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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 quarterly period ended MARCH 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No.: 0-27878
NORTHGATE INNOVATIONS, INC.
(Exact Name of Registrant as Specified in its charter)
Delaware 13-3779546
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
801 Sentous Street, City of Industry, California 91748
(Address of principal executive offices)(Zip code)
Registrant's telephone number, including area code: (626) 923-6000
Indicate by check whether the registrant (1) has 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 [ ]
Indicate by check whether the registrant is an accelerated filer (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [ ]
The number of shares outstanding of each of the issuer's classes of publicly
traded common equity; as of May 19, 2003 was 14,694,084 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 ............................ 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
Item 3. Quantitative and Qualitative Disclosures About Market Risks......... 13
Item 4. Controls and Procedures............................................. 13
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................... 13
SIGNATURE.................................................................... 14
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
MARCH 31, DECEMBER 31,
2003 2002
--------- ---------
(unaudited)
ASSETS (Note 4)
Current Assets:
Cash and cash equivalents $ 653 $ 1,837
Certificates of deposit - restricted 1,016 1,016
Marketable securities 506 490
Accounts receivable, net of allowance for doubtful accounts
of $280 in 2003 and 2002, respectively 10,495 2,898
Inventories, net 5,189 2,984
Income taxes receivable 543 92
Prepaid expenses and other current assets 129 170
Deferred tax assets - current 418 418
--------- ---------
Total current assets 18,949 9,905
Equipment, net 850 900
Deferred tax asset 1,247 1,247
Goodwill 3,886 3,886
Other assets 76 76
--------- ---------
$ 25,008 $ 16,014
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 11,424 $ 3,983
Accrued expenses 456 450
Accrued royalties 1,418 1,427
Convertible notes payable 100 100
Advances from shareholder 202 --
Line of credit 1,994 --
ESOP interest payable 847 746
--------- ---------
Total current liabilities 16,441 6,706
Notes payable 1,300 1,300
Guarantee of ESOP loan payable 6,750 6,750
--------- ---------
Total liabilities 24,491 14,756
--------- ---------
Commitments and contingencies
Stockholders' Equity:
Preferred stock, $0.01 par value; 5,000 shares authorized, 1,350
shares issued and outstanding, liquidation preference of $1,350 14 14
Common stock, $0.03 par value; 50,000 shares authorized,
14,694 shares issued and outstanding 441 441
Additional paid in capital 3,764 3,764
Accumulated other comprehensive gain (loss) 9 (7)
Retained earnings 2,852 3,609
--------- ---------
7,080 7,821
Less: Unearned ESOP shares (6,563) (6,563)
--------- ---------
Total stockholders' equity 517 1,258
--------- ---------
$ 25,008 $ 16,014
========= =========
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 ended
MARCH 31, 2003 MARCH 31, 2002
-------------- --------------
Net sales $ 20,065 $ 19,432
Cost of sales 19,027 17,376
--------- ---------
Gross profit 1,038 2,056
Selling, general and administrative expenses 2,079 2,461
--------- ---------
Loss from operations (1,041) (405)
Other expenses (income):
Interest expense, net 133 102
Other expense (income) 34 (107)
--------- ---------
Total other expense (income) 167 (5)
--------- ---------
Loss before income taxes (1,208) (400)
Benefit for income taxes (451) (160)
--------- ---------
Net (loss) income ($ 757) ($ 240)
========= =========
Basic and diluted income per share ($ 0.05) ($ 0.02)
========= =========
Weighted average shares of common stock outstanding:
Basic 14,694 10,666
========= =========
Diluted 14,694 10,666
========= =========
See accompanying notes to the consolidated financial statements
4
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE LOSS
(unaudited)
(in thousands)
ACCUMULATED TOTAL
ADDITIONAL OTHER UNEARNED STOCK- COMPRE-
PREFERRED STOCK COMMON STOCK PAID-IN COMPREHENSIVE ESOP RETAINED HOLDERS' HENSIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL LOSS (GAIN) SHARES EARNINGS EQUITY (LOSS)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Balance at January 1, 2003 1,350 $ 14 14,694 $ 441 $ 3,764 $ (7) $(6,563) $ 3,609 $ 1,258
Unrealized gain on marketable
Securities 16 16 $ 16
Net loss (757) (757) (757)
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Balance at March 31, 2003 1,350 $ 14 14,694 $ 441 $ 3,764 $ 9 $(6,563) $ 2,852 $ 517 $ (741)
See accompanying notes to the consolidated financial statements
5
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
For the three months ended
MARCH 31,
2003 2002
-------- --------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net (loss) income $ (757) (240)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 67 41
Stock issued for services -- 10
Changes in operating assets and liabilities, net
of Mcglen acquisition:
Accounts receivable (7,597) 6,540
Inventories (2,205) 349
Prepaid expenses and other current assets 41 23
Due from Mcglen -- (307)
Income taxes receivable (451) --
ESOP interest payable 101 119
Accounts payable 7,441 (3,913)
Accrued expenses 6 (966)
Accrued royalties (9) (1,695)
Income taxes payable -- (511)
Other assets -- (8)
-------- --------
Total adjustments (2,606) (318)
-------- --------
Net cash used in operating activities (3,363) (558)
-------- --------
Cash flows from investing activities:
Purchases of equipment (17) (104)
Purchases of marketable securities -- (1,094)
Proceeds from sale of marketable securities -- 946
Certificates of deposit -- (1,002)
Investments -- (200)
Cash acquired in Mcglen purchase -- 108
-------- --------
Net cash used in investing activities (17) (1,346)
-------- --------
Cash flows from financial activities:
Borrowings on line of credit 1,994 --
Advances from officer/shareholder 202 --
-------- --------
Net cash provided by borrowing activities 2,196 --
-------- --------
Net decrease in cash and cash equivalents (1,184) (1,904)
Cash and cash equivalents beginning of period 1,837 7,178
-------- --------
Cash and cash equivalents end of period $ 653 $ 5,274
======== ========
The Company paid $1 and $137 for interest and $0 and $0 for taxes, during the
three months ended March 31, 2003 and 2002, respectively. See Note 2 for
non-cash investing activities in 2002.
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,
2002.
In the opinion of management, the accompanying financial statements contain all
adjustments necessary to present fairly the financial position of the Company at
March 31, 2003 and 2002, and the results of operations and cash flows for the
three months ended March 31, 2003 and 2002. The results of operations for the
interim periods are not necessarily indicative of the results of operations for
the full year.
Certain reclassifications have been made to the December 31, 2002 balance sheet
to conform to the March 31, 2003 presentation.
2. OVERVIEW AND RECENT DEVELOPMENTS
The Company is a developer, manufacturer and distributor of innovative PCs,
peripherals, software, and over 30,000 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. 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.
On October 11, 2000, Northgate entered into a definitive merger agreement and
plan of merger with Lan Plus Corporation ("Lan Plus"). 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, totaling 9,854,000 shares, and owned approximately seventy-
five percent (75%), on a fully diluted basis, 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). 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 a subsidiary of 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 4,830,000 shares of
Northgate's $0.03 par value common stock. For accounting purposes, the shares
retained by Mcglen in the merger were valued on Lan Plus' books as an issuance
of new shares at $0.788 per share (after the 10:1 reverse stock split and based
on the weighted average closing price of the shares just prior to and after the
merger date), totaling $3,806,000. In addition, Lan Plus assumed previously
issued options and warrants resulting in additional fair value of $34,000.
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.
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 539
Fixed assets 95
Deferred income taxes 1,400
Intangibles 3,886
Accounts payable and accrued expenses (846)
Inter-company payables (1,152)
Notes payable (190)
--------
$ 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's estimated
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 three months ended March 31, 2003 and
2002, the Company recorded no intangible amortization.
On a pro forma basis, the statement of operations for the three months ended
March 31, 2002 would have been as follows if the acquisition had occurred on
January 1, 2002:
(in thousands, except per share data) MARCH 31, 2002
--------------
Net sales $23,832
Gross profit 2,546
Loss before taxes (406)
Net loss ($244)
Net loss per share ($0.02)
During March 2003, the Company's CEO and majority shareholder advanced the
Company approximately $202,000 for working capital needs. The Company
anticipates repayment of this advance in the second quarter of 2002.
Historically, Northgate has relied upon sales to a few customers and during the
first quarter of 2003, more than 25% of Northgate's revenues were from one
customer. This customer had an accounts receivable balance of more than $5.1
million at March 31, 2003. During the first quarter of 2002, more than 50% of
Northgate's revenues were from one customer.
In November 2002, the Financial Accounting Standards Board ("FASB") issued EITF
No. 02-16, "Accounting by a Customer (Including a Reseller) for Certain
Consideration Received from a Vendor" ("EITF 02-16"). EITF 02-16 requires that
consideration received by a customer from a vendor is considered (a) an
adjustment of the prices of the vendor's products or services and therefore,
characterized as a reduction of cost of sales when recognized in the reseller's
statement of operations, (b) an adjustment to a cost incurred by the reseller
and, therefore, characterized as a reduction of that cost when recognized in the
reseller's statement of operations, or (c) a payment for assets or services
delivered to the vendor, and therefore, characterized as revenue when recognized
in the reseller's statement of operations. Adoption of EITF 02-16 is required
for the Company for new agreements, including modifications of existing
agreements, entered into after December 31, 2002. The adoption of EITF 02-16,
did not have a material effect on the Company's financial statements.
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
As used in the following section, "Northgate", "we", "us", "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.
8
OVERVIEW
Northgate is a leading marketer of personal computers, or PCs, and related
products and services and 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
services, support programs and general merchandise.
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.
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 completed 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 has
reported 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
provider. Purchases from this vendor accounted for more than 15% of our
aggregate merchandise purchases for the three months ended March 31, 2003.
Northgate has no long-term contracts or arrangements with its vendors that
guarantee the availability of merchandise.
Historically, Northgate has relied upon sales to a few customers and during the
first quarter of 2003, more than 25% of Northgate's revenues were from one
customer. This customer had an accounts receivable balance of more than $5.1
million at March 31, 2003. During the first quarter of 2002, more than 50% of
Northgate's revenues were from one customer.
Accounts payable, accounts receivable and inventory has increased due to the
sales increase in the first quarter of 2003, the addition of distribution sales
focusing on motherboards, and longer credit terms provided to some of the
Company's new customers.
SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment of FASB Statement No. 123," SFAS No. 148 amends SFAS
No. 123 to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee compensation.
The Company did not record any stock based compensation charges for the three
months ended March 31, 2003 or 2002.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." One of the requirements of FIN 45 is for
product warranties. Guarantors are to disclose the maximum potential amount of
future payments under the product warranty and to disclose the guarantors
accounting policy and methodology used in determining its liability for product
warranties as well as a tabular reconciliation of the guarantor's product
warranty liability for the reporting period. 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.
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.
9
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,
effect its more significant judgments and estimates used in the preparation of
its consolidated financial statements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS: 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.
WARRANTIES: 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.
INVENTORY: 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.
PURCHASE AND ADVERTISING REBATES: We earn rebates from our vendors which are
based on various quantitative contract terms. Amounts expected to be received
from vendors relating to the purchase of merchandise inventories are recognized
as a reduction of cost of goods sold as the merchandise is sold. Amounts that
represent a reimbursement of incremental costs, such as advertising, are
recorded as a reduction to the related expense in the period that the related
expense is incurred. Several controls are in place that we believe allow us to
ensure that these amounts are recorded in accordance with the terms of the
contracts. Should vendors reach different judgments regarding the terms of these
contracts, they may seek to recover amounts from us.
IMPAIRMENT OF LONG-LIVED ASSETS: We review our long-lived assets for impairment
when indicators of impairment are present and the value of the assets are less
than the assets' carrying amount. If actual market conditions are less favorable
than the carrying value, future write-offs may be necessary.
IMPAIRMENT OF GOODWILL AND INDEFINITE LIVED INTANGIBLE ASSETS: As a result of
our adoption of Statement of Financial Accounting Standards No. 142 "Goodwill
and Other Intangible Assets" ("SFAS No. 142"), we now annually review goodwill
and other intangible assets that have indefinite lives for impairment and when
events or changes in circumstances indicate the carrying value of these assets
might exceed their current fair values. We determine fair value using discounted
cash flow analysis, which requires us to make certain assumptions and estimates
regarding industry economic factors and future profitability of acquired
businesses. It is our policy to conduct impairment testing based on our most
current business plans, which reflect changes we anticipate in the economy and
the industry. If actual results are not consistent with our assumptions and
judgments, we could be exposed to a material impairment charge.
DEFERRED TAXES: We record a valuation allowance to reduce our deferred tax
assets to the amount that is more likely than not to be realized. We have
considered estimated future taxable income and ongoing tax planning strategies
in assessing the amount needed for the valuation allowance. If actual results
differ unfavorably from those estimates used, we may not be able to realize all
or part of our net deferred tax assets and additional valuation allowances may
be required.
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.
10
PERCENTAGE OF NET SALES
-----------------------
PERIOD ENDED MARCH 31,
2002 2001
---- ----
Net sales 100.0% 100.0%
Cost of sales 94.8 89.4
------ ------
Gross profit 5.2 10.6
Operating expenses 10.4 12.7
------ ------
Loss from operations (5.2) (2.1)
Interest expense, net 0.6 0.5
Other expense (income) 0.2 (0.6)
------ ------
Loss before income taxes (6.0) (2.0)
Provision for income taxes (2.2) (0.8)
------ ------
Net loss (3.8%) (1.2%)
====== =======
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2002
Net sales increased by $0.7 million, or 3.6%, to $20.1 million for the three
months ended March 31, 2003, compared to $19.4 million for the three months
ended March 31, 2002. The increase in net sales was a result of an increase in
the number of computer systems and printers shipped during the period as the
Company added additional customers during the period ended March 31, 2003.
Gross profit decreased by $1.1 million or (52.3%) to $1.0 million for the three
months ended March 31, 2003, compared to $2.1 million for the three months ended
March 31, 2002. The decrease in gross profit was due to increased competition in
the marketplace, the Company responding to this competition while acquiring new
customers, and a $250,000 additional provision recorded for slow moving
inventory. Gross profit, as a percentage of net sales also decreased to 5.2% for
the three months ended March 31, 2003, compared to 10.6% for the three months
ended March 31, 2002. The decrease in gross profit margin was due to an increase
in distribution sales and a higher percentage of internet sales in 2003 as
compared to the first quarter of 2002, both which have a lower gross profit
percentage, increased competition in the computer industry, and the provision
for slow moving inventory discussed above.
On a forward-looking basis, future gross profit margins may fluctuate from
recent levels. The statement concerning future gross profit 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
March 31, 2003 or year ended December 31, 2002. Although the Company believes it
provides a high level of value and added services, pricing and gross profit
could be negatively impacted by the activities of larger computer manufacturers.
Operating expenses decreased by $0.4 million or (15.5%), to $2.1 million for the
three months ended March 31, 2003, from $2.5 million for the same period in
2002. The decrease in operating expenses was attributable to a decrease in
payroll and related costs, and a decrease in outside assembly costs in 2003.
Payroll and related costs decreased by approximately $200,000, or 14.3% for the
three months ended March 31, 2003 compared to the three months ended March 31,
2002 due to a smaller workforce in place in the first quarter of 2003. Outside
assembly and temporary labor costs decreased by approximately $210,000 to
$40,000 for three months ended March 31, 2003 as compared to $250,000 for the
first quarter of 2002. Outside assembly and temporary labor costs decreased due
to lower sales in Q4 of 2002 and also due to level production in the first
quarter of 2003.
Net interest expense increased $31,000 or 30.4% due to lower interest income
resulting from decreased investments in 2003. Other expense (income) decreased
by $141,000, or more than 100% to $34,000 for the three months ended March 31,
2003, from ($107,000) for same period in the prior year. The decrease was a
result of reduced capital gains on marketable securities for the period ended
March 31, 2003 as well as one-time settlement gains recorded in 2002.
Income tax benefit for the period ended March 31, 2003 was $451,000 versus a
benefit of $160,000 for the same period in the prior year.
INCOME TAXES
For the periods ended March 31, 2003 and 2002, 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.
11
As a result of the Company's reverse merger in March 2002, the Company has
federal and state net operating loss carryforwards of approximately $16 million
and $10 million, respectively. The net operating loss carryforwards will expire
at various dates beginning in 2012 through 2022 for federal purposes and 2003
through 2009 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 $3.8 million and $0.5 million,
to offset federal and state income, respectively, as of December 31, 2002. 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 operations was approximately
$3.4 million and $4.4 million for the three months ended March 31, 2003 and the
year ended December 31, 2002. Cash was used to fund Northgate's loss and to pay
down accounts payable obligations during the three months ended March 31, 2003.
During the three months ended March 31, 2003, Northgate's capital expenditures
were approximately $17,000 compared to $104,000 for the same period 2002,
primarily for computer software and hardware, and production equipment.
Historically, Northgate has relied upon sales to a few customers and during the
first quarter of 2003, more than 25% of Northgate's revenues were from one
customer. Accounts payable, accounts receivable and inventory has increased due
to the sales increase in the first quarter of 2003, the addition of distribution
sales focusing on motherboards, and longer credit terms provided to some of the
Company's new customers.
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 June 30, 2003. Advances under the line bear interest at the bank's prime rate
plus 0.5% (4.75% at March 31, 2003). The line contains certain covenants that
require Northgate to maintain, a minimum of ($4.25 million) tangible net worth
(as defined), a Current Ratio of at least 1.2:1, Working Capital of at least
$2.5 million, and limits the capital expenditures the Company can make in any
one year to $750,000. Management has entered into discussions with the lender to
extend the line of credit.
During the three months ended March 31, 2003, the Company's CEO advanced
$202,000 to the Company to cover operating cash flow needs. The Company expects
to repay this advance in the second quarter of 2003.
At March 31, 2003 and 2002, the Company had cash and short-term investments of
$1.2 million and $6.5 million, respectively, and working capital of $2.5 million
and $3.2 million, respectively. At March 31, 2003 and 2002, approximately $1.0
million of the Company's certificates of deposit was 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 2003. However,
if the Company needs extra funds, 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
12
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.
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 three-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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We are exposed to market risk from changes in interest rates. We have a risk
management control process to monitor our interest rate risk. The risk
management process uses analytical techniques, including market value,
sensitivity analysis, and value at risk estimates.
ITEM 4. CONTROLS AND PROCEDURES
In the 90-day period before the filing of this report, the Chief Executive
Officer and Chief Financial Officer of the Company (collectively, the
"certifying officers") have evaluated the effectiveness of the Company's
disclosure controls and procedures (as such term is defined in Rules 13a-14(c)
and 15d-14(c) under the Exchange Act). These disclosure controls and procedures
are designed to ensure that the information required to be disclosed by the
Company in its periodic reports filed with the Commission is recorded,
processed, summarized and reported within the time periods specified by the
Commission's rules and forms, and that the information is communicated to the
certifying officers on a timely basis.
The certifying officers concluded, based on their evaluation, that the Company's
disclosure controls and procedures are effective for the Company, taking into
consideration the size and nature of the Company's business and operations.
No significant changes in the Company's internal controls or in other factors
were detected that could significantly affect the Company's internal controls
subsequent to the date when the internal controls were evaluated.
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
a. Exhibits
99.1 Certification of the Chief Executive Officer of the Registrant pursuant to
18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
99.2 Certification of the Chief Financial Officer of the Registrant pursuant
to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
b. Reports on Form 8-K -
On January 6, 2003, the Company filed a Report on Form 8-K changing Northgate's
independent auditors from of Corbin & Wertz ("C&W"), to Corbin & Company LLP
("C&C"). C&C was a successor public accounting firm to C&W and substantially all
of C&W's audit and attest clients were transferred to C&C.
13
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: May 19, 2003 By /s/ Grant Trexler
---------------------------------------
Grant Trexler
Chief Financial Officer
(Duly Authorized Officer of the Registrant
and Principal Financial Officer)
14
CERTIFICATION
I, Andy Teng, Chief Executive Officer of Northgate
Innovations, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Northgate Innovations, Inc.;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this quarterly
report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) Designed such disclosure controls and procedures
to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons performing
the equivalent functions):
a) All significant deficiencies in the design or
operation of internal controls which could adversely affect the
registrant's ability to record, process, summarize and report financial
data and have identified for the registrant's auditors any material
weaknesses in internal controls; and
15
b) Any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 19, 2003
/s/ Andy Teng
- -------------------------------------
Andy Teng
Chief Executive Officer
16
CERTIFICATION
I, Grant Trexler, Chief Financial Officer of Northgate
Innovations, Inc. , certify that:
1. I have reviewed this quarterly report on Form 10-Q of
Northgate Innovations, Inc.;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this quarterly
report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) Designed such disclosure controls and procedures
to ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons performing
the equivalent functions):
a) All significant deficiencies in the design or
operation of internal controls which could adversely affect the
registrant's ability to record, process, summarize and report financial
data and have identified for the registrant's auditors any material
weaknesses in internal controls; and
17
b) Any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 19, 2003
/s/ Grant Trexler
- -------------------------------------
Grant Trexler
Chief Financial Officer
18