcglen.com and AccessMicro.com . We consider our employee relations to be
good. None of our employees is represented by a labor union, and we have
experienced no work stoppages. Competition for qualified personnel in the
electronic commerce industry is intense, particularly for software development
and other technically-oriented positions.
RESEARCH AND DEVELOPMENT
During the years ended December 31, 2001, 2000 and 1999, $0, $28,000 and $91,000
was expensed, respectively, for research and development related to our web
sites. As of December 31, 2001, there was $264,000 capitalized software
development costs; accumulated amortization of $264,000 has been recorded for
these assets.
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ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to other information contained in this report, the following factors
could affect our actual results and could cause such results to differ
materially from those achieved in the past or expressed in our forward-looking
statements.
An investment in our common stock involves a high degree of risk. You should
carefully review and consider the information below, as well as the other
information contained in this report and incorporated by reference.
WE INCURRED SIGNIFICANT LOSSES IN 2001, 2000 AND 1999.
We incurred a loss of $1.3 million in 2001, $5.7 million in 2000, and $3.5
million in 1999. As of December 31, 2001, we had a working capital deficit of
approximately $1.8 million and a stockholders' deficit of approximately $2.7
million. On a pro forma basis (after consideration of debt conversions and the
repayment of leases payable in March 2002) we had a working capital deficit of
approximately $0.5 million and a stockholders' deficit of approximately $1.5
million at December 31, 2002. Our auditors have included an explanatory
paragraph in their report for the year ended December 31, 2001, indicating there
is substantial doubt regarding our ability to continue as a going concern. There
can be no assurance that we will be profitable in the future. Furthermore,
future profits, if any, will be dependent on many factors, including, but not
limited to, our ability to return our operations to profitability in a timely
manner, the need for additional financing, and competition from other electronic
commerce retailers. If we are not able to significantly improve our operating
results, we may be required to cease or substantially curtail our operations.
OUR STOCK IS TRADED ON NASD'S OVER THE COUNTER ELECTRONIC BULLETIN BOARD
Our securities trading is conducted in the NASD's OTC Electronic Bulletin Board.
As a result, an investor may find it more difficult to purchase, dispose of, and
obtain accurate quotations as to the value of, our securities.
In addition, since the trading price of our common stock is less than $5.00 per
share, trading in the common stock is also be subject to the requirements of
Rule 15g-9 under the Securities Exchange Act of 1934. Under that rule,
broker/dealers who recommend such low-priced securities to persons other than
established customers and accredited investors 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 disclosure in connection with any trades involving a stock
defined as a penny stock (generally, any equity security not traded on an
exchange or quoted on Nasdaq SmallCap that has a market price of less than $5.00
per share), 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 securities and the ability of purchasers of our stock to sell their
securities in the secondary market.
WE HAVE A SIX YEAR ON-LINE OPERATING HISTORY THAT PROVIDES LITTLE INFORMATION
WITH WHICH TO EVALUATE OUR ELECTRONIC COMMERCE BUSINESS.
There is little information on which to evaluate our business and prospects as
an electronic commerce company. An investor in our common stock must consider
the risks and difficulties that early-stage companies frequently encounter in
the new and rapidly evolving market of electronic commerce. Such risks for
Mcglen include:
o our evolving and unpredictable business model;
o our competitors that have more established electronic commerce
operations;
o our need and ability to manage growth; and
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o the rapid evolution of technology in electronic commerce.
To address these risks and uncertainties, we must take various steps, including:
o improving our customer service and providing outstanding order
fulfillment;
o continuing to develop and upgrade our technology,
infrastructure and systems that support our on-line stores;
o expanding the number of products and categories of merchandise
offered at our on-line stores;
o increasing our customer base to achieve economies of scale;
o attracting, retaining and motivating qualified personnel; and
o making our on-line stores more user-friendly and appealing to
customers.
WE MAY NOT BE SUCCESSFUL IN IMPLEMENTING ANY OF OUR STRATEGIES OR IN ADDRESSING
THESE RISKS AND UNCERTAINTIES, AND EVEN IF WE ACCOMPLISH THESE OBJECTIVES, WE
STILL MAY NOT BE PROFITABLE IN THE FUTURE.
We incurred substantial losses from operations in 2001, 2000 and 1999. As of
December 31, 2001, we had an accumulated deficit of $10.5 million. We may
continue to incur net losses in the foreseeable future. We will need to generate
additional revenues to achieve profitability, and to maintain that profitability
if it is achieved.
OUR FUTURE REVENUES ARE UNPREDICTABLE AND OUR OPERATING RESULTS MAY FLUCTUATE
SIGNIFICANTLY.
Because electronic commerce is a new, emerging market, we cannot accurately
forecast our revenues. While our revenues from electronic commerce may increase
in certain quarters, an investor should not use these past results to predict
our future results. We base our current and future expenditures on our plans and
estimates of future revenues. Our expenses are, to a large degree, fixed. We may
be unable to adjust spending in a timely manner if we experience an unexpected
shortfall in our revenues. We expect that our future quarterly operating results
will fluctuate significantly because of many factors, many of which we do not
control. These factors include:
o our ability to satisfy and retain existing customers and
attract new customers at a sufficient rate;
o pricing competition, including, but not limited to, pricing
which results in no gross margin on certain products;
o our ability to acquire, price and market merchandise inventory
such that we maintain gross margins in our existing business
and in future product lines and markets;
o our ability to fulfill customer orders;
o the level of traffic at our web sites;
o the development, announcement or introduction of new sites,
services or products by Mcglen or by our competitors;
o the amount the Internet is used generally and, more
specifically, for the purchase of products such as those that
we offer;
o our ability to upgrade and develop our systems and
infrastructure and attract new employees;
9
o the occurrence of technical or communications failures, system
downtime and Internet disruptions, including disruptions which
may be caused by periodic interruptions in electrical service;
o the amount and timing of operating costs and capital
expenditures that we incur to expand our business;
o governmental regulation and taxation policies;
o disruptions in service by common carriers such as United
Parcel Service or unanticipated increases in shipping and
transaction-processing costs; and
o general economic conditions and economic conditions specific
to the Internet, electronic commerce and the computer
industry.
OUR REVENUES DEPEND ON THE NUMBER OF TIMES CUSTOMERS MAKE PURCHASES AT OUR
ON-LINE STORES.
The amount of sales at our on-line stores depends in part on the number of
customers, the competitiveness of our prices and the availability of merchandise
from our suppliers. We cannot forecast the number of our future customers, the
future pricing strategies of our competitors or the future availability of
merchandise with any degree of certainty. It is clear, however, that if the
number of customers does not increase, if our gross margins decrease or if the
amount of merchandise available to Mcglen decreases substantially, our business
will suffer. Because of these and other factors, we believe that
period-to-period comparisons of our historical results of operations are only
partial indicators of our future performance.
OUR OPERATING RESULTS MAY FLUCTUATE DEPENDING ON THE SEASON.
We expect to experience fluctuations in our operating results because of
seasonal fluctuations in traditional retail patterns. Retail sales in the
traditional retail industry tend to be significantly higher in the fourth
calendar quarter of each year than in the preceding three quarters; revenue is
typically lowest in the second quarter of the year. As a result of this and
other factors, our operating results in one or more future quarters may
fluctuate and, therefore, period-to-period comparisons of our historical results
of operations may not be good indicators of our future performance.
WE MAY SUFFER SYSTEMS FAILURES AND BUSINESS INTERRUPTIONS.
Our success, especially our ability to receive and fulfill customer orders,
largely depends on the efficient and uninterrupted operation of our computer and
telephone communications systems. Almost all of our computer and communications
systems are located at a single leased facility. We have experienced temporary
power failures and telecommunications failures from time to time at this
facility. Our systems are vulnerable to damage from fire, earthquakes, floods,
power loss, telecommunications failures, break-ins and other events. Despite any
precautions we may take, the occurrence of natural disasters or other
unanticipated problems could cause system interruptions, delays and loss of
critical data and could prevent Mcglen from providing services. Moreover,
although we have implemented network security measures, our servers are
vulnerable to computer viruses, physical or electronic break-ins, attempts by
third parties deliberately to exceed the capacity of our systems and similar
disruptions. Any of these events could lead to interruptions or delays in
service, loss of data or the inability to accept and confirm customer orders.
Generally, we do not have redundant systems or a formal disaster recovery plan,
and our coverage limits on our property and business interruption insurance may
not be adequate to compensate Mcglen for losses that may occur.
WE FACE RISKS OF CAPACITY CONSTRAINTS.
Our revenues depend to a significant degree on the number of customers who use
our on-line stores to buy merchandise. We depend on the satisfactory
performance, reliability and availability of our web sites,
transaction-processing systems, network infrastructure, customer support center,
and delivery and shipping systems. These factors are critical to our reputation,
10
our ability to attract and retain customers and to maintain adequate customer
service levels, and our operating results. Our on-line stores have experienced
periodic temporary capacity constraints from time to time, and we continue to
experience capacity constraints at our customer support center primarily related
to inbound customer telephone inquiries. Capacity constraints could prevent
customers from gaining access to our on-line stores or our customer support
center for extended periods of time and decrease our ability to fulfill customer
orders or decrease our level of customer acquisition or retention. Such
constraints would also decrease the appeal of our on-line stores and decrease
our sales. If the amount of traffic, the number of orders or the amount of
traffic to our web sites increases substantially, we may experience capacity
constraints and may need to further expand and upgrade our technology,
transaction-processing systems and network infrastructure. We may be unable to
sufficiently predict the rate or timing of increases in the use of our on-line
stores to enable Mcglen to quickly upgrade our systems to handle such increases.
In addition, we may be unable to increase our capacity at our customer support
center to handle the amount of current or future customer telephone inquiries.
WE FACE RISKS RELATING TO SYSTEMS DEVELOPMENT.
We are heavily dependent on our technological systems, some of which were not
designed for electronic commerce but have been modified by Mcglen for that use.
In the future, we may also upgrade and expand our systems to add automated
customer service, proactive e-mail and customer feedback features to provide
enhanced customer service, more complete customer data and better management
reporting information. These efforts would require Mcglen to integrate newly
developed and/or purchased technologies into our systems and to hire more
engineering and information technology personnel in the future. If we are unable
in a timely manner to hire required personnel, to add new software and hardware,
or to upgrade our existing systems to handle increased traffic, we could
experience unanticipated system disruptions, slower response times, degraded
customer service and a decrease in our ability to fulfill customer orders.
THE ELECTRONIC COMMERCE MARKET IS INTENSELY COMPETITIVE.
The electronic commerce industry is new, rapidly evolving and intensely
competitive. Several e-commerce companies have failed in the past eighteen
months, some with larger financial resources than Mcglen. We may not be
successful in competing against our present and future competitors. It is not
difficult to enter the electronic commerce market, and current and future
competitors can launch new electronic commerce web sites at relatively low cost.
We expect competition in electronic commerce to increase as retailers,
suppliers, manufacturers and direct marketers who have not traditionally sold
computer products and consumer goods directly to consumers through the Internet
enter this market segment. Furthermore, competition has increased to the extent
that mergers and acquisitions result in electronic commerce companies with
greater market share and revenues. Increased competition, or failure by Mcglen
to compete successfully, is likely to result in price reductions, fewer customer
orders, reduced gross margins, increased marketing costs, loss of market share,
or any combination of these problems.
We believe that the principal competitive factors affecting our market are brand
name recognition, competitive pricing, quality of customer service, quality of
product information, breadth of merchandise offerings, cost of customer
acquisition and ease of use of electronic commerce sites. Although we believe we
compete adequately with respect to such factors, we cannot assure you that we
can maintain our competitive position against current and potential competitors,
especially those with greater financial, marketing, customer support, technical
and other resources. For instance, some competitors sell certain products at or
near the purchase price paid by them to acquire the products. To improve our
competitive position, we are focused on increasing our level of customer service
and maintaining competitive pricing.
Current and potential competitors have established or may establish cooperative
relationships among themselves or directly with suppliers to obtain exclusive or
semi-exclusive sources of merchandise. New competitors or alliances among
competitors, or among competitors and suppliers, may emerge and rapidly acquire
market share. Many of our current and potential competitors have significantly
greater financial, marketing, customer support, technical and other resources
than we do. As a result, they may be able to secure merchandise from suppliers
on more favorable terms than we can, and they may be able to respond more
quickly to changes in customer preferences or to devote greater resources to the
development, promotion and sale of their merchandise than we can.
11
WE RELY HEAVILY ON CERTAIN MANUFACTURERS, DISTRIBUTORS AND SUPPLIERS.
We rely heavily on certain manufacturers, distributors and suppliers to supply
Mcglen with merchandise for sale at our on-line stores. We cannot assure you
that we will be able to develop and maintain satisfactory relationships with
such parties on acceptable commercial terms, or that we will be able to obtain
sufficient quality and quantities of merchandise at competitive prices. Also,
the quality of service provided by such parties may fall below the standard
needed to enable Mcglen to conduct our business effectively. We acquire products
for sale both directly from manufacturers and indirectly through distributors
and suppliers. Purchases from Ingram Micro Inc., a distributor of computers and
related products, accounted for approximately 12% and 24% of our aggregate
merchandise purchases for 2001 and 2000. Purchases from Lan Plus Corporation
accounted for more than 50% of our aggregate merchandise purchases for 2001. We
have no long-term contracts or arrangements with manufacturers, distributors or
suppliers that guarantee availability of merchandise for our on-line stores. We
cannot assure you that current manufacturers, distributors and suppliers will
continue to sell merchandise to Mcglen or otherwise provide merchandise for sale
by Mcglen or that we will be able to establish new manufacturer, distributor or
supplier relationships that ensure merchandise will be available for sale by
Mcglen. We also rely on many of our distributors and suppliers to ship
merchandise to customers. We have limited control over the shipping procedures
of these distributors and suppliers, and such shipments have often been subject
to delays.
WE RELY HEAVILY ON CERTAIN OTHER THIRD PARTIES, INCLUDING INTERNET SERVICE
PROVIDERS AND TELECOMMUNICATIONS COMPANIES.
Our operations depend on a variety of third parties for Internet access,
telecommunications, operating software, order fulfillment, merchandise delivery
and credit card transaction processing. We have limited control over these third
parties, and we cannot assure you that we will be able to maintain satisfactory
relationships with any of them on acceptable commercial terms. We cannot assure
you that the quality of products and services that they provide will remain at
the levels needed to enable Mcglen to conduct our business effectively.
We rely on Internet service providers to connect our web site to the Internet.
From time to time, we have experienced temporary interruptions in our web site's
connections and also our telecommunications access. Frequent or prolonged
interruptions of these web site connection services could result in significant
losses of revenues. Our web site software depends on operating systems, database
and server software that were produced by and licensed from third parties. From
time to time, we have discovered errors and defects in such software and, in
part, we rely on these third parties to correct these errors and defects
promptly.
Third-party distribution centers fulfill a significant portion of the sales for
which we are responsible. Accordingly, any service interruptions experienced by
these distribution centers as a result of labor problems or otherwise could
disrupt or prevent the fulfillment of some of our customers' orders. In
addition, we use United Parcel Service as the primary delivery service for our
products. Our business would suffer if labor problems or other causes prevented
this carrier from delivering our products for significant time periods.
Furthermore, we rely on a single credit card processing service for the
processing of credit card transactions. If computer systems failures or other
problems were to prevent our credit card service from processing our credit card
transactions, we would experience delays and business disruptions. Any such
delays or disruptions in customer service may damage our reputation or result in
a loss of customers.
WE MAY EVENTUALLY BE REQUIRED TO COLLECT SALES TAX FROM MOST OR ALL OF OUR
CUSTOMERS.
We currently collect sales tax on sales of products delivered to residents in
the state of California and drop-shipped from Ingram Micro to residents of
Massachusetts. Various states have tried to impose on direct marketers the
burden of collecting sales taxes on the sale of products shipped to state
residents. The United States Supreme Court affirmed its position that it is
unlawful for a state to impose sales tax collection obligations on an
out-of-state mail order company whose only contacts with the state are the
distribution of catalogs and other advertising materials through the mail and
subsequent delivery of purchased goods from out-of-state locations by parcel
post and interstate common carriers. It is possible that legislation may be
passed to supersede the Supreme Court's decision, or that the Court may change
its position. Additionally, it is uncertain whether any new rules and
regulations may be adopted, in terms of sales tax collection obligations, to
govern electronic commerce companies as the industry continues on its explosive
pace of growth. The imposition of new sales tax collection obligations on Mcglen
in states to which we ship products would result in additional administrative
expenses to Mcglen. More importantly, though, we may lose one of our most
competitive advantages because of a higher total price of products for our
customers.
12
SHIPPING AND POSTAGE COULD INCREASE OUR OPERATING EXPENSES.
We ship our products to customers generally by United Parcel Service and other
overnight delivery and surface services. We generally invoice customers for
shipping and handling charges. If we are unable to pass on to our customers
future increases in the cost of commercial delivery services, our operating
results will be adversely affected. Moreover, any increases in postal costs
could have an adverse effect on our operating results.
WE FACE RISKS RELATING TO OUR INVENTORY.
We directly purchase the majority of the merchandise that we sell at our on-line
stores. We assume the inventory, inventory obsolescence and price erosion risks
for products that we purchase directly. These risks are especially significant
because much of the merchandise we sell at our on-line stores (for example,
computer hardware, software and consumer electronics) is characterized by rapid
technological change, obsolescence and price erosion. In the recent past we have
recorded charges for obsolete inventory and have had to sell certain merchandise
at a discount or loss. It is impossible to determine with certainty whether an
item will sell for more than the price we pay for it. Because we rely heavily on
purchased inventory, our success will depend on our ability to liquidate our
inventory rapidly, the ability of our buying staff to purchase inventory at
attractive prices relative to its resale value, and our ability to manage
customer returns and the shrinkage resulting from theft, loss and mis-recording
of inventory. If we are unsuccessful in any of these areas, we may be forced to
sell our inventory at a discount or loss.
MOST MERCHANDISE SOLD BY MCGLEN CARRIES A WARRANTY FROM THE MANUFACTURER OR THE
SUPPLIER, AND WE ARE NOT OBLIGATED TO ACCEPT MERCHANDISE RETURNS.
Nevertheless, we in fact have accepted returns from customers for which we did
not receive reimbursements from our manufacturers or suppliers, and the levels
of returned merchandise in the future might exceed our expectations. We may also
find that we have to accept more returns in the future to maintain customer
satisfaction.
WE FACE RISKS RELATED TO EXPANSION INTO NEW SERVICES AND BUSINESS AREAS.
To increase our revenues, we will need to expand our operations over time by
promoting new or complementary products or by expanding the breadth and depth of
our product or service offerings. If we expand our operations in this manner, we
may require significant additional development resources and such expansion may
strain our management, financial and operational resources. We may not
significantly benefit in such expansion from the Mcglen brand name or from the
early entry advantage that we have experienced in the on-line computer products
market. Gross margins attributable to new business areas may be lower than those
associated with our existing business activities. We cannot assure you that our
expansions into new product categories, on-line sales formats or products or
service offerings will be timely or will generate enough revenue to offset their
costs. Also, any new product category or product or service offering that is not
favorably received by consumers could damage our brand reputation.
ELECTRONIC COMMERCE POSES SECURITY RISKS TO MCGLEN.
A significant barrier to electronic commerce and communications is the secure
transmission of confidential information over public networks. We rely upon
encryption and authentication technology licensed from third parties to provide
secure transmission of confidential information. Mcglen has experienced security
breaches in the past. Although we believe current security measures are
adequate, we cannot assure you that our security measures will prevent future
security breaches, and such breaches could expose Mcglen to operating losses,
litigation and possible liability. Advances in computer capabilities, new
discoveries in the field of cryptography or other events or developments may
result in a compromise or breach of the algorithms that we use to protect
customer transaction data. A party who is able to circumvent our security
measures could steal proprietary information or interrupt our operations. We may
need to spend a great deal of money and use other resources to protect against
the threat of such security breaches or to alleviate problems caused by such
breaches. Concerns over the security of on-line transactions and the privacy of
users may also inhibit the growth of the Internet generally, and the World Wide
Web in particular, especially as a means of conducting commercial transactions.
13
WE ARE DEPENDENT ON INTELLECTUAL PROPERTY.
Our performance and ability to compete are dependent to a significant degree on
our proprietary technology. We rely on a combination of trademark, copyright and
trade secret laws to establish and protect our proprietary rights. Although we
have applied for trademark protection for the Mcglen.com name, this name is not
currently a registered trademark in the United States. We cannot assure you that
we will be able to secure significant protection for this trademark and our
other trademarks or service marks. It is possible that our competitors or others
will adopt product or service names similar to "Mcglen.com" or other service
marks or trademarks of ours, thereby impeding our ability to build brand
identity and possibly confusing customers.
Copyright laws protect our proprietary software. The source code for our
proprietary software also is protected under applicable trade secret laws. We
cannot assure you that the steps we take to protect our software will prevent
misappropriation of our technology or that the agreements we enter into for that
purpose will be enforceable. It might be possible for a third party to copy or
otherwise obtain and use our software or other proprietary information without
authorization, or to develop similar software independently. Policing
unauthorized use of our technology is difficult, particularly because the global
nature of the Internet makes it difficult to control the ultimate destination or
security of software or other data transmitted. The laws of other countries may
not adequately protect our intellectual property.
In the systems and software industries, it is common that companies receive
notices from time to time alleging infringement of patents, copyrights or other
intellectual property rights of others. We may from time to time be notified of
claims that we may be infringing upon patents, copyrights or other intellectual
property rights owned by third parties. Companies may pursue claims against
Mcglen with respect to the alleged infringement of patents, copyrights or other
intellectual property rights owned by third parties. Although we believe we have
not violated or infringed upon any intellectual property rights and have taken
measures to protect our own rights, there is no assurance that we will avoid
litigation. Litigation may be necessary to protect our intellectual property
rights and trade secrets, to determine the validity of and scope of the
proprietary rights of others or to defend against third party claims of
invalidity. Any litigation could result in substantial costs and diversion of
resources away from the day-to-day operation of our business.
Existing copyright, trademark, patent and trade secret laws afford only limited
protection. Existing laws, in combination with the steps we have taken to
protect our proprietary rights, may be inadequate to prevent misappropriation of
our technology or other proprietary rights. Also, such protections do not
preclude competitors from independently developing products with functionality
or features similar or superior to our products and technologies.
We also rely on a variety of technologies that we license from third parties,
such as the database and Internet commerce server applications that we license.
We cannot assure you that these third-party technology licenses will continue to
be available to Mcglen on commercially reasonable terms. If we lose any such
licenses, or if we are unable to maintain or obtain upgrades to any of these
licenses, it could delay completion of our proprietary software enhancements
until equivalent technology is identified, licensed or developed, and
integrated.
WE ARE VULNERABLE TO THE RAPID EVOLUTION OF ELECTRONIC COMMERCE AND RELATED
TECHNOLOGY.
The Internet and the electronic commerce industry are characterized by rapid
technological change, changes in user and customer requirements, frequent new
service or product introductions embodying new technologies, and the emergence
of new industry standards and practices. Changes in the Internet, electronic
commerce and related technology could render our web site and technology
obsolete. To remain competitive, we must continue to enhance and improve the
customer service features, responsiveness and functionality of our web site. Our
success in achieving these goals depends on our ability to develop or license
new technologies and respond promptly and cost-effectively to technological
advances and emerging industry standards and practices. The development and
licensing of technologies relating to the Internet and electronic commerce
involve significant technical, financial and business risks. We may not be
successful in developing, licensing or integrating new technologies or promptly
adapting our web sites, proprietary technology and transaction-processing
systems to customer needs or emerging industry standards.
14
WE MAY BECOME SUBJECT TO MORE BURDENSOME GOVERNMENT REGULATION.
We are subject, both directly and indirectly, to various laws and governmental
regulations relating to our business. There are currently few laws or
regulations directly applicable to commercial on-line services or the Internet.
However, due to the increasing popularity and use of commercial on-line services
and the Internet, it is possible that new laws and regulations may be adopted.
These laws and regulations may cover issues including, for example, user
privacy, pricing and characteristics and quality of products and services.
Moreover, the applicability to commercial on-line services and the Internet of
existing laws governing issues including, for example, property ownership, libel
and personal privacy, is uncertain and could expose Mcglen to substantial
liability. Any new legislation or regulation or the application of existing laws
and regulations to the Internet could have a material and adverse effect on our
business.
In addition, because our services and products are available over the Internet
anywhere in the world, multiple jurisdictions may claim that we are required to
qualify to do business as a foreign corporation in each of those jurisdictions.
Our failure to qualify as a foreign corporation in a jurisdiction where we are
required to do so could subject Mcglen to taxes and penalties for the failure to
qualify. It is possible that state and foreign governments might also attempt to
regulate our transmissions of content on our web site or prosecute Mcglen for
violations of their laws. There can be no assurance that violations of local
laws will not be alleged or charged by state or foreign governments, that we
might not unintentionally violate these laws or that these laws will not be
modified, or new laws enacted, in the future.
WE ARE DEPENDENT ON THE CONTINUED DEVELOPMENT OF THE INTERNET INFRASTRUCTURE.
We depend almost entirely on the Internet for revenue and the increased use of
the Internet for commerce is essential for our business to grow. Accordingly,
our success depends in large part on the continued development of the
infrastructure for providing Internet access and services. The Internet could
lose its viability or its usage could decline due to many factors beyond our
control, including:
o delays in the development of the Internet infrastructure;
o power outages;
o the adoption of new standards or protocols for the Internet;
or
o changes or increases in governmental regulation.
We cannot be certain that the infrastructure or complementary services necessary
to maintain the Internet as a useful and easy means of buying goods will be
developed or that, if they are developed, the Internet will remain a viable
marketing and sales channel for the types of products and services that we offer
at our on-line stores.
WE FACE RISKS ASSOCIATED WITH MAINTAINING THE VALUE OF OUR DOMAIN NAMES.
We currently hold various Web domain names relating to our brand, including the
Mcglen.com and AccessMicro.com domain names. We cannot assure you that we will
be able to acquire or maintain relevant domain names in all jurisdictions in
which we conduct business. Governmental agencies and their designees generally
regulate the acquisition and maintenance of domain names. The regulation of
domain names in the United States and in foreign countries is subject to change.
Governing bodies may establish additional top-level domains, appoint additional
domain name registrars or modify the requirements for holding domain names. The
relationship between regulations governing domain names and laws protecting
trademarks and similar proprietary rights is unclear. Therefore, we may be
unable to prevent third parties from acquiring domain names that are similar to,
infringe on or otherwise decrease the value of our brand and our trademarks and
other proprietary rights.
15
VOLATILITY IN THE UNITED STATES STOCK MARKET, THE NASD OTC MARKET AND THE
TECHNOLOGY SECTOR, AS WELL AS OTHER FACTORS, MAY AFFECT THE MARKET PRICE OF OUR
COMMON STOCK.
The trading price of our common stock has been and may continue to be subject to
fluctuations in response to quarter-to-quarter variations in operating results,
changes in earnings estimates by analysts, announcements of technological
innovations or new products introduced by Mcglen or our competitors and other
events or factors. Recently, the stock market in general and the shares of
Internet-related companies in particular have experienced significant price
fluctuations. The market price may continue to fluctuate significantly in
response to various factors, including without limitation:
o quarterly variations in operating results;
o the announcement of technological innovations;
o the announcement of management changes;
o the introduction of new services by Mcglen and its
competitors;
o changes in estimates by securities analysts;
o market conditions in the industry;
o announcements and actions by competitors;
o limited trading volume of our securities on the
Over-the-Counter Bulletin Board;
o regulatory and judicial actions; and
o general economic conditions.
A SUBSTANTIAL PORTION OF OUR STOCK IS HELD BY LAN PLUS CORPORATION SHAREHOLDERS.
Upon completion of our reverse merger with Lan Plus Corporation in March 2002,
its shareholders, Andy Teng, Richard Shyu and the Lan Plus Corporation ESOP
influence all fundamental matters affecting Mcglen. As of April 15, 2002, these
three entities/persons controlled approximately 75% of the total combined voting
power of the outstanding common stock. Accordingly, they are able to wield
considerable influence in, among other things, determining the outcome of
corporate decisions, effecting corporate transactions (including mergers,
consolidations and the sale of all or substantially all of our assets), or
preventing or causing a change in control in the company.
WE ARE EXPOSED TO THE RISKS OF A GLOBAL MARKETPLACE.
A portion of our products are either produced in, or have major components
produced in, the Asia Pacific region. We have business relationships with
companies located in the region directly, and we engage in U.S. Dollar
denominated transactions with these companies and U.S. divisions and
subsidiaries of these companies. As a result, we may be indirectly affected by
risks associated with international events, including economic and labor
conditions, political instability, tariffs and taxes, availability of products
and currency fluctuations in the U.S. Dollar versus the regional currencies.
Countries in the Asia Pacific region, including Japan, have experienced
weaknesses in their currency, banking and equity markets from time to time.
These weaknesses could adversely affect the supply and prices of products and
components and, ultimately, our results of operations.
16
THE ISSUANCE OF ADDITIONAL PREFERRED STOCK COULD AFFECT VOTING RIGHTS OR DELAY
OR PREVENT A CORPORATE TAKEOVER.
Our Board of Directors is authorized to determine the rights and restrictions
granted to and imposed upon our preferred stock. They can decide the number of
shares of any series of preferred stock and the designation of any such series.
Our Board of Directors may authorize and issue additional preferred stock with
voting or conversion rights that could adversely affect the voting power or
other rights of the holders of common stock. In addition, the potential issuance
of preferred stock may:
o have the effect of delaying, deferring or preventing a change
in control of the company;
o discourage bids for the common stock at a premium over the
market price of the common stock; and
o adversely affect the market price of the common stock.
SHARES ELIGIBLE FOR PUBLIC SALE COULD ADVERSELY AFFECT OUR STOCK PRICE.
The issuance of further shares and the eligibility of issued shares for resale
will dilute our common stock and may lower the price of our common stock. There
were 18,961,162 common shares issued and outstanding as of April 12, 2002. In
addition, approximately 360,000 stock options and warrants were outstanding
at December 31, 2001, most of which were fully vested. Moreover, we may issue
additional shares in acquisitions and may grant additional stock options to our
employees, officers, directors and consultants under our stock option plan.
IF MCGLEN AND LAN PLUS DO NOT INTEGRATE THEIR OPERATIONS QUICKLY AND
EFFECTIVELY, SOME OR ALL OF THE POTENTIAL BENEFITS OF THE MERGER MAY NOT BE
REALIZED.
In order to achieve the benefits of the merger, Mcglen must successfully combine
its business with Lan Plus' business and make Lan Plus' technologies, products
and services operate together with Mcglen's technologies, products and services.
This integration may require the partial or wholesale conversion or redesign of
some or all of the technologies, products and services of either Mcglen or Lan
Plus. The companies may not be able to integrate their technologies and
operations quickly or smoothly, in which case serious harm to the combined
company's business, financial condition and prospects may result. Integrating
the two businesses will entail significant diversion of management's time and
attention. In addition, the combined entity may be required to spend additional
money and resources on integration issues that would otherwise be spent on
developing its business and services or other matters.
THE SUCCESS OF THE COMBINED COMPANY DEPENDS IN PART ON THEIR ABILITY TO RETAIN
KEY PERSONNEL AFTER THE MERGER, AND WE MAY NOT BE ABLE TO DO SO.
The success of the combined company after the merger depends in part on the
continued service of key Lan Plus and Mcglen personnel. Despite its efforts to
hire and retain quality employees, the combined company might lose some of Lan
Plus' and Mcglen's key employees following the merger. Mcglen and Lan Plus have
different corporate cultures. Some Lan Plus and Mcglen employees may be
unwilling to work for the combined company. Competitors may also recruit Lan
Plus or Mcglen employees during integration, as is common in high technology
mergers. In addition, some Lan Plus employees will acquire significant amounts
of Mcglen common stock in the merger. As a result, the companies may be required
to provide significant incentives for some of Lan Plus' employees to remain with
the combined company.
Similarly, the future performance of the combined company depends on its
continuing ability to attract and retain highly qualified technical and
managerial personnel following the merger. Competition for qualified management,
engineering, technical, sales and marketing employees is intense. If Lan Plus or
Mcglen employees leave as a result of the merger or if the combined company
cannot attract and retain qualified personnel, the combined company's business
would be harmed.
THE MERGER COULD HARM KEY THIRD PARTY RELATIONSHIPS.
Present and potential relationships of Mcglen and Lan Plus with customers and
other third parties with whom they have relationships may be harmed by the
merger. Uncertainties following the merger may cause these parties to delay
17
decisions regarding these relationships. Any changes in these relationships
could harm the combined company's business. In addition, Lan Plus customers may,
in response to the announcement of the merger, delay or defer decisions
concerning Lan Plus. Lan Plus could experience a decrease in expected revenue as
a consequence of customers' uncertainties associated with the merger. Any delay
or deferral in those decisions by Lan Plus customers could have a material
adverse effect on Lan Plus' or the combined company's business.
FROM TIME TO TIME LAN PLUS HAS INVESTED IN SHORT SALES OF SECURITIES
Lan Plus' management routinely invests the company's excess operating funds in
the stock market. From time to time, management invests these funds in short
sales of stock which they typically cover within 60 days of the date of the
short purchase. Short sales typically have a higher degree of risk than
traditional stock purchases and management attempts to limit the concentration
of short sales in the company's overall invested and cash portfolio. At December
31, 2001 and 2000, approximately $426,000 and $460,000, respectively, was
invested in short sales of common stock and unrealized losses of $102,000 and
$51,000, respectively, were recorded on these investments. Management covered
the December 31, 2000 short sales in January 2001, recording a gain of $9,000.
BUSINESS OF LAN PLUS CORPORATION
GENERAL
Lan Plus Corporation (Lan Plus or the "Company") is a leading marketer of
personal computers ("PCs") and related products and services. Lan Plus
manufactures, markets and supports a broad line of desktop PCs, servers and
workstations used by individuals, families, businesses, government agencies and
educational institutions. The Company also offers diversified products and
services such as software, peripherals, Internet access service and support
programs.
Lan Plus' strategy is to deliver the best value to customers by offering
quality, high-performance PCs and other products and services employing the
latest technology at competitive prices and by providing outstanding service and
support.
BUSINESS OPERATIONS
Lan Plus' business model is based on delivering turnkey drop-ship programs
allowing our channel partners, allowing its channel partners in catalog, TV
Shopping and Retail Chain Stores, to market PCs with no inventory risk while
maximizing its partners' and the Company's profit. This concept, together with
its flexible, build-to-order manufacturing process, enables Lan Plus to achieve
high inventory turnover, reduced inventory levels, and allows the Company to
rapidly incorporate new technologies and components into its product offerings.
Lan Plus has sold over one million PCs to date, and maintains a database of its
customers to provide a broader range of services to these customers. Lan Plus
maintains a web site at www.lan-plus.com, as well as epcdirect.com and
myshoppingclub.com. The lan-plus.com web site offers information about new
product offerings and technical support advice. In addition, regular surveys of
customers also provides Lan Plus valuable marketing, service and product
information.
PRODUCTS AND SERVICES
The Company's PC Systems business develops, markets, manufactures, sells and
supports a wide range of high performance desktop systems and network servers
under the Lan Plus, Northgate, Protek, e-Pcdirect, and Netway brand names. Lan
Plus also sells, resells and supports a variety of additional peripherals,
software and services. Systems built by the Company use microprocessors
manufactured by Intel Corporation and Advanced Micro Devices. Lan Plus offers
pre-configured PC's with differing memory and storage configurations, and
various operating systems and application software, as well as built-to-order
systems. The Company also offers a variety of hardware components and
peripherals to complement its desktop systems and network servers, including
monitors, modems, graphics cards, accelerators, and CD-ROM and DVD drives. In
addition, Lan Plus offers numerous hardware services and e-services, many
through third party service providers. Phone support, and web-based support and
services, are available 24 hours a day, seven days a week, 365 days per year.
18
TECHNICAL SUPPORT
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. Many inquiries
are resolved over the telephone without the need to repair or replace system
components. When repairs are necessary, Lan Plus may ship a replacement part or
system and advise customers via telephone regarding installation.
Alternatively, customers may elect to ship a system directly to Lan Plus for
repair. Technical support services are also provided through the Company's web
sites. These services enable customers to access system-specific information and
recent software updates for many of the software programs and drivers included
with the computer systems. In addition, many of systems are sold with system
diagnostic and repair software that has been optimized for the Company's
products.
SALES AND MARKETING
End-user customers are comprised primarily of small- and medium-sized
businesses, governmental entities and private consumers. In general, similar
sales and marketing approaches across all of these different customer groups, as
the demand levels of the various groups respond similarly to changes in market
prices and overall general economic conditions.
Lan Plus markets its systems primarily through high profile business partners in
retail, catalog, telemarketing, and other industries. The Company also sells a
limited number of systems through customer-direct relationships supported by
advertising, direct mail, telephone sales, field sales representatives, and its
web sites.
INTERNET BUSINESS - ACCESS AND E-COMMERCE
In April 1999, Lan Plus announced a wide-ranging relationship with the Microsoft
Network, Inc. (MSN) intended to accelerate distribution of each company's
products and services, including joint Internet service on either Lan-Plus.com
or MSN offered by Lan Plus in connection with product sales. This agreement was
terminated in 2001. The Company currently sells Earthlink or NetZero Internet
service bundled with its systems.
The Internet has emerged as a global platform that allows millions of people to
share information, communicate and conduct business. International Data
Corporation, or IDC, estimates that there were approximately 144 million
Internet users worldwide at the end of 1998 and that the number of users will
grow to approximately 602 million by the end of 2003. The increased availability
of compelling media content on the Internet has enabled the Internet to compete
with traditional media such as television and radio for the attention of
consumers and serve as an effective channel for marketing goods and services.
The PC is the primary means by which consumers access the Internet. According to
IDC, PCs accounted for approximately 95% of the access devices connected to the
Internet in the United States at the end of 1998. The increase in the number of
people with Internet access that was enabled by the proliferation of
lower-priced PCs has fueled the growth of Internet shopping, or e-commerce.
Lan Plus is committed to refining and extending the advantages of its business
model by moving even greater volumes of product sales, service and support to
the Internet. The Internet provides greater convenience and efficiency to
customers and, in turn, to the Company.
CUSTOMERS
Lan Plus develops and utilizes its customer relationships to understand
end-users' needs and to deliver high quality computer products and services
tailored to meet those needs. For large corporate and institutional customers,
the Company works with the customer prior to the sale to plan a strategy to meet
that customer's current and future technology needs. After a sale, it begins a
direct relationship with the end user by establishing customer service and
technical personnel contact with the customer, often on a pro-active basis. Lan
19
Plus also establishes direct relationships with small-to-medium businesses and
individuals, through account representatives, telephone sales representatives or
Internet contact. These direct customer relationships provide information about
customers' plans and requirements and enable the Company to weigh customers'
needs against emerging technologies.
For the year ended December 31, 2001, approximately 66% of Lan Plus' gross
revenues were from sales of PCs through channel partners drop-shipped to
consumers. This concentration of sales allows the Company to maintain a low-cost
infrastructure while establishing preferred vendor status with large leading
retailers. Lan Plus intends to continue to sell the majority of our PCs and
monitors to a limited number of large customers for the foreseeable future.
The growth in Lan Plus' net sales and earnings to date has resulted primarily
from the sale of desktop PCs to individuals, home offices, small businesses and
corporate customers, and to governmental entities and educational institutions
in the U.S. market. Sales and earnings have also grown due to the ongoing
diversification of the Company's revenue stream with the introduction and
expansion of new products and services, including software, peripheral devices,
Internet access and general merchandise. Management believes that most of our
continued growth will come from four areas: (a) the domestic consumer market,
including the developing market for family-use PCs such as Internet Appliances
and Home Networking; (b) businesses and institutions, including home offices,
small to medium-size businesses, as well as Fortune 1000 companies, governmental
entities and educational institutions; (c) the continued expansion of our
general merchandise offerings; and (d) the expansion of service and product
offerings to customers, including Internet access, e-commerce, and peripherals.
MANUFACTURING
Lan Plus operates manufacturing facilities in City of Industry, California. The
Company's manufacturing process consists of assembly, functional testing and
quality control of its computer systems. Production teams are used to assemble
most of the Company's desktop PCs with each member of a production team trained
to do several tasks, increasing flexibility and efficiency. Testing and quality
control processes are also applied to components, parts and subassemblies
obtained from suppliers. The Company's build-to-order manufacturing process is
designed to allow it to quickly produce customized computer systems and to
achieve rapid inventory turnover and reduced inventory levels, which lessens
exposure to the risk of declining inventory values. This flexible manufacturing
process also allows Lan Plus to incorporate new technologies or components into
product offerings quickly. Each PC is shipped from the Company's manufacturing
facilities ready-for-use, with an operating system and application software
already installed.
Quality control is maintained through the testing of components, parts and
subassemblies at various stages in the manufacturing process. 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. Lan Plus'
desktop computer manufacturing operations have been assessed and certified as
meeting the requirements of the International Organization for Standardization
(ISO) 9002. ISO 9002 certification recognizes compliance with international
standards for quality assurance.
PRODUCT DEVELOPMENT
Lan Plus' expenditures on research, development and engineering in each of the
last three years were less than 1% of net sales. The Company maintains close and
cooperative relationships with many of its suppliers and with other technology
developers. These working partnerships allow Lan Plus to use its business model
and build-to-order manufacturing process to deliver, on a timely and
cost-effective basis, those emerging technologies that are most relevant to its
customers. These relationships have also enabled Lan Plus to evaluate the latest
developments in PC technology and to quickly introduce new products and new
product features to the market. Lan Plus believes that its strong relationships
with suppliers will continue to give it access to new technology and enhance the
Company's ability to bring the latest technology to market on a timely basis.
Direct relationships with customers also enable Lan Plus to obtain valuable
market information, which it uses to assist in developing new product offerings.
Lan Plus must evaluate, obtain and incorporate new hardware, software, storage,
communications and peripherals technologies that are primarily developed by
others while taking steps to ensure that new products are compatible with
industry standards and that they meet cost objectives based on competitive
pricing targets.
20
PRODUCT QUALITY, WARRANTIES AND TECHNICAL SUPPORT
Lan Plus believes PC customers have in recent years become increasingly
sophisticated in their purchasing decisions, with quality and reliability
becoming increasingly important. The Company works closely with its suppliers to
develop high-quality components, manufactured to Lan Plus specifications. Lan
Plus believes that customers judge quality by evaluating the performance and
reliability of a company's products, as well as a company's ability to provide
comprehensive service and support for its PCs.
Lan Plus believes product warranties are an important part of achieving customer
satisfaction and maintaining its image. In general, it provides a 30-day
money-back guarantee for customer returns. Shipping and handling charges to and
from the customer are non-refundable. Lan Plus provides competitive warranty
packages on all of their manufactured products, ranging from one year to five
years. In many cases, customers have the option of customizing their limited
warranty to suit their particular needs.
On-line support solutions combine preloaded, automated system-repairing software
and online diagnostic and computer maintenance programs to deliver automated
technical support for Lan Plus customers.
Lan Plus provides a number of other basic technical support options to its
customers through their web sites, as well as through a variety of other
methods, including e-mail, fax and telephone support. Many of these technical
support options are available to customers without charge.
PATENTS, TRADEMARKS AND LICENSES
Lan Plus works closely with PC component suppliers and other technology
developers to stay abreast of the latest developments in PC technology and has
obtained patent licenses for some technologies where these licenses are
necessary or advantageous, some of which require significant royalty payments.
In addition, it has entered into nonexclusive licensing agreements with
Microsoft Corporation for various operating system and application software, as
well as various software licensing agreements with other companies.
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. 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.
COMPETITION
The PC industry is highly competitive, especially with respect to pricing and
the introduction of new products and product features. Lan Plus competes
primarily by expanding the total available market with flexible services, while
avoiding conflict in "high volume but low profit channels".
Lan Plus competes with a number of personal computer manufacturers including
Dell Computer, Inc., Gateway, Inc., Compaq Computer Corporation, Hewlett-Packard
Company, e-Machines, Systemax, among others. These manufacturers sell their
products through different combinations of national and regional distributors,
dealers, value-added resellers, retail stores and through the direct channel.
Most of Lan Plus' current and potential 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 they do. In addition, many of its competitors
have nationally-known brands or well-established relationships and have
extensive knowledge of our industry. Moreover, current and potential competitors
have established or may establish cooperative relationships among themselves or
with third parties to increase the ability of their products to address consumer
needs or to combine hardware product and service offerings. The introduction of
low-priced PCs combined with the brand strength, extensive distribution channels
and financial resources of the larger PC vendors may cause Lan Plus to lose
market share.
21
Competitive factors in our markets include logistics, on-line technical support
and services, Call Center management, OEM relationships with major component
manufacturers, price, new technology, variety of products, software and
features, marketing and sales capability.
SEASONALITY
Operating results have been subject to seasonality and to quarterly and annual
fluctuations. Factors involved include new product developments or
introductions, availability of components, changes in product mix and pricing
and product reviews and other media coverage. Historically, sales have increased
in the third and fourth quarters due, in part, to back-to-school and holiday
spending.
EMPLOYEES
As of April 12, 2002, Lan Plus had approximately 166 regular employees. It has
never experienced a work stoppage due to labor difficulties and believes that
its employee relations are good.
FACILITIES
Lan Plus' corporate headquarters and distribution facility is located in City of
Industry, California. The Company leases approximately 58,000 square feet
pursuant to a lease that expires in 2013, unless terminated earlier or extended.
Under the terms of the lease, Lan Plus makes monthly payments of approximately
$30,000 to its CEO, who owns the property.
GOVERNMENT REGULATION
Lan Plus' business is subject to regulation by various federal and state
governmental agencies including the U.S. Federal Communications Commission, the
U.S. Federal Trade Commission, Department of Justice, the U.S. Department of
Commerce and the U.S. Consumer Products Safety Commission.
Some risks of costs and liabilities related to environmental matters are
inherent in Lan Plus' business, and its operations are subject to federal, state
and local environmental regulatory requirements relating to environmental and
waste management. Lan Plus periodically generates and handles limited amounts of
materials that are considered hazardous waste under applicable law and contracts
for the off-site disposal of these materials. Lan Plus management believes its
business is operated in compliance with applicable environmental regulations.
BACKLOG
Lan Plus does not believe that backlog is a meaningful indicator of sales that
can be expected for any period, and there can be no assurance that the backlog
at any point in time will translate into sales in any subsequent period. Levels
of unfilled orders for systems fluctuate depending upon component availability,
demand for some products, the timing of large volume customer orders and
production schedules. Customers frequently change delivery schedules and orders
depending on market conditions and other reasons.
ITEM 2. DESCRIPTION OF PROPERTY
In December 2000, we moved our operations to a 50,000 square foot warehouse
owned by Lan Plus Corporation, of which we were subleasing less than 2,000
square feet. We also leased approximately 13,140 square feet of office space in
Los Angeles, California, pursuant to a non-cancelable lease that expired on
January 31, 2002. Approximately 50% of such office space was subleased to a
former Vice President of Western Technologies, Inc. under a sublease which
expired in September 2001. In September 2001, the Company stopped paying the
remaining $22,000 in lease payments required under the lease. Management has
begun the process of placing Western in Chapter 7 bankruptcy; the unpaid lease
commitments are included in net current liabilities of discontinued operations
at December 31, 2001.
The Company believes that its present facilities are adequate for its current
needs.
22
ITEM 3. LEGAL PROCEEDINGS
The Company is not presently a party to any pending litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2001.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Northgate's common stock is traded on the Over-the-Counter Bulletin Board under
the symbol "NGTE." On March 28, 2002, Mcglen changed its ticker symbol from MIGS
to NGTE in connection with the consummation of the reverse merger with Lan Plus
Corporation. The following table sets forth the range of the high and low
closing sales prices for Mcglen's common stock, for the periods indicated, as
reported by the Nasdaq SmallCap Market (for periods on and prior to April 12,
2001) and the Over-the-Counter Bulletin Board (for periods after April 12,
2001). The effect of the Company's March 2002 10:1 reverse stock split is not
reflected in the table below. Quotations reflect inter-dealer prices without
retail mark-ups, mark-downs or commissions and may not necessarily represent
actual transactions:
Price Range of Common Stock
---------------------------
High Low
---- ---
Year Ended December 31, 2000
----------------------------
FIRST QUARTER $5.31 $3.31
SECOND QUARTER 3.63 1.03
THIRD QUARTER 1.81 0.50
FOURTH QUARTER 1.09 0.13
Year Ended December 31, 2001
----------------------------
FIRST QUARTER $0.88 $0.16
SECOND QUARTER $0.33 $0.10
THIRD QUARTER $0.27 $0.09
FOURTH QUARTER $0.21 $0.07
On April 12, 2002, the closing price of the Company's Common Stock as reported
on the Over the Counter Market was $0.60 per share. On April 12, 2002, there
were 304 holders of record of our Common Stock.
The Company has never paid cash dividends on its Common Stock, and does not
anticipate paying cash dividends on its Common Stock in the future. The Company
intends to retain its earnings to finance the growth and development of its
business.
23
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data has been derived from the
financial statements of the Company, which have been prepared in accordance with
United States generally accepted accounting principles. The consolidated
financial statements of the Company for the years ended December 31, 1999, 2000
and 2001, and as of December 31, 1999, 2000 and 2001, and the related report of
BDO Seidman LLP are included elsewhere in this report. The financial statements
as of December 31, 1998 and 1997, and for the years then ended, have been
derived from financial statements audited by Singer Lewak Greenbaum & Goldstein
LLP. The following data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the financial statements included elsewhere in this report.
YEAR ENDED DECEMBER 31,
-----------------------
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
(in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Net sales ...................................... $ 3,661 $ 11,525 $ 27,494 $ 30,145 $ 21,231
Cost of sales .................................. 2,991 9,707 25,425 27,136 18,936
--------- --------- --------- --------- ---------
Gross profit ................................... 670 1,818 2,069 3,009 2,295
Selling, general and administrative .......... 520 1,779 5,549 8,461 4,006
--------- --------- --------- --------- ---------
Income (loss) from operations ............... 150 39 (3,480) (5,452) (1,711)
Interest (income) expense ................... (2) (20) 31 517 235
--------- --------- --------- --------- ---------
Income (loss) before income taxes and
extraordinary item .......................... 152 59 (3,511) (5,969) (1,946)
Provision for income taxes ..................... 3 1 1 1 1
--------- --------- --------- --------- ---------
Income (loss) before extraordinary item ........ 149 58 (3,512) (5,970) (1,947)
Extraordinary item, gain on retirement of debt . - - - 239 639
--------- --------- --------- --------- ---------
Net income (loss) .............................. $ 149 $ 58 ($ 3,512) ($ 5,731) ($ 1,308)
========= ========= ========= ========= =========
Basic and diluted income (loss) per share before
extraordinary item .......................... $ 0.10 - ($ 1.11) ($ 1.88) ($ 0.55)
========= ========= ========= ========= =========
Basic and diluted net income (loss) per share .. $ 0.10 - ($ 1.11) ($ 1.80) ($ 0.37)
========= ========= ========= ========= =========
Weighted average shares of common stock
outstanding:
Basic and diluted ........................... 2,000 2,075 3,173 3,175 3,551
========= ========= ========= ========= =========
DECEMBER 31,
------------
1997 1998 1999 2000 2001
---- ---- ---- ---- ----
Balance Sheet Data:
Cash and cash equivalents .......... $ 213 $ 437 $ 962 $ 2 $ 80
Working capital (deficit) .......... 150 168 (1,558) (2,721) (1,852)
Total assets ....................... 548 1,100 3,304 1,528 915
Long-term debt and capital leases .. - - 416 958 992
Total stockholders' equity (deficit) 161 211 (864) (3,099) (2,653)
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the Company's financial condition and
results of operations should be read in conjunction with the Company's
consolidated financial statements and notes thereto included elsewhere herein.
OVERVIEW
Mcglen Internet Group (Mcglen or the Company), formerly Adrenalin Interactive,
Inc. (Adrenalin), was acquired by Mcglen Micro, Inc. in December 1999 through a
transaction in which the stockholders of Mcglen Micro, Inc. acquired control of
the Company through a reverse acquisition. As a result of the acquisition, each
share of Mcglen Micro, Inc. was converted into 0.09889611 shares of the Company,
with approximately 2,548,600 shares being issued.
In connection with the acquisition, the Board of Directors of the Company
adopted a formal plan to discontinue the operations of Western Technologies,
Inc. (Western), the operating subsidiary of Adrenalin that developed video
games. As such, the accounting treatment for the reverse acquisition is that of
a recapitalization. The net liabilities of Western have been reclassified as
discontinued operations on the balance sheets for all periods presented. The
operations of Adrenalin and Western are not included in the tables below. See
Note 12 to the consolidated financial statements included in this report.
Mcglen Micro, Inc. was formed in May 1996 to sell computer products over the
Internet. Mcglen has since grown into a global Internet retailer of computer
hardware and peripheral products servicing individuals, small offices/home
offices, and the corporate market. As an aggregator of hi-tech products, Mcglen
offers over 100,000 stockkeeping units (SKUs) at its virtual superstore,
www.Mcglen.com. The Mcglen.com superstore has been in operation for more than
three years and already has brand recognition across 100,000 current customers.
Mcglen purchased AMT Component, Inc. (AMT) in March 1999, which operates the
AccessMicro.com web site and sells similar products at typically lower price
points. In November 1999, Mcglen opened the Techsumer.com website which focused
on "technologically minded consumers," Mcglen closed this web site in 2001.
On March 20, 2002, the Company closed its merger with Lan Plus. At the closing
of the merger, Lan Plus shareholders received a number of shares such that they
now own approximately 75% of the Company. In addition, at the close of the
merger, the Company also instituted a 10:1 reverse stock split and changed its
name to Northgate Innovations, Inc. Pursuant to the merger agreement, upon close
of merger, the Company's accounts payable to, and advances from Lan Plus, in the
amount of approximately $2.3 million was converted to common stock eliminating
the debt; the stock was then retired to Treasury and cancelled. The Company will
report combined operations with Lan Plus beginning with its 10-Q for the period
ended March 31, 2002.
The Company purchases a substantial percentage of its products from a single
distributor. Additionally, purchases from Lan Plus Corporation accounted for
more than 50% of our aggregate merchandise purchases for 2001. Mcglen has no
long-term contracts or arrangements with its vendors that guarantee the
availability of merchandise.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses Mcglen's consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an on-going basis, management evaluates its
estimates and judgments, including those related to customer incentives, product
returns, bad debts, inventories, intangible assets, financing operations,
warranty obligations, and contingencies and litigation. Management bases its
estimates and judgments on historical experience and on various other factors
that are believed to be 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 under different assumptions or conditions.
25
Management believes the following critical accounting policies, among others,
affect its more significant judgments and estimates used in the preparation of
its consolidated financial statements. Mcglen maintains allowances for doubtful
accounts for estimated losses resulting from the inability of its customers to
make required payments. If the financial condition of Mcglen's customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. Mcglen provides for the estimated cost of
product warranties at the time revenue is recognized. While the products Mcglen
sells are covered by third party manufacturer warranties, Mcglen may have
products returned by customers that Mcglen 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 the manufacturers go out of
business, Mcglen may be forced to cover these warranty costs and the costs may
differ from Mcglen's estimates. Mcglen writes down its inventory for estimated
obsolescence or unmarketable inventory equal to the difference between the cost
of inventory and the estimated market value based upon assumptions about future
demand and market conditions. If actual future demand or market conditions are
less favorable than those projected by management, additional inventory
write-downs may be required. We assess the impairment of identifiable
intangibles, and related goodwill whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Factors we consider
important which could trigger an impairment review include the following:
o significant underperformance relative to expected historical
or projected future operating results;
o significant changes in the manner of our use of the acquired
assets or the strategy for our overall business; and
o significant negative industry or economic trends.
When we determine that the carrying value of intangibles, and related goodwill
may not be recoverable based upon the existence of one or more of the above
indicators of impairment, we measure any impairment based on a projected
discounted cash flow method using a discount rate determined by our management
to be commensurate with the risk inherent in our current business model.
RESULTS OF OPERATIONS
The following table sets forth for the years indicated the percentage of net
sales represented by certain items reflected in the Company's consolidated
statements of operations. There can be no assurance that the trends in sales
growth or operating results will continue in the future. The discussion of the
"Results of Operations" includes AMT since the date of acquisition, March 31,
1999.
PERCENTAGE OF NET SALES
YEAR ENDED DECEMBER 31,
-----------------------
2001 2000 1999
---- ---- ----
Net sales 100.00% 100.00% 100.00%
Cost of sales 89.19 90.02 92.47
------- ------- -------
Gross profit 10.81 9.98 7.53
Operating expenses 17.67 24.86 17.46
Deferred compensation expenses 1.20 3.20 2.73
Interest expense 1.11 1.72 0.11
------- ------- -------
Loss before income taxes and extraordinary item (9.17) (19.80) (12.77)
Provision for income taxes - - -
------- ------- -------
Loss before extraordinary item (9.17) (19.80) (12.77)
Extraordinary item 3.01 0.79 -
------- ------- -------
Net loss (6.16%) (19.01%) (12.77%)
======== ======== ========
26
YEAR ENDED DECEMBER 31, 2001 COMPARED TO THE YEAR ENDED DECEMBER 31, 2000
Net sales decreased by $8.9 million, or 29.6%, to $21.2 million for the year
ended December 31, 2001, compared to $30.1 million for the year ended December
31, 2000. The decrease in net sales was primarily a result of the Company's
decision in July 2000 to focus its efforts on the business to business sector
(B2B), a return to a focus on products where the Company has a niche in the
marketplace and where the Company believes it has a strategic advantage in
product procurement and distribution, and a shift away from the business to
consumer market (B2C).
Gross profit decreased by approximately $700,000 or 23.3% to $2.3 million for
the year ended December 31, 2001, compared to $3.0 million for the same period
in the prior year. The decrease in gross profit was directly related to the
decrease in net sales as the Company focused its operations on the business to
business sector (B2B), a return to a focus on products where the Company has a
niche in the marketplace and where the Company believes it has a strategic
advantage in product procurement and distribution, and a shift away from the B2C
market in July 2000. Gross profit as a percentage of sales increased to 10.8%
for the year ended December 31, 2001, compared to 10.0% for the year ended
December 31, 2000. The increase in the gross profit margin was directly related
to the change in the Company's operations in July 2000, away from lower margin
B2C customers, memory and CPU's.
Selling, general and administrative expenses decreased by $4.5 million or 52.9%,
to $4.0 million for the year ended December 31, 2001, from $8.5 million for the
same period in the prior year. The decrease in operating expenses was
attributable to a decrease in personnel costs associated with the decreased
sales volume, a decrease in advertising costs resulting from decreased spending
on the placement of Company's websites on various shopping comparison search
engines, decreased credit card processing fees with lower sales volume as well
as a decrease in the rate charged by the Company's credit card processor, and
decreased stock compensation expense relating to options and stock issued to
consultants and employees, and decreased telephone charges. Advertising
decreased by approximately $1.3 million, or 73.6%, as Mcglen decreased spending,
primarily price comparison search engines and product placements on websites.
Payroll and related costs decreased by approximately $900,000, or 43.3%, for the
year ended December 31, 2001 compared to the same period of 2000, as Mcglen
consolidated positions and reduced head count. Mcglen employed more than 100
staff as of July 1, 2000 as compared to less than 30 staff at December 31, 2001.
Stock compensation charges decreased by approximately $600,000, or 62.9% as
Mcglen did not issue any stock or stock options at below market prices in 2001
and several employees who were issued options at lower than market prices left
the Company in Spring 2000. Bad debt expenses decreased by $140,000 or 59.3% to
less than $100,000 for the year ended December 31, 2001 due to the Company
reducing its open account sales and tightening its credit policies. The majority
of the Company's bad debt write-off in 2001 was related to funds held by the
Company's former credit card processor. Investor relations expenses decreased by
approximately $200,000 for the year ended December 31, 2001 to approximately
$40,000 as compared to $260,000 for the year ended December 31, 2000. The
Company decreased its IR budget due to its move to the OTC market and the
Company's cash flow. Finally, as a result of the Company's decline in sales,
credit card processing and phone charges decreased by approximately $300,000 and
$160,000, respectively, or 32.6% and 68.8%, respectively, for the year ended
December 31, 2001 compared to the same period in 2000. These two expense
categories decreased more than sales due to synergies the Company was able to
gain under its Interim Operating Agreement with Lan Plus Corporation.
Interest expense decreased by approximately $280,000 due to lower average
borrowings for the year ended December 31, 2001 as compared to the same period
in the prior year. There was $639,000 of gains on the settlements of debt for
the year ended December 31, 2001 compared to $239,000 in 2000.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO THE YEAR ENDED DECEMBER 31, 1999
Net sales increased by $2.6 million, or 9.5%, to $30.1 million for the year
ended December 31, 2000, compared to $27.5 million for the year ended December
31, 1999. The increase in net sales was primarily a result of a full year of
operations of AMT in 2000 as compared to only nine months in 1999; AMT was
acquired by Mcglen in March 1999.
Gross profit increased by $940,000 or 44.8% to $3.0 million for the year ended
December 31, 2000, compared to $2.1 million for the year ended December 31,
1999. The increase in gross profit was due to the Company's decision, in July
2000, to move away from the business to consumer market (B2C) and focus on
products where it could achieve a higher gross margin, key customer segments,
and products where it believed it had a strategic advantage in product
procurement and distribution. Gross profit as a percentage of net sales
27
increased 33.3%, to 10.0% in 2000 from 7.5% in 1999. The increase in gross
profit margin was the result of the Company's focusing its operations on the
business to business sector (B2B), a return to a focus on products where the
Company has a niche in the marketplace and where the Company believes it has a
strategic advantage in product procurement and distribution, and a shift away
from the B2C market in July 2000.
Selling, general and administrative expenses increased by $2.9 million or 51.8%,
to $8.5 million for the year ended December 31, 2000, from $5.6 million for the
prior year. The increase in operating expenses was attributable to an increase
in personnel costs associated with the increased sales volume, an increase in
advertising costs resulting from increased spending on the AccessMicro.com
website acquired in March 1999 and a full year of advertising for the
Techsumer.com website which was launched in November 1999. Advertising increased
by approximately $872,000, or 96.4% as Mcglen increased spending during the
first nine months of the year to promote its brand name awareness. Mcglen's
advertising expenditures for the fourth quarter averaged approximately $65,000
per month. Mcglen conducted almost all of its advertising on the Internet,
primarily through price comparison web sites. Additionally, Mcglen added
additional facilities, staff and capital infrastructure to support its growth
during the first seven months of 2000. Depreciation and amortization increased
by approximately $216,000, or 125.6% due to the infrastructure development and
twelve months of amortization of the intangible assets recorded in connection
with the acquisition of AMT Components. The majority of the Company's fixed
assets were placed in service during the second and third quarter of 1999.
Payroll and related costs increased by approximately $527,000, or 34.2% in 2000
compared to 1999, as Mcglen hired mid-level managers and senior management. Non
cash compensation charges of approximately $969,000, or 3.2% of sales, were
recorded in 2000, an increase of $200,000 or 26.0%, compared to $769,000 in
1999, resulting from options granted and stock provided to employees, key
management and consultants. As a result of the Company's growth, and its
worsening financial condition, credit card processing and phone charges
increased by approximately $175,000 and $41,000, or 22.1% and 21.9%,
respectively, in 2000 compared to 1999.
Interest expense increased by approximately $486,000 to $517,000 in 2000 from
$31,000 in 1999. The increase in interest expense was a result of increased
borrowings in March 2000 that were used to fund the Company's operating losses.
In 2000, the Company recorded an extraordinary gain from the retirement of debt
of approximately $239,000; no such gain was recorded in 1999.
INCOME TAXES
Prior to March 1999, we elected to be taxed under the provisions of Subchapter S
of the Internal Revenue Code for federal and California Franchise tax reporting
purposes. Accordingly, our results of operations for the period ended March 15,
1999 were reported on our stockholders' federal income tax returns. Income taxes
in 2000 and 1999 represent minimum California franchise taxes due.
For the periods from March 16, 1999 to December 31, 1999, and the years ended
December 31, 2001 and 2000, the difference between the amount of income tax
recorded and the amount of income tax benefit calculated using the federal
statutory rate of 34% is due to net operating losses having a valuation
allowance, due to uncertainties regarding our realization of these benefits in
future years. Accordingly, no tax benefit has been provided for the periods
ended December 31, 2000 or 1999.
As of December 31, 2001, Mcglen had federal and state net operating loss
carryforwards of approximately $15.8 million and $10.8 million, respectively.
The net operating loss carryforwards will expire at various dates beginning in
2012 through 2021 for federal purposes and 2002 through 2006 for state purposes,
if not utilized. 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 may result in the expiration of net operating
loss carryforwards prior to utilization.
28
LIQUIDITY AND CAPITAL RESOURCES
The Company incurred a net loss from operations for the years ended December 31,
2001, 2000 and 1999, has negative working capital and negative stockholders'
equity. The Company's independent certified public accountants have included an
explanatory paragraph in their opinion, expressing substantial doubt about the
Company's ability to continue as a going concern. See Note 1 to Consolidated
Financial Statements for additional information.
The Company's primary capital need has been the funding of operations and
working capital requirements created by its rapid growth. Historically, the
Company's primary sources of financing have been private placements of stock and
borrowings from its stockholders, private investors, and financial institutions.
Cash used by operations was $1.3 million in 2001, due to costs incurred to fund
the Company's loss from operations.
During the year ended December 31, 2001, the Company had no capital expenditures
as compared to $59,000 in 2000, primarily for computer software and hardware,
and distribution equipment. An additional $18,000 in computer equipment was
acquired through capital leases in 2000.
In September 2001, the Company stopped making payments on certain leases, with
unpaid balances of approximately $168,000 and stopped paying interest on its
$90,000 line of credit. As a result, the Company is currently in default on the
line of credit. Management has negotiated settlements with the lessors on the
remaining unpaid lease obligations, paid these settlements, and the leases were
terminated in March 2002. Management is attempting to negotiate a settlement for
the amount due under the line of credit. The Company recorded the remaining
balance due under the leases as a current liability at December 31, 2001 and
recorded a extraordinary gain of approximately $100,000 in March 2002 as a
result of the lease settlements. The line of credit is guaranteed by the
Company's founders/majority shareholders.
The Company has been dependent upon funding from Lan Plus for its working
capital needs. Lan Plus funded the Company's working capital needs through the
close of their merger on March 20, 2002.
During the fourth quarter of 2001, Mcglen used $28,000 for operating cash flow.
Of this amount, $64,000 related to the write off of deposits held by the
Company's credit card processor. During the third quarter of 2001, Mcglen used
$157,000 for its operating cash flow. Although the Company operating losses have
narrowed, Mcglen's ability to regain profitability is dependent upon its ability
to increase net sales and its ability to control its costs. To the extent that
Mcglen's marketing efforts do not result in significantly higher net sales,
Mcglen will be materially adversely affected. There can be no assurance that
sufficient revenues will be generated from the sale of its products to enable
Mcglen to regain profitability on a quarterly or annual basis. In view of the
rapidly evolving nature of Mcglen's business, Mcglen believes that
period-to-period comparisons of its operating results, including gross profit
and operating expenses as percentage of net sales, are not necessarily
meaningful and should not be relied upon as an indication of future performance.
Mcglen believes that one key factor affecting its long-term financial success is
its ability to attract and retain customers in a cost effective manner.
Currently, Mcglen seeks to expand its customer base and encourage repeat buying
through internal and other sales and marketing programs. Such programs include:
(i) brand development, (ii) online and off-line marketing and promotional
campaigns, (iii) linking programs with targeted Mcglen sites, (iv) personalized
direct marketing programs designed to generate repeat sales from existing
customers, (v) strategic alliances with Internet content providers and portal
sites, and (vi) the development of a one-stop online marketplace.
Mcglen expects to experience significant fluctuations in its future operating
results due to a variety of factors, many of which are outside its control.
Factors that may affect its operating results include the frequency of new
product releases, success of strategic alliances, mix of product sales and
seasonality of sales typically experienced by retailers. Sales in the computer
retail industry are significantly affected by the release of new products.
Infrequent or delayed new product releases can negatively impact the overall
growth in retail sales. Gross profit margins for hardware, software and
peripheral products vary widely, with computer hardware generally having the
lowest gross profit margins. While Mcglen has some ability to affect its product
mix through effective up-selling of high margin products, its sales mix will
vary from period to period and Mcglen's gross margins will fluctuate
accordingly.
29
In April 2000, the Company signed agreements that provided a $1.5 million
convertible bridge loan and a $24 million equity line of credit. On January 26,
2001, the holder of the convertible loan note converted $508,000 of principal
into 345,600 shares of common stock. In February 2002, the holder of the
convertible loan note agreed to convert the remaining balance and accrued
interest into common stock at $1.00 per share upon closing of the Company's
merger with Lan Plus. In March 2002, the Company closed its merger with Lan Plus
Corporation and issued 1,420,000 shares of common stock (after taking into
consideration the Company's 10:1 reverse spilt) as satisfaction of conversion of
the note. The $24 million equity line of credit was terminated in January 2001.
Prior to July 2000, the Company had two credit facilities of up to $1.0 million
with financial institutions. The credit facilities functioned in lieu of a
vendor trade payable for inventory purchases and are included in accounts
payable. In October and December 2000, $400,000 of these lines were repaid,
$126,000 of the outstanding balance was forgiven by the lender, and the
remaining outstanding balances of these credit lines were converted into 62,000
shares of the Company's common stock, of which 35,500 shares were issued from
the "Founders Pool", see below.
In August 2000, the Company entered into an agreement with Mcglen's Founders,
Alex Chen, Mike Chen, and George Lee (the "Founders"), to provide up to 1
million shares of their stock ("Founders Pool"), or approximately one-half of
their then current holdings, to assist the Company in raising capital to fund
its operations, growth, and development of Mcglen, and mergers and acquisitions.
The Founders made these shares available for an eighteen-month period and shares
not used for permitted purposes at the end of that period were to be retained by
the Founders. Under the agreement, the Founders are entitled to receive a fee
equal to 5% of the amount of cash raised by the Company using the shares
included in the pool. In conjunction with the closing of the merger with Lan
Plus Corporation, the Company issued all of the shares in the Founders Pool and
no shares were returned to the Founders.
In September 2000, the Company renegotiated the conversion price on a note it
issued in June 1999 from $25.00 per share to $10.00 per share. The lender then
agreed to convert the unpaid balance of the note, $100,000, and accrued interest
of approximately $12,000, to common stock.
During October 2000, the Company repaid $200,000 of one of its lines of credit
and converted $344,000 of this line into common stock at $10.00 per share,
issuing 34,400 shares of common stock from the Founders Pool. In connection
with this conversion, the Company also repriced warrants it had previously
granted to this supplier at exercise prices of $41.30 to $55.00 per share to
$10.00 per share. The Company recorded a gain of approximately $41,000 as
forgiveness of debt associated with this transaction.
In October 2000, the Company converted approximately $553,000 in accounts
payable to common stock at $10.00 per share. In connection with this
transaction, the Company issued 55,300 shares of common stock from the Founders
Pool and recorded a gain of approximately $72,000 as forgiveness of debt
In December 2000, the Company made a $200,000 payment on the outstanding balance
under this line and issued 27,500 shares of common stock to satisfy the
remaining outstanding balance. The Company recorded a gain of approximately
$126,000 as forgiveness of debt associated with this transaction. In addition,
the Company issued a warrant, valued at approximately $10,000, to purchase
13,750 shares of its common stock at a price of $2.60 per share to the lender.
This warrant expired in December 2001.
On December 22, 2000, we entered into a financing agreement with Dillow &
Dillow, Inc. Under the agreement, Dillow & Dillow introduced Mcglen to lenders
that loaned Mcglen $700,000. The promissory notes for the loans were secured by
a first priority security interest on all of our assets, and converted into
280,000 shares of our common stock, at a conversion price of $2.50 per share,
on March 21, 2001.
During the first quarter of 2001, the Company settled approximately $645,000 of
accounts payable and a note for $396,000 (included in net current liabilities of
discontinued operations) for approximately $316,000 in cash. The Company also
issued 23,100 shares of common stock and warrants to purchase 15,000 shares of
common stock in connection with these settlements. The Company recorded a gain
of approximately $611,000 in connection with these settlements. Finally, the
Company received notice from several individuals of their conversion of $109,000
of notes, accrued interest, late fees and penalties into common stock pursuant
to their note agreements. As a result, the Company issued 26,700 shares of
common stock and warrants to purchase 13,300 shares of common stock at an
exercise price of $10.00 per share. These warrants expire in February, 2004.
30
INFLATION
Inflation has not had a material impact upon operating results, and we do not
expect it to have such an impact in the future. There can be no assurances,
however, that our business will not be affected by inflation.
NEW ACCOUNTING PRONOUNCEMENTS
In October 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) 144, ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. SFAS 144 requires that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable value or include amounts for operating losses that have not yet
occurred. SFAS 144 is effective for financial statements issued for fiscal years
beginning after December 15, 2001 and, generally, is to be applied
prospectively.
In August 2001, the FASB issued SFAS 143, ACCOUNTING FOR ASSET RETIREMENT
OBLIGATIONS. SFAS No. 143 requires the fair value of a liability for an asset
retirement obligation to be recognized in the period in which it is incurred if
a reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
SFAS No. 143 is effective for fiscal years beginning after June 15, 2002.
In June 2001, the FASB finalized SFAS 141, BUSINESS COMBINATIONS and SFAS 142,
GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that Mcglen identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires Mcglen to complete a transitional
goodwill impairment test six months from the date of adoption. Mcglen is also
required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
Management is currently assessing the impact of the adoption of SFAS 141 or SFAS
142 will have on the financial position, results of operations, and cash flows
of the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial instruments include cash and long-term debt. At April
12, 2002, the carrying values of the Company's financial instruments
approximated their fair values based on current market prices and rates.
It is the Company's policy not to enter into derivative financial instruments.
The Company does not have any significant foreign currency exposure since it
does not transact business in foreign currencies. Therefore, the Company does
not have significant overall currency exposure at April 12, 2002.
ITEM 8. FINANCIAL STATEMENTS
The information required by this item is contained in the financial statements
listed in Item 14(a) under the caption "Consolidated Financial Statements" and
commencing on page F-1 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
INFORMATION RELATING TO EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information relating to our current
executive officers and directors*:
31
Name Age Position
---- --- --------
Andy Teng 47 Chairman of the Board, Chief Executive Officer,
Secretary and Director
Richard Shyu 36 President and Director
Mike Chen 29 Director
Grant Trexler 40 Chief Financial Officer
ANDY TENG was elected our Chairman of the Board and Chief Executive Officer,
Secretary and a director on March 20, 2002. He has served as Chairman of the
Board and Chief Executive Officer of Lan Plus Corporation since March 1992. From
March 1992 to September 2000, Mr. Teng also served as Lan Plus' President. Prior
to purchasing Lan Plus, Mr. Teng was the President and principal shareholder of
Syntax Computers, Inc. from 1987 to 1992. From 1985 to 1987, Mr. Teng was the
President and principal shareholder of Anncoa Chemical Company. Mr. Teng holds
Masters and Bachelor of Science degrees from Texas A&M University.
RICHARD SHYU was elected our President and to our board of directors on March
20, 2002. He has served as President of Lan Plus Corporation since September
2000, and as Lan Plus' Vice President of Sales and Marketing since 1996. Prior
to joining Lan Plus in August 1992, Mr. Shyu served as the General Manager of
DTC, Inc., a mainboard distributor located in Pico Rivera, California, servicing
VARs, instructional buyers and regional retail chain stores for two years. From
1988 to 1990, Mr. Shyu co-owned and managed a real estate development company
and also worked for Unisys Corporation designing Fault Tolerant SCSI Storage
Systems for the financial industry. Mr. Shyu holds a Bachelor of Science degree
in Electrical Engineering from California Polytechnic State University - Pomona
and later continued his post graduate studies in Computer Engineering at the
University of Southern California.
MIKE CHEN is one of our founders and served as our Chief Executive Officer from
January 2001 until the election of Mr. Teng in March 2002. Mr. Chen has served
as our President, Chief Technology Officer, and Secretary from May 1996 to March
2002. Mr. Chen has served as a director of the Company since May 1996. Prior to
founding the Company in 1996, he was an independent software programmer. Mr.
Chen received his Bachelor of Science in Electrical Engineering and Computer
Science in 1995 from the University of California at Berkeley.
GRANT TREXLER has served as our Chief Financial Officer since January 2000.
Prior to this, Mr. Trexler served as the Director of Finance and Administration
for El Monte RV, the nation's second largest motor home rental dealer, beginning
in July 1996. From August 1994 through May 1996, Mr. Trexler was the CFO of
Creative Computers, which completed its initial public offering and one
follow-on offering during this period. At Creative Computers, he was responsible
for implementing internal accounting and budgeting systems, financial reporting,
and financial due diligence. Prior to joining Creative, Mr. Trexler spent nine
years at PricewaterhouseCoopers, most recently as a Senior Manager in its
Mergers and Acquisitions group. Mr. Trexler holds Masters in Business
Administration and Bachelor of Arts degrees from California Polytechnic State
University - San Luis Obispo, and is a Certified Public Accountant.
* There are no family relationships among any of our directors or executive
officers.
SECTION 16(a) REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
executive officers and directors, among others, to file certain beneficial
ownership reports with the Securities and Exchange Commission. Based solely upon
its review of filings provided to it by its directors and executive officers,
the Company is aware of the following late filing: Alex Chen filed one late Form
4 reporting one transaction late.
ITEM 11. EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth the names, positions and
annual compensation paid by Mcglen for the years ended December 31, 2001, 2000,
and 1999, to George Lee, our Chief Executive Officer until January 12, 2001,
Mike Chen, our Chief Executive Officer from January 19, 2001 to March 20, 2002,
and Grant Trexler, our Chief Financial Officer.
32
SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------- ------
Fiscal All Other Securities Underlying
Name and Position Year Salary ($) Bonus ($) Compensation ($) Options (#)
- ----------------- ---- ---------- --------- ---------------- -----------
George Lee, former Chief Executive Officer 2001 26,923 - 1,000(2) -
2000 65,700 - 2,000(2) -
1999 49,000 - 1,800(2) 50,000(1)
Mike Chen, Chief Executive Officer 2001 78,461 - 2,000(2) -
2000 65,700 - 2,000(2) -
1999 49,000 - 1,800(2) 60,000(1)
Grant Trexler, Chief Financial Officer 2001 123,900 25,000 12,200(3) -
2000 122,200 - 10,150(3) 15,000
1999 - - - -
(1) In connection with the Company's reverse acquisition of Adrenalin in
December 1999, all unvested options were canceled. Mr. Lee had 40,000
options and Mr. Chen 48,000 options canceled as a result thereof, after
consideration of the Company's reverse spilt in March 2002.
(2) Reflects health insurance costs paid by the Company on Mr. Lee's and
Mr. Chen's behalf.
(3) Reflects a health insurance allowance and an automobile allowance paid
by the Company to Mr. Trexler.
The following table sets forth certain information with respect to all stock
options granted by Mcglen during 1999, 2000 and 2001 to Messrs. Chen, Lee and
Trexler:
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
Number of Securities % of Total Options
Fiscal Underlying Options Granted to Employees Exercise Price Expiration
Name Year Granted in Fiscal Year ($/Sh) Date
---- ---- ------- -------------- ------ ----
Mike Chen 2001 - - - -
2000 - - - -
1999 60,000 9.0% $1.00 4/1/05(1)
George Lee 2001 - - - -
2000 - - - -
1999 50,000 7.5% $1.00 4/1/05(1)
Grant Trexler 2001 - - - -
2000 15,000 17.9% $12.50 5/25/05
1999 - - - -
(1) In connection with the Company's reverse acquisition of Adrenalin in
December 1999, all unvested options were canceled. Mr. Lee had 40,000
options and Mr. Chen 48,000 options canceled as a result thereof, after
consideration of the Company's reverse spilt in March 2002.
33
The following table sets forth certain information with respect to the exercise
of stock options during the three years ended December 31, 2001 and the value of
unexercised stock options held by Messrs. Chen, Lee and Trexler at December 31,
1999, 2000 and 2001:
AGGREGATED OPTION EXERCISES IN LAST
YEAR AND YEAR-END (YE) OPTION VALUES
Number of Securities
Underlying Unexercised Value of Unexercised
Fiscal Shares Acquired Value Options at YE In-the-Money Options YE ($)
Name Year On Exercise (#) Realized Exercisable/Unexercisable Exercisable/Unexercisable
---- ---- --------------- -------- ------------------------- -------------------------
Mike Chen 2001 None N/A 12,000/0 12,000
2000 None N/A 12,000/0 22,500
1999 None N/A 12,000/0 -
George Lee 2001 None N/A 10,000/0 10,000
2000 None N/A 10,000/0 18,750
1999 None N/A 10,000/0 -
Grant Trexler 2001 None N/A 15,000/0 -
2000 None N/A 15,000/0 -
- - - - -
DIRECTORS' COMPENSATION
Non-employee directors receive a fee of $750 for each meeting of the Board
attended, no additional fees for any meetings of any committee of the Board
attended, and reimbursement of their actual expenses.
EXECUTIVE OFFICER EMPLOYMENT CONTRACTS
Upon completion of the reverse merger with Mcglen Micro, Inc. on December 2,
1999, the Company entered into a five-year employment agreement with Mike Chen.
The agreement provided that Mr. Chen serve as our President and Chief Technology
Officer or such other offices or positions as reasonably requested by the
Company. From January 12, 2001 to March 20, 2002, Mr. Chen also served as our
Chief Executive Officer. He received a base salary of $80,000 per year for his
services plus certain benefits (company automobile, four weeks of vacation, paid
medical insurance, and reimbursement for out-of-pocket expenses incurred in the
course of our business). Mr. Chen terminated his employment contract upon
completion of the merger with Lan Plus Corporation.
Upon completion of the reverse merger with Mcglen Micro, Inc., we entered into
an employment agreement with George Lee, pursuant to which he was to serve as
our Chief Executive Officer. On January 12, 2001, we entered into a severance
agreement with Mr. Lee whereby Mr. Lee agreed to terminate his employment
contract. The Company agreed to provide Mr. Lee with three months of severance
pay and pay Mr. Lee's medical insurance for six months.
Upon completion of the reverse merger with Mcglen Micro, Inc., we entered into a
three-year employment agreement with Alex Chen. The terms and conditions of this
agreement were substantially identical with those of our agreement with Mike
Chen, other than that the term of our agreement with A. Chen is three years, and
A. Chen is to serve as our Vice President of Business Development. Mr. A. Chen
terminated his employment contract upon completion of the merger with Lan Plus
Corporation.
On January 17, 2000 we entered into a three-year employment agreement with Grant
Trexler. The agreement provided that Mr. Trexler serve as our Chief Financial
Officer for a base salary of $130,000 per year and certain benefits (automobile
allowance, two weeks of vacation, and reimbursement for medical insurance.). He
was also entitled to receive a bonus of up to 10% of his salary and the option
to purchase up to 15,000 shares of our common stock with an exercise price of
$12.50 per share. Mr. Trexler terminated his employment contract upon completion
of the merger with Lan Plus Corporation.
34
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of April 10, 2002, the number of shares of
our common stock (after consideration of the Company's 10:1 reverse stock split
that was effected prior to the close of the merger with Lan Plus) held of record
or beneficially: (i) by each person who held of record, or was known by Mcglen
to own beneficially, more than 5% of the outstanding shares of our common stock;
(ii) by each of our current executive officers and directors; and (iii) by all
of our current executive officers and directors as a group:
NAME AND ADDRESS OF NUMBER OF PERCENT OF OUTSTANDING SHARES OF
BENEFICIAL OWNER SHARES OWNED(1) COMMON STOCK(2)
---------------- --------------- ---------------
Andy Teng 7,808,000 41.2%
16700 Gale Avenue
City of Industry, CA 91745
Northgate Innovations, Inc. 4,223,182(2) 22.3%
Employee Stock Ownership Plan (ESOP)
16700 Gale Avenue
City of Industry, CA 91745
Richard Shyu 2,111,591 11.1%
16700 Gale Avenue
City of Industry, CA 91745
AMRO International, S.A. 3,855,404(3) 8.7%
c/o Ultra Finanz
P. O. Box 4401
Zurich CH-8022
Switzerland
Mike Chen 408,295 2.2%
16700 Gale Avenue
City of Industry, CA 91745
Grant Trexler 90,252(4) *
16700 Gale Avenue
City of Industry, CA 91745
All current executive officers and 10,418,138(4) 54.9%
directors as a group (4 persons)
* Less than 1%.
(1) Except as otherwise indicated and subject to applicable community
property and similar statutes, the persons listed as beneficial owners
of the shares of our common stock have sole voting and dispositive
power with respect to such shares.
(2) Consists of 1,350,000 shares of our preferred stock which are
convertible into 4,223,182 shares of our common stock. Mr. Teng is the
Trustee of the ESOP. Under the terms of the ESOP, the participating
employees have the power to direct the voting of, as well as the
tendering of in a cash tender offer or exchange offer, the shares of
preferred stock that have been allocated to their accounts. The shares
that have not been allocated to the participating employees account
will be voted to the extent possible to reflect the voting or tender
directions, as the case may be, received from employee participants
with respect to the preferred stock allocated to their accounts. Mr.
Teng disclaims beneficial ownership of the shares of preferred stock
held by the ESOP.
35
(3) Includes 37,245 shares issuable upon conversion of a warrant.
(4) Includes 15,000 shares purchasable by Mr. Trexler within 60 days upon
exercise of outstanding stock options.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
BRIDGE LOAN FROM AMRO INTERNATIONAL, S.A.
On April 10, 2000, we received a bridge loan in the amount of $1,500,000 from
AMRO International, S.A. (AMRO), and simultaneously issued a 10% Convertible
Debenture (the "Debenture") whereby we promised to repay to AMRO the whole
amount of the loan on September 31, 2001, plus 10% interest per annum payable
quarterly. AMRO has the right, at any time after September 14, 2000, to convert
the principal or any portion thereof, and any accrued but unpaid interest, into
our common stock at a conversion price per share equal to 90% of the market
price of the stock on the date of the conversion. On January 26, 2001, AMRO
converted $508,000 of principal into 344,571 shares of our common stock. These
shares have been registered under the Company's SB-2 registration statement that
went effective March 21, 2001. In February 2002, AMRO agreed to convert the
remaining balance and accrued interest into common stock at $1.00 per share upon
closing of the Company's merger with Lan Plus. In March 2002, the Company closed
its merger with Lan Plus Corporation and issued 1,420,000 shares of common stock
(after taking into consideration the Company's 10:1 reverse spilt) to AMRO for
the remaining unpaid balance and accrued interest under the convertible note.
In connection with the bridge loan, we issued a warrant (the "Warrant") to AMRO
to purchase up to 37,245 shares of our common stock for $23.16 per share, 115%
of the daily volume weighted average price of our common stock on April 14,
2000, the last trading day prior to the closing of the loan. Two-thirds of the
shares covered by the Warrant were immediately exercisable, and the remaining
one-third of shares became exercisable on July 26, 2000. In addition, since we
did not redeem the Debenture in full on or prior to July 26, 2000, AMRO can
demand that we file a registration statement to register any shares covered by
the Warrant as well as at least 200% of the number of shares issuable upon
conversion of the Debenture and any additional shares we consider necessary to
cover any accrued interest on the Debenture.
CONSULTING AGREEMENT WITH PETER JANSSEN ASSOCIATES
In May 2000, we entered into a consulting agreement with Peter Janssen
Associates ("PJA"), a technology consulting firm of which Peter Janssen, our
Chairman of the Board, is President. Pursuant to the agreement, PJA provides
Mcglen with business and strategic planning, sales marketing, channel marketing
and related services. The agreement has been extended until March 31, 2001. PJA
currently receives $25,000 per month for its services. In addition, pursuant to
the agreement PJA received 50,000 shares of our common stock, which were
distributed to three principals of PJA, including Mr. Janssen, who received
22,500 of these shares. Moreover, the agreement provided for future stock
incentive payments in certain circumstances: upon successful completion of
financings aggregating no less than $2 million, we would grant to PJA an
additional 25,000 shares, and upon the closing of a sale or merger of Mcglen
that results in a change in control (including our proposed transaction with Lan
Plus), our founders would pay PJA an additional 125,000 shares. The Company
issued 150,000 shares of stock from the Founders Pool (see below) to PJA upon
close of our merger with Lan Plus Corporation.
FOUNDERS AGREEMENT
On August 15, 2000, we entered into an agreement with George Lee, Mike Chen and
Alex Chen (the "Founders") under which the Founders agreed to provide up to 1
million shares of their Mcglen common stock, comprising approximately one-half
of their total holdings, to assist Mcglen in raising capital to fund our
operations, growth and development, without causing additional dilution for our
other shareholders. Under the agreement, our Board of Directors may use the pool
for specified purposes including capital creation, mergers or acquisitions,
business development, management incentives, growth related activities and
remittance to treasury. The Founders made the shares available for an 18-month
period and any shares not used for permitted purposes at the end of that period
will be retained by the Founders. Under the agreement, the Founders are entitled
to receive a fee equal to 5% of the amount of cash we raise using the shares
included in the pool. George Lee and Mike Chen were members of our Board of
Directors in 1999 through the close of the merger with Lan Plus Corporation; Mr.
Chen remains on our Board of Directors.
36
In August 2000, the Company provided some consultants 73,500 shares and
employees 15,000 shares of common stock from the Founders Pool. In October 2000,
the Company converted approximately $553,000 in accounts payable to common stock
at $10.00 per share. The market price of the Company's common stock was $8.75 at
the time of conversion. In connection with this transaction, the Company issued
55,300 shares of common stock from the Founders Pool and recorded a gain of
approximately $69,000 (the difference between the market price and the
conversion price) as forgiveness of debt. Also, in October 2000, the Company
repaid $200,000 of an account payable line of credit and converted $322,000 of
accounts payable into common stock at $10.00 per share. The market price of the
Company's common stock was $8.75 at the time of conversion. In connection with
this transaction, the Company issued 32,200 shares of common stock from the
Founders Pool and recorded a gain of approximately $40,000 (the difference
between the market price and the conversion price) as forgiveness of debt.
In October 2000, the Company sold 206,000 shares of common stock from the
Founders Pool in a private placement and received proceeds of $1,425,000, net of
costs associated with the sale. Lan Plus Corporation received approximately
72,700 shares of common stock in this private placement at a price of $6.875,
the market price on the date the Company and Lan Plus signed their definitive
merger agreement. The remaining shares were sold to three investors at $3.75
per share and the Company also issued warrants to purchase an additional 66,700
shares at an exercise price of $10.00 per share to these investors. David Jones,
a director of the Company, purchased 53,300 shares of common stock and received
a warrant to purchase 26,700 shares of common stock at $10.00 in this private
placement. Included in accounts payable at December 31, 2000, was $25,000
payable to Mr. Chen and Mr. Lee. These amounts were repaid in 2001.
On December 22, 2000, the Company entered into a financing agreement with Dillow
& Dillow, Inc. Under the agreement, Dillow & Dillow introduced the Company to
lenders that loaned us $700,000, less fees and expenses. The promissory notes
for the loans were converted into 280,000 shares of the Company's common stock
on March 21, 2001 from the Founders Pool.
In 2001 and the first quarter of 2002, the Company settled various debts using
shares from the Founders Pool
Upon the close of our merger with Lan Plus Corporation, all of the shares in the
Founders Pool had been allocated.
MERGER AGREEMENT WITH LAN PLUS CORPORATION
On October 11, 2000, we entered into an agreement and plan of merger with Lan
Plus Corporation. Lan Plus is a manufacturer of both private-label and branded
turnkey computer solutions and services, with over nine years of operating
history.
The merger closed on March 20, 2002. At the closing of the merger, Lan Plus
shareholders received a number of shares such that the Lan Plus shareholders own
approximately 75% of the shares of the post merger combined entity.
Andy Teng, founder, Chairman and Chief Executive Officer of Lan Plus, became the
Chief Executive Officer and Chairman of the Board of the combined company.
Richard Shyu, currently President and Chief Operating Officer of Lan Plus,
became President and a Director of the combined company. Both were added to the
Company's Board of Directors in March 2002. Grant Trexler, previously Mcglen's
Chief Financial Officer, became Chief Financial Officer of the combined company.
Two of Mcglen's founders, Mike Chen and Alex Chen, have assumed management
positions within the newly merged company. Mike Chen also remained a Director of
the Company.
37
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHDEULES AND REPORTS ON FORM 8-K
The following consolidated financial statements of Registrant are filed as part
of this report:
(a) (1) Consolidated Financial Statements. See Index to Consolidated
Financial Statements.
(2) Financial Statement Schedules. See Index to Consolidated Financial
Statements.
(3) Exhibits.
The exhibits listed in the Exhibit Index following the
Consolidated Financial Statements are incorporated herein by
reference or are filed with this Form 10-K as indicated.
(b) Reports on Form 8-K.
Not applicable.
38
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Industry, State of California, on
April 12, 2002.
MCGLEN INTERNET GROUP, INC.
By: /s/ Andy Teng
-----------------------------------
Andy Teng, Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Signatures Title Date
---------- ----- ----
/s/ Andy Teng Chairman, Chief Executive Officer, and Secretary April 12, 2002
- --------------------- (Principal Executive Officer)
Andy Teng
/s/ Grant Trexler Chief Financial Officer (Principal Financial Officer April 12, 2002
- --------------------- and Principal Accounting Officer)
Grant Trexler
/s/ Richard Shyu President and Director April 12, 2002
- ---------------------
Richard Shyu
/s/ Mike Chen Director April 12, 2002
- ---------------------
Mike Chen
39
NORTHGATE INNOVATIONS, INC.
(formerly known as Mcglen Internet Group, Inc.)
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
Financial Statements and Supplementary Data:
Page
----
Report of Independent Certified Public Accountants F-1
Consolidated Financial Statements:
----------------------------------
Balance Sheets as of December 31, 2001 and 2000 F-2
Statements of Operations for the Years Ended December 31, 2001,
2000 and 1999 F-3
Statements of Changes in Stockholders' (Deficit) Equity for the
Years Ended December 31, 2001, 2000 and 1999 F-4
Statements of Cash Flows for the Years Ended December 31, 2001,
2000 and 1999 F-5
Notes to Financial Statements F-6
Financial Statement Schedule - Schedule II - Valuation and
Qualifying Accounts and Reserves F-24
All other schedules are omitted since the required information is not present or
is not present in amounts sufficient to require submission of the schedule, or
because the information required is included in the consolidated financial
statements and notes thereto.
40
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors and Stockholders
Northgate Innovations, Inc. (formerly known as Mcglen Internet Group, Inc.)
City of Industry, California
We have audited the accompanying consolidated balance sheets of Northgate
Innovations, Inc., as of December 31, 2001 and 2000 and the related consolidated
statements of operations, cash flows and changes in stockholders' (deficit)
equity for each of the three years in the period 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Northgate
Innovations, Inc., at December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered losses from
operations in 2001, 2000 and 1999, has negative working capital, and a
stockholders' deficit. Management's plans are included in Note 1 to the
consolidated financial statements. These matters raise substantial doubt about
the Company's ability to continue as a going concern. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ BDO Seidman, LLP
Los Angeles, CA
April 12, 2002
F-1
NORTHGATE INNOVATIONS , INC.
(formerly known as Mcglen Internet Group, Inc.)
CONSOLIDATED BALANCE SHEETS
(In thousands)
DECEMBER 31,
ASSETS (Note 4) 2001 2000
--------- ---------
Current Assets:
Cash and cash equivalents $ 80 $ 2
Accounts receivable, net of allowance for doubtful accounts and
estimated returns of $20 and $30 in 2001 and 2000 155 341
Inventories, net (Note 1) 469 192
Prepaid expenses and other current assets 20 210
Deposits (Note 1) - 203
--------- ---------
Total current assets 724 948
Equipment, net (Note 3) 25 297
Intangible assets, net (Note 1) 166 252
Other assets - 31
--------- ---------
$ 915 $ 1,528
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Accounts payable (Notes 2 and 4) $ 1,030 $ 1,701
Accrued expenses 300 211
Capital lease obligations - current portion (Note 3) 167 92
Advances from Lan Plus Corporation (Notes 2 and 13) 845 -
Line of credit (Note 4) 90 -
Convertible notes payable (Notes 5 and 13) 100 1,092
Net current liabilities of discontinued operations (Notes 1 and 13 ) 44 573
--------- ---------
Total current liabilities 2,576 3,669
Capital lease obligations (Note 3) - 141
Convertible notes payable (Note 5) 992 817
--------- ---------
Total liabilities 3,568 4,627
--------- ---------
Commitments and contingencies (Note 9)
Stockholders' deficit (Notes 1, 5, 7 and 12)
Preferred stock, $0.01 par value; 5,000 shares authorized,
none issued or outstanding (Note 14) - -
Common stock, $0.03 par value; authorized 50,000 shares, 3,590 in 2001,
3,190 in 2000, shares issued and outstanding (Note 14) 108 96
Additional paid in capital (Note 14) 7,722 5,980
Accumulated deficit (10,483) (9,175)
--------- ---------
Total stockholders' deficit (2,653) (3,099)
--------- ---------
$ 915 $ 1,528
========= =========
See accompanying notes to the consolidated financial statements
F-2
NORTHGATE INNOVATIONS, INC.
(formerly known as Mcglen Internet Group, Inc.)
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
DECEMBER 31,
------------
2001 2000 1999
--------- --------- ---------
Net sales $ 21,231 $ 30,145 $ 27,494
Cost of sales 18,936 27,136 25,425
--------- --------- ---------
Gross profit 2,295 3,009 2,069
Selling, general and administrative expenses (including $360,
$969 and $769 of non cash compensation in 2001, 2000 and 1999) 4,006 8,461 5,549
--------- --------- ---------
Loss from operations (1,711) (5,452) (3,480)
Interest expense 235 517 31
--------- --------- ---------
Loss before income taxes and extraordinary item (1,946) (5,969) (3,511)
Provision for income taxes (Note 6) 1 1 1
--------- --------- ---------
Loss before extraordinary item (1,947) (5,970) (3,512)
Extraordinary item, gain from retirement of debt, net of tax
of $0 (Notes 4 and 7) 639 239 -
--------- --------- ---------
Net loss ($ 1,308) ($ 5,731) ($ 3,512)
========= ========= =========
Basic and diluted net loss per share before extraordinary item ($ 0.55) ($ 1.88) ($ 1.11)
========= ========= =========
Basic and diluted net loss per share ($ 0.37) ($ 1.80) ($ 1.11)
========= ========= =========
Weighted average shares of common stock outstanding:
Basic and diluted (Note 14) 3,551 3,175 3,173
========= ========= =========
See accompanying notes to the consolidated financial statements
F-3
NORTHGATE INNOVATIONS, INC.
(formerly known as Mcglen Internet Group, Inc.)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
(In thousands)
ADDITIONAL ACCUMULATED TOTAL
PAID-IN DEFERRED EARNINGS STOCKHOLDERS'
COMMON STOCK CAPITAL COMPENSATION (DEFICIT) EQUITY (DEFICIT)
----------- ------- ------------ --------- ----------------
SHARES AMOUNT
------ ------
Balance at January 1, 1999 2,075 $ 6 $ 129 - $ 76 $ 211
Distribution to stockholders - - - - (8) (8)
Conversion of notes payable 20 - 20 - - 20
Shares issued in acquisition of AMT
Components, Inc. 450 1 402 - - 403
Private placements prior to reverse acquisition
(Note 1) 32 - 720 - - 720
Deferred compensation relating to stock options - - 1,345 $ (1,345) - -
Amortization of deferred compensation relating
to stock options - - - 769 - 769
Stock split in connection with reverse
acquisition (29) 69 (69) - - -
Shares issued in recapitalization (Note 1) 354 11 7,479 - - 7,490
Costs related to reverse acquisition transaction
(Note 1) 201 6 (8,908) - - (8,902)
Private placements of stock (Note 7) 70 2 1,943 - - 1,945
Net loss - - - - (3,512) (3,512)
--------- --------- --------- --------- --------- ---------
Balance at December 31, 1999 3,173 95 3,061 (576) (3,444) (864)
Stock returned to treasury and retired (Note 7) (52) (1) 1 - - -
Shares issued in guarantee of security price
(Note 7) 14 1 (1) - - -
Conversion of notes payable (Note 7) 11 - 112 - - 11
Cashless stock options exercised 12 - - - - -
Amortization of deferred compensation - - - 481 - 481
Stock/options issued to employees - - 394 (394) - -
Compensation relating to stock/option/warrant
grants to consultants - - 387 - - 387
Value of warrants issued for debt financing - - 624 - - 624
Reversal of deferred compensation for cancelled
options - - (218) 218 - -
Reversal of loss for discontinued operations
(Note 12) - - 120 - - 120
Private placements of stock from Founders Pool
(Note 7) - - 925 - - 925
Conversion of accounts payable (Notes 4 and 7) 32 1 846 - - 847
Net loss - - - - (5,731) (5,731)
--------- --------- --------- --------- --------- ---------
Balance at December 31, 2000 3,190 96 6,251 (271) (9,175) (3,099)
Conversion of notes payable 372 11 1,340 - - 1,351
Exercise of stock options 23 1 (1) - - -
Conversion of accounts payable to common
stock, shares issued from Founders Pool - - 104 - - 104
Reversal of deferred compensation for cancelled
options - - (14) 14 - -
Reversal of loss for discontinued operations
(Note 12) - - 42 - - 42
Amortization of deferred compensation 5 - - 257 - 262
Net loss - - - - (1,308) (1,308)
--------- --------- --------- --------- --------- ---------
Balance at December 31, 2001 3,590 $ 108 $ 7,722 - ($10,483) ($ 2,653)
========= ========= ========= ========= ========= =========
See accompanying notes to the consolidated financial statements
F-4
NORTHGATE INNOVATIONS, INC.
(formerly known as Mcglen Internet Group, Inc.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
DECEMBER 31,
2001 2000 1999
-------- -------- --------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net loss ($1,308) ($5,731) ($3,512)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 355 388 172
Non cash charges relating to stock options, warrants
and stock compensations 257 1,362 769
Gain on debt settlements (639) (239) -
(Decrease) increase in allowance for doubtful accounts (10) (40) 70
(Decrease) increase in inventory reserves (10) (50) 93
Amortization of beneficial debt conversion feature 51 85 -
Changes in operating assets and liabilities:
Accounts receivable 196 257 (278)
Inventories (267) 294 (414)
Prepaid expenses and other current assets 139 (78) (45)
Deposits 203 183 (238)
Other assets 31 (13) (18)
Accounts payable (199) 1,053 1,323
Accrued expenses 123 (157) 300
Net current liabilities of discontinued operations (213) (650) -
-------- -------- --------
Total adjustments 17 2,395 1,734
-------- -------- --------
Net cash used in operating activities (1,291) (3,336) (1,778)
-------- -------- --------
Cash flows from investing activities:
Purchases of equipment - (59) (209)
Acquisition of Adrenalin - - (68)
Notes receivable - related parties - - (34)
-------- -------- --------
Net cash used in investing activities - (59) (311)
-------- -------- --------
Cash flows from financial activities:
Borrowings under convertible notes payable 500 1,609 200
Advances from Lan Plus Corporation 845 - -
Payments on convertible notes payable - related parties - - (180)
Proceeds from sale of stock from Founders pool - 925 -
Borrowings under line of credit 90 - -
Distributions to stockholders - - (8)
Payments on capital lease obligations (66) (99) (63)
Net proceeds from sale of common stock - - 2,665
-------- -------- --------
Net cash provided by financing activities 1,369 2,435 2,614
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 78 (960) 525
Cash and cash equivalents beginning of year 2 962 437
-------- -------- --------
Cash and cash equivalents end of year $ 80 $ 2 $ 962
======== ======== ========
See accompanying notes to the consolidated financial statements
F-5
1. DESCRIPTION OF COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF COMPANY
On March 20, 2002, Northgate Innovations, Inc., formerly Mcglen Internet Group,
Inc. (Mcglen or the Company) closed its merger with Lan Plus Corporation (Lan
Plus). At the closing of the merger, Lan Plus shareholders received a number of
shares such that they now own approximately 75% of the Company. In addition, at
the close of the merger, the Company also instituted a 10:1 reverse stock split
and changed its name to Northgate Innovations, Inc., see Note 2.
The Company was acquired by Mcglen Micro, Inc. in December 1999 through a
transaction in which the stockholders of Mcglen Micro, Inc. acquired control of
the Adrenalin Interactive Inc. (Adrenalin) through a reverse acquisition. As a
result of the acquisition, each share of Mcglen Micro, Inc. was converted into
0.09889611 shares of the Company, with 2,548,553 shares being issued. In
addition, under the terms of the acquisition agreement between the Company,
Mcglen Micro, Inc., and a consulting firm, who arranged the acquisition, the
consulting firm received 201,093 shares of common stock upon completion of the
acquisition. The value of these shares has been accounted for as a cost of the
recapitalization. The equity section of the balance sheet and earnings per share
information have been retroactively restated to reflect the exchange ratio
established in the acquisition agreement and the issuance of shares to the
consulting firm.
In connection with the acquisition, the Board of Directors of the Company
adopted a formal plan to discontinue the operations of Western Technologies,
Inc. (Western), the operating subsidiary of Adrenalin Interactive, Inc. that
developed video games, prior to the merger with Adrenalin. To that end, the
Company entered into an employment agreement with the former Vice President of
Operations of Western to oversee the winding down of operations through February
15, 2000. As discussed in Note 12, the contracts to which Western was a party
were either canceled, transferred to a new company started by the former Vice
President of Operations of Western, or completed during the "phase-out period."
Since Mcglen discontinued the operations of Western, all of the assets and
liabilities of Western were written down to their net realizable value on
Adrenalin's books prior to the accounting for the recapitalization in Mcglen's
accounting records. The result of the recapitalization was a net liability for
discontinued operations that resulted from current liabilities for Western
exceeding current assets. No goodwill or other intangible asset was recorded.
The costs of the transaction were charged to equity since cash was received in
connection with the reverse merger. Mcglen was presented as the accounting
acquirer in accordance with SAB Topic 2A(2).
In March 1999, the Company acquired all of the assets and assumed the
liabilities of AMT Components, Inc., (AMT) dba AccessMicro.com, in exchange for
450,0000 shares of stock (pre recapitalization with Adrenalin). The purchase
price of the AMT acquisition was allocated to the acquired assets based on the
estimated fair values at the date of acquisition. This resulted in an excess of
purchase price over net assets acquired of approximately $400,000 which has been
allocated to goodwill and customer lists acquired and is being amortized on a
straight-line basis over 3 to 7 years. The operating results for AMT have been
included in the consolidated financial statements from the date of acquisition.
The Company is a brick and mortar developer, manufacturer and distributor of
innovative PCs, peripherals, software, and over 100,000 computer products. The
Company specializes in selling its 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.
GOING CONCERN
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern, which contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. The Company had losses of approximately $1.3 million, $5.7 million,
and $3.5 million for the years ended December 31, 2001, 2000 and 1999 and had
negative working capital of approximately $1.8 million, and $2.7 million as of
December 31, 2001 and 2000, and a stockholders deficit. These matters raise
substantial doubt about the Company's ability to continue as a going concern.
The consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
F-6
During 2001, the Company relied upon advances from Lan Plus Corporation (Lan
Plus) to fund its operating requirements. Lan Plus continued to fund the
Company's operations prior to the merger that closed on March 20, 2002, see Note
2.
Since mid 2000, management has settled various outstanding debts, and initiated
steps to achieve positive cash flow from operations prior to its merger with Lan
Plus. For the fourth quarter of 2001, the Company's operations used $28,000,
principally as a result of the write-off of $61,000 in merchant deposits with
its former credit card processor.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries, Mcglen Micro, Inc. and Western Technologies, Inc.
All significant inter-company balances and transactions have been eliminated in
consolidation.
CASH EQUIVALENTS
All highly liquid investments purchased with an original maturity of three
months or less are considered cash equivalents.
REVENUE RECOGNITION
For all items sold by the Company, whether those items are shipped from the
Company's own facility or drop shipped by a third party, the Company:
a) is the principal in the transaction (that is, the Company processes the
credit card, assumes any risk of fraud on the credit card transaction and
often takes the order over the phone or via the Internet);
b) takes title to the products once they are shipped from the drop-ship
vendors, such that risk of loss passes to the Company, and the Company is
solely responsible for fulfilling the ordered product;
c) has the risks and rewards of ownership (for example, if there is a
chargeback from a credit card or a bad debt from an open account customer
the Company suffers the loss, pays the cost of shipping directly and
refunds the customer for any returned product); and
d) does not receive any commission or fee.
The Company bears the inventory risk for all of its product. However, these
risks are mitigated to some extent by the warranties provided by Mcglen's
vendors, although these warranties are limited in some cases, for example, CPU's
and memory. The majority of CPU's and memory that the Company purchases carry a
30-day warranty. As such, if a customer returns a defective item to the Company
31 days after the Company buys the goods from its supplier, the Company takes
the inventory loss. The Company does not have any rights from any of its
vendors, on drop ship product or items purchased and held in inventory, to
return unsold product, or receive price protection on products purchased. The
Company maintains an allowance for potential slow-moving, obsolete, or damaged
inventory items that cannot be returned to vendors and may have to be sold below
current fair market value.
The Company sells only off-the-shelf software available from any major supplier
of computer or office products, and as such is not subject to the provisions of
SOP 97-2.
ACCOUNTING FOR SHIPPING AND HANDLING REVENUE, FEES AND COSTS
The Company classifies amounts billed for shipping and handling as revenue in
accordance with EITF Issue 00-10 "Accounting for Shipping and Handling Fees and
Costs." Shipping and handling fees and costs are included in cost of sales.
INVENTORIES
The Company accounts for inventory under the first-in first-out method.
Inventory is carried at lower of cost or market realization. The Company had
reserves of $51,000 for lower of cost or market, and potential excess and
obsolete inventory at December 31, 2001 and 2000.
F-7
MERCHANDISE RETURN POLICY
Merchandise sold by the Company carries the return policy of the manufacturer of
the merchandise. The Company provides for allowances for estimated future
returns at the time of shipment to the customer based on historical experience.
DEPOSITS
Deposits represent funds held by credit card processing companies as security
for potential credit card charge backs against the Company. Such funds can be
held up to 180 days subsequent to the termination of activity between the
Company and the processor. In the fourth quarter of 2001, the Company wrote off
$61,000 of deposits held by its former credit card processing company; the
Company is currently in litigation to recover these funds.
EQUIPMENT
Equipment is stated at cost. Depreciation is computed using the straight-line
method based on the estimated useful lives of the 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.
SOFTWARE DEVELOPMENT COSTS
In accordance with SOP 98-1 and EITF 00-2, internal and external costs incurred
to develop internal-use computer software are expensed during the preliminary
project stage and capitalized during the application development stage.
Capitalized software development costs are amortized over three years. As of
December 31, 2001, there was $264,000 capitalized software development costs,
which had been completely amortized.
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews intangible assets and equipment for impairment when events
or changes in circumstances indicate the carrying amount of an asset may not be
recoverable. In the event the sum of the expected undiscounted future cash flows
resulting from the use of the asset is less than the carrying amount of the
asset, an impairment loss equal to the excess of the asset's carrying value over
its fair value is recorded.
ADVERTISING COSTS
Advertising costs are charged to expense as incurred. Advertising expense was
$469,000, $1,777,000 and $905,000 for the years ended December 31, 2001, 2000
and 1999, respectively.
INCOME TAXES
The Company follows the provisions of Statement of Financial Accounting
Standards 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.
STOCK-BASED COMPENSATION
The Company has adopted SFAS No. 123, "Accounting for Stock-Based Compensation."
SFAS No. 123 which requires disclosure of the compensation cost for stock-based
incentives based on the fair value at grant date for awards. The Company
accounts for stock-based awards to employees using the intrinsic value method in
accordance with Accounting Principles Board (APB) Opinion No. 25, "Accounting
for Stock Issued to Employees."
NET LOSS PER SHARE
Basic net loss per share excludes dilution and is computed by dividing net loss
by the weighted average number of common shares outstanding during the reported
periods. Diluted net loss per share reflects the potential dilution that could
F-8
occur if stock options and other commitments to issue common stock were
exercised. During the years ended December 31, 2001, 2000 and 1999, 123,800,
137,900 and 210,700 options and 236,700, 204,000 and 49,300 warrants,
respectively, to purchase common shares, and other commitments to issue common
stock, were anti-dilutive and have been excluded from the weighted average share
computation.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to a concentration of
credit risk consist of accounts receivable from individuals and merchants, and
deposits held by credit card processing companies, located in the United States.
Sales are generally made through credit cards and are pre-approved. The Company
maintains an allowance for doubtful accounts receivable based upon the expected
collectability of accounts receivable and potential credit losses. Such losses
have been immaterial.
CONCENTRATION OF SUPPLIERS
The Company is dependent upon key distributors for merchandise. For the years
ended December 31, 2001, 2000 and 1999, one distributor accounted for
approximately 12.4%, 23.8% and 34.9%, respectively, of total purchases. In 2001,
the Company purchased also approximately $8.9 million, or approximately 51.1% of
its total purchases from Lan Plus.
NEW ACCOUNTING PRONOUNCEMENTS
In October 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) 144, ACCOUNTING FOR THE
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. SFAS 144 requires that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell, whether reported in continuing operations or in discontinued
operations. Therefore, discontinued operations will no longer be measured at net
realizable value or include amounts for operating losses that have not yet
occurred. SFAS 144 is effective for financial statements issued for fiscal years
beginning after December 15, 2001 and, generally, is to be applied
prospectively. The Company believes the adoption of this Statement will have no
material impact on its financial statements.
In August 2001, the FASB issued SFAS 143, ACCOUNTING FOR ASSET RETIREMENT
OBLIGATIONS. SFAS No. 143 requires the fair value of a liability for an asset
retirement obligation to be recognized in the period in which it is incurred if
a reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The
Company believes the adoption of this Statement will have no material impact on
its financial statements.
In June 2001, the FASB finalized SFAS 141, BUSINESS COMBINATIONS and SFAS 142,
GOODWILL AND OTHER INTANGIBLE ASSETS. SFAS 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
Management is currently assessing the impact of the adoption of SFAS 141 or SFAS
142 will have on the financial position, results of operations, and cash flows
of the Company.
F-9
ACCOUNTING FOR COMPREHENSIVE INCOME
SFAS No. 131, "Reporting Comprehensive Income" ("FAS 131") establishes standards
for reporting and displaying comprehensive income and its components in the
Company's consolidated financial statements. The Company does not currently
engage in activities that require it to report comprehensive income and the
adoption of this standard had no effect on its financial statements.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's balance sheets include the following financial instruments: cash,
accounts receivable, accounts payable, accrued expenses, capital lease
obligations and convertible notes payable. The Company considers the carrying
value of cash, accounts receivable, accounts payable, and accrued liabilities in
the financial statements to approximate fair value for these financial
instruments because of the relatively short period of time between origination
of the instruments and their expected realization. Based on borrowing rates
currently available, the fair value of the Company's financial instruments
generally approximate their fair values at December 31, 2001 and 2000.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the respective reporting
periods. Actual results could materially differ from those estimates.
2. MERGER WITH LAN PLUS CORPORATION AND PRIOR BUSINESS COMBINATIONS
On October 11, 2000, the Company entered into an agreement and plan of merger
with Lan Plus Corporation (Lan Plus). Lan Plus is a manufacturer of both
private-label and branded turnkey computer solutions and services, with over
nine years of operating history. On March 20, 2002, the Company closed the
merger with Lan Plus. At the closing of the merger, Lan Plus shareholders
received a number of shares such that they now own approximately 75% of the
Company. In addition, at the close of the merger, the Company also instituted a
10:1 reverse stock split and changed its name to Northgate Innovations, Inc.
Pursuant to the merger agreement, upon close of merger, the Company's accounts
payable to, and advances from Lan Plus, in the amount of approximately $2.3
million was converted to common stock eliminating the debt; the stock was then
retired to Treasury and cancelled. The Company will report combined operations
with Lan Plus beginning with its 10-Q for the period ended March 31, 2002. The
effect of the reverse stock split has been retroactively applied to the
financial statements for all periods presented.
Upon closing of the merger, Andy Teng, founder, Chairman and Chief Executive
Officer of Lan Plus, became the Chief Executive Officer and Chairman of the
Board of the combined company. Richard Shyu, previously President and Chief
Operating Officer of Lan Plus, became President of the combined company. Both
were added to the Board of Directors in March 2002. Grant Trexler, Mcglen's
Chief Financial Officer, became Chief Financial Officer of the combined company.
Two of Mcglen's founders, Mike Chen and Alex Chen, have assumed management
positions within the new company.
In December 2000, the Company signed an interim operating agreement with Lan
Plus Corporation whereby the two companies would share certain facilities, staff
and other resources, co-market certain products, and combine other operations
where beneficial to both entities. The Company subsequently moved its operations
to Lan Plus' facility. Mcglen purchased approximately $8.9 million, $310,000 and
$0 of merchandise from Lan Plus in 2001, 2000, and 1999, and had an accounts
payable balance to Lan Plus of approximately $184,000 and $75,000 at December
31, 2001 and 2000. Lan Plus purchased approximately $1.7 million of products
from Mcglen in 2001. Lan Plus also advanced Mcglen approximately $845,000 as of
December 31, 2001.
F-10
As discussed in Note 1, the Company acquired all the assets of AMT Components,
Inc. in March 1999. The following unaudited pro forma combined results of
operations for the Company for the year ended December 31, 1999 assumes that the
AMT acquisition was completed on January 1, 1999:
DECEMBER 31, 1999
-----------------
Net sales $29,379,000
Gross profit $2,292,000
Loss before taxes ($3,542,000)
Net loss ($3,542,000)
Net loss per share ($1.11)
3. EQUIPMENT
Equipment consists of the following at December 31:
2001 2000
---- ----
Computer hardware and equipment $ 371,000 $ 371,000
Computer software 326,000 326,000
Other 5,000 6,000
---------- ----------
702,000 703,000
Less accumulated depreciation and amortization (677,000) (406,000)
---------- ----------
$ 25,000 $ 297,000
========== ==========
Mcglen leases certain equipment, computer hardware and software under capital
leases. The following is a summary of this equipment at December 31, 2001:
Computer hardware $ 293,000
Computer software 102,000
----------
395,000
Less accumulated depreciation (378,000)
----------
$ 17,000
==========
The following is a schedule of future minimum payments required under capital
leases, together with their estimated present values as of December 31, 2002:
Total minimum lease payments $167,000
Less amount representing interest -
---------
Present value of minimum lease payments $167,000
=========
In September 2001, the Company stopped making payments on these leases. As such,
the amounts due there under are shown as a current liability. In March 2002, the
Company negotiated settlements on the remaining amounts due under these leases.
The Company paid $64,000 to settle the remaining obligations, will return
certain software and hardware with a net book value of zero, and will recognize
a gain of approximately $100,000 (see Note 14). The Company does not believe its
operations will be affected by the return of this equipment as it is now using
Lan Plus' software and hardware. Certain of these leases were personally
guaranteed by the Company's Founders.
4. LINES OF CREDIT
At December 31, 2001 and 2000, Mcglen had a $90,000 line of credit with a bank.
Borrowings under this line were $90,000 and $0 at December 31, 2001 and 2000,
respectively. The line of credit provides for borrowings secured by a personal
F-11
guarantee of two of the Company's Founders. In September 2001, the Company
stopped making interest payments on this line and entered into settlement
discussions with the lender. As of April 15, 2002, the Company is still
negotiating the settlement of the line and accrued but unpaid interest.
At December 31, 1999, Mcglen had a $1 million line of credit with two finance
companies to finance purchases from two of the Company's primary suppliers. The
lines of credit provided for borrowings secured by substantially all of the
Company's assets. Amounts owed under these lines were included in accounts
payable at December 31, 1999. The $500,000 line contained certain covenants that
required Mcglen to maintain a minimum level of tangible net worth (as defined).
In December 2000, the Company made a $200,000 payment on the outstanding balance
under a $500,000 line of credit with a finance company and issued 27,500 shares
of common stock to satisfy the remaining outstanding balance. The Company
recorded a gain of approximately $126,000 as forgiveness of debt associated with
this transaction, determined by determining the amount payable at the time of
the negotiation of the repayment and subtracting (a) the amount of funds
remitted as a partial payment to the debtor ($200,000), (b) the value of the
stock received by the debtor based upon the market price of the Company's stock
on the date of the transaction, (c) costs incurred to complete the transaction
(direct funds paid out to assist in negotiating the settlement as well as stock
provided to the entity funding the partial payment, at current market price),
less (d) the value of the warrant. In addition, the Company issued a warrant,
valued at approximately $10,000, to purchase 13,750 shares of its common stock
at a price of $2.60 per share to the lender. This warrant expired in December
2001.
During October 2000, the Company repaid $200,000 of a $1 million line of credit
with a finance company and converted $344,000 of accounts payable into common
stock at $1.00 per share, issuing 34,400 shares of common stock from the
Founders Pool (see Note 7). In connection with this conversion, the Company also
repriced warrants it had previously granted to this supplier at exercise prices
of $41.30 to $55.00 per share to $10.00 per share. The Company recorded a gain
of approximately $41,000 as forgiveness of debt associated with this
transaction.
On April 26, 2000, the Company entered into a $24 million equity line of credit
and Common Stock Purchase Agreement with Plumrose Holdings Inc. ("Plumrose").
The equity line of credit was terminated in January 2001 without being drawn
upon. In connection with this transaction, we issued to Plumrose a warrant to
purchase 10,000 shares of our common stock at an exercise price of $18.75, which
was the closing bid price of our common stock on the trading day prior to the
closing date of the agreement. Plumrose may exercise this warrant on a "cashless
exercise" basis to the extent that the average of the high and low trading
prices per share of common stock issuable upon exercise of such warrants on the
trading day immediately preceding the date of exercise exceeds the aggregate
exercise price for the shares as to which the warrants are being exercised. This
warrant was still outstanding as of December 31, 2001.
The Company valued the warrant at approximately $90,000 on the date of grant
using a Black-Scholes pricing model for the single warrant approach with the
following assumptions: risk-free interest rate of 5.8%, volatility factor of the
expected market price of the Company's common stock of 75%, an expected life of
the warrants of 1.5 years from the grant date, and a dividend yield of zero. The
fair value of the Company's common stock at the date the transaction was entered
into was $21.60 per share. Using these assumptions, the Company recorded a
deferred charge of approximately $90,000 in May 2000 and recorded non-cash
interest expense on a straight-line basis over the life of the warrant, until
January 2001, at which time the agreement was mutually terminated.
5. CONVERTIBLE SUBORDINATED DEBT AND NOTES PAYABLE
Mcglen is obligated under the following at December 31: 2001 2000
---- ----
Convertible notes payable to an individual, dated June 18, 1999. Interest payable
at 10% per annum through December 18, 2000 and 12% thereafter. Note and accrued
interest were due December 18, 2000. The note is convertible at $20.00 per share
and is currently in default. $ 100,000 $ 100,000
Convertible notes payable to three individuals, dated March 15, 2000. Interest
payable at 10% per annum. Notes and accrued interest were due September 31, 2000.
Notes were converted to common stock in February 2001. - 109,000
F-12
Convertible note payable to a group of investors, (Dillow & Dillow, Inc. Agreement)
dated December 28, 2000. Interest payable at 10% per annum. Notes and accrued
interest were converted to common stock in March 2001. - 200,000
Convertible note payable to AMRO, dated March 12, 2000. Interest payable quarterly
beginning June 1, 2000 at 10% per annum. Note and accrued interest were due September
30, 2001. $508,000 of the note, plus accrued interest of $40,000, was converted to
common stock in February 2001, the remaining balance was converted to common stock
in March 2002. (See Note 14). 992,000 1,500,000
----------- -----------
1,092,000 1,909,000
Less current portion (100,000) (1,092,000)
----------- -----------
$ 992,000 $ 817,000
=========== ===========
In September 2000, the Company received a $120,000 loan from Lan Plus
Corporation. This loan was repaid in October 2000 through the proceeds of a
private placement of common stock, as discussed in Note 7 below.
In January 2001, Mcglen was notified by AMRO of their conversion of $508,000 of
its note, plus accrued interest of $40,000, into 344,571 shares of Mcglen
common stock at a conversion price of $01.586 per share pursuant to their note
agreement. In March 2002, AMRO converted the remaining balance and accrued
interest into common stock at $1.00 per share upon closing of the Company's
merger with Lan Plus (see Note 14).
In January and February 2001, the Company received the remaining $500,000
investment under the December 22, 2000 financing, net of fees under the Dillow &
Dillow, Inc. Agreement (see Note 7). In March 2001, the $200,000 of convertible
subordinated debt that the Company received in December 2000, as well as the
additional $500,000 received under this agreement were converted into 280,000
shares of Mcglen common stock. All of the shares issued to the note holders were
from the Founders Pool and an increase to additional paid in capital was made to
record the conversion.
In February 2001, the Company received notice from several individuals of their
conversion of $109,000 of convertible notes payable, accrued interest of
$10,000, and late fees and penalties of approximately $12,000 into common stock
pursuant to their note agreements. The accrued interest, late fees and penalties
were included in accrued liabilities at December 31, 2000. As a result of these
conversions, the Company issued 26,700 shares of common stock and warrants to
purchase 13,300 shares of common stock at an exercise price of $10.00 per share.
These warrants expire in February 2004.
6. INCOME TAXES
Prior to March 1999, Mcglen elected to be taxed under the provisions of
Subchapter S of the Internal Revenue Code for federal and California Franchise
tax reporting purposes. Accordingly, results of operations of Mcglen for the
period ended March 15, 1999 are reported on Mcglen's stockholders' income tax
returns.
At December 31, 2001 and 2000, Mcglen had deferred tax assets of approximately
$6.3 million and $5.6 million resulting from the operating loss carryforward.
However, based upon uncertainties regarding Mcglen's realization of this asset
in future years, a valuation allowance has been provided for the full amount of
the deferred tax asset. Income taxes in 1999, 2000, and 2001 represent the
minimum California franchise taxes.
As of December 31, 2001, Mcglen had federal and state net operating loss
carryforwards of approximately $15.8 million and $10.2 million, respectively.
The net operating loss carryforwards will expire at various dates beginning in
2012 through 2021 for federal purposes and 2002 through 2006 for state purposes,
if not utilized. 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 the expiration of net operating
loss carryforwards prior to utilization.
7. STOCKHOLDERS' EQUITY AND RELATED PARTY TRANSACTIONS
PRE-MERGER MCGLEN FINANCINGS
In September 1999, Mcglen entered into an agreement with Pacific Rim Access to
raise $720,000, net of commission. Pursuant to the Pac Rim Agreement, Mcglen
sold 32,000 shares of common stock for $25.00 per share, its fair market value
at the time of sale.
F-13
In September 1999, Mcglen entered into an agreement with Redstone Securities
whereby Redstone would sell up to 75,000 shares of Mcglen's common stock at
$25.00 per share, its market price at the time of the agreement. Immediately
prior to the Merger and in connection with this Agreement, Mcglen sold 66,000
shares of common stock for $25.00 per share in a private placement pursuant to
Rule 506. Redstone received a commission equal to 10% of the gross proceeds of
the offering; the net proceeds to the Company were $1,350,000.
PRE-REVERSE ACQUISITION (MERGER) ADRENALIN FINANCING
In July 1999, Adrenalin received an irrevocable commitment from an investor to
purchase $750,000 of common stock upon the completion of the Merger. The
$750,000 was placed into escrow until the SEC approved the proxy statement
soliciting the consent of the Company's shareholders for the Merger and was
released upon the closing of the Merger. In December 1999, 13,809 shares of
Mcglen common stock were issued at $54.30 per share, based upon the Closing Bid
Price on the second day after the merger was completed, divided by 110%.
The investor also received a three-year warrant to purchase 2,900 shares of
common stock at an exercise price of $48.43 per share and an additional
three-year warrant to purchase 1,400 additional shares of common stock at an
exercise price of $67.90 per share. Pursuant to the provisions of SFAS No. 123,
the Company valued the warrants issued to the investor at the date of grant
using a Black-Scholes pricing model for the single warrant approach with the
following assumptions: risk-free interest rate of 5.8%, volatility factor of the
expected market price of the Company's common stock of 50%, an expected life of
the warrants of 3 years from the grant date and a dividend yield of zero. As
these warrants were issued prior to the merger, all costs associated with the
warrants were recorded as a reduction to additional paid in capital.
This financing agreement allowed for repricing rights if Mcglen's stock price
dropped below certain prices as defined in the agreement. The buyer exercised
its repricing rights in January and April 2000 and received an additional
14,300 shares of the Company's common stock.
DILLOW & DILLOW, INC. AGREEMENT
On December 22, 2000, the Company entered into a financing agreement with Dillow
& Dillow, Inc. Under the agreement, Dillow & Dillow introduced the Company to
lenders that loaned it $700,000, less fees and expenses. The first $200,000
under the convertible promissory notes was advanced on December 28, 2000. In
January and February 2001, the Company received the remaining $500,000
investment under the December 22, 2000 financing, net of fees. The promissory
notes for the loans were secured by a first priority security interest on all of
the Company's assets. In March 2001, the $200,000 of convertible subordinated
debt that the Company received in December 2000, as well as the additional
$500,000 received in 2002, were converted into 280,000 shares of Mcglen common
stock. All of the shares issued to the note holders were from the Founders Pool
(see discussion of Founders Pool below) and an increase to additional paid in
capital was made to record the conversion. The agreement provided Dillow &
Dillow with a one-year warrant to purchase one share of our common stock for
every eight shares of common stock issued to lenders under the financing
agreement, warrants for 35,000 shares were issued to Dillow & Dillow, at
exercise prices between $3.10 and $7.50. The warrants expired in February 2002.
In addition, Dillow & Dillow received a finders fee equal to 10% of any loan or
investment proceeds under the agreement, half payable in cash and half payable
in stock at a price of $2.50 per share. The Company paid Dillow & Dillow $47,000
in cash and 14,000 shares of common stock in connection with this financing.
Pursuant to the provisions of SFAS No. 123, the Company valued the warrants
issued to Dillow & Dillow at the date of grant using a Black-Scholes pricing
model for the single warrant approach with the following assumptions: risk-free
interest rate of 5.8%, volatility factor of the expected market price of the
Company's common stock of 50%, an expected life of the warrants of 1 year from
the grant date, and a dividend yield of zero. The fair value of the Company's
common stock at the date the transaction was entered into was $2.30 per share.
Using these assumptions, the Company reduced the amount recorded to additional
paid in capital by approximately $12,000 related to this financing in 2000.
CONVERSION OF NOTES PAYABLE
In June 1999, an individual loaned the Company $100,000 as evidenced by a
convertible promissory note. The note bore interest at 10%, matured in December
2000, and contained a conversion option to convert the note into shares of the
Company's stock at $25.00 per share. In September 2000, the Company renegotiated
the conversion feature to a conversion price of $10.00 per share and the note
F-14
and accrued interest were converted into 11,200 shares of common stock. As the
renegotiated conversion price was above the market price of the Company's common
stock at the time of conversion, the Company did not record additional expense
related to this transaction pursuant to SFAS Interpretation No. 44
FOUNDERS POOL
In August 2000, the Company entered into an agreement with Mcglen's Founders,
Alex Chen, Mike Chen, and George Lee, to provide up to 1 million shares of their
stock, or approximately one-half of their then current holdings, to assist the
Company in raising capital to fund its operations, growth, and development of
Mcglen, and mergers and acquisitions. The Founders made these shares available
for an eighteen-month period that ended in February 2002 and shares not used for
permitted purposes at the end of that period were to be retained by the
Founders. As such, all shares within the Pool are considered to be outstanding
for purposes of computing weighted average shares outstanding. Under the
agreement, the Founders are entitled to receive a fee equal to 5% of the amount
of cash raised by the Company using the shares included in the pool. At the end
of the agreement, all shares allocated to the Founders Pool had been used by the
Company.
In August 2000, the Company provided some consultants 73,500 shares of common
stock from the Founders Pool. Mcglen recognized $344,000 in non-cash
compensation related to the stock provided to consultants based upon its market
value on the date of grant.
In August 2000, the Company also issued 15,000 shares of common stock to some
employees for nominal consideration. Mcglen recorded deferred compensation of
approximately $206,000 for the aggregate differences between the market price of
the Company's common stock on the date of issuance and the amounts the employees
had to pay for the stock. These amounts are being charged to operations on a
straight line basis over the two year vesting period, $119,000 in 2000. The
Company recorded a credit of $466,000 to additional paid in capital related to
the above transactions.
PRIVATE PLACEMENT OF STOCK FROM FOUNDERS POOL
In October 2000, the Company sold 206,000 shares of common stock from the
Founders Pool in a private placement and received proceeds of $925,000, less
costs of approximately $60,000 associated with the sale. Lan Plus Corporation
received approximately 72,700 shares of common stock in this private placement
at a price of $6.875, the market price on the date the Company and Lan Plus
signed their definitive merger agreement. The remaining shares were sold to
three investors at $3.75 per share and the Company also issued warrants to
purchase an additional 66,700 shares at an exercise price of $10.00 per share to
these investors. David Jones, a former director of the Company, purchased 53,300
shares of common stock and received a warrant to purchase 26,700 shares of
common stock at $10.00 in this private placement.
Pursuant to the provisions of SFAS No. 123, the Company valued the warrants
issued to the investors at the date of grant using a Black-Scholes pricing model
for the single warrant approach with the following assumptions: risk-free
interest rate of 5.8%, volatility factor of the expected market price of the
Company's common stock of 135%, an expected life of the warrants of 2 years from
the grant date, and a dividend yield of zero. Using these assumptions, the
Company reduced additional paid in capital by $340,000 for this financing.
Included in accounts payable at December 31, 2000, was $25,000 payable to Mr.
Chen and Mr. Lee related to this transaction. These amounts were repaid in 2001.
OPTION GRANT BY FOUNDERS TO EMPLOYEES
In August 2000, George Lee and Mike Chen granted options to purchase 30,000
shares of common stock to two employees for nominal consideration. The Company
recorded non-cash compensation and a credit to additional paid in capital for
$187,500, the difference between the exercise price of the options and the
market price of the Company's common stock on the date of grant, $6.25 per
share.
SETTLEMENTS OF ACCOUNTS PAYABLE
In October 2000, the Company converted approximately $553,000 in accounts
payable to common stock at $10.00 per share. The market price of the Company's
common stock was $8.75 at the time of conversion. In connection with this
transaction, the Company issued 55,300 shares of common stock from the Founders
Pool and recorded a gain of approximately $69,000 (the difference between the
F-15
market price and the conversion price) as forgiveness of debt. The Company also
recorded an increase to additional paid in capital of $484,000 relating to this
transaction based upon the number of Founders shares distributed multiplied by
the market price of $8.75 per share.
In October 2000, the Company repaid $200,000 of an account payable line of
credit and converted $322,000 of accounts payable into common stock at $10.00
per share. The market price of the Company's common stock was $8.75 at the time
of conversion. In connection with this transaction, the Company issued 32,200
shares of common stock from the Founders Pool and recorded a gain of
approximately $40,000 (the difference between the market price and the
conversion price) as forgiveness of debt. The Company also recorded an increase
to additional paid in capital of $282,000 relating to this transaction based
upon the number of Founders shares distributed multiplied by the market price of
$8.75 per share.
In October 2000, in connection with the conversion of $322,000 of accounts
payable under one of the Company's lines of credit, the Company repriced
warrants it had previously granted to a supplier at exercises prices of $41.30
to $55.00 per share to $10.00 per share. At the time of repricing, the warrant
was valued at approximately $27,000 using a Black-Scholes pricing model for the
single warrant approach with the following assumptions: risk-free interest rate
of 5.8%, volatility factor of the expected market price of the Company's common
stock of 100%, an expected life of the warrants of 1.5 years from the repricing
date, and a dividend yield of zero. The fair value of the Company's common stock
at the repricing date was $10.00 per share. The Company did not record an
additional charge for the warrant repricing as the increase in the value of the
warrant due to the repricing was nominal.
In December 2000, the Company made a $200,000 payment on the outstanding balance
of $425,000 of an account payable. The Company also issued 31,500 shares of
common stock to satisfy the remaining outstanding balance. In addition, the
Company issued a warrant, valued at approximately $10,000, to purchase 13,750
shares of its common stock at a price of $2.60 per share to the lender. This
warrant expired in December 2001. Pursuant to the provisions of SFAS No. 123,
the Company valued the warrant at the date of grant using a Black-Scholes
pricing model for the single warrant approach with the following assumptions:
risk-free interest rate of 5.8%, volatility factor of the expected market price
of the Company's common stock of 100%, an expected life of the warrants of 1
year from the grant date, and a dividend yield of zero.
The Company also recorded an increase to common stock and additional paid in
capital of $9,000 and $72,000, respectively, relating to this transaction, based
upon the 31,500 shares of common stock issued at the conversion price of
$1.719 per share, and $25,000 of costs associated with the transaction. The
Company recorded a gain of approximately $125,000 as forgiveness of debt
associated with this transaction. The gain was calculated as the amount owed
less: a) the amount of funds remitted as a partial payment to the lender
($200,000); b) the value of the stock received by the lender based upon the
number of shares issued and the market price of the Company's common stock on
the date of the transaction; c) costs incurred to complete the transaction; and
d) less the value of the warrant.
CONSULTING AGREEMENT WITH PETER JANSSEN ASSOCIATES
In May 2000, the Company entered into a consulting agreement with Peter Janssen
Associates, or PJA, a technology consulting firm of which Peter Janssen, our
former Chairman of the Board, is President. Pursuant to the agreement, PJA
provided us with business and strategic planning, sales marketing, channel
marketing and related services. The agreement was extended until August 31,
2001. PJA received $25,000 per month for its services, decreased to $10,000 in
March 2001. In addition, pursuant to the agreement PJA received 50,000 shares
of our common stock, which was distributed to three principals of PJA, including
Mr. Janssen, who received 22,500 of these shares. The 50,000 shares were
issued from the Founders Pool. As such, the Company recorded a charge to
compensation expense of approximately $344,000 in the third quarter of 2000
relating to the fair market value ($6.875 per share) of these shares with a
corresponding entry to additional paid in capital, included in non cash
compensation of the statement of shareholders equity. Moreover, the agreement
provided for future stock incentive payments upon: the successful completion of
financings aggregating no less than $2 million, which we granted to PJA an
additional 25,000 shares to PJA in March 2002, and upon the closing of our
merger with Lan Plus we paid PJA an additional 125,000 shares. The 150,000
shares were issued from the Founders Pool. As a result of the merger with Lan
Plus, the combined entity's pro forma goodwill will be increased by the fair
market value of the shares paid to PJA at the closing date with a corresponding
credit to additional paid in capital for the difference between fair market and
par values of the 150,000 shares issued.
F-16
STOCK SETTLEMENT AGREEMENT
In August 2000, the Company entered into an agreement with an advisor to the
Company whereby the advisor agreed to give back to the Company approximately
49,200 shares of the Company's common stock held by the advisor in exchange for
a settlement and mutual release of any claims relating to the remaining 25,000
shares held by the advisor and issued under a consulting agreement between the
Company and the advisor. These shares were then retired by the Company.
WARRANTS
In August 2000, the Company entered into a consulting agreement with Global
Integrated Business Solutions (Global) whereby the Company would provide Global
a warrant to purchase 2,000 shares of the Company's common stock, at $2.00 per
share, for each month Global conducted investor relations services for Mcglen.
The Company issued 12,000 warrants, valued at approximately $72,000, under this
agreement in 2000.
Pursuant to the provisions of SFAS No. 123, the Company valued the warrant
issued to Global at the date of grant using a Black-Scholes pricing model for
the single warrant approach with the following assumptions: risk-free interest
rate of 5.8%, volatility factor of the expected market price of the Company's
common stock of 139%, an expected life of the warrants of 3 years from the grant
date, and a dividend yield of zero.
In September 2000, the Company entered into consulting agreements with two
individuals who assisted Global in identifying prospective investors and
investor relations services. In connection with these agreements, the Company
issued warrants to purchase 11,000 shares of the Company's common stock, at
$10.00 per share, with 50% vesting upon grant of the warrants and 50% vesting
January 15, 2001. The warrants were valued at $38,000 using the same assumptions
for SFAS No. 123 discussed in the previous paragraph.
Warrant activity for the years ended December 31, 2001, 2000 and 1999 are as
follows:
Number Warrant price Weighted Average
of shares per share Price per Share
--------- --------- ---------------
Outstanding at January 1, 1999 - - -
Issued in connection with private placements 7,100 $19.80 to $61.70 $36.50
Issued in connection with 37,900 $40.80 to $54.40 $43.70
Assumed in connection with acquisition 4,300 $180.00 $180.00
--------- ---------------- ------
Outstanding at December 31, 1999 49,300 $19.80 to $180.00 $54.60
Issued in connection with private placements 66,700 $10.00 $10.00
Issued in connection with subordinated debt agreements 57,200 $3.10 to $23.20 $21.30
Issued in connection with accounts payable conversions 13,800 $2.60 $2.60
Issued in connection with consulting agreement 17,000 $2.00 to $10.00 $6.20
--------- ---------------- ------
Outstanding and exercisable at December 31, 2000 204,000 $2.00 to $180.00 $17.90
Issued in connection with private placements 32,000 $3.00 to $7.50 $5.20
Issued in connection with subordinated debt agreements 23,000 $10.00 $10.00
Issued in connection with accounts payable conversions 5,000 $5.00 $5.00
Issued in connection with consulting agreement 7,000 $10.00 $10.00
Expired (34,600) $2.60 to $180.00 $67.00
--------- ---------------- ------
Outstanding and exercisable at December 31, 2001 236,700 $2.00 to $61.70 $12.50
========= ================ ======
In 1996, Adrenalin closed an initial public offering of common stock and
warrants. In connection with the offering, the investment banker received, for
nominal consideration, five year warrants to purchase 4,333 shares of common
stock, this warrant expired in 2001.
F-17
NON-PLAN OPTIONS
The Company has granted non-qualified options to certain employees and directors
of the Company to purchase common stock. The terms of the options provide for
vesting, over a 1 to 3-year period, except for options to purchase 18,300
shares of common stock which vested upon completion of the Company's reverse
acquisition with Adrenalin in 1999.
At December 31, 2001, 2000 and 1999, there were 56,167, 83,166, and 83,166,
respectively of non-plan options outstanding and exercisable at prices that
ranged from $7.50 to $150.00 per share and a weighted average exercise price of
$3.05 per share. In February 2001, the Company repriced 23,700 non-plan options
held by the former CEO of the Company from $18.75 per share to $05.00 per share.
Upon repricing, these options were immediately exercised. In 2001, 3,333
options expired per their terms.
Adrenalin entered into an agreement with a consultant in August 1999 to perform
certain market consultation and corporate finance services. In consideration for
the services to be performed by the consultant, the Company granted 50,000
stock options with exercise prices between $25.00 and $50.00 per share, and are
included in the paragraph above.
EMPLOYEE STOCK OPTION PLANS
The Company accounts for its stock option plans using the intrinsic value method
under Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock
Issued to Employees. Terms and conditions of the Company's option plans,
including exercise price and the period in which options are exercisable,
generally are at the discretion of the Board of Directors; however, no options
are exercisable for more than 10 years after date of grant.
In 1999, Mcglen granted stock options to attract and retain key employees. In
connection with the grant of options to employees Mcglen recorded deferred
compensation of $1,345,000 for the aggregate differences between the exercise
price of the options at their date of grant and the fair market value for
accounting purposes of the common shares subject to these options. The deferred
compensation relating to these options has been amortized as of December 31,
2001.
In August 2000, Mike Chen and George Lee, two of Mcglen's founders, granted
options to purchase 31,000 shares of the Company's common stock to two
employees for nominal consideration. The Company recorded the difference between
the fair value of the Company's stock at the time of grant and the exercise
price of the options, approximately $131,000, as compensation expense.
The Company recognized approximately $257,000, $481,000 and $769,000 in
compensation expense for the years ended December 31, 2001, 2000 and 1999,
respectively, relating to these options and grants.
In February 2000, the Board of Directors of Mcglen approved the 1999 Stock
Option Plan (the 1999 Plan) for issuance of common stock to eligible
participants. The Plan provides for the granting of incentive stock options and
non-qualified stock options. Options generally expire after 10 years.
The following table summarizes employee stock option plan activity:
The following table summarizes employee stock option plan activity:
OPTIONS OUTSTANDING
-------------------
WEIGHTED
NUMBER PRICE AVERAGE PRICE
OF SHARES PER SHARE PER SHARE
--------- --------- ---------
Options granted 319,400 $1.00 to $36.30 $5.40
Assumed in connection with acquisition 9,200 $6.60 to $32.80 $17.70
Options forfeited (117,900) $1.00 $1.00
----------- --------------- ------
Outstanding December 31, 1999 210,700 $1.00 to $36.30 $9.10
Options granted 83,700 $8.80 to $15.90 $11.70
Cashless options exercised (11,600)
Options forfeited (144,900) $9.40 to $36.30 $10.10
----------- --------------- ------
Outstanding December 31, 2000 137,900 $1.00 to $15.90 $6.20
Options forfeited (14,100) $9.40 to $12.50 $10.50
----------- --------------- ------
Outstanding December 31, 2001 123,800 $1.00 to $15.90 $6.70
=========== =============== =====
F-18
The following table summarizes information about Mcglen's stock options
outstanding at December 31, 2001:
Options Outstanding Options Exercisable
------------------- -------------------
Number Weighted Weighted Number Weighted
Outstanding at Average Average Exercisable at Average
Range of December 31, Remaining Exercise December 31, Exercise
Exercise Price 2001 Contractual Life (Yrs) Price 2001 Price
-------------- ---- ---------------------- ----- ---- -----
$ 1.00 58,300 3.0 $ 1.00 58,000 $ 1.00
12.50 42,500 3.5 12.50 42,500 12.50
8.80 to 9.80 20,500 3.5 9.50 19,300 9.50
15.90 2,500 3.3 15.90 2,500 15.90
_---- ------ --- ----- ------ -----
$1.00 to $15.90 123,800 3.3 $6.70 122,600 $6.50
=============== ======= === ===== ======= =====
Pro forma information regarding net loss and net loss per share is required by
SFAS 123, and has been determined as if the Company had accounted for its
employee stock purchase plan and employee stock options granted under the fair
value method of SFAS 123. The fair value for these options was estimated at the
date of grant using a Black-Scholes option pricing model for the single option
approach with the following assumptions: risk-free interest rate of 5.8%,
volatility factor of the expected market price of the Company's common stock of
150%, an expected life of the options of 2 years from the grant date, a 33%
forfeiture rate, and a dividend yield of zero. The average fair value of options
at the date of grant was $2.00 per share during 2001.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to pro forma net loss over the options' vesting period. The
Company's historical and pro forma information at December 31 follows:
2001 2000 1999
---- ---- ----
Net loss before extraordinary item As reported ($1,947,000) ($5,970,000) ($3,512,000)
Pro forma ($1,947,000) ($6,097,000) ($4,293,000)
Net loss As reported ($1,308,000) ($5,731,000) ($3,512,000)
Pro forma ($1,308,000) ($5,858,000) ($4,293,000)
Basic and diluted EPS before extraordinary item As reported ($0.50) ($1.90) ($1.10)
Pro forma ($0.50) ($1.90) ($1.40)
Basic and Diluted EPS As reported ($0.40) ($1.80) ($1.10)
Pro forma ($0.40) ($1.80) ($1.40)
OTHER TRANSACTIONS
In December 2000, the Company entered into a settlement and release agreement
with Deutsche Financial Services Corporation, or DFS, pursuant to which DFS
agreed to settle the Company's outstanding debt of approximately $425,000 in
exchange for a cash payment of $200,000 and a grant of 3,500 shares of the
Company's common stock. In addition, DFS exercised its warrant to purchase
27,500 shares of the Company's common stock for $3.41 per share, with the
aggregate exercise price being applied against the Company's debt, and the
Company issued an additional warrant for 13,750 shares of common stock at $3.41
per share as required by DFS's warrant upon its exercise. The additional warrant
expired in 2001. See Note 4 above for an explanation of the accounting treatment
for this transaction.
In consideration of its role as placement agent in the financing transaction
between the Company and AMRO International, S.A., the Company issued to
Ladenburg Thalmann & Co. Inc. a warrant to purchase up to 4,966 shares of the
Company's common stock at any time until April 17, 2002 for an exercise price of
$20.137. The Company booked the value of the warrant as computed under FAS 123
and recorded the cost as a financing charge.
The Company issued warrants to Keiji Miyagawa as a commission for his assistance
with (a) the private placement of common stock by the Company in September 1999,
prior to Mcglen's reverse merger with Adrenaline Interactive, Inc., and (b)
arranging the borrowing by the Company of $200,000 in June 1999. The Company
booked the value of the warrant as computed under FAS 123 and recorded the cost
as a financing charge in 1999. These warrants have expired.
F-19
Synnex Information Technologies, Inc. entered into an alliance with Mcglen Micro
in May 1999, pursuant to which Synnex granted to Mcglen Micro open account terms
on up to $1,000,000 in trade payables and provided Mcglen Micro with favorable
pricing terms on products Synnex distributes in the United States. In connection
with this agreement, Mcglen Micro issued to Synnex a warrant to purchase up to
$1 million of Mcglen Micro's common stock at the price of $41.719 per share, or
23,970 shares. The warrant was fully vested and non-forfeitable when issued. The
Company booked the value of the warrant as computed under FAS 123 and recorded
the cost as a charge of approximately $20,000 to cost of sales in 1999. The fair
value for this warrant was estimated at the date of grant using a Black-Scholes
pricing model with the following assumptions: risk-free interest rate of 6.8%,
volatility factor of the expected market price of the Company's common stock of
55%, an expected life of the options of 3 years from the grant date, and a
dividend yield of zero. This agreement was terminated in October 2000 when
Synnex agreed to convert the amounts owed by Mcglen into common stock. The stock
issued upon conversion was from the Founders Pool. The Company accounted for the
conversion by reducing accounts payable for the amount owed Synnex and recording
a corresponding credit to additional paid in capital based upon the market price
of the common stock issued, as well as recording an extraordinary gain of
$41,000 for the difference between the market price and the conversion price.
In connection with a financing pursuant to a purchase agreement to sell
$2,000,000 of common stock to Escalade Investors, LLC, the Company issued to
Escalade two three-year warrants to purchase a total of 4,313 shares of common
stock in 1999. Adrenalin booked the value of the warrants, as computed under FAS
123, as a reduction to paid in capital prior to its merger with Mcglen in
December 1999.
STOCK SPLITS
On April 30, 1999, the Board of Directors of the Company approved a 10 for 1
stock split. All common shares and per share data have been retroactively
adjusted to reflect the stock split. On January 21, 2002, the Board of Directors
of the Company approved a 10 for 1 stock split in connection with the merger
with Lan Plus, see Note 14. All common shares and per share data have been
retroactively adjusted to reflect the stock split.
8. SEGMENT INFORMATION
Statement of Financial Accounting Standards No. 131 "Disclosure about Segments
of an Enterprise and Related Information" (SFAS No.131) 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 the Company's products or services, the countries in which the company
earns 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 the Company has only one reportable segment, has no concentration
of customers in one specific geographic area within the United States and does
not have any major customers, as defined.
9. COMMITMENTS AND CONTINGENCIES
The Company sub-leased its office facilities from Lan Plus and certain equipment
under non-cancelable operating leases that provide for minimum annual rentals
and escalations based on increases in real estate taxes and other operating
expenses. Minimum annual operating lease commitments at December 31, 2001, were
approximately $14,000 and payable as follows: 2002 - $6,000, 2003 - $5,000 and
2004 - $3,000.
Rent expense was $101,000, $135,000 and $90,000 for the years ended December 31,
2001, 2000 and 1999, respectively. In March 2000, the Company agreed to
sub-lease a portion of the facility previously occupied by Western to its former
Vice President through September 2001. In September 2001, the Company stopped
paying the remaining $22,000 in lease payments required under the lease of the
facility previously occupied by Western. Management has begun the process of
placing Western in Chapter 7 bankruptcy; the unpaid lease commitments are
included in net current liabilities of discontinued operations at December 31,
2001.
In 1999, the Company entered into employment agreements with various officers
for periods of three to five years. These agreements were terminated by the
officers in connection with the merger with Lan Plus in March 2002.
F-20
10. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
2001 2000 1999
---- ---- ----
Cash paid during the year ended December 31:
Interest $190,000 $409,000 $21,000
Income taxes 1,000 2,000 2,000
Non-cash investing and financing activities:
Equipment acquired under capital lease obligations - 18,000 376,000
Discount on convertible debt - 166,000 -
Repayment of note receivable through payroll reduction - (34,000) -
Payment of accounts payable through issuance of convertible note payable - 200,000 -
Conversion of convertible notes payable and accrued interest to equity 1,357,000 112,000 -
Conversion of convertible notes payable - related parties to equity - - 20,000
Conversion of accounts payable to equity 104,000 847,000 -
Net current liabilities of discontinued operations assumed in connection
with acquisition of Adrenalin 42,000 (120,000) 1,343,000
11. FOURTH QUARTER ADJUSTMENTS
In the fourth quarter of 1999, the Company recorded net adjustments that
increased its net loss by approximately $981,000. These adjustments primarily
consist of $250,000 write-off of various accounts receivable, $167,000 write-off
of inventory, recording $101,000 of inventory reserves, recording $43,000
amortization of goodwill for the AMT acquisition, $344,000 of non-cash
compensation expense, and other accruals of $76,000.
12. DISCONTINUED OPERATIONS
Upon consummation of the reverse acquisition, the Board of Directors of Mcglen
adopted a formal plan to discontinue the operations of Western Technologies,
Inc. (Western). Western is a wholly owned subsidiary of the Company and was
acquired as part of the reverse acquisition between Adrenalin Interactive, Inc.
and Mcglen Micro, Inc. The Company fulfilled two of the software development
contract obligations being conducted by Western in April 2000. The other two
contracts were terminated. An additional contract was assigned to Western's
former Vice President of Operations for completion, releasing Mcglen from any
further contractual liability. However, Mcglen is still responsible for any
product liability issues that may arise from the two completed contracts.
Mcglen accounted for the reverse acquisition as a recapitalization in accordance
with generally accepted accounting principles. As a result, Mcglen has been
shown as the acquirer for accounting purposes and the net liabilities of
Adrenalin and Western have been recapitalized as net liabilities of discontinued
operations on Mcglen's balance sheet.
The assets and liabilities of Western are included in the accompanying
consolidated balance sheet as of December 31, 2001 as follows:
2001 2000
---- ----
Current assets:
Prepaid expenses and other assets - $ 10,000
---------- ----------
Total current assets - 10,000
---------- ----------
Current liabilities:
Accounts payable and accrued liabilities - 17,000
Notes payable 396,000
Loss on disposal $ 44,000 170,000
---------- ----------
Total current liabilities 44,000 583,000
---------- ----------
Net current liabilities ($44,000) ($573,000)
========== ==========
F-21
Included in notes payable for Western at December 31, 2000, was a $396,000 note
to a finance company, interest only, at prime plus 3.5%. The Note was personally
guaranteed by the Company's former CEO and his wife, was secured by a Second
Trust Deed on their residence and was due January 31, 2001. On February 15,
2001, the Company reached an agreement with the former CEO, and the finance
company, whereby the Company converted $100,000 of the note, repriced 23,700
options held by the former CEO from $18.75 per share to $5.00 per share, which
he immediately exercised through forgiveness of the note, and paid expenses in
the amount of $15,000. Mcglen also issued a warrant to purchase 10,000 shares
of the Company's common stock at $5.00 per share to the former CEO. The warrant
was fully vested and non-forfeitable when issued. The Company booked the value
of the warrant, approximately $15,000, as computed under FAS 123 and reduced the
extraordinary gain by the value of the warrant. The Company was then released
from the remaining balance of the note. The Company recorded an extraordinary
gain of approximately $271,000 on this transaction.
The fair value for this warrant was estimated at the date of grant using a
Black-Scholes pricing model with the following assumptions: risk-free interest
rate of 5.8%, volatility factor of the expected market price of the Company's
common stock of 120%, an expected life of the options of 3 years from the grant
date, and a dividend yield of zero. This warrant expires in February, 2004.
Information relating to the operations of Western for the year ended December
31, 1999 is as follows:
1999
----
Net revenue $ 3,234,000
Expenses 6,272,000
------------
Loss from discontinued operations (3,038,000)
Loss from disposal of Western Technologies, Inc. (2,864,000)
------------
Net loss ($5,902,000)
============
Information for 2001 and 2000 was not material and therefore has not been
presented. Included in the 1999 net loss are write-offs of patents, goodwill,
and property and equipment of $2,020,000, $1,579,000, and $217,000,
respectively.
13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables contain selected unaudited consolidated quarterly financial
data for the Company (in thousands, except per share data):
F-22
QUARTER ENDED
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
2000 2000 2000 2000 2001 2001 2001 2001
---- ---- ---- ---- ---- ---- ---- ----
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Net sales $ 10,909 $ 8,155 $ 5,485 $ 5,596 $ 5,804 $ 4,789 $ 5,257 $ 5,381
Cost of sales 9,658 7,521 5,004 4,953 5,107 4,250 4,749 4,830
--------- --------- --------- --------- --------- --------- --------- ---------
Gross Profit 1,251 634 481 643 697 539 508 551
Selling, general and administrative 1,860 2,120 2,655 1,823 1,440 931 869 766
--------- --------- --------- --------- --------- --------- --------- ---------
Loss from operations (609) (1,486) (2,176) (1,180) (743) (392) (361) (215)
Interest expense 5 69 105 338 67 123 21 24
--------- --------- --------- --------- --------- --------- --------- ---------
Loss before income taxes and
extraordinary item (614) (1,555) (2,281) (1,519) (810) (515) (382) (239)
Provision for income taxes - - - 1 - - - 1
--------- --------- --------- --------- --------- --------- --------- ---------
Loss before extraordinary item (614) (1,555) (2,281) (1,520) (810) (515) (382) (240)
Extraordinary item, gain on retirement
of debt - - - 239 616 23 - -
--------- --------- --------- --------- --------- --------- --------- ---------
Net loss ($ 614) ($ 1,555) ($ 2,281) ($ 1,281) ($ 194) ($ 492) ($ 382) ($ 240)
========= ========= ========= ========= ========= ========= ========= =========
Basic and diluted loss per
share before extraordinary item ($ 0.19) ($ 0.49) ($ 0.72) ($ 0. 48) ($ 0.24) ($ 0.14) ($ 0.11) ($ 0.07)
========= ========= ========= ========= ========= ========= ========= =========
Basic and diluted net loss
per share ($ 0.19) ($ 0.49) ($ 0.72) ($ 0.40) ($ 0.06) ($ 0.14) ($ 0.11) ($ 0.07)
========= ========= ========= ========= ========= ========= ========= =========
Weighted average shares of common
stock outstanding:
Basic and diluted 3,200 3,187 3,147 3,175 3,387 3,585 3,585 3,585
========= ========= ========= ========= ========= ========= ========= =========
14. SUBSEQUENT EVENTS
On January 21, 2002, the Board of Directors of the Company approved a 10 for 1
stock split in connection with the merger with Lan Plus. The reverse spilt was
effective on March 20, 2002.
In January 2002, the Company entered into a settlement agreement and mutual
release with one of its suppliers, whereby the supplier and the Company agreed
to settle all pending issues in exchange for the Company paying the supplier
approximately $70,000. In exchange, the supplier returned approximately 49,500
shares of the Company's common stock; the stock was cancelled in March 2002.
On March 20, 2002, the Company closed its merger with Lan Plus. At the closing
of the merger, Lan Plus shareholders received a number of shares such that they
now own approximately 75% of the Company. In addition, at the close of the
merger, the Company also instituted the 10:1 reverse stock split and changed its
name to Northgate Innovations, Inc. Pursuant to the merger agreement, upon close
of merger, the Company's accounts payable to, and advances from Lan Plus, in the
amount of approximately $2.3 million was converted to common stock, eliminating
the debt; the stock was then retired to Treasury and cancelled.
F-23
Upon closing of the merger, Andy Teng, founder, Chairman and Chief Executive
Officer of Lan Plus, became the Chief Executive Officer and Chairman of the
Board of the combined company. Richard Shyu, previously President and Chief
Operating Officer of Lan Plus, became President of the combined company. Both
were added to the Board of Directors. Grant Trexler, Mcglen's Chief Financial
Officer, became Chief Financial Officer of the combined company. Two of Mcglen's
founders, Mike Chen and Alex Chen, have assumed management positions within the
new company. All of Mcglen's Board of Directors, except Mike Chen, resigned in
connection with the merger.
Upon completion of the merger with Lan Plus, the Company issued 150,000 shares
of common stock to PJA in connection with Mcglen's consulting agreement with
PJA. These shares were issued from the Founders Pool. Additionally, the Company
issued 6,300 shares of common stock to the Company's Chief Financial Officer
(CFO) pursuant to a stock grant by the Company in June 2000 and issued 20,000
shares of common stock pursuant to an agreement between the Founders and the CFO
in March 2002. These shares were issued from the Founders Pool. The accounting
for these transactions will be such that, the combined entity's goodwill will be
increased by the fair market value of the shares paid to PJA and the 20,000
shares CFO at the closing date with a corresponding credit to additional paid in
capital for the difference between fair market and par values of the 170,000
shares issued.
In March 2002, the Company entered into a settlement agreement and mutual
release with an individual, as a successor to the Josephthal & Co. Inc., whereby
the individual agreed to accept 125,000 shares of the Company's common stock
upon close of merger with Lan Plus, instead of $300,000 worth of stock, in
exchange for the Company releasing the individual for any claims related to the
Company's investment banking agreement with Josephthal. The accounting for this
transaction will be such that, the combined entity's goodwill will be increased
by the fair market value of the 125,000 shares closing date with a corresponding
credit to additional paid in capital for the difference between fair market and
par values of the 125,000 shares issued.
In March 2002, Mcglen was notified by AMRO of their conversion of $992,000 of
its note, plus accrued interest of $171,000 at a conversion price of $9.379 per
share pursuant to their note agreement. Upon closing of the merger with Lan Plus
and the reverse split of the Company's stock this transaction was completed and
the Company issued approximately 1,242,000 shares of its common stock.
Also in March 2002, the Company negotiated settlement agreements with several of
its lessors on certain past due equipment leases. The Company will record a gain
in March 2002 of approximately $100,000 as a result of these settlements.
Finally, in March 2002, the Company issued 10,000 shares of its common stock to
an investor relations consultant in exchange for services through June 1, 2002.
The Company will record the fair value of these shares, $10,000, as an expense
in March 2002.
INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS' REPORT ON SCHEDULE II
The Board of Directors and Stockholders
Northgate Innovations, Inc. (formerly known as Mcglen Internet Group, Inc.)
City of Industry, California
The audits referred to in our report, dated April 12, 2002, included
the related financial statement schedule as of December 31, 2001, and for each
of the three years in the period ended December 31, 2001, included in the annual
report on Form 10-K of Northgate Innovations, Inc. This financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion on this financial statement schedule based on our
audits. In our opinion, such financial statement schedule presents fairly, in
all material respects, the information set forth therein.
BDO Seidman, LLP
Los Angeles, California
April 12, 2002
F-24
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Balance at Balance at
Beginning End of
Description of year Additions Deductions Year
----------- ----------- ----------- ----------- -----------
2001
----
Allowance for doubtful accounts deducted
from accounts receivable in the balance sheet $30,000 $67,000 $77,000 $20,000
Reserve for obsolescence deducted from
inventories on the balance sheet 51,000 5,000 5,000 51,000
----------- ----------- ----------- -----------
$81,000 $72,000 $82,000 $71,000
=========== =========== =========== ===========
2000
----
Allowance for doubtful accounts deducted
from accounts receivable in the balance sheet $ 70,000 $236,000 $276,000 $30,000
Reserve for obsolescence deducted from
inventories on the balance sheet 101,000 - 50,000 51,000
----------- ----------- ----------- -----------
$171,000 $236,000 $326,000 $81,000
=========== =========== =========== ===========
1999
----
Allowance for doubtful accounts deducted
from accounts receivable in the balance sheet - $70,000 - $ 70,000
Reserve for obsolescence deducted from
inventories on the balance sheet $8,000 93,000 - 101,000
----------- ----------- ----------- -----------
$8,000 $163,000 - $171,000
=========== =========== =========== ===========
F-25
EXHIBIT INDEX
Exhibit No. Description
----------- -----------
2.1 Amended and Restated Agreement and Plan of Merger, dated as of
March 21, 2001, by and among Mcglen Internet Group, Inc.,
Mcglen Acquisition Company, Lan Plus Corporation and Andy
Teng, incorporated by reference to Appendix A to the Proxy
Statement/Prospectus included in
2.2 Amendment No. 3 to our Registration Statement on Form S-4, No.
333-66750. Amendment No. 4 dated March 14, 2002 to the Amended
and Restated Agreement and Plan of Merger, incorporated by
reference to Exhibit 2.1 to our Current Report on Form 8-K,
filed April 9, 2002.
3.1 Amended Certificate of Incorporation of Adrenalin Interactive,
Inc., incorporated by reference from Exhibit 3.1 to our
Current Report on Form 8-K, dated December 8, 1999.
3.2 Certificate of Amendment of Certificate of Incorporation of
Mcglen Internet Group, Inc., filed with the Delaware Secretary
of State on March 15, 2002.
3.3 Bylaws of Mcglen Internet Group, Inc., incorporated by
reference from Exhibit 3.2 to Amendment No. 1 filed April 17,
2000 to our Form 10-KSB for the year ended December 31, 1999
("April 2000 Form 10-KSB/A").
10.1 1999 Stock Option Plan of Mcglen Micro, Inc., as amended, as
adopted by the Company after the merger with Adrenalin
Interactive, Inc., incorporated by reference from Exhibit 10.1
to our April 2000 Form 10-KSB/A.
10.2 2000 Stock Option Plan, incorporated by reference from Exhibit
10.21 to Amendment No. 1 filed September 27, 2000 to our
Registration Statement on Form SB-2, No. 333-41070 ("Form
SB-2").
10.3 Convertible Promissory Note, dated March 20, 2000, by and
between Mcglen Internet Group, Inc. and various Lenders
introduced by Institutional Equity Holdings Corporation,
incorporated by reference from Exhibit 10.14 to our April 2000
Form 10-KSB/A.
10.4 Employment Agreement, dated January 1, 2000, between Mcglen
Internet Group, Inc. and Grant Trexler, incorporated by
reference from Exhibit 10.15 to our April 2000 Form 10-KSB/A.
10.5 Employment Agreement, dated December 2, 1999, between
Adrenalin Interactive, Inc. and George Lee, incorporated by
reference from Exhibit 10.16 to our April 2000 Form 10-KSB/A.
10.6 Employment Agreement, dated December 2, 1999, between
Adrenalin Interactive, Inc. and Mike Chen, incorporated by
reference from Exhibit 10.17 to our April 2000 Form 10-KSB/A.
10.7 Employment Agreement, dated December 2, 1999, between
Adrenalin Interactive, Inc. and Alex Chen, incorporated by
reference from Exhibit 10.18 to our April 2000 Form 10-KSB/A.
10.8 Founders Agreement, dated August 15, 2000, between Mcglen
Internet Group, Inc. and George Lee, Mike Chen and Alex Chen,
incorporated by reference from Exhibit 10.22 to Amendment No.
1 filed September 27, 2000 to our Form SB-2.
10.9 Financing Agreement, dated December 22, 2000, between Mcglen
Internet Group, Inc. and Dillow and Dillow, Inc., incorporated
by reference from Exhibit 10.23 to Amendment No. 2 filed
January 10, 2001 to our Form SB-2.
10.10 Consulting Agreement, dated August 17, 2000, between Mcglen
Internet Group, Inc. and Peter Janssen Associates,
incorporated by reference from Exhibit 10.10 to our 2000 Form
10-KSB.
21 Subsidiaries of Mcglen Internet Group, Inc., incorporated by
reference from Exhibit 21 to our April 2000 Form 10-KSB/A.
23 Consent of BDO Seidman, LLP.
Exhibit Index - 1