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 SEPTEMBER 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 November 14, 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' Deficit and Comprehensive
Income.................................................................... 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................................................... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risks......... 16
Item 4. Controls and Procedures............................................. 16
PART II - OTHER INFORMATION
Item 1. Legal proceedings................................................... 17
Item 2. Changes in securities and use of proceeds........................... 17
Item 3. Defaults upon senior securities..................................... 17
Item 4. Submission of matters to a vote of security holders................. 17
Item 5. Other information................................................... 17
Item 6. Exhibits and Reports on Form 8-K.................................... 17
SIGNATURE................................................................... 17
2
PART I - FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
SEPTEMBER 30, DECEMBER 31,
2003 2002
-------- --------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 362 $ 1,837
Certificates of deposit - restricted -- 1,016
Marketable securities 669 490
Accounts receivable, net of allowance for doubtful accounts 7,070 2,898
Inventories, net 4,249 3,178
Prepaid expenses and other current assets 740 560
-------- --------
Total current assets 13,090 9,979
Equipment, net 786 900
Goodwill 3,886 3,886
Other assets 76 76
-------- --------
$ 17,838 $ 14,841
======== ========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 8,038 $ 5,030
Accrued expenses 482 440
Accrued royalties 1,415 1,427
Convertible notes payable 100 100
Advances from shareholder 1,210 210
Line of credit 110 --
ESOP interest payable 1,683 746
Dividends payable 186 --
-------- --------
Total current liabilities 13,224 7,953
Notes payable 1,375 1,300
Guarantee of ESOP loan payable 7,217 6,750
-------- --------
Total liabilities 21,816 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) 176 (7)
Retained earnings (accumulated deficit) (1,810) 1,189
-------- --------
2,585 5,401
Less: Unearned ESOP shares (6,563) (6,563)
-------- --------
Total stockholders' deficit (3,978) (1,162)
-------- --------
$ 17,838 $ 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 nine months ended
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002 SEPTEMBER 30, 2003 SEPTEMBER 30,2002
------------------ ------------------ ------------------ -----------------
Net sales $ 17,415 $ 18,562 $ 54,878 $ 53,639
Cost of sales 16,113 16,473 52,113 47,170
-------- -------- -------- --------
Gross profit 1,302 2,089 2,765 6,469
Selling, general and administrative expenses 1,696 2,002 5,450 6,088
-------- -------- -------- --------
(Loss) income from operations (394) 87 (2,685) 381
-------- -------- -------- --------
Other expenses (income):
Interest expense, net 148 108 416 326
Other expense (income) (23) (144) (23) 5
-------- -------- -------- --------
Total other expense (income) 125 (36) 393 331
-------- -------- -------- --------
Loss before income taxes (519) 123 (3,078) 50
Provision for (benefit from) income taxes -- 45 (79) 12
-------- -------- -------- --------
Net income (loss) $ (519) $ 78 $ (2,999) $ 38
======== ======== ======== ========
Basic and diluted income (loss) per share $ (0.04) $ 0.00 $ (0.20) $ 0.00
======== ======== ======== ========
Weighted average shares of common stock outstanding:
Basic 14,694 14,737 14,694 9,854
======== ======== ======== ========
Diluted 14,694 16,927 14,694 10,454
======== ======== ======== ========
See accompanying notes to the consolidated financial statements
4
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
AND COMPREHENSIVE INCOME
(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 DEFICIT (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 183 183 $ 183
Net loss (2,999) (2,999) (2,999)
------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total comprehensive loss $(2,816)
========
Balance at September 30, 2003 1,350 $ 14 14,694 $ 441 $ 3,764 $ 176 $(6,563) $(1,810) $ (3,978)
====== ======== ======== ======= ======= ======== ======= ======== =========
See accompanying notes to the consolidated financial statements
5
NORTHGATE INNOVATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
For the nine months ended
SEPTEMBER 30,
2003 2002
------- -------
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net (loss) income $(2,999) $ 38
------- -------
Adjustments to reconcile net (loss) income to net
cash used in operating activities:
Depreciation and amortization 250 195
Stock issued for services -- 10
Changes in operating assets and liabilities, net
of Mcglen acquisition:
Gain on debt settlements -- (50)
Deferred income taxes -- 45
Provision for doubtful accounts -- 24
Inventory reserves -- 61
Accounts receivable (4,172) 4,059
Inventories (1,071) (39)
Prepaid expenses and other current assets (180) (45)
ESOP interest payable 304 (278)
Accounts payable 4,406 (5,875)
Accrued expenses (70) (890)
Accrued royalties (12) (2,251)
Advance to Mcglen -- (307)
Income taxes payable -- (403)
Other assets -- (46)
------- -------
Total adjustments (545) (5,790)
------- -------
Net cash used in operating activities (3,544) (5,752)
------- -------
Cash flows from investing activities:
Purchases of equipment (61) (269)
Purchases of marketable securities -- (3,006)
Proceeds from sale of marketable securities 4 2,329
Proceeds from sale of certificates of deposit 1,016 --
Purchase of certificates of deposit -- (1,014)
Purchase of Investments -- (200)
Sales of investment -- 200
Cash acquired in Mcglen purchase -- 108
------- -------
Net cash provided by (used in) investing activities 959 (1,852)
------- -------
Cash flows from financing activities:
Borrowings on line of credit, net 110 1,242
Payment of dividends -- (186)
Payment on ESOP debt -- (467)
Principal borrowings from related party 1,706 --
Principal repayments to related party (706) --
------- -------
Net cash provided by financing activities 1,110 589
------- -------
Net decrease in cash and cash equivalents (1,475) (7,015)
Cash and cash equivalents beginning of period 1,837 7,178
------- -------
Cash and cash equivalents end of period $ 362 $ 163
======= =======
Supplemental disclosure of cash flows information:
Cash paid during the periodfor:
Interest $ 131 $ 825
======= =======
Income taxes $ 0 $ 417
======= =======
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
September 30, 2003 and 2002, and the results of operations and cash flows for
the three months and nine months ended September 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.
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
September 30, 2003 and December 31, 2002:
September 30, December 31,
2003 2002
------- -------
Raw materials $ 4,363 $ 2,757
WIP and finished goods 278 614
------- -------
4,641 3,371
Obsolescence and lower of cost or
market reserves (392) (193)
------- -------
$ 4,249 $ 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 September 30, 2003. The Company expects to continue to increase its
revenues and cash flows from its operations during the last fiscal quarters of
the year ended December 31, 2003 and are in discussions regarding the
modification of the line of credit agreement. If the cash flows form 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.
IN THOUSANDS, EXCEPT PER SHARE DATA
---------------------------------------------
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
2003 2002 2003 2002
-------- -------- --------- --------
Net income (loss) as reported $ (519) $ 78 $ (2,999) $ 38
Deduct:
Total stock-based employee
compensation expense under
fair value based method
for all awards, net of
related tax effects (10) (18) (30) (26)
--------- -------- --------- --------
Pro forma net income (loss) $ (529) $ 60 $ (3,029) $ 12
======== ======== ========= ========
Basic and diluted EPS as reported $ (0.04) $ 0.00 $ (0.20) $ (0.00)
Basic and diluted EPS pro forma $ (0.04) $ 0.00 $ (0.20) $ (0.00)
Non-cash Financing Activities
- -----------------------------
As of September 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 pay down 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 September 30, 2003.
8
During the period ended September 30, 2003, the Company purchased $75,000 of
fixed assets by issuance of notes payable.
Concentration of Risk
- ---------------------
The Company purchases a substantial percentage of its products from a single
provider. Purchases from this vendor accounted for 17.8% and 10% of our
aggregate merchandise purchases for the three and nine months ended September
30, 2003. There was no such concentration during the three and nine months ended
September 30, 2002. The Company has no long-term contracts or arrangements with
its vendors that guarantee the availability of merchandise, but believes these
alternative suppliers could be found to replace those currently utilized.
Historically, Northgate has relied upon sales to a few customers and during the
third quarter of 2003, more than 50% of Northgate's revenues were from three
customers. These customers account for 74% of the accounts receivable balance at
September 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.
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
September 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 nine month statements of operations ended September 30,
2002 to conform with the September 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.
9
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.
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. As a result of losses generated subsequent to the merger, the
Company has recorded a valuation allowance equal to the entire NOL balance.
On a pro forma basis, the statement of operations for the nine months ended
September 30, 2002 would have been as follows if the acquisition had occurred on
January 1, 2002:
(in thousands, except per share data) SEPTEMBER 30, 2002
------------------
Net sales $58,078
Gross profit 3,255
Income before taxes 44
Net income 32
Net loss per share ($0.00)
LINE OF CREDIT
At September 30, 2003, Northgate had a $1,700,000 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 November 30, 2003. Advances under the line bear
interest at the bank's prime rate (4.0%) plus 1.0% (a total of 5.0% at
September 30, 2003). As of November 13, 2003, the Company is currently working
with the lender for the loan extension, and also discussing with other
commercial lender for other loan options. No formal agreement has been reached.
As of November 13, 2003, the Company has an outstanding loan balance at
$605,306 and an available line of credit at $894,694.
RELATED PARTY TRANSACTION
In July 2003 the Company borrowed approximately $1.7 million from the Company's
majority shareholder and CEO. This borrowing is unsecured and bears interest at
the rate of 3.5% per annum. This borrowing is due on demand. In August 2003, the
Company repaid approximately $0.7 million of this loan. As of September 30, 2003
the Company has accrued $9,150 of interest expense related to this loan, which
is included in accrued liabilities in the accompanying balance sheet as of
September 30, 2003. This shareholder is willing to assist the Company on an
interim basis to fund future operating shortfalls.
10
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 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
owned 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.
11
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.
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.
12
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
----------------------- ------------------------------
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
2003 2002 2003 2002
------ ------ ------ ------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 92.5 88.7 95.0 87.9
------ ------ ------ ------
Gross profit 7.5 11.3 5.0 12.1
Operating expenses 9.7 10.8 9.9 11.4
------ ------ ------ ------
Income (loss) from operations (2.2) 0.5 (4.9) 0.7
Interest expense, net 0.8 0.5 0.7 0.6
Other expense (income) (0.1) (0.6) 0.0 0.0
------ ------ ------ ------
Profit (loss) before income taxes (2.9) 0.6 (5.6) 0.1
Provision for income taxes -- 0.2 (0.1) 0.0
------ ------ ------ ------
Net profit (2.9%) 0.4% (5.5) 0.1
====== ====== ====== ======
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2002.
Net sales decreased by $1.2 million, or 6%, to $17.4 million for the three
months ended September 30, 2003, compared to $18.6 million for the three months
ended September 30, 2002. The decrease in net sales was a result of an decrease
in the number of computer systems shipped during the period as the Company
streamlined distribution channels with computer retailers during the period
ended September 30, 2003.
Gross profit decreased to $1.3 million for the three months ended September 30,
2003, compared to $2.1 million for the three months ended September 30, 2002.
The decrease in gross profit was due to increased product price erosion, higher
component price and overall increased competition in the marketplace. The
Company is responding to this competition by establishing more component
supplier channels and aggressively acquiring new market share by procuring new
distribution agreements with computer retailers. Gross profit, as a percentage
of net sales also decreased to 7.5% for the three months ended September 30,
2003, compared to 11.3% for the three months ended September 30, 2002. The
decrease in gross profit margin was due to an increase in component price, and
flat sales to retailers, which historically have a lower gross margin, as
compared to the third 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 third quarter of 2003.
On a forward-looking basis, future gross profit margins may continue to
significantly fluctuate due to market industry conditions. 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 those achieved for the three months ended September 30, 2003.
Operating expenses decreased by $0.3 million or (20.1%), to $1.7 million for the
three months ended September 30, 2003 from $2.0 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 $40,000 or 37% due to lower interest income
resulting from decreased investments in 2003. Other income decreased by $121,000
or more than 84% to other income of $23,000 for the three months ended September
30, 2003, from $144,000 of other income for same period in the prior year. The
decrease was a result of decreased capital gains on marketable securities for
the period ended September 30, 2003.
13
No income tax benefit for the period ended September 30, 2003 was recorded
versus a provision of $45,000 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.
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2002
Net sales increased by $1.2 million, or 2.2%, to $54.9 million for the nine
months ended September 30, 2003, compared to $53.6 million for the nine months
ended September 30, 2002. The increase in net sales was a result of an increase
in the number of computer systems shipped during the nine months ended September
30, 2003 as the Company added new distribution channels with computer retailers
during the period ended September 30, 2003.
Gross profit decreased to $2.8 million for the nine months ended September 30,
2003, compared to $6.5 million for the nine months ended September 30, 2002. The
decrease in gross profit was due to increased product price erosion, higher
component price, competition in the marketplace, the Company is responding to
this competition by having more purchasing channels with lower costs and
aggressively acquiring new market share by procuring new distribution agreements
with computer retailers. Gross profit, as a percentage of net sales also
decreased to 5.0% for the nine months ended September 30, 2003, compared to
12.1% for the nine months ended September 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 nine months ended September 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 third quarter of 2003.
On a forward-looking basis, future gross profit margins may continue to
significantly fluctuate due to market and industry conditions. 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 those achieved for the nine months ended September 30, 2003.
Operating expenses decreased by $0.6 million or (10%), to $5.5 million for the
nine months ended September 30, 2003 from $6.1 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 $90,000 or 27% due to lower interest income
resulting from decreased investments in 2003. Other expense decreased by $28,000
from $5,000 of expense to $23,000 of income for the nine months ended September
30, 2003. The decrease was a result of increased capital gains on marketable
securities for the period ended September 30, 2003.
The Company recorded a tax benefit of $79,000 for the nine month period ended
September 30, 2003 versus $12,000 as tax provision 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 operation. 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
$3.5 million and $5.8 million for the nine months ended September 30, 2003 and
2002, respectively. Cash was primarily used to fund Northgate's loss during the
nine months ended September 30, 2003.
14
During the nine months ended September 30, 2003, the Company had $61,000 of
capital expenditures compared to $269,000 for the same period 2002. The Company
believes its current equipment is adequate for its current production needs.
The Company has a $1,700,000 line of credit with a bank, which will expire on
November 30, 2003. The line of credit provides for borrowings secured by
substantially all of the Company's assets. Borrowings under the line are
advanced based upon 70% of eligible accounts receivable, as defined. Advances
under the line bear interest at the bank's prime rate plus 1.0% (4.0% at
September 30, 2003). The line contains certain covenants that require Northgate
to maintain. As of November 13, 2003, the Company is currently working with the
lender to obtain a loan extension, and also discussing with other commercial
lender for other loan options. No formal agreement has been reached. As of
November 13, 2003, the Company has an outstanding loan balance at $605,306
and an available line of credit at $894,694.
In July 2003 the Company borrowed approximately $1.7 million from the Company's
majority shareholder and CEO. This borrowing is unsecured and bears interest at
the rate of 3.5% per annum. This borrowing is due on demand. In August 2003, the
Company repaid approximately $0.7 million of this loan. As of September 30, 2003
the Company has accrued $9,150 of interest expense related to this loan, which
is included in accrued liabilities in the accompanying balance sheet as of
September 30, 2003. This shareholder is willing to assist the Company on an
interim basis to fund future operating shortfalls.
At September 30, 2003 and December 31, 2002, the Company had cash and short-term
investments of $1.0 million and $2.3 million, respectively, and working capital
of ($0.1) million and $2.0 million, respectively. At 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. As of September 30, the Company's certificates
of deposits was matured and transferred to operating accounts due to the new
agreement with the Company's primary vendors.
The Company expects to increase its revenues and cash flows from its operations
during the final fiscal quarter of the year ended December 31, 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 remain 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 and may benefit from component
volume purchasing that are more favorable in terms of pricing and component
availability.
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.
15
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
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.
16
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
-----------------
Inapplicable
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
-----------------------------------------
Inapplicable
Item 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
Inapplicable
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
----------------------------------------------------
Inapplicable
Item 5. OTHER INFORMATION
-----------------
Inapplicable
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
a. Exhibits
31 Certificate of Chief Executive Officer/Acting Chief Financial Officer
pursuant to Section 302 of the Sarbanes Oxley Act of 2002
32 Certification of Chief Executive Officer/Acting Chief Financial Officer of
Periodic Financial Reports pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, 18 U.S.C. ss.1350
b. 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: November 14, 2003 By /s/ Andy Teng
---------------------------------------
Andy Teng, CEO and Acting CFO
17