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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 JUNE 30, 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 [X]
The number of shares outstanding of each of the issuer's classes of publicly
traded common equity; as of September 17, 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 (Deficit)
and Comprehensive Loss.....................................................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.................................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risks.........17
Item 4. Controls and Procedures.............................................17
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K..................................18
SIGNATURE...................................................................19
2
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
JUNE 30, DECEMBER 31,
2003 2002
-------- --------
(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 631 $ 1,837
Certificates of deposit - restricted 1,016 1,016
Marketable securities 606 490
Accounts receivable, net of allowance for doubtful accounts 5,556 2,898
Inventories, net 5,584 3,178
Prepaid expenses and other current assets 579 560
-------- --------
Total current assets 13,972 9,979
Equipment, net 806 900
Goodwill 3,886 3,886
Other assets 77 76
-------- --------
$ 18,741 $ 14,841
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Accounts payable $ 9,184 $ 5,030
Accrued expenses 524 440
Accrued royalties 1,418 1,427
Convertible notes payable 100 100
Advances from shareholder 210 210
Line of credit borrowings 401 --
ESOP interest payable 1,694 746
Dividends payable 186 --
-------- --------
Total current liabilities 13,717 7,953
Notes payable 1,331 1,300
Guarantee of ESOP loan payable 7,217 6,750
-------- --------
Total liabilities 22,265 16,003
-------- --------
Commitments and contingencies
Stockholders' Equity (Deficit):
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) 113 (7)
Retained earnings (accumulated deficit) (1,293) 1,189
-------- --------
3,039 5,401
Less: Unearned ESOP shares (6,563) (6,563)
-------- --------
Total stockholders' equity (deficit) (3,524) 1,162
-------- --------
$ 18,741 $ 14,841
======== ========
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 For the six months ended
JUNE 30, 2003 JUNE 30, 2002 JUNE 30, 2003 JUNE 30, 2002
-------------- ------------- ------------- -------------
Net sales $ 17,398 $ 15,645 $ 37,463 $ 35,077
Cost of sales 16,773 12,750 36,000 30,126
-------- -------- -------- --------
Gross profit 625 2,895 1,463 4,951
Selling, general and administrative expenses 1,876 2,196 3,755 4,657
-------- -------- -------- --------
(Loss) income from operations (1,251) 699 (2,292) 294
-------- -------- -------- --------
Other expenses (income):
Interest expense, net 136 117 269 219
Other expense (income) (34) 255 -- 148
-------- -------- -------- --------
Total other expense (income) 102 372 269 367
-------- -------- -------- --------
Loss before income taxes (1,353) 327 (2,561) (73)
Provision for (benefit from) income taxes -- 127 (79) (33)
-------- -------- -------- --------
Net income (loss) $ (1,353) $ 200 $ (2,482) $ (40)
======== ======== ======== ========
Basic and diluted income (loss) per share $ (0.09) $ 0.01 $ (0.17) $ (0.00)
======== ======== ======== ========
Weighted average shares of common stock outstanding:
Basic 14,694 14,737 14,694 12,703
======== ======== ======== ========
Diluted 14,694 16,927 14,694 12,703
======== ======== ======== ========
See accompanying notes to the consolidated financial statements
4
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
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) $ 1,189 $(1,162)
Change in unrealized gain
on marketable securities 120 120 $ 120
Net loss (2,482) (2,482) (2,482)
------- ------- ------- ------- ------- -------- ------- ------- ------- -------
Total comprehensive loss $(2,362)
=======
Balance at June 30, 2003 1,350 $ 14 14,694 $ 441 $ 3,764 $ 113 $(6,563) $(1,293) $(3,524)
======= ======= ======= ======= ======= ======== ======= ======= =======
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,
2003 2002
------- -------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net loss $(2,482) $ (40)
------- -------
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 159 116
Stock issued for services -- 10
Changes in operating assets and liabilities, net
of Mcglen acquisition:
Accounts receivable (2,658) 3,561
Inventories (2,406) 782
Prepaid expenses and other current assets (19) 34
ESOP interest payable 315 239
Accounts payable 5,552 (6,128)
Accrued expenses (28) (891)
Accrued royalties (9) (1,953)
Advance to Mcglen -- (307)
Income taxes payable -- (386)
Other assets (1) (8)
------- -------
Total adjustments 905 (4,931)
------- -------
Net cash used in operating activities (1,577) (4,971)
------- -------
Cash flows from investing activities:
Purchases of equipment (34) (105)
Purchases of marketable securities -- (2,636)
Proceeds from sale of marketable securities 4 1,710
Certificates of deposit -- (1,002)
Investments -- (200)
Cash acquired in Mcglen purchase -- 108
------- -------
Net cash used in investing activities (30) (2,125)
------- -------
Cash flows from financing activities:
Borrowings on line of credit, net 401 591
------- -------
Net cash provided by financing activities 401 591
------- -------
Net decrease in cash and cash equivalents (1,206) (6,506)
Cash and cash equivalents beginning of period 1,837 7,178
------- -------
Cash and cash equivalents end of period $ 631 $ 672
======= =======
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 134 $ 117
======= =======
Income taxes $ 0 $ 0
======= =======
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/A 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
June 30, 2003 and 2002, and the results of operations and cash flows for the
three months and six months ended June 30, 2003 and 2002. The results of
operations for the interim periods are not necessarily indicative of the results
of operations for the full year.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Company
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.
Inventories
Northgate accounts for inventory under the average cost method. Inventory costs
include raw materials, labor and overhead. Inventory is carried at lower of cost
or market realization. The following are the major classes of inventory as of
June 30, 2003 and December 31, 2002:
June 30, December 31,
2003 2002
(unaudited)
------- -------
Raw materials $ 5,900 $ 2,757
WIP and finished goods 150 614
------- -------
6,050 3,371
Obsolescence and lower of cost or
market reserves (466) (193)
------- -------
$ 5,584 $ 3,178
======= =======
The Company from time to time also maintains at its facilities consigned
inventory that remains the property of the vendors supplying the
inventory ("consigned inventory") until such time as the Company elects to use
the inventory. At the time that the Company elects to use the consigned
inventory, the cost of such inventory is reflected in the Company's accounts and
a corresponding account payable to the vendor is recorded.
7
Risks and Uncertainties
The Company is subject to risks and uncertainties common to growing companies
engaged in the distribution and manufacture of computers and related products.
The computer industry is a highly competitive environment with a rapidly
changing technology and a high rate of business failures.
The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern, which contemplates, among other
things, the realization of assets and satisfaction of liabilities in the normal
course of business. The Company has experienced significant losses from
operations during the last three fiscal quarters, is currently out of compliance
with the terms of its line of credit agreement, and has limited working capital
as of June 30, 2003. The Company expects to continue to increase its revenues
and cash flows from its operations during the last two fiscal quarters of the
year ended December 31, 2003 and are in discussions regarding the modification
and extension of the line of credit agreement. If the cash flows from operations
are insufficient to fund the operations through December 31, 2003, the Company
will seek additional funds from securing additional debt or equity financing.
There are no assurances, however, that the Company will generate sufficient cash
flows from operations or complete any financing transactions or, even if such
transactions are completed, have sufficient funds to execute its intended
business plan over an extended period of time. The accompanying financial
statements do not include any adjustments that might be necessary should the
Company be unable to continue as a going concern.
Stock-Based Compensation
Northgate has adopted SFAS No. 123, "Accounting for Stock-Based Compensation."
SFAS No. 123 requires disclosure of the compensation cost for stock-based
incentives granted after January 1, 1995 based on the fair value at grant date
for awards. The Company currently has one stock-based employee compensation
plan. The Company accounts for those plans under the recognition and measurement
principles of APB 25, and related interpretations. No stock-based employee
compensation cost is reflected in the statement of operations, as all options
granted under those plans had exercise prices equal to the market value of the
underlying common stock on the date of grant. The following table illustrates
the effect on net income and earnings per share if the Company had applied the
fair value recognition provisions SFAS 123, to stock-based employee
compensation.
8
IN THOUSANDS, EXCEPT PER SHARE DATA
-----------------------------------------
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
2003 2002 2003 2002
------- ------- ------- -------
Net income (loss) as reported $(1,353) $ 200 $(2,482) $ (40)
Deduct:
Total stock-based employee
compensation expense under
fair value based method for
all awards, net of related tax
effects (10) (8) (20) (8)
------- ------- ------- -------
Pro forma net income (loss) $(1,363) $ 192 $(2,502) $ (48)
======= ======= ======= =======
Basic and diluted EPS as reported $ (0.09) $ 0.01 $ (0.17) $ (0.00)
Basic and diluted EPS pro forma $ (0.09) $ 0.01 $ (0.17) $ (0.00)
Non-cash Financing Activities
As of June 30, 2003, the Company's majority shareholder returned a $1.4 million
check given to him by the Company. The check was originally written in 2002
primarily to paydown the ESOP loan payable. The outstanding check had been
classified as an accounts payable in the December 31, 2002 financial statements,
but as the check has been returned to the Company, the related amounts have been
reclassified into Guarantee of ESOP loan payable, dividends payable and ESOP
interest payable as of June 30, 2003.
During the quarter ended June 30, 2002, the Company purchased $31,000 of fixed
assets by issuance of a note payable.
Concentration of Risk
The Company purchases a substantial percentage of its products from a single
provider. Purchases from this vendor accounted for 10% of our aggregate
merchandise purchases for the six months ended June 30, 2003. There was no such
concentration during the six months ended June 30, 2002. The Company 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
second quarter of 2003, more than 50% of Northgate's revenues were from three
customers. These customers account for 61% of the accounts receivable balance at
June 30, 2003.
Indemnities and Guarantees
During the normal course of business, the Company has made certain indemnities
and guarantees under which it may be required to make payments in relation to
certain transactions. These indemnities include certain agreements with the
Company's officers, under which the Company may be required to indemnify such
persons for liabilities arising out of their employment relationship. The
duration of these indemnities and guarantees varies and, in certain cases, is
indefinite. The majority of these indemnities and guarantees do not provide for
any limitation of the maximum potential future payments the Company could be
obligated to make. Historically, the Company has not been obligated to make
significant payments for these obligations and no liabilities have been recorded
for these indemnities and guarantees in the accompanying consolidated balance
sheets.
9
Recent Accounting Pronouncements
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). SFAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. It is to be implemented by reporting the cumulative effect of a change
in an accounting principal for financial instruments created before the issuance
date of the Statement and still existing at the beginning of the interim period
of adoption. Restatement is not permitted. The Company does not expect the
adoption of SFAS 150 to have a material impact upon our financial position, cash
flows or results of operations.
Reclassifications
Certain reclassifications have been made to the December 31, 2002 balance sheet
and the three month and six month statements of operations ended June 30, 2002
to conform with the June 30, 2003 presentation. These reclassifications had no
effect on previously reported results of operations.
3. MERGER WITH McGLEN INTERNET GROUP, INC.
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.
10
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 at the time of the merger
of Mcglen's net operating loss carryforwards ("NOLs") that were expected to be
used to offset Northgate's estimated future taxable income, after considering
limitations imposed on NOLs upon a change in control. As a result of losses
generated subsequent to the merger, the Company has recorded a valuation
allowance equal to the entire NOL balance.
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 June 30, 2003 and
2002, the Company recorded no intangible amortization.
On a pro forma basis, the statement of operations for the six months ended June
30, 2002 would have been as follows if the acquisition had occurred on January
1, 2002:
(in thousands, except per share data) JUNE 30, 2002
-------------
Net sales $39,515
Gross profit 5,455
Loss before taxes (17)
Net loss (17)
Net loss per share ($0.01)
LINE OF CREDIT
At June 30, 2003, Northgate had a $2,500,000 line of credit with a bank. The
line of credit provides for borrowings secured by substantially all of
Northgate's assets and is guaranteed by Northgate'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 Northgate's behalf,
and a $200,000 holdback for potential chargebacks on credit cards processed. The
line of credit expires on September 30, 2003. Advances under the line bear
interest at the bank's prime rate (4.22%) plus 0.5% (a total of 4.72% at June
30, 2003). The line contains certain covenants (as defined) that required
Northgate to maintain profitability in the third and fourth quarter of 2002, 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. As of June 30,
2003, the Company is not in compliance with the terms of certain of these
covenants, and is currently working with the lender to resolve this instance of
non-compliance and extend the credit facility.
11
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.
OVERVIEW
Northgate is a 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
owned after the merger 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.
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,
effect its more significant judgments and estimates used in the preparation of
its consolidated financial statements.
12
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.
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. Northgate provides for the estimated cost of product warranties at
the time revenue is recognized.
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.
From time to time the Company holds inventory from certain vendors whereby the
Company only purchases such inventory when it is used in the production process.
Any unused portion of such inventory may be returned to the vendor without any
payment due for such unused inventory. For presentation purposes the amount of
unused consignment inventory is excluded from the Company's assets, as well as
the amount payable for such unused inventory.
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.
13
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.
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.
PERCENTAGE OF NET SALES PERCENTAGE OF NET SALES
-------------------------- ------------------------
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30
2003 2002 2003 2002
------ ------ ------ ------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 96.4 81.5 96.1 85.9
------ ------ ------ ------
Gross profit 3.6 18.5 3.9 14.1
Operating expenses 10.8 14.0 10.0 13.3
------ ------ ------ ------
(Loss)income from operations (7.2) 4.5 (6.1) 0.8
Interest expense, net 0.8 0.8 0.7 0.6
Other expense (income) (0.2) 1.6 0.0 0.4
------ ------ ------ ------
Net (loss) income before
income taxes (7.8) 2.1 (6.8) (0.2)
Provision (benefit)for
income taxes -- 0.8 (0.2) (0.1)
------ ------ ------ ------
Net (loss) income (7.8%) 1.3% (6.6) (0.1)
====== ====== ====== ======
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
2002.
Net sales increased by $1.7 million, or 11%, to $17.4 million for the three
months ended June 30, 2003, compared to $15.6 million for the three months ended
June 30, 2002. The increase in net sales was a result of an increase in the
number of computer systems shipped during the period as the Company added new
distribution channels with computer retailers during the period ended June 30,
2003.
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Gross profit decreased to $0.6 million for the three months ended June 30, 2003,
compared to $2.9 million for the three months ended June 30, 2002. The decrease
in gross profit was due to increased product price erosion and overall increased
competition in the marketplace. The Company is responding to this competition by
purchasing component materials with lower costs and aggressively acquiring new
market share by exploring new markets and customers and procuring new
distribution agreements with computer retailers. Gross profit, as a percentage
of net sales also decreased to 3.6% for the three months ended June 30, 2003,
compared to 18.5% for the three months ended June 30, 2002. The decrease in
gross profit margin was due to an increase in sales to retailers, which
historically have a lower gross margin, as compared to the second quarter of
2002 where a larger percentage of our sales were internet and infomercial sales,
which generally have higher margins. The Company also cut prices for its
internet sales during the second quarter of 2003. On a forward-looking basis,
future gross profit margins may continue to significantly fluctuate due to
market and industry conditions.
Operating expenses decreased by $0.3 million or (15.1%), to $1.9 million for the
three months ended June 30, 2003 from $2.2 million for the same period in 2002.
The decrease in operating expenses was attributable to a decrease in payroll and
related costs.
Net interest expense increased $19,000 or 16% due to lower interest income
resulting from decreased investments in 2003. Other expense (income) decreased
by $289,000, or more than 100% to other income of $34,000 for the three months
ended June 30, 2003, from $255,000 of other expenses for same period in the
prior year. The decrease was a result of increased capital gains on marketable
securities for the period ended June 30, 2003.
No income tax benefit for the period ended June 30, 2003 was recorded versus a
benefit of $127,000 for the same period in the prior year. No benefit is being
recorded in the current quarter or upcoming quarters until such time as the
Company projects taxable income.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2002
Net sales increased by $2.4 million, or 7%, to $37.5 million for the six months
ended June 30, 2003, compared to $35.1 million for the six months ended June 30,
2002. The increase in net sales was a result of an increase in the number of
computer systems shipped during the six months ended June 30, 2003 as the
Company added new distribution channels with computer retailers during the
period ended June 30, 2003.
Gross profit decreased to $1.5 million for the six months ended June 30, 2003,
compared to $5.0 million for the six months ended June 30, 2002. The decrease in
gross profit was due to increased product price erosion and overall increased
competition in the marketplace. The Company is responding to this competition by
purchasing component materials with lower costs and aggressively acquiring new
market share by exploring new markets and customers and procuring new
distribution agreements with computer retailers. Gross profit, as a percentage
of net sales also decreased to 3.9% for the six months ended June 30, 2003,
compared to 14.1% for the six months ended June 30, 2002. The decrease in gross
profit margin was due to an increase in sales to retailers which historically
have a lower gross margin, as compared to the six months ended June 30, 2002
where a larger percentage of our sales were internet and infomercial sales,
which generally have higher margins. The Company also cut prices for its
internet sales during the second quarter of 2003. On a forward-looking basis,
future gross profit margins may continue to significantly fluctuate due to
market and industry conditions.
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Operating expenses decreased by $1.0 million or (20%), to $3.7 million for the
six months ended June 30, 2003 from $4.7 million for the same period in 2002.
The decrease in operating expenses was attributable to a decrease in payroll and
related costs.
Net interest expense increased $50,000 or 22% due to lower interest income
resulting from decreased investments in 2003. Other expense decreased by
$148,000, or 100% to $0 for the six months ended June 30, 2003. The decrease was
a result of increased capital gains on marketable securities for the period
ended June 30, 2003.
The Company recorded a tax benefit of $79,000 for the six month period ended
June 30, 2003 versus $33,000 for the same period in the prior year. The benefit
in the current year was recorded for estimated income tax refunds available to
the Company as a result of its losses. No additional benefit will be recorded in
the upcoming quarters until such time as the Company projects taxable income.
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
$1.6 million and $4.9 million for the six months ended June 30, 2003 and 2002,
respectively. Cash was used to fund Northgate's loss during the six months ended
June 30, 2003.
During the six months ended June 30, 2003, the Company had $65,000 of capital
expenditures compared to $105,000 for the same period 2002. The Company believes
that it will not require substantial capital expenditures through 2003.
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 was
extended to September 30, 2003. Advances under the line bear interest at the
bank's prime rate plus 0.5% (4.72%) at June 30, 2003. The line contains certain
covenants that required Northgate to maintain profitability in the third and
fourth quarters of 2002, 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. As of June 30, 2003, the Company is not in compliance with
these covenants, but is working with the lender to obtain forbearance agreements
and extend the term of the facility. The Company believes that current working
capital, together with cash flows from operations, will be adequate to support
the Company's current operating plans through 2003.
At June 30, 2003 and December 31, 2002, the Company had cash and short-term
investments of $2.3 million and $3.3 million, respectively, and working capital
of $0.2 million and $2.0 million, respectively. At June 30, 2003 and December
31, 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.
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The Company expects to continue to increase its revenues and cash flows from its
operations during the last two fiscal quarters of the year ended December 31,
2003. The Company believes that current working capital, together with cash
flows from operations, will be adequate to support the Company's current
operating plans through 2003. If the cash flows from operations are insufficient
to fund the operations through December 31, 2003, the Company will seek
additional funds from securing additional debt or equity financing. There are no
assurances, however, that the Company will generate sufficient cash flows from
operations or complete any financing transactions or, even if such transactions
are completed, have sufficient funds to execute its intended business plan over
an extended period of time.
Since computer retailers typically have low product gross margins, Northgate's
ability to be profitable is dependent upon its ability to continue to develop
new customers, introduce new products and 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 affected.
Northgate may experience 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, after sales services, 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.
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 trends for sales reflected in this report
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
The Chief Executive Officer and Acting Chief Financial Officer of the Company
(collectively, the "certifying officer") has evaluated as of the end of the
period covered by this report 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
officer on a timely basis.
The certifying officer concluded, based on his 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.
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PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
a. Exhibits
31 Section 302 CEO/CFO Certification
32 Section 906 CEO/CFO Certification
b. Reports on Form 8-K -
None
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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: September 17, 2003 By /s/ Andy Teng
---------------------------------------
Andy Teng, CEO and Acting CFO
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