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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the period ended JUNE 30, 2002
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
Commission File No.: 0-27878
NORTHGATE INNOVATIONS, INC.
(Name of issuer 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
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 [ ]
The number of shares outstanding of each of the issuer's classes of publicly
traded common equity; as of August 12, 2002 was 14,736,665 shares of Common
Stock.
NORTHGATE INNOVATIONS, INC.
INDEX TO FORM 10-Q
PART I - FINANCIAL INFORMATION Page
----
Item 1 Financial Statements
Consolidated Balance Sheets................................................. 3
Consolidated Statements of Operations....................................... 4
Consolidated Statements of Stockholders' Equity (Deficit)................... 5
Consolidated Statements of Cash Flows....................................... 6
Condensed Notes to Consolidated Financial Statements........................ 7
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................... 8
PART II - OTHER INFORMATION
Item 6. Exhibit and Reports on Form 8-K................................... 13
SIGNATURE................................................................... 13
2
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
ASSETS JUNE 30, DECEMBER 31,
2002 2001
-------- --------
(unaudited)
Current Assets:
Cash and cash equivalents $ 672 $ 7,178
Certificates of deposit 1,189 187
Marketable securities 1,496 1,377
Accounts receivable, net of allowance for doubtful
accounts and estimated returns of $300 at June 30,
2002 and $254 at December 31, 2001 6,489 9,475
Inventories 3,510 3,944
Advances to Mcglen Internet Group, Inc. - 845
Prepaid expenses and other current assets 176 182
Investments 200 -
Deferred tax - current 198 123
-------- --------
Total current assets 13,930 23,311
-------- --------
Equipment, net 834 750
Deferred tax asset - long term 1,325 -
Goodwill 4,145 -
Other assets 38 30
-------- --------
$20,272 $24,091
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Accounts payable $ 4,980 $10,048
Securities sold short - 426
Accrued expenses 570 1,076
Line of credit 680 -
Accrued royalties 3,046 4,999
Income taxes payable 667 1,053
Convertible notes payable 100 -
Dividends payable 186 186
ESOP interest payable 517 278
-------- --------
Total current liabilities 10,746 18,066
-------- --------
Notes payable - long term 1,300 1,300
ESOP loan payable 7,963 7,963
-------- --------
Total liabilities 20,009 27,329
-------- --------
Stockholders' equity (deficit):
Preferred stock, $0.01 par value; 5,000 shares
authorized, 1,350 issued and outstanding 285 285
Common stock, $0.03 par value; authorized 50,000
shares, 14,737 and 9,854 shares issued and
outstanding in 2002 and 2001, respectively 442 -
Additional paid in capital 3,308 -
Unrealized loss on marketable equity securities (805) (496)
Retained earnings 3,708 3,748
-------- --------
6,938 3,537
Unearned ESOP shares (6,675) (6,775)
-------- --------
Total stockholders' equity (deficit) 263 (3,238)
-------- --------
$20,272 $24,091
======== ========
See accompanying condensed notes to the consolidated financial statements
3
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share data)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2002 2001 2002 2001
--------- --------- --------- ---------
Net sales $ 15,645 $ 7,839 $ 35,077 $ 22,218
Cost of sales 12,750 5,996 30,126 19,589
Gross profit 2,895 1,843 4,951 2,629
--------- --------- --------- ---------
Operating expenses 2,196 1,464 4,657 2,790
--------- --------- --------- ---------
Income (loss) from operations 699 379 294 (161)
--------- --------- --------- ---------
Interest expense 142 195 294 312
Interest income (25) (64) (75) (120)
Other expense (income) 255 (438) 148 (1,073)
--------- --------- --------- ---------
Total other 372 (307) 367 (881)
--------- --------- --------- ---------
Income (loss) before taxes 327 686 (73) 720
Provision (benefit) for income taxes 127 203 (33) 217
--------- --------- --------- ---------
Net income (loss) $ 200 $ 483 $ (40) $ 503
========= ========= ========= =========
Basic and diluted net income per share $ 0.01 $ 0.05 $ - $ 0.05
========= ========= ========= =========
Weighted average shares of common stock outstanding:
Basic 14,737 9,854 12,703 9,854
========= ========= ========= =========
Diluted 16,927 10,129 14,893 10,129
========= ========= ========= =========
See accompanying notes to the consolidated financial statements
4
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(unaudited)
(in thousands)
ACCUMULATED TOTAL
ADDITIONAL OTHER UNEARNED STOCKHOLDERS'
COMMON STOCK PREFERRED STOCK PAID-IN COMPREHENSIVE ESOP RETAINED EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL LOSS SHARES EARNINGS (DEFICIT)
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Balance at January 1, 2002 3,150 1,350 $ 285 $ (496) $ (6,775) $ 3,748 $ (3,238)
Unrealized loss on marketable
securities (309) (309)
Stock split in connection with
reverse acquisition 6,704 $ 296 $ (296) --
Shares issued in recapitalization 4,873 146 3,694 3,840
Shares issued to consultant 10 10 10
Decrease in fair value of
released ESOP shares, net of tax (100) 100 --
Net loss (40) (40)
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Balance at June 30, 2002 14,737 $ 442 1,350 $ 285 $ 3,308 $ (805) $ (6,675) $ 3,708 $ 263
========= ========= ========= ========= ========= ========= ========= ========= =========
See accompanying notes to the consolidated financial statements
5
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
For the six months
ended June 30,
2002 2001
-------- --------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net (loss) income $ (40) $ 503
Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:
Depreciation and amortization 116 54
Stock issued for services 10 -
Provision for losses on accounts receivable 46 (281)
Inventory reserves 133 (108)
Changes in operating assets and liabilities, net
of Mcglen acquisition:
Accounts receivable 3,515 2,158
Inventories 649 1,069
Prepaid expenses and other current assets 34 (714)
Other assets (8)
ESOP contribution payable 239 253
Accounts payable (6,128) (1,388)
Accrued expenses (891) (82)
Advances to Mcglen (307) (696)
Accrued royalties (1,953) (17)
Income taxes payable (386) -
-------- --------
Total adjustments (4,931) 282
-------- --------
Net cash (used in) provided by operating activities (4,971) 785
-------- --------
Cash flows from investing activities:
Purchases of equipment (105) (214)
Purchases of marketable securities (2,636) (11,592)
Proceeds from sale of marketable securities 1,710 8,459
Certificates of deposit (1,002) 12
Purchases of investments (200) -
Cash acquired in Mcglen purchase 108 -
-------- --------
Net cash (used in) provided by investing activities (2,125) (3,335)
-------- --------
Cash flows from financing activities:
Line of credit 590 -
-------- --------
Net cash provided by financing activities 590 -
-------- --------
Net (decrease) increase in cash and cash equivalents (6,506) (2,550)
Cash and cash equivalents beginning of period 7,178 2,884
-------- --------
Cash and cash equivalents end of period $ 672 $ 334
======== ========
The Company paid $161 and $59 for interest and $400 and $0 for taxes, during the
six months ended June 30, 2002 and 2001, respectively. See Note 2 for non-cash
investing activities.
See accompanying notes to the consolidated financial statements
6
NORTHGATE INNOVATIONS, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated interim financial statements include the accounts of Northgate
Innovations, Inc. (a Delaware corporation) (formerly Mcglen Internet Group, Inc.
"Mcglen") and its wholly owned subsidiaries ("Northgate" or the "Company") and
have been prepared, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such regulations. These financial statements should be read in
conjunction with the audited financial statements and the notes thereto included
in the Company's Annual Report on Form 10-K for the year ended December 31, 2001
and Form 8-K filed on May 20, 2002.
In the opinion of management, the accompanying financial statements contain all
adjustments necessary to present fairly the financial position of the Company at
June 30, 2002 and 2001, and the results of operations and cash flows for the
three and six months ended June 30, 2002 and 2001. The results of operations for
the interim periods are not necessarily indicative of the results of operations
for the full year.
2. OVERVIEW AND RECENT DEVELOPMENTS
The Company is a 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. The 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 the business divisions located in the City
of Industry, California. The business divisions include sales, marketing,
content management, product management and service management teams focused on
building unique customer experiences for each business division.
On October 11, 2000, Northgate 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 products and services, with over ten
years of operating history. On March 21, 2001, the companies entered into an
amended and restated merger agreement that, among other things, eliminated
certain conditions to closing contained in the original merger agreement. The
amended and restated merger agreement was subsequently amended several times,
ending on March 14, 2002. Upon the close of the merger on March 20, 2002, Lan
Plus shareholders received approximately 3.128 shares of Northgate common stock
for each Lan Plus share they owned, and owned approximately seventy-five (75%)
of the outstanding stock of Northgate (after taking into account a 10:1 reverse
split that took place immediately prior to the close of the merger). The
historical equity section of the balance sheet and earnings per share
information have been retroactively restated to reflect the exchange ratio
established in the merger agreement. 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.
Although Lan Plus was merged into Northgate, the merger was accounted for as a
reverse acquisition since Lan Plus shareholders controlled the combined entity
after the merger. As a result, for financial accounting purposes, the merger is
treated as a purchase of Northgate by Lan Plus. Therefore, the historical
financial statements of Lan Plus are presented for comparison purposes for all
periods presented.
After the 10:1 reverse stock split, Mcglen shareholders held 4,872,583 shares of
Northgate's $0.03 par value common stock. For accounting purposes, the shares
issued to Mcglen were valued at $0.788 per share (after the 10:1 reverse stock
split and based on the weighted average closing price of the shares just prior
to and after the merger date).
7
The following represents the estimated fair value of net assets acquired by Lan
Plus in the reverse acquisition at March 14, 2002 (in thousands):
Cash $ 108
Other current assets 879
Fixed assets 95
Deferred income taxes 1,400
Intangibles 4,145
Accounts payable and accrued expenses (1,278)
Inter-company payables (1,152)
Notes payable (357)
---------
$ 3,840
=========
Deferred income taxes represent the Company's estimate of Mcglen's net operating
loss carryforwards ("NOLs") that can be used to offset Northgate estimate future
taxable income, after considering limitations imposed on NOLs upon a change in
control.
Intangibles represent the excess of the purchase price of Mcglen over the
estimated fair value of the tangible assets acquired. The Company has not yet
determined if any specifically identifiable intangibles should be recorded
related to this purchase in accordance with Statement of Financial Accounting
Standards (SFAS) No. 141. Any unidentified intangibles will be reflected as
non-amortizable goodwill and will be evaluated periodically for recoverability
in accordance with SFAS No. 142. For the six months ended June 30, 2002, the
Company has recorded no intangible amortization.
On a pro forma basis, the statements of operations would have been as follows if
the acquisition had occurred on January 1, 2002 and 2001, respectively:
(in thousands, except per share data) June 30, 2002 June 30, 2001
-------------- -------------
Net sales $39,515 $30,711
Gross profit 5,441 3,865
Loss before taxes and extraordinary item (79) (605)
Extraordinary item, gain on debt settlements - 639
Net (loss) income (44) 34
Net (loss) income per share ($0.00) ($0.00)
In May and June 2002, the Company issued approximately 500,000 stock options to
employees with exercise prices ranging from $0.35 to $0.50. These options vest
over three to five years.
3. SUBSEQUENT EVENTS
In July 2002, the Company repaid its line of credit and extended the line to
September 30, 2002. In August 2002, the Company renegotiated its $1.3 million
note payable, extending the due date to January 1, 2005. As such, this note is
shown as a long term liability as of June 30, 2002.
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
As used in the following section, "Northgate", "we", "the Company" and "our"
refer to Northgate Innovations, Inc., unless the context requires otherwise.
The following discussion and analysis of Northgate's financial condition and
results of operations should be read in conjunction with Northgate's unaudited
condensed consolidated financial statements and the notes thereto included
elsewhere herein. The following table sets forth for the periods 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.
OVERVIEW
Northgate was incorporated in the State of Delaware in 1994 and is a leading
marketer of personal computers, or PCs, and related products and services.
Northgate manufactures, markets, and supports a broad line of desktop PCs,
servers and workstations used by individuals, families, businesses, government
agencies and educational institutions. Northgate also offers diversified
products and services such as software, peripherals, Internet access services,
support programs and general merchandise.
8
Net sales of the Company are primarily derived from the sale of personal
computer hardware, software, peripherals and accessories. Gross profit consists
of net sales less product and shipping costs.
Critical Accounting Policies and Estimates
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses Northgate'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.
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:
Northgate maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. If the
financial condition of Northgate's customers were to deteriorate, resulting in
an impairment of their ability to make payments, additional allowances may be
required.
Northgate provides for the estimated cost of product warranties at the time
revenue is recognized. While the products Northgate sells are covered by third
party manufacturer warranties, Northgate may have products returned by customers
that Northgate 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, Northgate may be forced
to cover these warranty costs and the costs may differ from Northgate's
estimates.
Northgate 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.
Northgate's management assesses 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 management determines 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, it measures the impairment based on a projected
discounted cash flow method using a discount rate determined by management to be
commensurate with the risk inherent in our current business model.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of net
sales represented by certain items reflected in the Company's condensed
statements of operations. There can be no assurance that the trends in sales
growth or operating results will continue in the future.
9
PERCENTAGE OF NET SALES
-----------------------
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2002 2001 2002 2001
---- ---- ---- ----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 81.5 78.8 85.9 88.2
------ ------ ------ ------
Gross profit 18.5 22.2 14.1 11.8
Operating expenses 14.0 17.0 13.3 12.5
------ ------ ------ ------
Income (loss) from operations 4.5 5.2 0.8 (0.7)
Other expense (income) 2.4 (4.0) 1.0 (4.0)
------ ------ ------ ------
Income before income taxes 2.1 9.2 (0.2) 3.3
(Benefit)provision for taxes 0.8 2.8 (0.1) 1.0
------ ------ ------ ------
Net (loss) income 1.3% 6.4% (0.1%) 2.3%
====== ====== ====== ======
Three Months Ended June 30, 2002 Compared to the Three Months Ended June 30,
2001
Net sales increased by $7.8 million, or 100.0%, to $15.6 million for the three
months ended June 30, 2002, compared to $7.8 million for the three months ended
June 30, 2001. The increase in net sales was a result of an increase in the
number of laptop computer systems shipped during the period as well as an
increase in the average selling price per system due to a higher selling price
for the laptop systems as compared to desktop systems.
Gross profit increased by $1.2 million or 70.6% to $2.9 million for the three
months ended June 30, 2002, compared to $1.7 million for the period ended June
30, 2001. The increase in gross profit was due to the increase in sales. Gross
profit, as a percentage of net sales decreased by 3.6% to 18.5%, from 22.2% for
the three months ended June 30, 2001. Gross profit as a percentage for the
second quarter of 2002 increased 74.5% as compared to the first quarter of 2002
due to higher margins on the sale of notebooks as well as the Company reducing
its reserve for obsolete and slow moving inventory by more than $30,000 due to
tighter inventory controls, and reducing packing expenses by approximately
$53,000, due to renegotiated costs, as compared to the first quarter of 2002.
On a forward-looking basis, management anticipates future gross profit margins
to decline from second quarter levels and be more in line with those recognized
for the years ended December 31, 2001 and 2000. The statement concerning future
gross profit margins is a forward looking statement that involves certain risks
and uncertainties which could result in a fluctuation of gross margins below
those achieved for the three months ended June 30, 2002. Although the Company
believes it provides a high quality product and after sale services, pricing and
gross profit could be negatively impacted by the activities of larger computer
manufacturers and product supply and demand.
Operating expenses increased by $900,000 or 69.2%, to $2.2 million for the three
months ended June 30, 2002, from $1.3 million for the same period in 2001. The
increase in operating expenses was attributable to an increase in payroll and
related costs, telephone charges and an increase in depreciation expense in
2002. Payroll and related costs increased by approximately $660,000, or 87.1%
for the three months ended June 30, 2002 compared to the same period in 2001 due
to increased production and call center staffing due to increased sales, as well
as the hiring of mid-level managers to help support the Company's growth.
Insurance costs increased by approximately $70,000 as the Company incurred
insurance for its Directors and officers, as well as increased premiums for
workers compensation, general liability and health insurance due to overall
increases in the insurance market. Depreciation charges increased by
approximately $50,000 due to infrastructure investments in Northgate's telephone
system and enterprise software.
Other expense (income) decreased by approximately $700,000 to $250,000 for the
three months ended June 30, 2002, from ($450,000) for same period in the prior
year. The decrease was primarily the result of a $650,000 decrease in gains on
marketable securities.
The income tax provision for the three months ended June 30, 2002 was $130,000
versus a provision of $210,000 for the same period in the prior year. The
decrease in the provision was due to lower income before taxes during the three
months ended June 30, 2002, due to lower capital gains on marketable securities.
10
Six Months Ended June 30, 2002 Compared to the Six Months Ended June 30, 2001
Net sales increased by $12.9 million, or 58.1%, to $35.1 million for the six
months ended June 30, 2002, compared to $22.2 million for the six months ended
June 30, 2001. The increase in net sales was a result of an increase in the
number of desk top and laptop computer systems shipped during the period as well
as an increase in the average selling price per system due to a higher selling
price for the laptop systems as compared to desktop systems.
Gross profit increased by $2.3 million or 88.5% to $4.9 million for the three
months ended June 30, 2002, compared to $2.6 million for the period ended June
30, 2001. The increase in gross profit was due to the increase in sales as well
as well as more favorable pricing on certain components. Gross profit, as a
percentage of net sales increased by 19.5% to 14.1%, from 11.8% for the six
months ended June 30, 2002 as compared to the six months ended June 30, 2001.
The increase in gross profit as a percentage of sale was due to higher margins
on the sale of notebooks as well as the Company taking advantage of quarter end
promotions from various manufacturers providing lower cost of goods sold.
Operating expenses increased by $1.9 million or 67.8%, to $4.7 million for the
six months ended June 30, 2002, from $2.8 million for the same period in 2001.
The increase in operating expenses was attributable to an increase in payroll
and related costs, telephone charges and an increase in bad debt expense in
2002. Payroll and related costs increased by approximately $1.5 million, or
100.0% for the six months ended June 30, 2002 compared to 2001 as Northgate
increased production and call center staffing due to increased sales, as well as
the hiring of mid-level managers to help support the Company's growth and
temporary staff for peak periods during the six months ended June 30, 2002.
Credit card fees increased by approximately $100,000, due to additional credit
card sales through AccessMicro.com and Mcglen.com where the Company's historical
business was through open account sales. Insurance costs increased by
approximately $100,000 as the Company incurred insurance for its Directors and
Officers, as well as increased premiums for general liability and health
insurance due to overall increases in the insurance market . Bad debt expense
increased by approximately $50,000 to $5,000 for the six months ended June 30,
2002 compared to bad debt recoveries of $45,000 in the prior year.
Other expense (income) decreased by $1.2 million or more than 800% to $150,000
for the six months ended June 30, 2002, from ($1.1 million) for same period in
the prior year. The decrease was a result of losses on marketable securities of
$250,000 during the six months ended June 30 2002 as compared to a gains of
$1,020,000 for the six months ended June 30, 2001.
The income tax (benefit) provision for the six months ended June 30, 2002 was
($30,000) versus a provision of $217,000 for the same period in the prior year.
The decrease in the provision was due to lower income before taxes during the
six months ended June 30, 2002, due to lower gains on marketable securities.
INCOME TAXES
For the periods ended June 30, 2002 and 2001, the difference between the amount
of income tax recorded and the amount of income tax expense calculated using the
federal statutory rate of 34% is due to state income taxes and other permanent
differences.
As a result of the Company's reverse merger in March 2002, the Company has
federal and state net operating loss carryforwards of approximately $23 million
and $12 million, respectively. The net operating loss carryforwards will expire
at various dates beginning in 2020 through 2022 for federal purposes and 2010
through 2012 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 Company being able to only utilize $3.9 million and $0.5 million,
to offset federal and state income, respectively. The remaining net operating
loss carryforwards will go unused.
LIQUIDITY AND CAPITAL RESOURCES
Northgate's primary capital need has been the funding of working capital
requirements created by its growth. Historically, Northgate's primary sources of
financing have been cash provided by operations and borrowings from private
investors, and financial institutions. Cash (used in) provided by operations was
approximately ($5.0 million) and $785,000 for the six months ended June 30, 2002
and 2001, respectively. Cash was used to pay down Northgate's working capital
obligations during the six months ended June 30, 2002.
11
During the six months ended June 30, 2002, Northgate's capital expenditures were
approximately $105,000 compared to $214,000 for the same period in 2001,
primarily for computer software and hardware, and production equipment.
The Company has a $2,500,000 line of credit with a bank. The line of credit
provides for borrowings secured by substantially all of the Company's assets and
is guaranteed by the Company's majority shareholder. Borrowings under the line
are advanced based upon 70% of eligible accounts receivable, as defined, less
any letters of credit issued on the Company's behalf. The line of credit expires
on September 30,2002. Advances under the line bear interest at the bank's prime
rate plus 0.5% (5.25% at June 30, 2002). The line contains certain covenants
that require Northgate to maintain on a quarterly basis: a minimum level of
tangible net worth (as defined), profitability for at least one quarter in
three, a Current Ratio of at least 1.4:1, a Debt to Tangible Net Worth ratio of
not more than 5.0 to 1.0, Working Capital of at least $2.5 million, and limits
the capital expenditures the Company can make in any one year to $750,000,
respectively. At June 30, 2002 and 2001,approximately $1.0 million and $1.4
million of the Company's short term investments were held as collateral for
letters of credit taken out to secure open account terms with one of the
Company's primary vendors. The Company believes that current working capital,
together with cash flows from operations and available lines of credit, will be
adequate to support the Company's current operating plans through 2002.
The Company was not in compliance with the minimum tangible net worth and
current ratio covenants at June 30, 2002. Additionally, the Company was not in
compliance with the debt to tangible net worth covenant at June 30, 2002 due to
the accounting requirement for Northgate to record the ESOP debt guarantee as a
liability with a corresponding entry to Unearned ESOP Shares in Stockholders
Equity in accordance with SOP 93-6. However, the borrowings outstanding under
this line were repaid in July 2002. Management has entered into discussions with
the lender, to extend the line of credit, and to redefine the covenant to
exclude ESOP debt and related entry to Stockholders Equity.
In August 2002, the Company renegotiated its $1.3 million note payable,
extending the due date to January 1, 2005. As such, this note is shown as a long
term liability as of June 30, 2002.
At June 30, 2002 and 2001, the Company had cash and short-term investments of
$3.4 million and $8.5 million, respectively, and working capital of $3.2 million
and $4.3 million, respectively. However, if the Company needs extra funds, such
as for acquisitions or expansion or to fund a significant downturn in sales that
causes losses, there are no assurances that adequate financing will be available
at acceptable terms, if at all.
Since computer retailers typically have low product gross margins, Northgate's
ability to remain profitable is dependent upon its ability to continue to drive
down the cost of its computer systems through its product sourcing, inventory
management and labor management systems. To the extent that Northgate does not
continue to effectively manage its business, Northgate may be materially
adversely affected.
Northgate may 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 and success
of new product introductions, mix of product sales and seasonality of sales
typically experienced by retailers, and the pricing of component parts in the
world-wide marketplace. Many of Northgate's competitors offer broader product
lines, have substantially greater financial, technical, marketing and other
resources than Northgate and may benefit from component volume purchasing
arrangements that are more favorable in terms of pricing and component
availability than the arrangements enjoyed by the Company. 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.
As part of its growth strategy, Northgate may, in the future, acquire other
companies, in the same or complementary lines of business, in addition to the
acquisition of Mcglen described elsewhere herein. Any such acquisition and the
ensuing integration of the operations of the acquired company with those of
Northgate would place additional demands on Northgate's management, and
operating and financial resources.
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BUSINESS FACTORS
Except for historical information, all of the statements, expectations and
assumptions contained in the foregoing are forward-looking statements. The
realization of any or all of these expectations is subject to a number of risks
and uncertainties and it is possible that the assumptions made by management may
not materialize. In addition, there can be no assurances that current sales
levels will be sustained, and that the six-month trends for sales will continue
in future periods. In addition to the factors set forth above, other important
factors that could cause actual results to differ materially from expectations
include lack of working capital to carry out our business plan; competition from
companies either currently in the market or entering the market; competition
from other Internet, catalog and retail store resellers and price pressures
related thereto; uncertainties surrounding the supply of and demand for computer
and computer related products; reliance on our vendors; and risks due to shifts
in market demand and/or price erosion of owned inventory. This list of risk
factors is not intended to be exhaustive. Reference should also be made to the
risk factors set forth elsewhere in this document and from time to time in our
other SEC reports and filings.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
a. Reports on Form 8-K -
None.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Northgate Innovations, Inc.
Date: August 12, 2002 By /s/ Grant Trexler
---------------------------------------
Grant Trexler
Chief Financial Officer
(Duly Authorized Officer of the Registrant
and Principal Financial Officer)
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