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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year ended December 31, 2003
0-27878
(Commission File Number)
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NORTHGATE INNOVATIONS, INC.
(Exact name of registrant as specified in its charter)
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Delaware 13-3779546
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
801 S. Sentous Street
City of Industry, California 91748
(Address of principal executive offices)
(626) 923-6000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.03 par value
(Title of Class)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K: / /
Indicate by check whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes / / No /X/
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant at June 30, 2003, based on the $0.11 per share
closing price for our common stock on the OTC Bulletin Board, was approximately
$560,000.
The number of shares of the registrant's common stock outstanding as of
February 27, 2004 was 18,942,808.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information from the definitive Proxy Statement for the registrant's
2004 Annual Meeting of Stockholders to be filed with the Securities and Exchange
Commission pursuant to Regulation 14A not later than 120 days after the end of
the registrant's fiscal year, is incorporated by reference into Part III of this
Form 10-K.
Table of Contents
Page
----
PART I ................................................................................................1
ITEM 1. BUSINESS........................................................................................1
ITEM 2. PROPERTIES.....................................................................................17
ITEM 3. LEGAL PROCEEDINGS..............................................................................17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................17
PART II ...............................................................................................18
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..........................18
ITEM 6. SELECTED FINANCIAL DATA........................................................................19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..........20
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.....................................29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................................29
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...........29
ITEM 9A. CONTROLS AND PROCEDURES........................................................................29
PART III ...............................................................................................30
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.............................................30
ITEM 11. EXECUTIVE COMPENSATION.........................................................................30
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.30
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................................30
ITEM 14. PRINCIPAL ACCOUNT FEES AND SERVICES............................................................30
PART IV ...............................................................................................31
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K...............................31
SIGNATURES.....................................................................................34
INDEX TO EXHIBITS..............................................................................35
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS..............................................................F-1
INDEPENDENT AUDITORS' REPORTS...........................................................................F-2
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............................................................F-4
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PART I
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS AND RISK FACTORS
This report contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, both as amended. All statements other than statements of
historical fact are "forward-looking statements" for purposes of federal and
state securities laws, including: any projections of earnings, revenues or other
financial items; any statements of the plans, strategies and objectives of
management for future operations; any statements concerning proposed new
products, services or developments; any statements regarding future economic
conditions or performance; any statements of belief; and any statements of
assumptions underlying any of the foregoing. Forward-looking statements may
include the words "may," "will," "estimate," "intend," "continue," "believe,"
"expect," "plan" or "anticipate" and other similar words. Such forward-looking
statements may be contained in the sections "Factors Affecting Operating
Results," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business," among other places in this report.
Although we believe that the expectations reflected in our
forward-looking statements are reasonable, actual results could differ
materially from those projected or assumed. Our future financial condition and
results of operations, as well as any forward-looking statements, are subject to
change and to inherent risks and uncertainties, such as those disclosed in this
report. We do not intend, and undertake no obligation, to update any
forward-looking statement.
ITEM 1. BUSINESS
Overview
Since 1992, when our predecessor was formed, we have primarily offered
consumers personal computers and related products through distribution channels
that include television shopping networks, mail order catalog companies and
large electronic and office supply chain stores. In December 2003, an investor
group acquired a majority of our outstanding common stock and appointed a
majority of the members of our board of directors. In January and February of
2004, our new board of directors employed new members of our management team,
including a new chief executive officer. Under the direction of our restructured
management team, we began implementing a new strategic focus designed to
complement our existing business. We are now developing a business plan to
launch a hardware and software offering targeted at what we believe is an
underserved segment of the personal computer and Internet market.
We were incorporated in Delaware in May 1994. On December 2, 1999, we
completed a merger with Mcglen Micro, Inc. in which the stockholders of Mcglen
Micro acquired a majority of our outstanding shares of common stock. On December
17, 1999, we changed our name to Mcglen Internet Group, Inc.
On March 20, 2002, we completed a merger with Lan Plus Corporation, a
manufacturer of branded turnkey computer products and services. In the merger,
the shareholders of Lan Plus acquired a majority of our outstanding common
stock. In addition, upon the closing of the merger, we completed a one-for-ten
reverse stock split and changed our name to Northgate Innovations, Inc. As a
result of the merger, for financial accounting purposes, we treat the merger as
a purchase of our company by Lan Plus. Therefore, we present the historical
financial statements of Lan Plus, for comparison purposes, for all periods
presented. We have adjusted all share information contained in this report to
reflect the one-for-ten reverse stock split.
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Consumer Personal Computer Business
Our current business model is focused on offering turnkey,
build-to-order, personal computers, notebooks, accessories and software products
through television shopping networks, mail order catalog companies and large
electronic and office supply chain stores, primarily in the United States. Our
build-to-order manufacturing process is designed to enable us to achieve high
inventory turnover rates and reduced inventory levels. We also believe that,
since products are sold closer to the time they are actually manufactured, this
process gives us the ability to more rapidly incorporate new technologies and
components into our products.
Products and Services
Our personal computer business develops, manufactures, markets, sells
and supports a wide range of desktop systems, notebook computers, workstations
and network servers under the Northgate, Protek, and Netway brand names. We also
sell, resell and support a variety of additional peripherals, software and
services. We offer pre-configured computers with various memory and storage
configurations, and various operating systems and application software, as well
as our built-to-order systems. We also offer a variety of hardware components
and peripherals to complement our desktop systems, notebook computers and
network servers, including monitors, modems, graphics cards, accelerators,
CD-ROM and DVD drives, software and services. In addition, we offer numerous
hardware and Internet services, mainly through third party service providers.
Revenue Breakdown by
Product Group Year Ended December 31,
----------------------------------------------------------------------
2003 2002 2001
---------------------- ------------ --------------- ------------------
Systems $ 53,162 $ 41,061 $ 47,063
---------------------- ------------ --------------- ------------------
Barebone/bundles 5,393 3,259 222
---------------------- ------------ --------------- ------------------
Components 18,491 20,856 26,598
---------------------- ------------ --------------- ------------------
Total Revenue $ 77,046 $ 65,176 $ 73,883
---------------------- ------------ --------------- ------------------
Sales and Marketing
Our end-users are comprised primarily of private consumers, with small
and medium-sized businesses and governmental entities making up a much smaller
portion. In general, we use similar sales and marketing approaches across all of
these different customer groups, since we believe that the demand levels of
these various groups respond similarly to changes in market prices and overall
general economic conditions. We market and sell our systems primarily through
high profile distribution channels in retail, catalog, telemarketing and other
industries. We have a direct sales organization focused on selling to these
large distribution channels. We also sell through some of these channels using a
network of field manufacturers representatives. We also sell a limited number of
systems through customer-direct relationships supported by advertising, direct
mail, telephone sales and our www.accessmicro.com web site.
In the second quarter of fiscal 2002, we began marketing and selling
our personal computer products through a network of value-added resellers.
Through this program, we now have relationships with approximately 159
resellers throughout the United States. We have a dedicated sales force, with
experience in selling through resellers, supporting this sales channel. Our
arrangements with value-added
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resellers are non-exclusive, territory specific, generally cover all of our
products and provide for appropriate discounts based on a variety of factors,
including volume purchases. We support this distribution channel with our
www.northgate.com web site, which focuses on information for our reseller
program.
Research and Development
We must continuously evaluate, obtain and incorporate into our
offerings new hardware, software, storage, communications and peripherals
technologies that are developed by third parties to ensure that our products are
compatible with industry standards. Historically, we have not devoted a material
amount of our resources to direct research and development activities with
respect to our existing business. In the past three years, we have had less than
five employees dedicated to this effort. However, we maintain relationships with
many of our suppliers and other technology developers, and believe that we
benefit from the significant research and development activities conducted by
those suppliers and developers.
We believe that these relationships enable us to evaluate the latest
developments in technology, and to quickly introduce new products and new
product features to the market. We believe that our turnkey, build-to-order
manufacturing process allows us to use these relationships to deliver to our
customers these emerging technologies on a timely and more cost-effective basis.
We also believe that our relationships with our customers enable us to obtain
valuable market information, which we use to assist our suppliers in developing
new product offerings.
Manufacturing and Materials
We currently use third parties to manufacture sub-assemblies for our
desktop personal computers and to manufacture our laptop personal computers. We
perform final product assembly and quality testing at our headquarters in City
of Industry, California. Our manufacturing process consists of assembly,
functional testing and quality control of our computer systems. We use
production teams to assemble most of our desktop personal computers. We train
each member of a production team to do several tasks, which we believe increases
flexibility and efficiency. We also apply testing and quality control processes
to components, parts and sub-assemblies that we obtain from suppliers. We ship
each of our computer systems from our manufacturing facilities ready-for-use,
with an operating system and application software installed.
We maintain quality control through testing components, parts and
subassemblies at various stages in the manufacturing process. Our quality
control also includes a burn-in period for completed units after assembly,
on-going production reliability audits, failure tracking for early
identification of production and component problems and information from our
customers obtained through our direct relationships and service and support
programs. Our computer manufacturing operations have been assessed and certified
as meeting the requirements of the International Organization for
Standardization (ISO) 9002, a certification that recognizes compliance with
international standards for quality assurance.
We purchase materials, supplies and product subassemblies from a number
of vendors. Some key components included in our line of products are currently
available only from single or limited sources. In the past, we have experienced
significant price increases and limited availability of certain components that
are not available from multiple sources. We are dependent upon Microsoft
Corporation for various software products.
Like other participants in the computer manufacturing industry, we
ordinarily acquire materials and components through a combination of blanket and
scheduled purchase orders to support our
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requirements for periods averaging 90 to 120 days. At times, we have been
constrained by parts availability in meeting our product orders. From time to
time, we have obtained scarce components for somewhat higher prices on the open
market, which may have an impact on gross margins but does not disrupt
production. On occasion, we have also acquired component inventory in
anticipation of supply constraints.
Competition
The personal computer industry represents a mature segment of the
consumer electronics industry and is highly competitive, especially with respect
to pricing and the introduction of new products and new product features. We
expect competition in the personal computer industry to continue to be intense
for the foreseeable future. We believe that the principal competitive factors in
the market include price, logistics, on-line technical support and services,
call center management, Original Equipment Manufacture (OEM) relationships with
major component manufacturers, new technology, variety of products, software and
features, marketing and sales capability. Although we believe that our products
generally compete favorably with respect to such factors, we cannot guarantee
that we will compete successfully against current and potential competitors,
especially those with greater financial resources or brand name recognition.
We are considered one of the second tier personal computer
manufacturers, which include Systemax, Sys Technologies and Acer, among others.
Although we compete with these manufacturers, we also compete with a number of
large, national brand, personal computer manufacturers, including Dell, Inc.,
Gateway, Inc., Hewlett-Packard Company, Apple Computer, Inc., Sony, e-Machines
and Toshiba. These manufacturers sell their products through different
combinations of national and regional distributors, dealers, value-added
resellers, retail stores and direct sales. Most of our current competitors have
longer operating histories, significantly greater financial, technical,
marketing and other resources, significantly greater name recognition and a
substantially larger installed base of customers than we do. In addition,
because of the high volume of components that many of our competitors purchase
from their suppliers, they are able to keep their costs of supply relatively low
and, as a result, may be able to recognize higher margins on their personal
computer sales than we do. The introduction of lower-priced personal computers
combined with the brand strength, extensive distribution channels and financial
resources of the larger vendors may cause us to lose market share.
Customer Service and Technical Support
Our technical support and customer service representatives respond to a
variety of inquiries from customers, including questions concerning product
offerings, order status and post-installation hardware and software issues. We
resolve many inquiries over the telephone without the need to repair or replace
system components. When repairs are necessary, we may ship a replacement part or
system and advise customers by telephone regarding installation. Alternatively,
customers may elect to ship a system directly to us for repair. We also provide
technical support services through our web sites, www.accessmicro.com and
www.northgate.com. These services enable customers to access system-specific
information and recent software updates for many of the software programs and
drivers included with our computer systems. In addition, many of our systems are
sold with system diagnostic and repair software that has been optimized for our
products.
Significant Customers
For the year ended December 31, 2003, our sales to Staples the Office
Superstore, Inc. represented approximately 36.5% of our total net sales for the
year. We expect that we will continue to be dependent upon Staples for a
significant portion of our revenues in future periods. Our agreement with
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Staples expires at the end of 2004. The agreement is renewable annually upon
mutual agreement between Staples and us.
Management Systems
Our site management, search, customer interaction, transaction
processing and fulfillment systems consist of a combination of our own
proprietary technologies and third-party technologies. We have enhanced the
capability and scalability of our systems through the acquisition of new
third-party technologies and in-house development. In 2002, we implemented new
enterprise software for our procurement, accepting and verifying orders,
managing orders, creating customer interaction instructions, automatically
selecting fulfillment methods, assigning inventory to customer orders, managing
shipment of products to customers, recording tracking numbers and authorizing
and charging customer credit cards, with address verification.
New Product Initiative
Currently, we are developing a business plan to launch a new product
line that is complementary to our current product line, but will include
hardware, software and services designed specifically to be attractive to a
segment of the personal computer and online market that we believe is currently
underserved. In entering this untested and rapidly changing market sector, we
will face a variety of obstacles and challenges.
We believe, but can give no assurance, that there will be a significant
demand for well-designed and attractive consumer electronics products that focus
on satisfying the computing desires of our target market segment. As a result of
this demand, we hope to be able to charge a relatively higher price for our new
line of personal computers and related products, thereby increasing our margins.
We are still in the planning stages of our new growth strategy and can give no
assurance that we will achieve any of our objectives. Currently, we are
developing prototypes and conducting market testing to assess the feasibility of
our new business plan. We have no sales contracts with potential customers for
our anticipated suite of products and services.
At this early stage of our efforts with our new product initiative, and
given the dynamic nature of the market we hope to serve, we cannot be sure as to
the final form that our solutions will take. Our new products, if successfully
developed, will be the first in what we hope will be our continuing line of
business serving our new target market. We can give no assurance that any of
these efforts will be successful.
We plan to market our new product initiative through specific direct
marketing efforts that are focused on the market segment we have targeted. We
intend to expend a large portion of our sales and marketing resources on these
marketing efforts. We cannot give any assurance that any of these efforts will
be successful.
We believe that strong product development capabilities will be
essential to our new product initiative. In early 2004, we began to invest
significant time and resources in creating a structured process for undertaking
all product development projects for this initiative. After implementing our new
product initiative, we actively recruited and hired engineers and software
developers with expertise in the areas of hardware design and software. Although
we have hired some employees to perform this work, we are currently relying on
outside consulting firms to provide the bulk of these resources. We anticipate
hiring additional employees in these specialties as our new product initiative
matures. We have supported this effort with individuals and additional
management with extensive backgrounds in the consumer electronic and enterprise
software industries. We will focus our ongoing research and development efforts
on our
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new suite of consumer electronic products. We intend to expend a large portion
of our resources on these research and development efforts. We cannot give any
assurance that any of these efforts will be successful.
We intend to use third party manufacturers to produce our new line of
consumer products. We believe that it will be essential for us to have
relationships with these manufacturers to assure that we have a stable and
predictable supply of our products. We are actively seeking manufacturers to
supply our products. We have no contracts with potential suppliers for our new
suite of products.
Intellectual Property
We rely, and intend to rely, on a combination of trademark, trade
secret and copyright law and contractual restrictions to protect the proprietary
aspects of our products. We have applied to register, or intend to register,
various trademarks relating to our existing business and our new product
initiative. Although we have yet to file any patent applications for inventions
related to our new line of products, we anticipate filing patent applications
for inventions relating to that product line that we determine will be key to
our new product initiative. We can give no assurance that we will obtain any
such patents, or that any patents we obtain will be useful in our new business.
If we are not successful in obtaining the patent protection we seek, our
competitors may be able to replicate our new products and more effectively
compete with us.
In our existing business, we work closely with component suppliers and
other technology developers to stay abreast of the latest developments in
personal computer technology. We obtain patent licenses for some technologies,
some of which require significant royalty payments, when we believe those
licenses are necessary or advantageous to our business. We have entered into
non-exclusive licensing arrangements with Microsoft and other software suppliers
for various operating systems and application software that we sell with our
personal computers. Our licensing agreement with Microsoft expires on July 31,
2004.
From time to time, third parties assert exclusive patent, copyright,
trademark or other intellectual property rights to technologies or marks that
are important to our business. We evaluate each such claim relating to our
products and, if appropriate, seek a license to use the protected technology.
The licensing agreements with these parties generally do not require the
licensor to assist us in duplicating the protected technology. These agreements
also generally do not protect us or our suppliers from claims by third parties
of trade secret, copyright or other violations involved in developing or selling
these products.
Seasonality
Our operating results have been subject to seasonality and to quarterly
and annual fluctuations. Factors involved in that seasonality include new
product developments or introductions, availability of components, changes in
product mix and pricing and product reviews and other media coverage.
Historically, our sales have increased in the third and fourth calendar quarters
due, in part, to back-to-school and holiday spending, respectively. We expect
that the sales of our new product line will have similar seasonality patterns.
Employees
We had 116 full-time employees and 15 part-time employees as of
February 29, 2004, a substantial majority of whom are non-management personnel.
None of our employees are represented by a labor union. We have not experienced
any work stoppages, and we believe that we have satisfactory employee relations.
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Government Regulation
Our business is subject to regulation by various federal and state
governmental agencies. Such regulation includes the radio frequency emission
regulatory activities of the U.S. Federal Communications Commission, the
anti-trust regulatory activities of the U.S. Federal Trade Commission and
Department of Justice, the consumer protection laws of the Federal Trade
Commission, the import/export regulatory activities of the U.S. Department of
Commerce, the product safety regulatory activities of the U.S. Consumer Products
Safety Commission and environmental regulation by a variety of regulatory
authorities in each of the areas in which we conduct business.
Backlog
We do not believe that our backlog is a meaningful indicator of sales
that we can expect for any period, and there can be no assurance that our
backlog at any point in time will translate into sales in any subsequent
periods. Historically, our levels of unfilled orders for systems fluctuate
depending upon component availability, demand for products, the timing of large
volume customer orders and production schedules. Our customers frequently change
delivery schedules and orders depending on market conditions and other factors.
Factors Affecting Operating Results
There are numerous risks affecting our business, some of which are
beyond our control. An investment in our common stock involves a high degree of
risk and may not be appropriate for investors who cannot afford to lose their
entire investment. In addition to the risks outlined below, risks and
uncertainties not presently known to us or that we currently consider immaterial
may also impair our business operations. Our future operating results and
financial condition are heavily dependent on our ability to successfully
develop, manufacture and market technologically innovative solutions in order to
meet customer demands for personal computers and related products. Inherent in
this process are a number of factors that we must successfully manage if we are
to achieve positive operating results in the future. Potential risks and
uncertainties that could affect our operating results and financial condition
include, without limitation, the following:
We cannot predict our future results because we have recently
implemented a new strategic initiative and have no operating history
with that line of business.
Although we have over ten years of operating history, we have no
history operating our new business model. We began exploring our new product
initiative in December 2003. Our product initiative is still in the early
planning stage and is a new strategic focus for us. There are significant risks
and costs inherent in our efforts to undertake our new product initiative. These
include the risk that we may not be able to develop viable products, achieve
market acceptance for our proposed line of products or earn adequate revenues
from the sale of such products, that our new business model, if started at all,
may not be profitable and other significant risks related to the implementation
of a new business model described below. Our prospects must be considered in
light of the uncertainties and difficulties frequently encountered by companies
in their early stages of development. We will devote a great deal of our
resources to implementing our new product initiative. Therefore, if that
initiative is not successful, we may not be able to continue to operate our
existing business. It is possible that we will exhaust all available funds
before we reach the positive cash flow phase of our proposed business model,
which would hurt our existing business.
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We may have difficulty in raising capital because our common stock is
not traded on a recognized public market.
In order to implement our new product growth strategy, we will need to
raise significant amounts of additional capital. In April 2001, our common stock
was de-listed from trading on the Nasdaq SmallCap Market. Our common stock is
presently traded in the over-the-counter market, which is viewed by most
investors as a less desirable, and less liquid, marketplace. As a result, an
investor may find it more difficult to purchase, dispose of and obtain accurate
quotations as to the value of our common stock.
In addition, since the trading price of our common stock is less than
$5.00 per share, trading in our common stock is also subject to the requirements
of Rule 15g-9 of the Exchange Act. Our common stock is also considered a penny
stock under the Securities Enforcement Remedies and Penny Stock Reform Act of
1990, which defines a penny stock, generally, as any equity security not traded
on an exchange or quoted on the Nasdaq SmallCap Market that has a market price
of less than $5.00 per share. Under Rule 15g-9, brokers who recommend our common
stock to persons who are not established customers and accredited investors, as
defined in the Exchange Act, must satisfy special sales practice requirements,
including requirements that they:
o make an individualized written suitability determination for
the purchaser; and
o receive the purchaser's written consent prior to the
transaction.
The Securities Enforcement Remedies and Penny Stock Reform Act of 1990
also requires additional disclosures in connection with any trades involving a
penny stock, including the delivery, prior to any penny stock transaction, of a
disclosure schedule explaining the penny stock market and the risks associated
with that market. Such requirements may severely limit the market liquidity of
our common stock and the ability of purchasers of our equity securities to sell
their securities in the secondary market. For all of these reasons, an
investment in our equity securities may not be attractive to our potential
investors. Although we intend to apply to have our common stock listed on the
Nasdaq National Market or the Nasdaq SmallCap Market, there is no assurance that
we will be successful in getting such listing in the foreseeable future.
The implementation of our new product initiative is risky and
expensive, and it is possible that we may never become profitable.
Successful implementation of our new product initiative continues to
involve several risks. These risks include:
o reliance upon unproven products;
o our unproven and evolving business model;
o unknown market acceptance of our new product line and any
additional products that we may be able to develop;
o our ability to anticipate and adapt to a rapidly developing
market and to changing technologies;
o the effect of competitive pressures in the marketplace;
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o our need to structure our internal resources to support the
development, marketing and future growth of our existing and
proposed product offerings;
o uncertainties concerning our strategic direction and financial
condition;
o our need to introduce additional reliable products that meet
the demanding needs of our target market; and
o our need to enhance our business development, research and
development, product development and support organizations,
and to expand our distribution channels, to develop our new
product initiative.
In addition, although we believe that the actions that we are taking
will help us become profitable, we cannot assure you that such actions will
succeed in the long or short term.
Internal and external changes resulting from our financial condition
may concern our prospective customers, investors, suppliers and employees, and
produce a prolonged period of uncertainty, which could have a material adverse
affect on our business. Our growth strategy requires substantial changes,
including pursuing new strategic relationships, increasing our research and
development expenditures, adding employees who possess the skills we believe we
will need going forward, establishing leadership positions in what we believe
will be new high-growth markets, establishing distribution channels for our new
products and realigning and enhancing our sales and marketing departments. Many
factors may impact our ability to successfully implement our growth strategy,
including our ability to finalize agreements with other companies, sustain the
productivity of our workforce, introduce innovative new products in a timely
manner, manage operating expenses and quickly respond to, and recover from,
unforeseen events associated with our strategy.
As a result of our new growth strategy, it is extremely difficult to
forecast our future financial performance. We are now in the initial stages of
pursuing our new business plan. Therefore, we do not expect to achieve
profitability, and expect to continue to incur net losses, at least through the
end of 2004. We expect to incur significant product development, administrative
and operating expenses relating to our new product initiative in the future.
Only if we are able to successfully develop our proposed products, bring them to
market before our competitors, and gain the acceptance of our products by our
target market, will we be able to generate any significant revenues from our new
business model. It is possible that we will exhaust all available funds before
we reach the positive cash flow phase of that business model.
If we are unable to develop our new line of products and services, our
business will suffer.
We hope to develop and then deliver to market an offering of hardware,
software and services focused on a segment of the personal computer and online
market that we believe is currently underserved. If we are unsuccessful in
developing these new products, we will have no new products or services to bring
to market and, therefore, will never be able to generate revenues from our new
product initiative, and our business will suffer. Also, if we exhaust all
available funds before we can develop our new line of products and services, our
new business model will fail, and our existing business will suffer.
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The market potential for our new products is unproven, and may not
develop as we hope, which could result in our failure to achieve sales
and profits from our new product initiative.
Our business model involves competing in a dynamic, but mature, market.
Therefore, our financial performance and any future growth will depend, in large
part, upon our ability to obtain market share from existing competitors. We
intend to invest a significant portion of our resources in the market segment we
have targeted, which we anticipate will grow at a significantly higher rate than
the broader consumer electronics industry on average. The markets for consumer
electronics products are highly competitive, and we are not certain that our
target customers will widely adopt our new products. Our target customers may
not choose to use our products for technical, style, cost, support or other
reasons. If we are incorrect in our assumption that our target market is
underserved, and that market does not develop as we hope, or if our new products
and services do not meet the demand in that market, we may never achieve
significant revenues and profits from our new product initiative. We cannot be
certain that a market for our new products or services will ever emerge or be
sustainable if it does emerge. If this market does not develop, or develops more
slowly than we expect, our business, results of operations and financial
condition will be seriously harmed.
If we are unable to develop and introduce our new product line quickly,
our business will suffer.
The market for consumer electronics products is characterized by rapid
technological change, frequent new product introductions and changes in customer
requirements. We believe that we have identified a segment of the personal
computer market that is currently underserved. Therefore, our success will
depend upon our ability to develop and introduce our new products in a timely
manner and to gain market acceptance of any products developed, before a
competitor can introduce products aimed at our target market segment. In
developing our new line of products, we have made, and will continue to make,
assumptions with respect to which features and performance criteria our target
customers will require. If we implement features and performance criteria that
are different from those required by our target customers, market acceptance of
our products may be significantly reduced or delayed and our business would be
seriously harmed.
Competition in the personal computer market may reduce the demand for,
or price of, our products.
We are considered one of the second tier personal computer
manufacturers, which include Systemax, Sys Technologies and Acer, among others.
Although we compete with these manufacturers, we also compete with a number of
large, national brand, personal computer manufacturers, including Dell, Inc.,
Gateway, Inc., Hewlett-Packard Company, Apple Computer, Inc., Sony, e-Machines
and Toshiba. We may also face additional competition from new entrants into the
personal computer market that we have not yet identified. The market for
personal computers and related products is highly competitive, and we expect
competition to intensify in the future. Our competitors may introduce new
competitive products aimed at the same markets targeted by our line of products.
These products may have better performance, lower prices and broader acceptance
than our products. Competition may reduce the overall market for our products.
Most of these current and potential competitors have longer operating
histories, greater name recognition, larger customer bases and significantly
greater financial, technical, sales, marketing and other resources than we do.
In addition, because of the higher volume of components that many of our
competitors purchase from their suppliers, they are able to keep their costs of
supply relatively low and, as a result, may be able to recognize higher margins
on their personal computer sales than we do. Many
10
of our competitors may also have existing relationships with the resellers who
we use to sell our products, or with our potential customers. This competition
may result in reduced prices, reduced margins and longer sales cycles for our
products. The introduction of lower-priced personal computers, combined with the
brand strength, extensive distribution channels and financial resources of the
larger vendors, would cause us to lose market share and would reduce our margins
on those personal computers we sell. If any of our larger competitors were to
commit greater technical, sales, marketing and other resources to our markets,
our ability to compete would be adversely affected.
We are dependent on Staples for a substantial portion of our revenues.
We are dependent upon our relationship with Staples for a substantial
portion of our existing and anticipated revenues. For the year ended December
31, 2003, sales to Staples represented approximately 36.5% of our total net
sales for the year. We expect that we will continue to be dependent upon Staples
for a significant portion of our revenues in future periods. As a result of this
concentration of sales, our business, operating results or financial condition
would suffer as a result of the termination of, or an adverse change in, our
relationship with Staples. In addition, we cannot assure you that our
relationship with Staples will continue, or if continued, will not decrease in
any future period. Staples may also use this concentration of sales to negotiate
lower prices for our products, which would result in lower margins on the
products we sell to Staples. Our agreement with Staples expires at the end of
2004. The agreement is renewable annually upon mutual agreement between Staples
and us. Therefore, we cannot assure you that we will generate significant
revenues in future periods from Staples. The loss of all or any significant part
of our relationship with Staples would seriously harm our business.
We will not be able to develop or continue our business if we fail to
attract and retain key personnel.
Our future success depends on our ability to attract, hire, train and
retain a number of highly skilled employees and on the service and performance
of our senior management and other key personnel. The loss of the services of
our executive officers or other key employees could adversely affect our
business. Competition for qualified personnel possessing the skills necessary
for success in the competitive consumer electronics industry is intense, and we
may fail to attract or retain the employees necessary to execute our business
model successfully. Because we have experienced operating losses, and because
our common stock is not traded on a recognized national market, we may have a
more difficult time in attracting and retaining the employees we need. Our
relationships with most of these key employees are "at will." Moreover, we do
not have "key person" life insurance policies covering any of our employees.
Some members of our management team have joined us only recently. Our
success depends to a significant degree upon the continued contributions of our
key management, business development and marketing, engineering, research and
development and other personnel, many of whom would be difficult to replace. In
particular, we believe that our future success is highly dependent on Kent A.
Savage, our chief executive officer.
The brand for our new product initiative may not achieve the broad
recognition necessary to grow our customer base.
We believe that recognition and a favorable perception of our new
products and services by our target market is essential to the success of our
new product initiative. If we are unsuccessful in establishing or maintaining a
favorable perception of our products and services, we may not be able to grow
our customer base. Our success in promoting and maintaining the brand that we
use in connection with the new business model, will depend largely on:
11
o the success of our brand-enhancement strategy, including
marketing and advertising, promotional programs and public
relations activities;
o the quality and ease-of-use of our products, services and
applications;
o our ability to provide high quality customer service; and
o our ability to enhance and improve the quality and features of
our products and services.
We cannot assure you that we will be able to achieve success in any of
these areas. In addition, in order to attract and retain customers and to
promote and maintain our brands, we will need to substantially increase our
marketing expenditures. If we incur excessive expenses in promoting and
maintaining our brands, our financial results could be seriously harmed.
If we are unable to acquire key components or are unable to acquire
them on favorable terms, our business will suffer.
Some key components included in our line of products are currently
available only from single or limited sources. In addition, some of the
suppliers of these components are also supplying certain of our competitors. We
cannot be certain that our suppliers will be able to meet our demand for
components in a timely and cost-effective manner. We expect to carry little
inventory of some of our products and product components, and we will rely on
our suppliers to deliver necessary components to our contract manufacturers in a
timely manner based upon forecasts we provide. We may not be able to develop an
alternate source of supply in a timely manner, which could hurt our ability to
deliver our products to our customers. If we are unable to buy these components
on a timely and a cost-efficient basis, we may not be able to deliver products
to our customers, or the margins we receive for our products may suffer, which
would negatively impact our future financial performance and, in turn, seriously
harm our business.
We purchase a substantial portion of our products from a single
manufacturer. Purchases from this manufacturer accounted for more than 11% of
our aggregate merchandise purchases for 2003. We have no long-term contracts or
arrangements with this manufacturer, or our other suppliers, that guarantee the
availability of components. If we lose our relationship with this manufacturer,
we may not be able to find an alternate supplier on a timely basis, or on
reasonable terms.
At various times, some of the key components for our products have been
in short supply. Delays in receiving components would harm our ability to
deliver our products on a timely basis. In addition, because we expect to rely
on purchase orders rather than long-term contracts with our suppliers, we cannot
predict with certainty our ability to procure components in the longer term. If
we receive a smaller allocation of components than is necessary to manufacture
products in quantities sufficient to meet our customers' demand, those customers
could choose to purchase competing products.
Our reliance on third parties to manufacture and assemble our products
could cause a delay in our ability to fill orders, which might cause us
to lose sales.
We currently use third parties to manufacture sub-assemblies of our
products and we purchase our components on a purchase order basis. We expect to
continue this method of procurement indefinitely, at least with respect to our
existing business. If we cannot continue our arrangement with our contract
manufacturers, and if we cannot establish an arrangement with at least one
contract manufacturer who agrees to manufacture our sub-assemblies on terms
acceptable to us, we may not be able to produce and ship our products, and our
business will suffer. If we fail to manage our relationships with our contract
manufacturers effectively, or if they experience delays, disruptions or quality
control
12
problems in their manufacturing operations, our ability to ship products to our
customers could be delayed.
The absence of dedicated capacity with our contract manufacturers means
that, with little or no notice, they could refuse to continue manufacturing, or
increase the pricing of, some or all of our products. Qualifying new contract
manufacturers and commencing volume production would be expensive and
time-consuming. If we are required or choose to change contract manufacturers,
we could lose revenues and damage our customer relationships.
Our reliance on third-party manufacturers also exposes us to the
following risks that are outside our control:
o unexpected increases in manufacturing and repair costs;
o interruptions in shipments if one of our manufacturers is
unable to complete production;
o inability to control delivery schedules;
o unpredictability of manufacturing yields; and
o inability of a manufacturer to maintain the financial strength
to meet our procurement and manufacturing needs.
We may not be able to compete effectively if we are not able to protect
our intellectual property.
We rely, and intend to rely, on a combination of trademark, trade
secret and copyright law and contractual restrictions to protect the proprietary
aspects of our products. We have applied to register, or intend to apply to
register, various trademarks relating to our existing business and our new
product initiative. Although we have yet to file any patent applications for
inventions related to our new line of products, we anticipate filing patent
applications for inventions relating to that product line which we determine
will be key to our new product initiative. If we are not successful in obtaining
the patent protection we need, our competitors may be able to replicate our
technology and compete more effectively against us. We also enter, and plan to
continue to enter, into confidentiality or license agreements with our
employees, consultants and other parties with whom we contract, and control
access to and distribution of our software, documentation and other proprietary
information. The legal protections described above would afford only limited
protection. Unauthorized parties may attempt to copy aspects of our products, or
otherwise attempt to obtain and use our intellectual property. Monitoring
unauthorized use of our products will be difficult, and the steps we have taken
may not prevent unauthorized use of our technology, particularly in foreign
countries where the laws may not protect our proprietary rights as fully as in
the United States.
Undetected product errors or defects could result in loss of revenues,
delayed market acceptance and claims against us.
We offer a warranty on all of our products, allowing the end user to
have any defective unit repaired or to receive a replacement product within a
certain period after the date of sale. Our products may contain undetected
errors or defects. If one of our products fails, we may have to replace all
affected products without being able to record any revenue for the replacement
units, or we may have to refund the purchase price for the defective units. Some
errors are discoverable only after a product has been
13
installed and used by end users. Any errors discovered after our products have
been widely used could result in loss of revenues and claims against us.
If we are unable to fix errors or other problems that later are
identified after installation, in addition to the consequences described above,
we could experience:
o failure to achieve market acceptance;
o loss of customers;
o loss of market share;
o diversion of development resources;
o increased service and warranty costs; and
o increased insurance costs.
If we fail to predict our manufacturing requirements accurately, we
could incur additional costs or experience manufacturing delays, which
could reduce our gross margins or cause us to lose sales.
We provide forecasts of our demand to our contract manufacturers prior
to the scheduled delivery of products to our customers. If we overestimate our
requirements, our contract manufacturers may have excess component inventory,
which would increase our costs. If we underestimate our requirements, our
contract manufacturers may have an inadequate component inventory, which could
interrupt the manufacturing of our products and result in delays in shipments
and revenues. In addition, lead times for materials and components that we order
vary significantly and depend on factors such as the specific supplier, contract
terms and demand for each component at a given time. We may also experience
shortages of components from time to time, which also could delay the
manufacturing of our products or increase the costs of our products.
We could become subject to litigation regarding intellectual property
rights that could be costly and result in the loss of significant
rights.
In recent years, there has been a significant increase in litigation in
the United States involving patents and other intellectual property rights. In
the future, we may become a party to litigation to protect our intellectual
property or to defend against an alleged infringement by us of another party's
intellectual property. Claims for alleged infringement and any resulting
lawsuit, if successful, could subject us to significant liability for damages
and invalidation of our intellectual property rights. These lawsuits, regardless
of their success, would likely be time-consuming and expensive to resolve and
would divert management time and attention. Any potential intellectual property
litigation could also force us to do one or more of the following:
o stop or delay selling, integrating or using products that use
the challenged intellectual property;
o obtain from the owner of the infringed intellectual property
right a license to sell or use the relevant technology, which
license might not be available on reasonable terms, or at all;
or
o redesign the products that use that technology.
14
If we are forced to take any of these actions, our business might be
seriously harmed. Our business insurance may not cover potential claims of this
type or may not be adequate to indemnify us for all liability that could be
imposed.
The inability to obtain any third-party license required to develop new
products and product enhancements could seriously harm our business,
financial condition and results of operations.
From time to time, we are required to license technology from third
parties to develop new products or product enhancements. Third-party licenses
may not be available to us on commercially reasonable terms, or at all. Our
inability to obtain any third-party license necessary to develop new products or
product enhancements could require us to obtain substitute technology of lower
quality or performance standards, or at greater cost, which could seriously harm
our business, financial condition and results of operations.
Our officers and directors own a large percentage of our outstanding
stock and could significantly influence the outcome of actions.
Glenbrook Group, LLC, an entity controlled by members of our board of
directors, owned approximately 50.1% of our outstanding stock as of February 29,
2004. Our executive officers, directors and entities affiliated with them,
including Glenbrook Group and our employee stock ownership plan, in the
aggregate, beneficially own approximately 78.0% of our outstanding stock as of
February 29, 2004. These stockholders, if acting together, would be able to
determine all matters requiring approval by our stockholders, including the
election of directors and the approval of mergers or other business combination
transactions.
Shares of common stock eligible for public sale could cause our stock
price to decline.
The market price of our common stock could decline as a result of sales
by our existing stockholders of a large number of shares of our common stock in
the market, or the perception that such sales could occur. This circumstance may
be more significant because of the relatively low volume of our common stock
that is traded on any given day. All of our outstanding common stock that was
issued in private placements prior to December 2003 may currently be resold in
reliance on Rule 144 of the Securities Act. We have the obligation to file a
registration statement registering the resale of the shares of our common stock
issued in our December 2003 private placement, and the shares purchased from our
former majority shareholder, on or before April 7, 2004, and that registration
statement must be declared effective prior to May 22, 2004, or June 21, 2004 if
the registration statement is subject to review by the Securities Exchange
Commission. Such registration may result in additional shares being sold in the
market, which may have a negative impact on the market price of our common
stock.
We may be unable to obtain the additional capital required to grow our
business, which could seriously harm our proposed business. If we raise
additional funds, our current stockholders may suffer substantial
dilution.
As of December 31, 2003, we had approximately $464,000 in cash and cash
equivalents on hand. We currently do not have a traditional line of credit with
a commercial bank. We may need to raise additional funds at any time and, given
our history, we cannot be certain that we will be able to obtain additional
financing on favorable terms, if at all. Due to the recent volatility of the
U.S. equity markets, particularly for smaller technology companies, we may not
have access to new capital investment when we need to raise additional funds.
15
Our future capital requirements will depend upon several factors,
including whether we are successful in developing our products, and our level of
operating expenditures. Our expenditures are likely to rise as we continue our
technology and business development efforts. If our capital requirements vary
materially from those we currently plan, we may require additional financing
sooner than anticipated. If we cannot raise funds on acceptable terms, we may
not be able to develop our new products and services, take advantage of future
opportunities or respond to competitive pressures or unanticipated requirements,
any of which could have a material adverse effect on our ability to develop and
grow our business.
Further, if we issue equity securities, our existing stockholders will
experience dilution of their ownership percentages, and the new equity
securities may have rights, preferences or privileges senior to those of our
common stock. If we do not obtain additional funds when needed, we could quickly
cease to be a viable going concern.
We do not intend to declare dividends and our stock could be subject to
volatility.
We have never declared or paid any cash dividends on our common stock.
We presently intend to retain all future earnings, if any, to finance the
development of our business and do not expect to pay any dividends on our common
stock in the foreseeable future.
The market price of our common stock may fluctuate significantly in
response to a number of factors, some of which are beyond our control,
including:
o variations in the magnitude of our losses from operations from
quarter to quarter;
o changes in market valuations of companies in the consumer
electronics industry;
o changes in the dynamics of the market segment that we are
targeting with our new product initiative;
o announcements by us or our competitors of new technology,
products, services, significant contracts, acquisitions,
strategic relationships, joint ventures, capital commitments
or other material developments that affect our prospects and
our relative competitive position in our prospective markets;
o our inability to locate or maintain suppliers of components of
our line of consumer electronics products at prices that will
allow us to attain profitability;
o product or design flaws, or our inability to bring functional
products to market, product recalls or similar occurrences, or
failure of a substantial market to develop for our planned
products;
o additions or departures of key personnel;
o sales of capital stock in the future;
o stock liquidity or cash flow constraints; and
o fluctuations in stock market prices and volume, which are
particularly common for the securities of highly volatile
technology companies pursuing untested markets and new
technologies.
16
ITEM 2. PROPERTIES
Our principal property consists of our headquarters located in a leased
facility (approximately 78,000 square feet) at 801 S. Sentous Street, City of
Industry, California. We believe that our present facilities are adequate for
our current needs.
ITEM 3. LEGAL PROCEEDINGS
On or about December 16, 2002, the Pension and Welfare Benefits
Administration of the U.S. Department of Labor informed us that they had
selected our employee stock ownership plan for review. The Department of Labor
has raised issues regarding the December 1999 transaction between our former
chief executive officer and majority stockholder and the Lan Plus, Inc. [sic]
Employee Stock Ownership Plan. In the December 1999 transaction, our former
chief executive officer sold shares of our preferred stock to the plan in
connection with the establishment the plan. The Department of Labor has
indicated that this transaction may have been a prohibited transaction because
the purchase price of the shares may have been above fair market value at the
time of the transaction, which would require the unwinding or correction of the
transaction. Although our former chief executive officer is primarily
responsible for remedying any prohibited transaction, we may have some liability
as a co-fiduciary of the plan. However, our former chief executive officer has
agreed to indemnify us against any costs or damages incurred by us in connection
with the Department of Labor investigation. We intend to cooperate with the
Department of Labor in connection with its review of our employee stock
ownership plan, and to bring such review to conclusion as quickly as possible.
At this time, we are not involved in any other legal proceedings that
our management currently believes would be material to our business, financial
condition or results of operations. We could be forced to incur material
expenses with respect to these legal proceedings, and in the event there is an
outcome in any that is adverse to us, our financial position and prospects could
be harmed.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is quoted on the Over-the-Counter Bulletin Board under
the symbol "NGTE". Prior to March 28, 2002, our common stock was quoted on the
Over-the-Counter Bulletin Board under the symbol "MIGS". Effective March 28,
2002, we implemented a one-for-ten reverse stock split in connection with our
merger with Lan Plus Corporation and, on that date, every ten shares of common
stock outstanding were converted into one share of common stock.
The following table shows the high and low daily closing sale prices
per share of our common stock on the Over-the Counter Bulletin Board for each
quarterly period within the two most recent fiscal years. We have adjusted all
of the price information to reflect the one-for-ten reverse stock split as if it
had taken place on December 31, 2001.
Price Range
-----------
Quarter Ending High Low
- -------------- ---- ---
March 31, 2002................................... $2.00 $0.50
June 30, 2002.................................... 1.01 0.17
September 30, 2002............................... 0.90 0.08
December 31, 2002................................ 0.51 0.16
March 31, 2003................................... 0.25 0.11
June 30, 2003.................................... 0.25 0.12
September 30, 2003............................... 0.25 0.07
December 31, 2003................................ 1.35 0.11
As of February 29, 2004, there were approximately 120 holders of record
of our common stock, and the closing price on the OTC Bulletin Board was $0.95.
We have not declared cash dividends on our common stock since our
inception. Our board of directors intends to retain any of our earnings to
support operations and to finance expansion and does not intend to pay cash
dividends on our common stock in the foreseeable future. Any future
determinations as to the payment of dividends will be at the discretion of our
board of directors, and will depend on our financial condition, results of
operations, capital requirements, and such other factors as our board of
directors deems relevant.
Recent Sales of Unregistered Securities
On December 9, 2003, we sold 4,000,000 shares of our common stock to
Glenbrook Group, LLC for $0.25 per share, or a total of $1 million, in cash. In
connection with that offering, we also entered into a consulting agreement with
J&M Interests, LLC, a controlling member of Glenbrook, under which we agreed to
issue to J&M Interests warrants to purchase 2.5 million shares of our common
stock for $0.50 per share. The warrants, which are exercisable over a five-year
period, was consideration for consulting services provided to us by J&M
Interests over the six-month period following the date of issuance. The offering
to Glenbrook and J&M Interests was exempt from registration under the Securities
Act pursuant to Section 4(2) of that act and Regulation D promulgated by the
Securities Exchange Commission.
In March 2002, we entered into a corporate consulting agreement with
Investor Relation Resources. In exchange for various corporate consulting and
public relations services, we agreed to issue 10,000 shares of our common stock.
We valued these shares at the market price on the date of the agreement, $1.00
per share. These shares were not registered under the Securities Act pursuant to
Sectiuon 4(2) of the Securities Act.
18
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and our audited financial statements and the notes
thereto included elsewhere in this report. The consolidated balance sheet data
as of December 31, 2003 and 2002 and the consolidated statement of operations
data for the years ended December 31, 2003, 2002 and 2001 set forth below are
derived from, and qualified by reference to, our audited financial statements
appearing elsewhere in this annual report. The consolidated balance sheet data
for the years ended December 31, 2001, 2000 and 1999 and the consolidated
statement of operations data for the years ended December 31, 2000 and 1999 are
derived from audited consolidated financial statements not included herein.
Statements of Operations Data: Years ended December 31,
2003 2002 2001 2000 1999
-------------- ------------- ---------------- --------------- ------------
(in thousands, except per share data)
Net sales........................ $ 77,046 $ 65,176 $ 73,883 $ 69,101 $ 87,158
Cost of sales.................... 72,790 58,650 64,872 60,326 76,845
-------------- ------------- ---------------- --------------- ------------
Gross profit..................... 4,256 6,526 9,011 8,775 10,313
Operating expenses............... 8,724 8,032 7,273 7,700 10,176
-------------- ------------- ---------------- --------------- ------------
Income (loss) from operations.... (4,468) (1,506) 1,738 1,075 137
Other (income) expense........... 330 268 (217) 202 (282)
-------------- ------------- ---------------- --------------- ------------
Income (loss) before income
taxes............................ (4,798) (1,774) 1,955 873 419
Provision (benefit) for income
taxes............................ (79) 489 467 358 173
-------------- ------------- ---------------- --------------- ------------
Net income (loss)................ $ (4,719) $(2,263) $ 1,488 $ 515 $ 246
============== ============= ================ =============== ============
Basic income (loss) per common
share............................ $ (0.31) $ (0.16) $ 0.15 $ 0.05 $ 0.02
Fully-diluted income (loss) per
common share..................... $ (0.31) $ (0.16) $ 0.13 $ 0.05 $ 0.02
As of December 31,
2003 2002 2001 2000 1999
-------------- ------------- ---------------- --------------- ------------
(in thousands, except per share data)
Balance Sheet Data:
Cash and cash equivalents........ $ 464 $ 1,983 $ 8,555 $ 2,884 $ 1,307
Working capital.................. 2,133 3,239 5,245 3,836 5,483
Total assets..................... 15,397 15,183 24,091 13,913 20,775
Long-term debt................... 1,355 9,263 9,263 9,880 11,303
Stockholders' equity (deficit)... 5,061 (966) (3,238) (5,609) (5,412)
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the section "Selected Financial Data" and the financial statements and
related notes included elsewhere in this report.
The information contained below may be subject to risk factors. We urge
you to review carefully the section "Factors Affecting Operating Results" in
this report for a more complete discussion of the risks associated with an
investment in our securities. See "Special Note on Forward-Looking Statements
and Risk Factors" above under Item 1.
Executive Overview
Since 1992, when our predecessor was formed, we have primarily offered
consumers personal computers and related products through distribution channels
that include television shopping networks, mail order catalog companies and
large electronic and office supply chain stores. In December 2003, an investor
group acquired a majority of our outstanding common stock and appointed a
majority of the members of our board of directors. In January and February of
2004, our new board of directors employed new members of our management team,
including a new chief executive officer. Under the direction of our restructured
management team, we began implementing a new strategic focus designed to
compliment our existing business. We are now developing a business plan to
launch a hardware and software offering targeted at what we believe is an
untapped segment of the personal computer and Internet market.
On March 20, 2002, we completed a merger with Lan Plus Corporation, a
manufacturer of both private-label and branded turnkey computer products and
services. In that merger, the shareholders of Lan Plus acquired approximately
75% of our outstanding common stock as of that date. In addition, upon the
closing of the merger, we completed a one-for-ten reverse stock split and
changed our name from Mcglen Internet Group, Inc. to Northgate Innovations, Inc.
As a result of the merger, for financial accounting purposes, we treat the
merger as a purchase of us by Lan Plus. Therefore, we present the historical
financial statements of Lan Plus for comparison purposes for all periods
presented.
In the consumer electronics industry, and particularly with respect to
the distribution of personal computers, financial performance is closely tied to
the ability of the distributor to receive adequate gross profit margins. Since
our operating expenses are relatively non-variable, we must increase our gross
margins in order to generate more income, and cash. Competition has driven down
the selling prices for personal computers. Due primarily to the competitive
pressures on our selling prices, over the last two fiscal years we have
experienced increasing pressure on our gross profit margins, which have dropped
from 12.2% in 2001 to 5.5% in 2003. As a result, we have also experience
operating losses and net losses in each of the past two fiscal years. These
losses have been the primary reason for a decrease in our cash and cash
equivalents from approximately $8.6 million at the end of 2001 to approximately
$464,000 at the end of 2003. We expect that there will be continued pressure on
our margins in the foreseeable future.
In order to improve our gross profit margins, we have adopted our new
product initiative to try to decrease the competitive pressures on our margins.
Our new product initiative is designed to increase demand for our products, so
that we can charge a higher price for, and thereby increase the profit margin
on, those products. If we are unsuccessful in increasing the demand for our new
products, resulting in a higher price for those products, we will probably not
be successful in improving our profit margins. We are also trying to increase
the profit margins on both our new products and our existing product line by
lowering our component costs, which decreases our cost of goods sold. However,
lowering component
20
costs has proven difficult in the past. If we cannot improve our margins through
our new product initiative, or by lowering our component costs, our financial
performance is likely to continue to suffer in 2004 and beyond.
Critical Accounting Policies and Estimates
Management's discussion and analysis of financial condition and results
of operations is based upon our financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States
of America. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities
and expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, we evaluate our estimates, including those related to our
revenue recognition, deferred taxes, impairment of long-lived assets and
inventory. We base our estimates on historical experience and on various other
assumptions that we believe are 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.
Our critical accounting policies are as follows:
Revenue Recognition. We derive revenue primarily from sales of our
personal computers, and to a lesser extent, from software, peripherals and
accessories. Generally, we will recognize revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the fee is fixed or determinable and
collection is probable. We provide for estimated costs of doubtful accounts and
product warranties as a reduction in revenue at the time we recognize revenue.
Our estimate of costs of doubtful accounts is based upon our historical
collection experience. If our collections decrease due to the deterioration of
the financial condition of our customers, or otherwise, we would have to
increase the doubtful account allowance, which would reduce revenues. Securities
and Exchange Commission Staff Accounting Bulletin No. 101 - Revenue Recognition
in Financial Statements requires us to estimate returns and warranty expenses
prior to recognizing revenue. While certain of the products we sell are covered
by third party manufacturer warranties, we may have products returned by
customers the costs of which we 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 if the manufacturers go out of
business or refuse to honor their warranty obligations, we may be forced to
cover these warranty costs and the costs may differ from our estimates. We will
record discounts provided to resellers for achieving purchasing targets as a
reduction of revenue on the date of sale.
Vendor Rebates. We earn rebates from our vendors that are based on
various quantitative contract terms. Amounts we expect to receive from vendors
relating to the purchase of merchandise inventories are recognized as a
reduction of cost of goods sold at the time the merchandise is sold. If the
amounts of those rebates we actually receive are less than we expected, our cost
of sales will be understated for the period covered. We record rebates received
that represent a reimbursement of incremental costs, such as advertising, as a
reduction to the related expense in the period that the related expense is
incurred. We have several controls in place that we believe allow us to ensure
that these amounts are recorded in accordance with the terms of the applicable
contracts. Should the vendors paying the rebates reach different judgments
regarding the terms of these contracts, they may seek to recover all or a
portion of the rebates from us.
Deferred Taxes. As part of the process of preparing our financial
statements, we are required to estimate our income taxes. This process involves
estimating our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets and liabilities, which
are included within our
21
balance sheet. We must then assess the likelihood that our deferred tax assets
will be recovered from future taxable income and to the extent we believe that
recovery is not likely, we must establish a valuation allowance. To the extent
we establish a valuation allowance or increase this allowance in a period, we
must include an expense within the tax provision in our statement of operations.
Significant judgment involving multiple variables is required in
determining our deferred tax assets and liabilities and any valuation allowance
recorded against our net deferred tax assets. In assessing the potential
realization of deferred tax assets, we consider whether it is more likely than
not that some portion or all of the deferred tax assets will be realized. The
ultimate realization of deferred tax assets is dependent upon achieving future
taxable income during the period in which our deferred tax assets are
recoverable. If our estimates regarding our future taxable income prove to be
incorrect, we may have to write down the value of the deferred tax assets.
Impairment of Long-Lived Assets. We evaluate the recoverability of our
long-lived assets and review these assets for recoverability when events or
circumstances indicate a potential impairment. Factors we consider important
that could trigger an impairment review include the following:
o significant underperformance relative to historical or
projected operating results;
o significant changes in the manner or use of the assets or the
strategy for our overall business; and
o significant negative industry or economic trends.
When we determine that the carrying value of these assets may not be
recoverable based on the existence of one or more of the above indicators of
impairment, we measure any impairment by estimating the undiscounted cash flows
to be generated from the use and ultimate disposition of these assets. We record
assets to be disposed of at the lower of the carrying amount or fair market
value less anticipated costs of sales.
Impairment of Goodwill and Other Intangible Assets. As a result of our
adoption of Statement of Financial Accounting Standards No. 142 "Goodwill and
Other Intangible Assets", we now annually review goodwill and other intangible
assets that have indefinite lives for impairment and whether events or changes
in circumstances indicate the carrying value of these assets might exceed their
current fair values. These reviews require us to estimate the fair value of our
identified reporting units and compare those estimates against the related
carrying values. For each of the reporting units, the estimated fair value is
determined as compared to our stock price.
Inventory. We adjust our inventory values so that the carrying value
does not exceed net realizable value. We estimate net realizable value based
upon forecasted demand. However, forecasted demand is subject to revisions and
actual demand may differ. This difference may require a write-down of our
inventory, which could have a material effect on our financial condition and
results of operations. From time to time, we maintain at our facilities
component parts inventory that remains the property of our vendors supplying the
inventory until such time as we elect to use the inventory. At the time we elect
to use the inventory, we reflect the cost of that inventory in our inventory
account, and generate a corresponding account payable.
2002 Restatement
In connection with the preparation of our quarterly report for the
six-month period ended June 30, 2003, we became aware of certain differences in
our detailed records and the liabilities included in our
22
financial statements for the year ended December 31, 2002. We conducted an
investigation into those differences. As a result of that investigation, we
concluded that the amount of our accounts payable reported for December 31, 2002
was understated as a result of an incorrect adjustment for consigned inventory.
This understatement of accounts payable in the period resulted in a lower costs
of goods sold and higher net income for the period. The restatement caused our
net loss to be increased for the year ended December 31, 2002. In addition, in
connection with the restatement, we reviewed certain tax assets reflected in the
financial statements as of December 31, 2002 and determined that certain of
those assets may expire before we can utilize them. Therefore, we recorded a
valuation allowance for the deferred tax assets as of December 31, 2002.
Results of Continuing Operations for the Years Ended December 31, 2003 and 2002
Results of Operations
The following table sets forth for the years indicated the percentage
of net sales represented by certain items reflected in our consolidated
statements of operations. There can be no assurance that the trends indicated
will continue in the future.
PERCENTAGE OF NET SALES
Year Ended December 31,
2003 2002 2001
---- ---- ----
STATEMENTS OF OPERATIONS DATA:
Net sales 100.0% 100.0% 100.0%
Cost of sales 94.5% 90.0% 87.8%
Gross profit 5.5% 10.0% 12.2%
Operating expenses 11.3% 12.3% 9.8%
Income (loss) from operations (5.8%) (2.3%) 2.4%
Other (income) expense 0.4% 0.4% (0.2%)
Income (loss) before income taxes (6.2%) (2.7%) 2.6%
(Provision) benefit for income taxes 0.1% (0.8%) (0.6%)
Net income (loss) (6.1%) (3.5%) 2.0%
Net Sales
Our net sales are primarily derived from our sale of personal computer
hardware, software, peripherals and accessories. Our net sales increased by
approximately $11.9 million, or 18.2%, to approximately $77.0 million for the
year ended December 31, 2003, compared to approximately $65.2 million for the
year ended December 31, 2002. The increase in net sales was a result of an
increase in the number of computer systems shipped during the period with the
addition of Staples as our largest customer in late 2002.
Gross Profit
Our gross profit consists of net sales less our product and shipping
costs. Our gross profit decreased by $2.3 million, or 34.8%, to approximately
$4.3 million for the year ended December 31, 2003, compared to $6.5 million for
the year ended December 31, 2002. The decrease in our gross profit
23
was a result of a decrease in the average selling price per system due to lower
component costs and competition in the marketplace. Our gross profit in 2003 was
significantly impacted by price reductions in the marketplace by competitors
such as Dell and Gateway, as well as reduction in consumer demand, each of which
took place in the fourth quarter of 2002. In addition, in the fourth quarter of
2002 our airtime on one of the home shopping networks decreased significantly as
compared to the prior year. Our gross profit margins may continue to be impacted
by competitive pressures in the future. However, our new product initiative is
designed to decrease those competitive pressures and increase our gross profit
margins for our new products.
Operating Expenses
Our operating expenses increased by approximately $692,000, or 8.6%, to
$8.7 million for the year ended December 31, 2003, from $8.0 million for 2002.
The increase in operating expenses was attributable to a $590,000 impairment
loss on goodwill and $625,000 of non-cash stock compensation expense. These
amounts were offset in part by a decrease in salaries of approximately $330,000
and a decrease in costs related to outsourcing assembly of approximately
$180,000. We did not make any discretionary contributions to our employee stock
ownership plan in 2002 or 2003.
Other (Income) Expense
Our net other expense increased by approximately $62,000, or 23.1%, to
$330,000 for the year ended December 31, 2003, from $268,000 for the prior year.
The increase was primarily due to lower interest income in 2003. We expect that
our operating expenses will increase in our current fiscal year and beyond. Our
new product initiative will require significant increases in research and
development expenses and sales and marketing expenses. We will also incur higher
general and administrative expenses related to the expansion of our management
team in early 2004 and related costs.
Income Taxes
Our provision for income taxes for the year ended December 31, 2003 was
a credit of $79,000, versus $489,000 for the year ended December 31, 2002. The
income tax provision for 2003 decreased primarily as a result of our taxable
losses.
Results of Continuing Operations for the Years Ended December 31, 2002 and 2001
Net Sales
Our net sales decreased by $8.7 million, or 11.8%, to $65.2 million for
the year ended December 31, 2002, compared to $73.9 million for the year ended
December 31, 2001. The decrease in net sales was a result of a decrease in the
number of computer systems shipped during the period, as well as a decrease in
the average selling price per system due to lower component costs and
competition in the marketplace. The fourth quarter of 2002 was significantly
impacted by price reductions in the marketplace by our competitors, such as Dell
and Gateway, as well as reduction in consumer demand. In addition, in the fourth
quarter of 2002 our airtime on one of the home shopping networks decreased
significantly as compared to the prior year.
Gross Profit
Our gross profit decreased by $2.5 million, or 27.6%, to $6.5 million
for the year ended December 31, 2002, compared to $9.0 million for the year
ended December 31, 2001. The decrease in gross profit was due to the decrease in
net sales discussed above and the resulting decrease in our gross
24
profit margin. Our gross profit margin, as a percentage of net sales, decreased
to 10.0% for the year ended December 31, 2002 from 12.2% for the year ended
December 31, 2001. The decrease in gross profit margin as a percentage of sales
was due to an increase in labor and applied overhead costs associated with the
integration of Mcglen and Lan Plus following the 2002 merger of those companies,
an increase in costs due to integration of our new enterprise software in 2002
and less units being produced in 2002 as compared to 2001.
Operating Expenses
Our operating expenses increased by $0.7 million, or 9.6%, to $8.0
million for the year ended December 31, 2002, from $7.3 million for 2001. The
increase in operating expenses was attributable to an increase in payroll and
related costs and an increase in advertising costs in 2002. Compensation expense
related to our employee stock ownership plan decreased by $0.3 million for the
year ended December 31, 2002, as we did not make any discretionary contributions
to the plan in 2002. Payroll and related costs increased by approximately $0.9
million, or 19.1%, for the year ended December 31, 2002 compared to 2001. The
increase in payroll and payroll related costs was due to a 15% increase in
insurance costs in 2002 and a 20% increase in average head count for the year
ended December 31, 2002. Advertising expense increased by approximately $250,000
in 2002 as we received less market development funds from our suppliers. We also
increased our print advertising expenditures as we began to advertise the
Northgate brand. We also experienced an increase in labor and applied overhead
costs associated with the integration of two operations following our March 2002
merger with Mcglen Internet Group and an increase in costs due to the
integration of our new enterprise software in 2002.
Other (Income) Expense
Our other income decreased by approximately $485,000, or 223.5%, to a
net other expense of $268,000 for the year ended December 31, 2002, from a net
other income of $217,000 for the prior year. The decrease was partially due to
decreased gains on our marketable securities portfolio and lower interest income
in 2002. We also recorded an $827,000 loss in 2002 on our marketable securities
portfolio as the result of the overall decline in the stock and bond markets
from when we purchased the securities, as well as specific factors affecting
individual investments within the portfolio. As a partial offset to these
decreases, in the fourth quarter of 2002, we reached a settlement with the
lender under our predecessor's line of credit. Under that settlement, we repaid
$40,000 of the $90,000 that was due under the line of credit. The resulting gain
of $50,000 is included in other income for the year ended December 31, 2002.
Also in 2002, we revised our estimate for accruals related to our liability for
certain subscriber fees to an Internet service provider, resulting in
recognition of other income of approximately $1.0 million.
Income Taxes
Our provision for income taxes for the year ended December 31, 2002 was
$489,000, versus $467,000 for the year ended December 31, 2001. The income tax
provision for 2002 increased primarily as a result of a valuation allowance
applied to our tax asset acquired during 2002, offset by certain changes in the
estimates for our past income tax liabilities, and amounts refundable from prior
years' tax payments.
Liquidity and Capital Resources
Historically, our primary financing need has been the funding of
working capital requirements. We financed our operations and met our capital
expenditure requirements primarily from cash provided by operations, borrowings
from private individuals, including our former chief executive officer and
25
majority stockholder, and financial institutions. As of December 31, 2003, we
had approximately $464,000 in cash, cash equivalents and short-term investments,
compared to approximately $2.5 million at December 31, 2002. Our new product
initiative will require significant capital to fund operating expenses,
including research and development expenses and sales and marketing expenses,
capital expenditures and working capital needs until we achieve positive cash
flows from that initiative. We expect to seek between $10.0 million and $15.0
million in external equity financing by the end of our current fiscal year to
fund our new product initiative. We have yet to enter into discussions with
potential investors regarding the terms of any such equity financing. We also
expect to seek a new revolving credit facility of between $5.0 million and $10.0
million with a commercial bank to fund the working capital needs of our current
operations and our new product initiative. We have contacted several commercial
banks regarding a revolving credit facility, but we do not currently have any
binding commitments regarding such a facility. We cannot give any assurance that
any additional financing will be available, that we can ever achieve positive
operating cash flows from our new product initiative or that we will have
sufficient cash from any source to meet our needs. It is possible that we will
exhaust all available funds before we reach positive cash flow from our new
product initiative. If we are not able to raise sufficient external financing,
we will have to curtail our efforts to implement our new product initiative.
During the year ended December 31, 2003, we had a revolving credit
facility with a commercial bank. The line of credit was collateralized by a
first priority lien on substantially all of our assets and the personal
guarantee of our former chief executive officer and majority stockholder. Under
the facility, we could borrow up to $2.3 million for working capital purposes,
subject to availability under a borrowing base. As of December 31, 2003, we had
no borrowings under the facility. The revolving credit facility terminated and
all amounts borrowed thereunder and not previously repaid were due and payable
in full (including any accrued interest) on January 31, 2004. Advances under the
line of credit accrued interest at a rate equal to the bank's prime rate plus
0.75% per annum. The loan agreement relating to the revolving credit facility
contained customary covenants and restrictions on additional indebtedness,
liens, disposition of assets, capital expenditures, investments and the
repayment of indebtedness to third parties. As of December 31, 2003, we were not
in compliance with the financial covenants contained in the loan agreement, but
had obtained a forbearance agreement from the bank. We were also out of
compliance with the restriction on repayment of indebtedness to third parties.
In January 2004 we repaid $500,000 of the approximately $1.0 million in
indebtedness we owed to our former chief executive officer and majority
stockholder in violation of that restriction. In addition, that payment was in
violation of a subordination agreement that our former chief executive officer
and majority stockholder executed for the benefit of the bank. Our former chief
executive officer and majority stockholder repaid the $500,000 to us on February
2, 2004.
On December 9, 2003, we closed a private placement of 4 million shares
of our common stock for a purchase price of $0.25 per share, and realized gross
proceeds of approximately $1 million. The investor in the private placement was
a limited liability company, which is controlled by Samuel J. Furrow, Jr. and
Marc B. Crossman, each of whom joined our board of directors as a result of that
private placement. We used the proceeds of the private placement for working
capital needs.
On or about February 6, 2004, we entered into a purchase and sale
agreement with a financial institution. Under the terms of that agreement, we
may assign certain of our accounts receivable to the financial institution for
immediate cash in the amount of 75% of the assigned receivables. We also receive
a portion of the remaining balance of the assigned accounts receivable,
depending on how soon after assignment the financial institution receives
payment on those accounts. We expect to keep this financing purchase line in
place until we can obtain another revolving credit facility from a commercial
bank.
26
In the year ended December 31, 2003, our cash and cash equivalents
decreased by approximately $1.5 million, to approximately $464,000 from
approximately $2.0 million as of December 31, 2002. During the same period, our
working capital decreased by approximately $1.1 million to approximately $2.1
million from approximately $3.2 million as of December 31, 2002. The decrease in
cash during the year was primarily the result of net cash used in our operating
activities during 2003, which was partially offset by approximately $1 million
in gross proceeds from the sale of our common stock. The decrease in working
capital during the year was primarily due to an increase in our accounts payable
balances and related party borrowings.
Net cash used in operating activities for the year ended December 31,
2003 was approximately $5.5 million, as compared to net cash used in operating
activities of $4.0 million for the year ended December 31, 2002 and net cash
provided by continuing operating activities of approximately $3.5 million for
the year ended December 31, 2001. The decrease in net cash used in continuing
operating activities in the year ended December 31, 2003, as compared with the
year ended December 31, 2002, was primarily the result of an increase in our net
loss and an increase in our accounts receivable of approximately $3.8 million
during fiscal year 2003, as compared to a decrease of approximately $6.8 million
in accounts receivables during fiscal year 2002. The decrease in net cash
provided by operating activities in the year ended December 31, 2002, as
compared with the year ended December 31, 2001, was primarily the result of our
net loss and a reduction of trade accounts payable and accrued liabilities of
approximately $7.5 million during the year, which was partially offset by an
increase of accounts receivable of approximately $6.8 million, as compared to an
increase of trade accounts payable and accrued liabilities of approximately $6.4
million, which was partially offset by a decrease of accounts receivable of
approximately $5.8 million, in 2001.
Net cash provided by investing activities was approximately $1.7
million for the year ended December 31, 2003, compared to net cash used in
investing activities of approximately $1.1 million for the year ended December
31, 2002 and net cash provided by investing activities of approximately $1.5
million for the year ended December 31, 2001. Cash provided by, or used in,
investing activities consists of the net result of the sale and purchase of
property and equipment and the maturity, purchase or sale of certain investment
securities. During the year ended December 31, 2003, our capital expenditures
were approximately $168,000, compared to approximately $337,000 for the same
period in 2002. This decrease was primarily due to expenditures in 2002 for
computer hardware and leasehold improvements incurred in connection with our
facility, which we occupied in September 2002.
Net cash provided by financing activities was approximately $2.3
million for the year ended December 31, 2003, compared to net cash used in
financing activities of approximately $40,000 for the year ended December 31,
2002 and net cash used in financing activities of approximately $713,000 for the
year ended December 31, 2001. This increase in net cash provided by financing
activities for the year ended December 31, 2003, as compared to the year ended
December 31, 2002, was primarily the result of approximately $1 million in gross
proceeds from the sale of our common stock and borrowings from our former
majority stockholder and chief executive officer. In the past, we have invested
excess operating funds in the stock market. From time to time, we invested these
funds in short sales of stock that we typically covered within 60 days after the
date of the short purchase. Short sales typically have a higher degree of risk
than traditional stock purchases. At December 31, 2001, we had approximately
$426,000 invested in short sales of securities, and we recorded an unrealized
loss of $102,000 on these investments. We covered the short sales in January and
April 2002, recording a loss of $60,000. We did not make any more of investments
in short sales after that time, and we do not intend to make any such
investments in the future.
27
At December 31, 2003, our aggregate contractual obligations were as
follows:
Payments Due by Period
----------------------
Less Than 1 1-3 3-5 More Than
Contractual Obligations Total Year Years Years 5 Years
----------------------- ----- ---- ----- ----- -------
Long term debt...................................... $ 1,371 $ 16 $ 1,344 $ 11 $ -
Capital lease obligations........................... - - - - -
Operating leases.................................... 1,462 494 968 - -
Purchase obligations................................ - - - - -
Other long-term liabilities reflected on the
balance sheet under GAAP............................ - - - - -
Recently Issued Accounting Standards
In November 2002, the FASB issued FASB Interpretation No. 45 ("FIN
45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN 45 requires that a
liability be recorded in the guarantor's balance sheet upon issuance of certain
guarantees. FIN 45 also requires disclosure about certain guarantees that an
entity has issued. We have implemented the disclosure requirements required by
FIN 45, which were effective for fiscal years ending after December 15, 2002. We
will apply the recognition provisions of FIN 45 prospectively to guarantees
issued after December 31, 2002. Our adoption of FIN 45 did not have a material
effect on our financial position, cash flows or results of operations.
In December 2003, FASB issued Interpretation No. 46R ("FIN 46R") which
replaced Interpretation No. 46, "Consolidation of Variable Interest Entities, an
interpretation of Accounting Research Bulletin No. 51, Consolidated Financial
Statements," to improve financial reporting of special purpose and other
entities. In accordance with the interpretation, business enterprises that
represent the primary beneficiary of another entity by retaining a controlling
financial interest in that entity's assets, liabilities, and results of
operations must consolidate the entity in their financial statements. Prior to
the issuance of FIN 46R, consolidation generally occurred when an enterprise
controlled another entity through voting interests. The disclosure requirements
of FIN 46R are effective for financial statements issued after December 31,
2003. The initial recognition provisions of FIN 46R are to be implemented no
later than the end of the first reporting period that ends after March 15, 2004.
We do not expect FIN 46R to have a material impact on our financial statements.
In November 2002, the FASB's Emerging Issues Task Force ("EITF")
reached a consensus on Issue No. 00-21, "Revenue Arrangements with Multiple
Deliverables." EITF Issue No. 00-21 provides guidance on how to account for
arrangements that involve the delivery or performance of multiple products,
services and/or rights to use assets. The provisions of EITF Issue No. 00-21
will apply to revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. We do not expect EITF Issue No. 00-21 to have a material
effect on our financial position, cash flows or results of operations.
In January 2003, the EITF reached a consensus on Issue No. 02-16,
"Accounting by a Customer (Including a Reseller) for Certain Consideration
Received from a Vendor." EITF Issue No. 02-16 provides guidance regarding how a
reseller of a vendor's products should account for cash consideration received
from a vendor. The provisions of EITF Issue No. 02-16 will apply to vendor
arrangements entered into after December 31, 2002, including modifications of
existing arrangements. Our adoption of EITF 02-16 did not have a material effect
on our financial position, cash flows or results of operations.
28
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not use derivative financial instruments to hedge interest rate
and foreign currency exposure. We do not believe that we have any material
exposure to interest rate risk. We did not experience a material impact from
interest rate risk during fiscal 2003.
Currently, we do not have any significant investments in financial
instruments for trading or other speculative purposes, or to manage our interest
rate exposure.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following table contains our selected unaudited consolidated
quarterly financial data (in thousands, except per share data):
Three Months Ended
===========================================================================================================
December 31, September 30, June 30, March 31, December 31, September 30, June 30, March 31,
2003 2003 2003 2003 2002 2002 2002 2002
===========================================================================================================
Statement of Operations
and Other Data:
Net sales................. $ 22,168 $ 17,415 $ 17,398 $ 20,065 $ 11,537 $ 18,562 $ 15,645 $ 19,432
Cost of sales............. 20,677 16,113 16,773 19,227 11,480 16,473 13,005 17,692
Gross profit.............. 1,491 1,302 625 838 57 2,089 2,640 1,740
Net income (loss)......... (1,718) (519) (1,353) (1,129) (2,301) 78 200 (240)
Net income (loss) per
share ............. (0.11) (0.03) (0.09) (0.08) (0.15) 0.01 0.01 (0.01)
Shares used in per share
calculation........ 15,900 14,943 14,943 14,943 14,943 14,943 14,943 10,827
We believe that you should not rely upon period-to-period comparisons
of our financial results as an indication of future performance. Our results of
operations have been subject to significant fluctuations, particularly on a
quarterly basis, and results of operations could fluctuate significantly
quarter-to-quarter and year-to-year.
The financial statements and supplementary data required by this item
are set forth in Item 15(a)(1) and begin at page F-1 of this report.
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The term "disclosure controls and procedures" is defined in Rules
13a-15(e) and 15d-15(e) of the Exchange Act. This term refers to the controls
and procedures of a company that are designed to ensure that information
required to be disclosed by a company in the reports it files or submits under
the Exchange Act is recorded, processed, summarized and reported within the time
periods specified by the Securities and Exchange Commission. Our management,
including our chief executive officer and chief financial officer, each of whom
joined us after the end of the period covered by this annual report, has
evaluated the effectiveness of our disclosure controls and procedures as of the
end of the period covered by this annual report. Based upon that evaluation, our
chief executive officer and chief financial officer have concluded that our
disclosure controls and procedures were not effective in all material respects
as of the end of the period covered by this annual report.
29
There were no changes to our internal controls over financial reporting
during our last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal controls over financial reporting.
However, in the first quarter of our current fiscal year we took corrective
actions with regard to significant deficiencies and material weaknesses that our
management discovered in its evaluation of the effectiveness of our disclosure
controls and procedures.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference to our proxy statement for the May 27,
2004 Annual Meeting of Stockholders under the caption "Management- Executive
Officers and Directors."
We have adopted a code of ethics applicable to our chief executive
officer, who is our principal executive officer, and our chief financial
officer, who is our principal financial and accounting officer. We will provide
a copy of the code of ethics to any person, without charge, upon written request
delivered to our offices at 801 S. Sentous Street, City of Industry, California
91748.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference to our proxy statement for the May 27,
2004 Annual Meeting of Stockholders under the caption "Executive Compensation
and Other Information," provided that the Compensation Committee Report on
Executive Compensation, the Report of the Audit Committee and the Comparison of
Stockholder Returns are expressly not incorporated herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Incorporated herein by reference to our proxy statement for the May 27,
2004 Annual Meeting of Stockholders under the caption "Security Ownership of
Certain Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference to our proxy statement for the May 27,
2004 Annual Meeting of Stockholders under the caption "Certain Relationships and
Related Transactions."
ITEM 14. PRINCIPAL ACCOUNT FEES AND SERVICES
Incorporated herein by reference to our proxy statement for the May 27,
2004 Annual Meeting of Stockholders under the caption "Principal Accountant Fees
and Services."