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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission File No.: 0-27878
NORTHGATE INNOVATIONS, INC.
Delaware 13-3779546
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
801 Sentous Street, City of Industry, California 91748
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (626) 923-6000
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: None
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
TITLE OF CLASS
Common Stock, $.03 par value
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 in 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. X
---
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes No X
--- ---
The aggregate market value of shares of Common Stock held by
non-affiliates of the registrant on the last business day of the registrant's
most recently completed second fiscal quarter (June 30, 2002) was approximately
$1,287,000 (computed on the basis of $0.30 per share, the last reported sale
price for shares of the Company's Common Stock on the OTC Bulletin Board on such
date).
As of April 14, 2003, the registrant had outstanding 14,694,084 shares
of Common Stock.
TABLE OF CONTENTS
PAGE
PART I.
ITEM 1. BUSINESS.....................................................1
ITEM 2. DESCRIPTION OF PROPERTY.....................................15
ITEM 3. LEGAL PROCEEDINGS...........................................15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........15
PART II.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS....15
ITEM 6. SELECTED FINANCIAL DATA.....................................16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.........................17
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISKS................................................23
ITEM 8. FINANCIAL STATEMENTS........................................23
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.........................23
PART III.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS; COMPLIANCE WITH
SECTION 16(A) OF THE EXCHANGE ACT...........................23
ITEM 11. EXECUTIVE COMPENSATION......................................24
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT..................................................26
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............27
ITEM 14. CONTROLS AND PROCEDURES.....................................28
PART IV.
ITEM 15. EXHIBITS AND REPORTS ON FORM 8-K............................29
SIGNATURES....................................................................31
-i-
PART I
ITEM 1. BUSINESS
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K and, in particular, the management discussion
and analysis included in this report, incorporate a number of 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 (the "Exchange Act"). The
documents incorporated herein by reference also may contain forward-looking
statements. Forward looking statements are based on current expectations,
estimates and projections about our industry, management's beliefs and certain
assumptions made by management. When used in this report and elsewhere by
management, from time to time, the words "believes," "plans," "estimates,"
"intends," "anticipates," "seeks," and "expects" and similar expressions are
intended to identify forward-looking statements. These forward-looking
statements are not guarantees of future performance, are not statements of
historical fact, are subject to certain risks and uncertainties that are
difficult to predict and should be read in conjunction with our consolidated
financial statements and notes to consolidated financial statements included in
this report. Accordingly, actual results may differ materially from those
anticipated or expressed in such statements. Potential risks and uncertainties
include, among others, those set forth herein under "Additional Factors That May
Affect Future Results." Particular attention should be paid to the cautionary
statements involving our limited operating history, unpredictability of future
revenues, potential fluctuations in operating results, systems failures,
business interruptions, capacity constraints, systems development, management of
growth, the intensely competitive nature of the electronic commerce industry and
reliance on third parties, manufacturers, distributors and suppliers. Readers
are cautioned not to place undue reliance on the forward-looking statements,
which speak only as of the date made. Except as required by law, we undertake no
obligation to update any forward-looking statement, whether as a result of new
information, future events or otherwise. Readers, however, should carefully
review the factors set forth in other reports or documents that we file from
time to time with the Securities and Exchange Commission ("SEC").
GENERAL
As used in the following section, "Northgate," "we," "the Company" and "our"
refer to Northgate Innovations, Inc. (formerly known as Mcglen Internet Group,
Inc.) and our subsidiaries including Western Technologies, Inc., Mcglen Micro,
Inc., AMT Components, Inc. and Lan Plus Corporation ("Lan Plus"), unless the
context requires otherwise. We were incorporated in Delaware in May 1994. In
March 1995, we changed our name to Wanderlust Interactive, Inc., and in May
1998, we changed our name to Adrenalin Interactive, Inc. On December 2, 1999, we
completed a reverse acquisition with Mcglen Micro, Inc. in which the
stockholders of Mcglen Micro, Inc. acquired control of the Company. On December
17, 1999, we changed our name to Mcglen Internet Group, Inc.
On October 11, 2000, we entered into an agreement and plan of merger with Lan
Plus Corporation, a manufacturer of both private-label and branded turnkey
computer products and services, with over ten years of operating history. On
March 21, 2001, we entered into an amended and restated merger agreement that,
among other things, eliminated certain conditions to closing contained in the
original merger agreement. The amended and restated merger agreement was
subsequently amended in June and September 2001 and March 2002. On March 20,
2002, the merger, a reverse acquisition pursuant to which the shareholders of
Lan Plus acquired control of Mcglen Internet Group, Inc., was completed. As a
result of the acquisition, each share of Lan Plus was converted into 3.128
shares of Mcglen's common stock, with approximately 9,854,000 shares being
issued (after consideration of a 10:1 reverse stock split instituted by the
Company at the close of the merger). In addition, at the closing of the merger,
the Company's accounts payable to, and advances from Lan Plus, in the amount of
approximately $2.3 million were converted into common stock, eliminating the
debt; the stock was then retired to Treasury and cancelled. The Company has
reported combined operations with Lan Plus beginning March 20, 2002. As a
result, for financial accounting purposes, the merger is treated as a purchase
of Northgate by Lan Plus. Therefore, the historical financial statements of Lan
Plus are presented for comparison purposes for all periods presented.
Andy Teng, founder, Chairman and Chief Executive Officer of Lan Plus, became the
Chief Executive Officer and Chairman of the Board of the combined company and
Richard Shyu, Vice President of Lan Plus, became President of the combined
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company. Grant Trexler, formerly Mcglen's Chief Financial Officer, became Chief
Financial Officer of the combined company. One of Mcglen's founders, Mike Chen,
remained on the Company's Board of Directors.
At the close of the merger the Company changed its name to Northgate
Innovations, Inc., and on March 28, 2002, the Company's ticker symbol on the OTC
Bulletin Board was changed to "NGTE." Northgate's executive offices are located
at 801 Sentous Street, City of Industry, California 91748. Northgate's Internet
address is http://www.Northgate.com. Information contained on Northgate's web
site is not, and should not be considered, part of this filing.
Northgate is a leading marketer of personal computers ("PCs") and related
products and services. Northgate manufactures, markets and supports a broad line
of desktop PCs, Notebooks servers and workstations used by individuals,
families, businesses, government agencies and educational institutions. The
Company also offers diversified products and services such as software,
peripherals, Internet access service and support programs.
Northgate's strategy is to deliver the best value to customers by offering
quality, high-performance PCs and other products and services employing the
latest technology at competitive prices and by providing outstanding service and
support.
BUSINESS OPERATIONS
Northgate's business model is based on delivering turnkey drop-ship programs
allowing its channel partners in catalog, TV Shopping and Retail Chain Stores,
to market PCs while reducing inventory risk and maximizing its partners' and the
Company's profit. This concept, together with its flexible, build-to-order
manufacturing process, enables Northgate to achieve high inventory turnover and
reduced inventory levels, and further allows the Company to rapidly incorporate
new technologies and components into its product offerings.
Northgate maintains a database of its customers to provide a broader range of
services to these customers. Northgate maintains the following web sites:
www.northgate.com, www.accessmicro.com and www.mcglen.com.
PRODUCTS AND SERVICES
The Company's PC Systems business develops, markets, manufactures, sells and
supports a wide range of high performance desktop systems, notebook computers
and network servers under the Northgate, Northstar, Lan Plus, Protek, and Netway
brand names. Northgate also sells, resells and supports a variety of additional
peripherals, software and services. Systems built by the Company use
microprocessors manufactured by Advanced Micro Devices and Intel Corporation.
Northgate offers pre-configured computers with differing memory and storage
configurations, and various operating systems and application software, as well
as built-to-order systems. The Company also offers a variety of hardware
components and peripherals to complement its desktop systems, notebook computers
and network servers, including monitors, modems, graphics cards, accelerators,
CD-ROM and DVD drives, software and services. In addition, Northgate offers
numerous hardware services and e-services, many through third party service
providers. Phone support is available 18 hours a day, seven days a week, 365
days per year; web-based support and services are also available.
TECHNICAL SUPPORT
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. Many inquiries
are resolved over the telephone without the need to repair or replace system
components. When repairs are necessary, Northgate may ship a replacement part or
system and advise customers via telephone regarding installation.
Alternatively, customers may elect to ship a system directly to Northgate for
repair. Technical support services are also provided through the Company's web
sites. These services enable customers to access system-specific information and
recent software updates for many of the software programs and drivers included
with the computer systems. In addition, many of systems are sold with system
diagnostic and repair software that has been optimized for the Company's
products.
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SALES AND MARKETING
End-user customers are comprised primarily of small- and medium-sized
businesses, governmental entities and private consumers. In general, similar
sales and marketing approaches are used across all of these different customer
groups, as the demand levels of the various groups respond similarly to changes
in market prices and overall general economic conditions.
Northgate markets its systems primarily through high profile business partners
in retail, catalog, telemarketing, and other industries. The Company also sells
a limited number of systems through customer-direct relationships supported by
advertising, direct mail, telephone sales, field sales representatives, and its
web sites.
INTERNET BUSINESS - ACCESS AND E-COMMERCE
In April 1999, Northgate announced a marketing agreement with the Microsoft
Network, Inc. (MSN); this agreement was terminated in 2001. The Company
currently sells Earthlink Internet service bundled with its systems.
The PC is the primary means by which consumers access the Internet. According to
IDC, PCs accounted for approximately 95% of the access devices connected to the
Internet in the United States at the end of 1998. The increase in the number of
people with Internet access that was enabled by the proliferation of
lower-priced PCs has fueled the growth of Internet shopping, or e-commerce.
Northgate is committed to refining and extending the advantages of its business
model by moving even greater volumes of product sales, service and support to
the Internet. The Internet provides greater convenience and efficiency to
customers and, in turn, to the Company.
MERCHANDISING
We currently host three sites with product compositions including computing,
entertainment and communication products. By utilizing these three sites
(www.northgate.com, www.accessmicro.com and www.mcglen.com), we have the ability
to gear our marketing campaigns to three different segments of the market--the
Company's resellers, the consumer and small office/home office market, and the
IT professionals market. Our approach to merchandising allows us to offer each
segment of our target audience a unique shopping experience, giving us the
advantage of pricing flexibility, the ability to offer our customers only what
is relevant to their needs, focused cross-selling and up-selling of products,
and the potential of expanding our products and services to each one of these
markets.
Our Northgate.com site focuses on information for our reseller program which was
begun in the second quarter of 2002. Through this program, the Company has
signed up approximately thirty new resellers of the Company's computers.
CUSTOMERS
Northgate develops and utilizes its customer relationships to understand
end-users' needs and to deliver high quality computer products and services
tailored to meet those needs. For large corporate and institutional customers,
the Company works with the customer prior to the sale to plan a strategy to meet
that customer's current and future technology needs. After a sale, it begins a
direct relationship with the end user by establishing customer service and
technical personnel contact with the customer, often on a pro-active basis.
Northgate also establishes direct relationships with small-to-medium businesses
and individuals, through account representatives, telephone sales
representatives or Internet contact. These direct customer relationships provide
information about customers' plans and requirements and enable the Company to
weigh customers' needs against emerging technologies.
For the year ended December 31, 2002, approximately 66% of Northgate's gross
revenues were from sales of PCs through channel partners drop-shipped to
consumers. This concentration of sales allows the Company to maintain a low-cost
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infrastructure while establishing preferred vendor status with large leading
retailers. Northgate intends to continue to sell the majority of our PCs and
monitors to a limited number of large customers for the foreseeable future.
The growth in Northgate's net sales and earnings to date has resulted primarily
from the sale of desktop PCs to individuals, home offices, small businesses and
corporate customers, and to governmental entities and educational institutions
in the U.S. market. Sales and earnings have also grown due to the ongoing
diversification of the Company's revenue stream with the introduction and
expansion of new products and services, including software, peripheral devices,
Internet access and general merchandise. Management believes that most of our
continued growth will come from four areas: (a) the domestic consumer market,
including the developing market for family-use PCs such as Internet Appliances
and Home Networking; (b) businesses and institutions, including home offices,
small to medium-size businesses, as well as Fortune 1000 companies, governmental
entities and educational institutions; (c) the expansion of distribution sales
of mother boards and other system components; and (d) the expansion of service
and product offerings to customers, including Internet access, e-commerce, and
peripherals.
MANUFACTURING
Northgate operates manufacturing facilities in City of Industry, California. The
Company's manufacturing process consists of assembly, functional testing and
quality control of its computer systems. Production teams are used to assemble
most of the Company's desktop PCs with each member of a production team trained
to do several tasks, increasing flexibility and efficiency. Testing and quality
control processes are also applied to components, parts and subassemblies
obtained from suppliers. The Company's build-to-order manufacturing process is
designed to allow it to quickly produce customized computer systems and to
achieve rapid inventory turnover and reduced inventory levels, which lessens
exposure to the risk of declining inventory values. This flexible manufacturing
process also allows Northgate to incorporate new technologies or components into
product offerings quickly. Each PC is shipped from the Company's manufacturing
facilities ready-for-use, with an operating system and application software
already installed.
Quality control is maintained through the testing of components, parts and
subassemblies at various stages in the manufacturing process. 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. Northgate's
computer manufacturing operations have been assessed and certified as meeting
the requirements of the International Organization for Standardization (ISO)
9002. ISO 9002 certification recognizes compliance with international standards
for quality assurance.
PRODUCT DEVELOPMENT
The Company maintains close and cooperative relationships with many of its
suppliers and with other technology developers. These working partnerships allow
Northgate to use its business model and build-to-order manufacturing process to
deliver, on a timely and cost-effective basis, those emerging technologies that
are most relevant to its customers. These relationships have also enabled
Northgate to evaluate the latest developments in PC technology and to quickly
introduce new products and new product features to the market. Northgate
believes that its strong relationships with suppliers will continue to give it
access to new technology and enhance the Company's ability to bring the latest
technology to market on a timely basis. Direct relationships with customers also
enable Northgate to obtain valuable market information, which it uses to assist
in developing new product offerings.
Northgate must evaluate, obtain and incorporate new hardware, software, storage,
communications and peripherals technologies that are primarily developed by
others while taking steps to ensure that new products are compatible with
industry standards and that they meet cost objectives based on competitive
pricing targets.
PRODUCT QUALITY, WARRANTIES AND TECHNICAL SUPPORT
Northgate believes PC customers have in recent years become increasingly
sophisticated in their purchasing decisions, with quality and reliability
becoming increasingly important. The Company works closely with its suppliers to
develop high-quality components, manufactured to Northgate specifications.
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Northgate believes that customers judge quality by evaluating the performance
and reliability of a company's products, as well as a company's ability to
provide comprehensive service and support for its PCs.
Northgate believes product warranties are an important part of achieving
customer satisfaction and maintaining its image. In general, we provide a 30-day
money-back guarantee for our customer returns. Shipping and handling charges to
and from the customer are non-refundable. Northgate provides competitive
warranty packages on all of our manufactured products, ranging from one year to
five years. In many cases, customers have the option of customizing their
limited warranty to suit their particular needs.
On-line support solutions combine preloaded, automated system-repairing software
and online diagnostic and computer maintenance programs to deliver automated
technical support for Northgate customers.
Northgate provides a number of other basic technical support options to its
customers through their web sites, as well as through a variety of other
methods, including e-mail, fax and telephone support. Many of these technical
support options are available to customers without charge.
CUSTOMER SERVICE
We believe that our ability to establish and maintain long-term relationships
with our customers, and to encourage repeat visits and purchases, depends, in
part, on the strength of our customer support and service operations as well as
our staff. We seek to achieve frequent automated e-mail communication with our
customers to continually improve customer service for our stores and services.
We offer toll-free phone numbers and e-mail addresses for sales, technical
support, return merchandise and general customer service. Many of our
competitors only offer e-mail support. We will continue to acquire new tools and
technology to improve customer satisfaction.
PATENTS, TRADEMARKS AND LICENSES
Northgate works closely with PC component suppliers and other technology
developers to stay abreast of the latest developments in PC technology and has
obtained patent licenses for some technologies where these licenses are
necessary or advantageous, some of which require significant royalty payments.
In addition, we have entered into nonexclusive licensing agreements with
Microsoft Corporation for various operating system and application software, as
well as various software licensing agreements with other companies.
From time to time, other companies and individuals assert exclusive patent,
copyright, trademark or other intellectual property rights to technologies or
marks that are important to the technology industry or our business. We evaluate
each claim relating to our products and, if appropriate, seek a license to use
the protected technology. The licensing agreements generally do not require the
licensor to assist us in duplicating its patented technology nor do these
agreements protect us from trade secret, copyright or other violations by us or
our suppliers in developing or selling these products.
COMPETITION
The PC industry is highly competitive, especially with respect to pricing and
the introduction of new products and product features. Northgate competes
primarily by expanding the total available market with flexible services, while
avoiding conflict in "high volume but low profit channels".
Northgate competes with a number of personal computer manufacturers including
Dell Computer, Inc., Gateway, Inc., Hewlett-Packard Company, e-Machines,
Systemax, among others. These manufacturers sell their products through
different combinations of national and regional distributors, dealers,
value-added resellers, retail stores and through the direct channel.
Most of Northgate's current and potential 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, many of our competitors
have nationally-known brands or well-established relationships and have
extensive knowledge of our industry. Moreover, current and potential competitors
have established or may establish cooperative relationships among themselves or
5
with third parties to increase the ability of their products to address consumer
needs or to combine hardware product and service offerings. The introduction of
low-priced PCs combined with the brand strength, extensive distribution channels
and financial resources of the larger PC vendors may cause Northgate to lose
market share.
Competitive factors in our markets include logistics, on-line technical support
and services, Call Center management, OEM relationships with major component
manufacturers, price, new technology, variety of products, software and
features, marketing and sales capability.
SEASONALITY
Operating results have been subject to seasonality and to quarterly and annual
fluctuations. Factors involved include new product developments or
introductions, availability of components, changes in product mix and pricing
and product reviews and other media coverage. Historically, sales have increased
in the third and fourth quarters due, in part, to back-to-school and holiday
spending.
FACILITIES
Northgate's corporate headquarters and distribution facility is located in City
of Industry, California. The Company leases approximately 80,000 square feet
pursuant to a lease that expires in 2006, unless terminated earlier or extended.
Under the terms of the lease, Northgate makes monthly payments of approximately
$37,000 to an unaffiliated third party.
TECHNOLOGY
Our site management, search, customer interaction, transaction processing and
fulfillment systems consist of a combination of our own proprietary technologies
and third-party technology. We have enhanced the capability and scalability of
our systems through acquisition of new third-party technologies and in-house
development. In 2002, the Company implemented new enterprise software for its
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.
The hosting of our Web servers is subcontracted to an Internet data center
specialist, Exodus Communications, Inc. Exodus has an extensive national network
backbone with redundant Internet connections to multiple Internet access points,
a secure physical environment, climate control and redundant power supply.
Exodus provides Northgate access to the facility 24 hours a day, seven days a
week. Exodus also monitors our Web servers continuously.
EMPLOYEES
As of April 14, 2003, we employed approximately 150 employees. We consider our
employee relations to be good. None of our employees is represented by a labor
union, and we have experienced no work stoppages. Competition for qualified
personnel in the electronic commerce industry is intense, particularly for
software development and other technically-oriented positions.
GOVERNMENT REGULATION
Northgate's business is subject to regulation by various federal and state
governmental agencies including the U.S. Federal Communications Commission, the
U.S. Federal Trade Commission, Department of Justice, the U.S. Department of
Commerce and the U.S. Consumer Products Safety Commission.
Some risks of costs and liabilities related to environmental matters are
inherent in Northgate's business, and its operations are subject to federal,
state and local environmental regulatory requirements relating to environmental
and waste management. Northgate periodically generates and handles limited
amounts of materials that are considered hazardous waste under applicable law
and contracts for the off-site disposal of these materials. Northgate's
management believes its business is operated in compliance with applicable
environmental regulations.
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BACKLOG
Northgate does not believe that backlog is a meaningful indicator of sales that
can be expected for any period, and there can be no assurance that the backlog
at any point in time will translate into sales in any subsequent period. Levels
of unfilled orders for systems fluctuate depending upon component availability,
demand for some products, the timing of large volume customer orders and
production schedules. Customers frequently change delivery schedules and orders
depending on market conditions and other reasons.
RESEARCH AND DEVELOPMENT
During the three years ended December 31, 2002, $162,000, $52,000 and $62,000
was expensed, respectively, for research and development.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to other information contained in this report, the following factors
could affect our actual results and could cause such results to differ
materially from those achieved in the past or expressed in our forward-looking
statements.
An investment in our common stock involves a high degree of risk. You should
carefully review and consider the information below, as well as the other
information contained in this report and incorporated by reference.
OUR STOCK IS TRADED ON NASD'S OVER THE COUNTER ELECTRONIC BULLETIN BOARD AND THE
SALE OF OUR STOCK IS SUBJECT TO SIGNIFICANT RESTRICTIONS
Our securities trading is conducted in the NASD's OTC Electronic Bulletin Board.
As a result, an investor may find it more difficult to purchase, dispose of, and
obtain accurate quotations as to the value of, our securities.
In addition, since the trading price of our common stock is less than $5.00 per
share, trading in the common stock is also be subject to the requirements of
Rule 15g-9 under the Exchange Act. Under that rule, broker/dealers who recommend
such low-priced securities to persons other than established customers and
accredited investors 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 disclosure in connection with any trades involving a stock
defined as a penny stock (generally, any equity security not traded on an
exchange or quoted on Nasdaq SmallCap that has a market price of less than $5.00
per share), 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 securities and the ability of purchasers of our stock to sell their
securities in the secondary market.
OUR FUTURE REVENUES AND OUR OPERATING RESULTS MAY FLUCTUATE.
Because we have historically relied on a few customers for a large percentage of
our revenues, we cannot accurately forecast our revenues. While our revenues may
increase in certain quarters depending upon shipments to these customers, an
investor should not use these past results to predict our future results. We
base our current and future expenditures on our plans and estimates of future
revenues. Our expenses are, to a large degree, fixed. We may be unable to adjust
spending in a timely manner if we experience an unexpected shortfall in our
revenues or lose a significant key customer. We expect that our future quarterly
operating results will fluctuate significantly because of many factors, many of
which we do not control. These factors include:
o our ability to satisfy and retain existing customers and attract
new customers at a sufficient rate;
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o pricing competition, including, but not limited to, pricing which
results in no gross margin on certain products;
o our ability to acquire, price and market merchandise inventory
such that we maintain gross margins in our existing business and
in future product lines and markets;
o our ability to fulfill customer orders;
o the level of traffic at our web sites;
o the amount the Internet is used generally and, more specifically,
for the purchase of products such as those that we offer;
o our ability to upgrade and develop our systems and infrastructure
and attract new employees;
o the occurrence of technical or communications failures, system
downtime and Internet disruptions, including disruptions which may
be caused by periodic interruptions in electrical service;
o the amount and timing of operating costs and capital expenditures
that we incur to expand our business;
o governmental regulation and taxation policies;
o disruptions in service by common carriers such as United Parcel
Service or unanticipated increases in shipping and
transaction-processing costs; and
o general economic conditions, international economic conditions,
political instability, and economic conditions specific to the
Internet and the computer industry.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE.
Our operating results have fluctuated from quarter to quarter in the past, and
we expect that they will continue to do so in the future. Our earnings may not
continue to grow at rates similar to the growth rates achieved in recent years
and may fall short of either a prior fiscal period or investors' expectations.
Factors that could cause these quarterly fluctuations include the following: the
mix of products sold; pricing actions of competitors; the level of advertising
and promotional expenses; and seasonality, primarily because the sales and
profitability of the Company are typically slightly lower in the first and
second quarter of the fiscal year than in other quarters. Most of our operating
expenses, such as rent expense, advertising expense and employee salaries, do
not vary directly with the amount of sales and are difficult to adjust in the
short term. As a result, if sales in a particular quarter are below expectations
for that quarter, we may not proportionately reduce operating expenses for that
quarter, and therefore this sales shortfall would have a disproportionate effect
on our net income for the quarter.
WE MAY SUFFER SYSTEMS FAILURES AND BUSINESS INTERRUPTIONS.
Our success, especially our ability to receive and fulfill customer orders,
largely depends on the efficient and uninterrupted operation of our computer and
telephone communications systems. Almost all of our computer and communications
systems are located at a single leased facility. We have experienced temporary
power failures and telecommunications failures from time to time at this
facility. Our systems are vulnerable to damage from fire, earthquakes, floods,
power loss, telecommunications failures, break-ins and other events. Despite any
precautions we may take, the occurrence of natural disasters or other
unanticipated problems could cause system interruptions, delays and loss of
critical data and could prevent Northgate from providing services. Moreover,
although we have implemented network security measures, our servers are
vulnerable to computer viruses, physical or electronic break-ins, attempts by
third parties deliberately to exceed the capacity of our systems and similar
disruptions. Any of these events could lead to interruptions or delays in
service, loss of data or the inability to accept and confirm customer orders.
Generally, we do not have redundant systems or a formal disaster recovery plan,
and our coverage limits on our property and business interruption insurance may
not be adequate to compensate for losses that may occur.
8
WE FACE RISKS OF CAPACITY CONSTRAINTS.
We depend on the satisfactory performance, reliability and availability of our
web sites, transaction-processing systems, network infrastructure, customer
support center, and delivery and shipping systems. These factors are critical to
our reputation, our ability to attract and retain customers and to maintain
adequate customer service levels, and our operating results. Our production
facility has experienced periodic temporary capacity constraints from time to
time, and we may continue to experience capacity constraints at our customer
support center primarily related to inbound customer telephone inquiries.
Capacity constraints could prevent customers from gaining access to our on-line
stores or our customer support center for extended periods of time and decrease
our level of customer acquisition or retention. If we incur a significant
increase in revenues, we may be unable to increase our capacity at our customer
support center in a timely manner to handle the amount of customer telephone
inquiries.
WE FACE RISKS RELATING TO SYSTEMS DEVELOPMENT.
We are heavily dependent on our technological systems. Although we replaced our
transaction-processing systems in March 2002 and our phone system in November
2001, these systems are relatively new and untested. In the future, we may also
upgrade and expand our systems to add automated customer service, proactive
e-mail and customer feedback features to provide enhanced customer service, more
complete customer data and better management reporting information. These
efforts would require Northgate to integrate newly developed and/or purchased
technologies into our systems and to hire more engineering and information
technology personnel in the future. If we are unable in a timely manner to hire
required personnel, to add new software and hardware, or to upgrade our existing
systems to handle increased revenue, we could experience unanticipated system
disruptions, slower response times, degraded customer service and a decrease in
our ability to fulfill customer orders.
THE PERSONAL COMPUTER MARKET IS INTENSELY COMPETITIVE.
The personal computer industry continues to be rapidly evolving and intensely
competitive. In the past eighteen months, several companies have merged, been
sold or are repositioning themselves due to continued losses. Many of these
companies have larger financial resources than Northgate. We may not be
successful in competing against our present and future competitors. It is not
difficult to enter the computer industry, and we expect competition to increase
with soft demand for computer systems and excess capacity in the market.
Furthermore, competition has increased to the extent that mergers and
acquisitions result in companies with greater market share and revenues.
Increased competition, or failure by Northgate to compete successfully, is
likely to result in price reductions, fewer customer orders, reduced gross
margins, increased marketing costs, loss of market share, or any combination of
these problems. It is possible that increased competition or improved
performance by our competitors may reduce our market share, may reduce our
profit margin, and may adversely affect our business and financial performance
in other ways.
We believe that the principal competitive factors affecting our market are brand
name recognition, competitive pricing, quality of customer service, quality of
product information, and breadth of merchandise offerings. Although we believe
we compete adequately with respect to such factors, we cannot assure you that we
can maintain our competitive position against current and potential competitors,
especially those with greater financial, marketing, customer support, technical
and other resources. For instance, currently some competitors sell certain
products at or near the purchase price paid by them to acquire the products to
cover their fixed overhead costs. To improve our competitive position, we are
focused on increasing our level of customer service and maintaining competitive
pricing.
Current and potential competitors have established or may establish cooperative
relationships among themselves or directly with suppliers to obtain exclusive or
semi-exclusive sources of merchandise. New competitors or alliances among
competitors, or among competitors and suppliers, may emerge and rapidly acquire
market share. Many of our current and potential competitors have significantly
greater financial, marketing, customer support, technical and other resources
than we do. As a result, they may be able to secure merchandise from suppliers
on more favorable terms than we can, and they may be able to respond more
quickly to changes in customer preferences or to devote greater resources to the
development, promotion and sale of their merchandise than we can.
9
WE RELY HEAVILY ON CERTAIN MANUFACTURERS, DISTRIBUTORS AND SUPPLIERS.
We rely heavily on certain manufacturers, distributors and suppliers to supply
Northgate with merchandise for our production needs. We cannot assure you that
we will be able to develop and maintain satisfactory relationships with such
parties on acceptable commercial terms, or that we will be able to obtain
sufficient quality and quantities of merchandise at competitive prices. Also,
the quality of service provided by such parties may fall below the standard
needed to enable Northgate to conduct our business effectively. We acquire
products for sale both directly from manufacturers and indirectly through
distributors and suppliers. Purchases from one manufacturer of computers and
related computer products, accounted for approximately 15% of our aggregate
merchandise purchases for 2002. We have no long-term contracts or arrangements
with manufacturers, distributors or suppliers that guarantee the availability of
merchandise to us. We cannot assure you that current manufacturers, distributors
and suppliers will continue to sell merchandise to Northgate or otherwise
provide merchandise for sale, or that we will be able to establish new
manufacturer, distributor or supplier relationships that ensure merchandise will
be available to Northgate.
WE RELY HEAVILY ON CERTAIN OTHER THIRD PARTIES, INCLUDING INTERNET SERVICE
PROVIDERS, TELECOMMUNICATIONS COMPANIES AND DELIVERY COMPANIES.
Our operations depend on a variety of third parties for Internet access,
telecommunications, operating software, order fulfillment, merchandise delivery
and credit card transaction processing. We have limited control over these third
parties, and we cannot assure you that we will be able to maintain satisfactory
relationships with any of them on acceptable commercial terms. We cannot assure
you that the quality of products and services that they provide will remain at
the levels needed to enable Northgate to conduct our business effectively.
We rely on Internet service providers to connect our web site to the Internet.
From time to time, we have experienced temporary interruptions in our web site's
connections and also our telecommunications access. Frequent or prolonged
interruptions of these web site connection services could result in significant
losses of revenues. Our web site software depends on operating systems, database
and server software that were produced by and licensed from third parties. From
time to time, we have discovered errors and defects in such software and, in
part, we rely on these third parties to correct these errors and defects
promptly.
We use United Parcel Service as the primary delivery service for our products.
Our business would suffer if labor problems or other causes prevented this
carrier from delivering our products for significant time periods. Third-party
distribution centers fulfill a portion of the sales for which we are
responsible. Accordingly, any service interruptions experienced by these
distribution centers as a result of labor problems or otherwise could disrupt or
prevent the fulfillment of some of our customers' orders. In addition, we rely
on a single credit card processing service for the processing of credit card
transactions. If computer systems failures or other problems were to prevent our
credit card service from processing our credit card transactions, we would
experience delays and business disruptions. Any such delays or disruptions in
customer service may damage our reputation or result in a loss of customers.
We cannot assure you that we will be able to maintain satisfactory relationships
with any of these parties on acceptable commercial terms. Moreover, we have
limited control over these third parties, and we cannot assure you that the
quality of products and services that they provide will remain at the levels
needed to enable us to conduct our business effectively. In addition, we could
experience delays or business disruptions as a result of labor problems, systems
failures or other business interruptions suffered by these third parties. The
loss of these business relationships on favorable terms, or the inability or
unwillingness of these third parties to provide us with efficient and
cost-effective services, could adversely affect our results of operations.
10
WE MAY EVENTUALLY BE REQUIRED TO COLLECT SALES TAX FROM MOST OR ALL OF OUR
CUSTOMERS.
We currently collect sales tax on sales of products delivered to residents in
the state of California and drop-shipped from Ingram Micro to residents of
Massachusetts. Various states have tried to impose on direct marketers the
burden of collecting sales taxes on the sale of products shipped to state
residents. The United States Supreme Court affirmed its position that it is
unlawful for a state to impose sales tax collection obligations on an
out-of-state mail order company whose only contacts with the state are the
distribution of catalogs and other advertising materials through the mail and
subsequent delivery of purchased goods from out-of-state locations by parcel
post and interstate common carriers. It is possible that legislation may be
passed to supersede the Supreme Court's decision, or that the Court may change
its position. Additionally, it is uncertain whether any new rules and
regulations may be adopted, in terms of sales tax collection obligations, to
govern sales via electronic commerce as the Internet continues on its explosive
pace of growth and states face significant budget deficits. There have been
recent legislative initiatives to impose a standardized national sales tax on
e-commerce. The imposition of new sales tax collection obligations on Northgate
in states to which we ship products would result in additional administrative
expenses to Northgate. More importantly, though, we may lose one of our most
competitive advantages because of a higher total price of products for our
customers.
SHIPPING AND POSTAGE COULD INCREASE OUR OPERATING EXPENSES.
We ship our products to customers generally by United Parcel Service and other
overnight delivery and surface services. We generally invoice customers for
shipping and handling charges. If we are unable to pass on to our customers
future increases in the cost of commercial delivery services, our operating
results will be adversely affected. Moreover, any increases in postal costs
could have an adverse effect on our operating results.
WE FACE RISKS RELATING TO OUR INVENTORY.
We directly purchase the majority of the merchandise that we sell and we assume
the inventory, inventory obsolescence and price erosion risks for products that
we purchase directly. These risks are especially significant because much of the
merchandise we sell (computer hardware, software and consumer electronics) is
characterized by rapid technological change, obsolescence and price erosion. In
the recent past we have recorded charges for obsolete inventory, our inventory
turnover declined in 2002, and we have had to sell certain merchandise at a
discount or loss. It is impossible to determine with certainty whether an item
will sell for more than the price we pay for it. Because we rely heavily on
purchased inventory, our success will depend on our ability to liquidate our
inventory rapidly, the ability of our buying staff to purchase inventory at
attractive prices relative to its resale value, and our ability to manage
customer returns and the shrinkage resulting from theft, loss and mis-recording
of inventory. If we are unsuccessful in any of these areas, we may be forced to
sell our inventory at a discount or loss.
MOST MERCHANDISE SOLD BY US CARRIES A WARRANTY FROM THE MANUFACTURER OR THE
SUPPLIER, AND WE ARE NOT OBLIGATED TO ACCEPT MERCHANDISE RETURNS.
Nevertheless, we in fact have accepted returns from customers for which we did
not receive reimbursements from our manufacturers or suppliers, and the levels
of returned merchandise in the future might exceed our expectations. We may also
find that we have to accept more returns in the future to maintain customer
satisfaction. Merchandise returns as a percentage of total sales were 12.8% in
2002, 6.6% in 2001, and 8.6% in 2000.
OUR SYSTEMS ARE VULNERABLE TO SECURITY BREACHES.
A significant barrier to electronic commerce and communications is the secure
transmission of confidential information over public networks. We rely upon
encryption and authentication technology licensed from third parties to provide
secure transmission of confidential information. Northgate has experienced
security breaches in the past. Although we believe current security measures are
adequate, we cannot assure you that our security measures will prevent future
security breaches, and such breaches could expose the Company to operating
losses, litigation and possible liability. Advances in computer capabilities,
new discoveries in the field of cryptography or other events or developments may
result in a compromise or breach of the algorithms that we use to protect
customer transaction data. A party who is able to circumvent our security
measures could steal proprietary information or interrupt our operations. We may
11
need to spend a great deal of money and use other resources to protect against
the threat of such security breaches or to alleviate problems caused by such
breaches. Concerns over the security of on-line transactions and the privacy of
users may also inhibit the growth of the Internet generally, and the World Wide
Web in particular, especially as a means of conducting commercial transactions.
WE ARE VULNERABLE TO THE RAPID EVOLUTION OF THE COMPUTER INDUSTRY.
The computer industry is characterized by rapid technological change, changes in
user and customer requirements, frequent new service or product introductions
embodying new technologies, and the emergence of new industry standards and
practices. Changes in technology could render our existing inventory and
products obsolete. To remain competitive, we must continue to enhance and
improve our product offerings. Our success in achieving these goals depends on
our ability to develop or license new technologies and respond promptly and
cost-effectively to technological advances and emerging industry standards and
practices. The development, licensing, and production of computer products
involves significant technical, financial and business risks. We may not be
successful in developing, licensing or integrating new technologies or promptly
adapting our production methods, proprietary technology and
transaction-processing systems to customer needs or emerging industry standards.
WE ARE DEPENDENT ON THE CONTINUED DEVELOPMENT OF THE INTERNET INFRASTRUCTURE.
Approximately 15 percent of our 2002 revenue was derived from sales via the
Internet and the increased use of the Internet for commerce is essential for our
business to grow. Accordingly, our success depends on the continued development
of the infrastructure for providing Internet access and services. The Internet
could lose its viability or its usage could decline due to many factors beyond
our control, including:
o Delays in the development of the internet infrastructure;
o Power outages;
o the adoption of new standards or protocols for the Internet; or
o changes or increases in governmental regulation.
We cannot be certain that the infrastructure or complementary services necessary
to maintain the Internet as a useful and easy means of buying goods will be
developed or that, if they are developed, the Internet will remain a viable
marketing and sales channel for the types of products and services that we offer
at our on-line stores.
OUR DEBT LEVEL COULD IMPACT OUR ABILITY TO OBTAIN FUTURE FINANCING.
Our consolidated outstanding debt at December 31, 2002 was approximately $8.2
million. Our consolidated debt may have the effect generally of restricting our
flexibility in responding to changing market conditions and could make us more
vulnerable in the event of a downturn in our business. In addition, our level of
indebtedness may have other important consequences, including: restricting our
growth; making it more difficult for us to satisfy our obligations; limiting our
ability to borrow additional amounts for working capital, capital expenditures,
debt service requirements, future acquisitions or other corporate purposes; and
limiting our ability to use operating cash flow in other areas of our business.
In such a situation, additional funds may not be available on satisfactory terms
when needed, or at all, whether in the next twelve to eighteen months or
thereafter.
VOLATILITY IN THE UNITED STATES STOCK MARKET, THE NASD OTC MARKET, THE
TECHNOLOGY SECTOR, THE WORLD POLITICAL ENVIRONMENT, AS WELL AS OTHER FACTORS,
MAY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
The trading price of our common stock has been and may continue to be subject to
fluctuations in response to quarter-to-quarter variations in operating results,
announcements of technological innovations or new products introduced by
Northgate or our competitors and other events or factors. The trading price of
our common stock has been and may continue to be subject to fluctuations in
12
response to quarter-to-quarter variations in operating results, announcements of
technological innovations or new products introduced by us or our competitors,
limited trading volume of our securities on the Over-the-Counter Bulletin Board,
regulatory and judicial actions, and other events or factors. From January 2,
2002 through March 31, 2003, the closing price of our common stock has ranged
from a low of $0.12 per share to a high of $2.10 per share, as adjusted for the
10:1 reverse stock split. The stock market in general, and the shares of
technology companies in particular, have experienced extreme price fluctuations
in recent years. This volatility has had a substantial impact on the market
prices of securities issued by many companies for reasons unrelated to the
operating performance of the companies affected. These broad market fluctuations
may adversely affect the market price of our common stock.
OUR OPERATING RESULTS MAY BE IMPACTED BY CHANGES IN THE ECONOMY AND
INTERNATIONAL CONFLICT.
Our operating results are directly impacted by the health of the North American
and Asian economies. Current economic conditions and the current war with Iraq
may adversely affect our business and our results of OPERATIONS.
WE MAY FACE INTERRUPTION OF PRODUCTION AND SERVICES DUE TO INCREASED SECURITY
MEASURES IN RESPONSE TO TERRORISM.
Our business depends on the free flow of products and services through the
channels of commerce. Recently, in response to terrorist's activities and
threats aimed at the United States, transportation, mail, financial, and other
services have slowed or stopped altogether. Further delays or stoppages in
transportation, mail, financial or other services could have a material adverse
effect on our business, results of operations and financial condition.
Furthermore, we may experience an increase in operating costs, such as costs for
transportation, insurance and security, as a result of terrorists' activities
and potential activities. We may also experience delays in receiving payments
from payers that have been affected by the terrorist activities. Any general
economic downturn as a result of terrorist activities could adversely impact our
results of operations, impair our ability to raise capital or otherwise
adversely affect our ability to grow our business.
WE ARE DEPENDENT ON INTELLECTUAL PROPERTY.
Our performance and ability to compete depend to a significant degree on our
proprietary technology. We rely on a combination of trademark, copyright and
trade secret laws to establish and protect our proprietary rights. While we have
applied for trademark protection for the Mcglen.com name, we cannot assure you
that we will receive a registered trademark for this name in the United States,
or that competitors will not adopt similar marks, thereby impeding our ability
to build brand identity and possibly confusing customers. Existing copyright,
trademark, patent and trade secret laws afford only limited protection, and
intellectual property laws (particularly those of other countries) may be
inadequate to prevent misappropriation of our technology or other proprietary
rights. It might be possible for a third party to copy or otherwise obtain and
use our software or other proprietary information without authorization, or to
develop similar software independently. Policing unauthorized use of our
technology is difficult, particularly because the global nature of the Internet
makes it difficult to control the ultimate destination or security of software
or other data transmitted.
OUR INTELLECTUAL PROPERTY MAY INFRINGE ON THAT OF OTHERS AND EXPOSE US TO COSTS
RELATED TO LITIGATION.
In the systems and software industries, it is common that companies receive
notices from time to time alleging infringement of patents, copyrights or other
intellectual property rights of others. We may from time to time be notified of
claims that we may be infringing upon patents, copyrights or other intellectual
property rights owned by third parties. Companies may pursue claims against us
with respect to the alleged infringement of patents, copyrights or other
intellectual property rights owned by third parties. Although we believe we have
not violated or infringed upon any intellectual property rights and have taken
measures to protect our own rights, there is no assurance that we will avoid
litigation. Litigation may be necessary to protect our intellectual property
rights and trade secrets, to determine the validity of and scope of the
proprietary rights of others or to defend against third party claims of
invalidity. Any litigation could result in substantial costs and diversion of
resources away from the day-to-day operation of our business.
13
A SUBSTANTIAL PORTION OF OUR STOCK IS HELD BY THREE PARTIES.
Upon completion of our reverse merger with Lan Plus Corporation in March 2002,
its shareholders, Andy Teng, Richard Shyu and the Lan Plus Corporation ESOP
influence all fundamental matters affecting Northgate. As of March 31, 2003,
these three entities/persons controlled approximately 75% of the total combined
voting power of the outstanding common stock, on a fully diluted basis.
Accordingly, they are able to wield considerable influence in, among other
things, determining the outcome of corporate decisions, effecting corporate
transactions (including mergers, consolidations and the sale of all or
substantially all of our assets), or preventing or causing a change in control
in the company.
WE ARE EXPOSED TO THE RISKS OF A GLOBAL MARKETPLACE.
A significant portion of our products are either produced in, or have major
components produced in, the Asia Pacific region. We have business relationships
with companies located in the region directly, and we engage in U.S. Dollar
denominated transactions with these companies and U.S. divisions and
subsidiaries of these companies. As a result, we may be indirectly affected by
risks associated with international events, including economic and labor
conditions, political instability, tariffs and taxes, availability of products
and currency fluctuations in the U.S. Dollar versus the regional currencies.
Countries in the Asia Pacific region, including Japan, have experienced
weaknesses in their currency, banking and equity markets from time to time.
These weaknesses could adversely affect the supply and prices of products and
components and, ultimately, our results of operations.
THE ISSUANCE OF ADDITIONAL PREFERRED STOCK COULD AFFECT VOTING RIGHTS OR DELAY
OR PREVENT A CORPORATE TAKEOVER.
Our Board of Directors is authorized to determine the rights and restrictions
granted to and imposed upon our preferred stock. They can decide the number of
shares of any series of preferred stock and the designation of any such series.
Our Board of Directors may authorize and issue additional preferred stock with
voting or conversion rights that could adversely affect the voting power or
other rights of the holders of common stock. In addition, the potential issuance
of preferred stock may:
o have the effect of delaying, deferring or preventing a change in
control of the company;
o discourage bids for the common stock at a premium over the market
price of the common stock; and
o adversely affect the market price of the common stock.
THE SUCCESS OF THE COMPANY DEPENDS ON ITS ABILITY TO RETAIN KEY PERSONNEL.
The success of the Company depends in a large part on the continued service of
key personnel. Despite its efforts to hire and retain quality employees, the
Company might lose some of its key employees. Competitors may recruit key
employees who could take key customers with them. As a result, the company may
be required to provide significant incentives for some employees to remain with
the Company.
Similarly, the future performance of the Company depends on its continuing
ability to attract and retain highly qualified technical and managerial
personnel. Competition for qualified management, engineering, technical, sales
and marketing employees is intense. If employees leave, or if the Company cannot
attract and retain qualified personnel, the Company's business would be harmed.
FROM TIME TO TIME NORTHGATE HAS INVESTED IN SHORT SALES OF SECURITIES
Northgate's management routinely invested the Company's excess operating funds
in the stock market. From time to time, management invests these funds in short
sales of stock that they typically cover within 60 days of the date of the short
purchase. Short sales typically have a higher degree of risk than traditional
stock purchases and management attempts to limit the concentration of short
sales in the Company's overall invested and cash portfolio. At December 31,
14
2001, approximately $426,000 was invested in short sales of common stock and
unrealized losses of $102,000 were recorded on these investments. Management
covered the December 31, 2001 short sale in January and April 2002, recording a
loss of $60,000. The Company had no such investments at December 31, 2002.
ITEM 2. PROPERTIES
In September 2002, we moved our operations to a 80,000 square foot warehouse,
located in the City of Industry, California. Prior to this time, the Company
leased a 47,000 square foot warehouse from its CEO and Chairman. The Company
believes that its present facilities are adequate for its current needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is not presently a party to any pending litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Northgate's common stock is traded on the Over-the-Counter Bulletin Board under
the symbol "NGTE." The following table sets forth the range of the high and low
closing sales prices for our common stock, for the periods indicated, as
reported by the Nasdaq SmallCap Market (for periods on and prior to April 12,
2001) and the Over-the-Counter Bulletin Board (for periods after April 12,
2001). Quotations reflect inter-dealer prices without retail mark-ups,
mark-downs or commissions and may not necessarily represent actual transactions:
Price Range of Common Stock
---------------------------
High Low
------ ------
Year Ended December 31, 2001
----------------------------
FIRST QUARTER $0.88 $0.16
SECOND QUARTER $0.33 $0.10
THIRD QUARTER $0.27 $0.09
FOURTH QUARTER $0.21 $0.07
Year Ended December 31, 2002
----------------------------
FIRST QUARTER $0.03 $1.15*
SECOND QUARTER* $0.55 $1.00
THIRD QUARTER* $0.08 $0.90
FOURTH QUARTER* $0.16 $0.51
* The pricing of the Company's stock beginning March 28, 2002 reflects a 10:1
reverse stock split that was effective upon close of the Company's merger with
Lan Plus Corporation.
On April 14, 2003, the closing price of the Company's Common Stock as reported
on the Over the Counter Market was $0.17 per share. On April 14, 2003, there
were 116 holders of record of our Common Stock.
15
The Company has never paid cash dividends on its Common Stock, and does not
anticipate paying cash dividends on its Common Stock in the future. The Company
intends to retain its earnings to finance the growth and development of its
business.
In March 2002, we entered into a corporate consulting agreement with Investor
Relation Resources ("IRR"). In exchange for various corporate consulting and
public relations services, we agreed to issue 10,000 shares of the Company's
common stock. The Company 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 of 1934 pursuant to Section 4(2).
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data has been derived from the
financial statements of the Company, which have been prepared in accordance with
United States generally accepted accounting principles. The consolidated
financial statements of the Company for the year ended December 31, 2002, and as
of December 31, 2002, and the related report of Corbin & Company LLP are
included elsewhere in this report. The financial statements for the years ended
December 31, 2001 and 2000, and as of December 31, 2001, and the related report
of Singer Lewak Greenbaum & Goldstein LLP are included elsewhere in this report.
The financial statements as of December 31, 2000, 1999 and 1998, and for the
years ended December 31, 1999 and 1998 , have been derived from financial
statements audited by Singer Lewak Greenbaum & Goldstein LLP. The following data
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the financial statements
included elsewhere in this report.
YEAR ENDED DECEMBER 31,
1998 1999 2000 2001 2002
--------- --------- --------- --------- ---------
(in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Net sales ................................ $ 78,919 $ 87,158 $ 69,101 $ 73,883 $ 65,176
Cost of sales ............................ 69,718 76,845 60,326 64,872 57,589
--------- --------- --------- --------- ---------
Gross profit ............................. 9,201 10,313 8,775 9,011 7,587
Selling, general and administrative ... 6,186 10,176 7,700 7,273 8,032
--------- --------- --------- --------- ---------
Income (loss) from operations ......... 3,015 137 1,075 1,738 (445)
Other (income) expense ............... (46) (282) 202 (217) 268
Income (loss) before income taxes ........ 3,061 419 873 1,955 (713)
Provision for income taxes ............... 1,060 173 358 467 (870)
--------- --------- --------- --------- ---------
Net income ............................... $ 2,001 $ 246 $ 515 $ 1,488 $ 157
========= ========= ========= ========= =========
Basic income per share ................... $ 0.20 $ 0.02 $ 0.05 $ 0.15 $ 0.01
========= ========= ========= ========= =========
Diluted income per share ................. $ 0.20 $ 0.02 $ 0.05 $ 0.13 $ 0.01
========= ========= ========= ========= =========
Weighted average shares of common stock
outstanding:
Basic ................................. 9,854 9,854 9,854 9,854 13,694
========= ========= ========= ========= =========
Diluted .............................. 10,129 10,129 10,714 11,305 15,145
========= ========= ========= ========= =========
DECEMBER 31,
1998 1999 2000 2001 2002
--------- --------- --------- --------- ---------
Balance Sheet Data:
Cash and cash equivalents ................ $ 51 $ 1,307 $ 2,884 $ 8,555 $ 2,135
Working capital .......................... 2,629 5,483 3,836 5,245 3,199
Total assets ............................. 19,688 20,775 13,913 24,091 16,014
Long-term debt ........................... -- 11,303 9,880 9,263 8,050
Total stockholders' equity (deficit) ..... 2,946 (5,412) (5,609) (3,238) 1,258
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the Company's financial condition and
results of operations should be read in conjunction with the Company's
consolidated financial statements and notes thereto included elsewhere herein.
The following table sets forth for the periods indicated the percentage of net
sales represented by certain items reflected in the Company's consolidated
statements of operations. There can be no assurance that the trends in sales
growth or operating results will continue in the future.
OVERVIEW
Northgate is a leading marketer of personal computers, or PCs, and related
products and services and manufactures, markets, and supports a broad line of
desktop PCs, servers and workstations used by individuals, families, businesses,
government agencies and educational institutions. The Company also offers
diversified products and services such as software, peripherals, Internet access
services, support programs and general merchandise.
Net sales of the Company are primarily derived from the sale of personal
computer hardware, software, peripherals and accessories. Gross profit consists
of net sales less product and shipping costs.
On March 20, 2002, the Company closed its merger with Lan Plus. At the closing
of the merger, Lan Plus shareholders received a number of shares such that they
now own approximately 75% of the Company. In addition, at the close of the
merger, the Company also instituted a 10:1 reverse stock split and changed its
name to Northgate Innovations, Inc. Pursuant to the merger agreement, upon close
of merger, the Company's accounts payable to, and advances from Lan Plus, in the
amount of approximately $2.3 million was converted to common stock eliminating
the debt; the stock was then retired to Treasury and cancelled. The Company has
reported combined operations with Lan Plus beginning with its 10-Q for the
period ended March 31, 2002.
The Company purchases a substantial percentage of its products from a single
manufacturer. Purchases from this manufacturer accounted for more than 15% of
our aggregate merchandise purchases for 2002. The Company has no long-term
contracts or arrangements with this manufacturer, or other vendors, that
guarantee the availability of merchandise.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses Northgate's consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an on-going basis, management evaluates its
estimates and judgments, including those related to customer incentives, product
returns, bad debts, inventories, intangible assets, financing operations,
warranty obligations, and contingencies and litigation. Management bases its
estimates and judgments on historical experience and on various other factors
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
Management believes the following critical accounting policies, among others,
affect its more significant judgments and estimates used in the preparation of
its consolidated financial statements.
17
ALLOWANCE FOR DOUBTFUL ACCOUNTS: Northgate maintains allowances for doubtful
accounts for estimated losses resulting from the inability of its customers to
make required payments. If the financial condition of Northgate's customers were
to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. Northgate provides for the estimated cost
of product warranties at the time revenue is recognized.
WARRANTIES: While certain of the products Northgate sells are covered by third
party manufacturer warranties, Northgate may have products returned by customers
that Northgate may not be able to recover from the manufacturer. Returns of this
nature have been immaterial in the past; however, should actual product failure
rates increase or the manufacturers go out of business, Northgate may be forced
to cover these warranty costs and the costs may differ from Northgate's
estimates.
INVENTORY: Northgate writes down its inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost of inventory and
the estimated market value based upon assumptions about future demand and market
conditions. If actual future demand or market conditions are less favorable than
those projected by management, additional inventory write-downs may be required.
PURCHASE AND ADVERTISING REBATES: We earn rebates from our vendors which are
based on various quantitative contract terms. Amounts expected to be received
from vendors relating to the purchase of merchandise inventories are recognized
as a reduction of cost of goods sold as the merchandise is sold. Amounts that
represent a reimbursement of incremental costs, such as advertising, are
recorded as a reduction to the related expense in the period that the related
expense is incurred. Several controls are in place that we believe allow us to
ensure that these amounts are recorded in accordance with the terms of the
contracts. Should vendors reach different judgments regarding the terms of these
contracts, they may seek to recover amounts from us.
IMPAIRMENT OF LONG-LIVED ASSETS: We review our long-lived assets for impairment
when indicators of impairment are present and the undiscounted cash flow
estimated to be generated by those assets are less than the assets' carrying
amount. If actual market conditions are less favorable than management's
projections, future write-offs may be necessary.
IMPAIRMENT OF GOODWILL AND INDEFINITE LIVED INTANGIBLE ASSETS: As a result of
our adoption of Statement of Financial Accounting Standards No. 142 "Goodwill
and Other Intangible Assets" ("SFAS No. 142"), we now annually review goodwill
and other intangible assets that have indefinite lives for impairment and when
events or changes in circumstances indicate the carrying value of these assets
might exceed their current fair values. These reviews require the Company to
estimate the fair value of its 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 the Company's stock price.
DEFERRED TAXES: We record a valuation allowance to reduce our deferred tax
assets to the amount that is more likely than not to be realized. We have
considered estimated future taxable income and ongoing tax planning strategies
in assessing the amount needed for the valuation allowance. If actual results
differ unfavorably from those estimates used, we may not be able to realize all
or part of our net deferred tax assets and additional valuation allowances may
be required.
RESULTS OF OPERATIONS
The following table sets forth for the years indicated the percentage of net
sales represented by certain items reflected in the Company's consolidated
statements of operations. There can be no assurance that the trends in sales
growth or operating results will continue in the future. The discussion of the
"Results of Operations" includes both Northgate and Mcglen since the date of
merger, March 15, 2002.
18
PERCENTAGE OF NET SALES
YEAR ENDED DECEMBER 31,
2002 2001 2000
------ ------ ------
Net sales 100.0% 100.0% 100.0%
Cost of sales 88.4 87.8 87.3
------ ------ ------
Gross profit 11.6 12.2 12.7
Operating expenses 12.3 9.8 11.1
------ ------ ------
Operating (loss) income (0.7) 2.4 1.6
Other (income)expense, net 0.4 (0.3) 0.3
------ ------ ------
(Loss) income before income taxes (1.1) 2.7 1.3
(Benefit) provision for income taxes (1.3) 0.7 0.5
------ ------ ------
Net income 0.2% 2.0% 0.8%
====== ====== ======
YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31, 2001
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 also
competition in the marketplace. The fourth quarter of 2002 was significantly
impacted by price reductions in the marketplace by competitors such as Dell and
Gateway as well as reduction in consumer demand. In addition, in the fourth
quarter of 2002 the Company's airtime on one of the home shopping networks
decreased significantly as compared to the prior year.
Gross profit decreased by $1.4 million or 15.6% to $7.6 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
sales. Gross profit, as a percentage of net sales decreased to 11.6% 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
the two companies following the merger; an increase in costs due to integration
of the Company's new enterprise software in 2002; and less units being produced
in 2002 as compared to 2001.
On a forward-looking basis, future gross profit margins may fluctuate
from recent levels. The statement concerning future gross profit is a forward
looking statement that involves certain risks and uncertainties which could
result in a fluctuation of gross margins below those achieved for the year ended
December 31, 2002. Although the Company believes it provides a high level of
value and added services, pricing and gross profit could be negatively impacted
by the activities of larger computer manufacturers.
Operating expenses 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 a increase in payroll and related
costs and an increase in advertising costs in 2002. ESOP compensation expense
decreased by $0.2 million for the year ended December 31, 2002 as the Company
did not make an discretionary ESOP contribution in 2002. Payroll and related
costs (e.g., employer taxes, health and workers compensation insurance)
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 as the Company exceeded sales
forecasts through September 2002. Advertising expense increased by approximately
$250,000 in 2002 as Northgate received less market development funds from OEM
suppliers such as Intel. Northgate also increased its print advertising
expenditures as the Company began to advertise the Northgate brand.
Other (income) expense decreased by approximately $485,000 or 223.5%,
to $268,000 for the year ended December 31, 2002, from ($217,000) for the prior
year. The increase was partially due to decreased gains on the Company's
marketable securities portfolio in 2002 and lower interest income in 2002. In
addition, during the fourth quarter of 2002 the Company reviewed its MSN royalty
accrual and determined that the accrual was overstated by approximately $1.0
million; the result was an increase in other income by $1.0 million.
Additionally, also in the fourth quarter of 2002, the Company reviewed its
marketable securities portfolio for permanent impairment. Due to the overall
decline in the stock and bond markets from when the Company purchased the
investments, as well as specific factors affecting individual investments within
the portfolio, the Company recorded a $827,000 loss on its marketable securities
portfolio.
Income tax (benefit) provision for the year ended December 31, 2002
was ($870,000) versus a provision of $467,000 for the year ended December 31,
2001. The effective tax rate for 2002 decreased to (122.0%) from 23.9% in 2001
primarily as a result of certain changes in the estimates for the Company's past
income tax liabilities.
19
YEAR ENDED DECEMBER 31, 2001 COMPARED TO THE YEAR ENDED DECEMBER 31, 2000
Net sales increased by $4.8 million, or 6.9%, to $73.9 million for the
year ended December 31, 2001, compared to $69.1 million for the year ended
December 31, 2000. The increase in net sales was a result of an increase in the
number of computer systems shipped during the year ended December 31, 2000,
mainly in the fourth quarter of 2001. Northgate recorded record revenues for the
fourth quarter of 2001 as compared to prior years.
Gross profit increased by $0.2 million or 2.3% to $9.0 million for the
year ended December 31, 2001, compared to $8.8 million for the year ended
December 31, 2000. The increase in gross profit was due to the increase in
sales. Gross profit, as a percentage of net sales decreased to 12.2% for the
year ended December 31, 2001 from 12.7% for the year ended December 31, 2000.
The decrease in gross profit margin was due to lower royalties paid during 2000,
Lan Plus developing more relationships with original equipment manufacturers
(OEM) that provide component products at lower costs than distributors, and the
acquisition of new customers in 2001with sales at a higher margin.
Operating expenses decreased by $0.4 million or 5.2%, to $7.3 million
for the year ended December 31, 2001, from $7.7 million for 2000. The decrease
in operating expenses was attributable to a $640,000 decrease in bad debt
expense in 2001. In 2000, one of the Company's largest accounts filed for
bankruptcy resulting in the Northgate writing off more than $1.0 million for
this account. In 2001, a customer closed resulting in approximately $300,000 of
write-offs. The decrease in bad debt expense was offset with a $180,000 increase
in payroll and payroll related costs due to a higher average headcount in 2001
as compared to 2000; a $200,000 increase in the Company's ESOP expense in 2001
as the discretionary contribution increased in 2001 as compared to 2000; and a
$100,000 increase in professional fees, primarily related to the merger of the
Company and Mcglen.
Other (income) expense increased by $419,000 or 207.4%, to ($217,000)
for the year ended December 31, 2001, from $202,000 for the prior year. The
increase was a result of lower interest costs associated with Lan Plus' ESOP due
to a reduction in the average amount outstanding during the year as well as a
decrease in the ESOP loan interest rate from 8% to 6%. Additionally, the Company
recorded larger capital gains on its investments in 2001 as compared to 2000.
Income tax provision for the year ended December 31, 2001 was $467,000
versus a provision of $358,000 for the year ended December 31, 2000. The
effective tax rate for 2001 decreased to 23.9% from 41.0% in 2000. The decrease
in income taxes was a result of increased ESOP contributions in 2001 as compared
to 2000.
INCOME TAXES
For the three years ended December 31, 2002, the difference between the amount
of income tax recorded and the amount of income tax expense calculated using the
federal statutory rate of 34% is due to state income taxes and other permanent
differences.
As a result of the Company's reverse merger in March 2002, the Company has
federal and state net operating loss carryforwards of approximately $16 million
and $10 million. The net operating loss carryforwards will expire at various
dates beginning in 2012 through 2022 for federal purposes and 2003 through 2009
for state purposes, if not utilized. Utilization of the net operating loss
carryforwards is subject to a substantial annual limitation due to the ownership
change limitations provided by the Internal Revenue Code of 1986, as amended,
and similar state provisions. The annual limitation will result in the Company
being able to only utilize $3.8 million and $0.5 million, to offset federal and
state income, respectively as of December 31, 2002. The remaining net operating
loss carryforwards will go unused.
LIQUIDITY AND CAPITAL RESOURCES
Northgate's primary capital need has been the funding of working capital
requirements created by its growth. Historically, Northgate's primary sources of
financing have been cash provided by operations and borrowings from private
investors and financial institutions. Cash (used in) provided by operations was
20
approximately ($2.8 million), $3.5 million, and $5.0 million for the three years
ended December 31, 2002. Cash was used to pay down Northgate's working capital
obligations during the year ended December 31, 2002.
During the year ended December 31, 2002, Northgate's capital expenditures were
approximately $337,000 compared to $511,000 for the same period in 2001,
primarily for computer hardware and leasehold improvements related to
Northgate's new facility that it occupied in September 2002.
The Company has a $2,500,000 line of credit with a bank. The line of credit
provides for borrowings secured by substantially all of the Company's assets and
is guaranteed by the Company's majority shareholder. Borrowings under the line
are advanced based upon 70% of eligible accounts receivable, as defined, less
any letters of credit issued on the Company's behalf. The line of credit was
extended in February, 2003 and expires April 30, 2003. Advances under the line
bear interest at the bank's prime rate plus 0.5% (4.75% at December 31, 2002).
The line contains certain covenants that required Northgate to maintain
profitability in the third and fourth quarter of 2002, a minimum of ($4.25
million) tangible net worth (as defined), a Current Ratio of at least 1.2:1,
Working Capital of at least $2.5 million, and limits the capital expenditures
the Company can make in any one year to $750,000. At December 31, 2002,
approximately $1.0 million of the Company's short term investments were held as
collateral for letters of credit taken out to secure open account terms with one
of the Company's primary vendors. The Company believes that current working
capital, together with cash flows from operations and available lines of credit,
will be adequate to support the Company's current operating plans through 2003.
In August 2002, the Company renegotiated its $1.3 million note payable,
extending the due date to January 1, 2005. In September 2002, the Company
reached a settlement with the Mcglen line of credit holder whereby Northgate
repaid $40,000 of the $90,000 due under the line. The resulting gain of $50,000
is included in other income for the year ended December 31, 2002.
In September 2002, the Company paid the $186,000 dividends payable to holders of
the Company's preferred stock, and funded $1,067,000 to the Company's ESOP to
reduce the ESOP note.
At December 31, 2002 and 2001, the Company had cash and short-term investments
of $2.3 million and $8.6 million, respectively, and working capital of $3.2
million and $5.2 million, respectively. However, if the Company needs extra
funds, such as for acquisitions or expansion or to fund a significant downturn
in sales that causes losses, there are no assurances that adequate financing
will be available at acceptable terms, if at all. The Company operates in a very
competitive market against many companies that are substantially larger than
Northgate. Pricing and gross profit could be negatively impacted by the
activities of larger computer manufacturers and product supply and demand in the
market.
Northgate's management has routinely invested excess operating funds in the
stock market. From time to time, management invests these funds in short sales
of stock that they typically cover within 60 days of the date of the short
purchase. Short sales typically have a higher degree of risk than traditional
stock purchases and management attempts to limit their concentration in
Northgate's overall invested and cash portfolio. At December 31, 2001,
approximately $426,000 was invested in short sales of common stock and an
unrealized loss of $102,000 was recorded on these investments. Management
covered the short sales in January and April 2002 recording a loss of $60,000.
The Company had no such investments at December 31, 2002.
Since computer retailers typically have low product gross margins, Northgate's
ability to remain profitable is dependent upon its ability to continue to drive
down the cost of its computer systems through its product sourcing, inventory
management and labor management systems. To the extent that Northgate does not
continue to effectively manage its business, Northgate may be materially
adversely affected. Northgate may also experience significant fluctuations in
its future operating results due to a variety of factors, many of which are
outside its control.
Factors that may affect its operating results include: the frequency and success
of new product introductions, mix of product sales and seasonality of sales
typically experienced by retailers, political unrest, and the pricing of
component parts in the world-wide marketplace. Many of Northgate's competitors
offer broader product lines, have substantially greater financial, technical,
marketing and other resources than Northgate and may benefit from component
volume purchasing arrangements that are more favorable in terms of pricing and
component availability than the arrangements enjoyed by the Company. Sales in
the computer retail industry are significantly affected by the release of new
products. Infrequent or delayed new product releases can negatively impact the
overall growth in retail sales.
21
As part of its growth strategy, Northgate may, in the future, acquire other
companies, in the same or complementary lines of business. Any such acquisition
and the ensuing integration of the operations of the acquired company with those
of Northgate would place additional demands on Northgate's management, and
operating and financial resources.
INFLATION AND SEASONALITY
While neither inflation nor deflation has had, nor do we expect it to have, a
material impact upon operating results, there can be no assurance that our
business will not be affected by inflation or deflation in the future. We
believe that our business is somewhat seasonal, with sales and profitability
slightly lower during the first and second quarters of our fiscal year.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities", an interpretation of Accounting
Research Bulletin 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 46, consolidation
generally occurred when an enterprise controlled another entity through voting
interests. FIN 46 is effective immediately for all new variable interest
entities created or acquired after January 31, 2003. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN 46
must be applied for the first interim or annual period beginning after June 15,
2003. The Company does not expect FIN 46 to have a material impact on its
financial statements as it has no variable interest entities.
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment of FASB Statement No. 123." SFAS 148 amends SFAS 123
to provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition guidance and annual disclosure
provisions of SFAS 148 are effective for financial statements issued for fiscal
years ending after December 15, 2002. The interim disclosure provisions are
effective for financial reports containing financial statements for interim
periods beginning after December 15, 2002. The Company has applied the
disclosure provisions in SFAS 148 in its consolidated financial statements and
the accompanying notes.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN 45 elaborates on the disclosures to
be made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and initial measurement provisions of FIN 45
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements in FIN 45 are effective for
financial statements of interim or annual periods ending after December 15,
2002. The Company does not expect FIN 45 to have a material impact on its
financial position or results of operations as it does not act as a guarantor.
In June 2002, the FASB issued Statement of Financial Accounting Standards No.
146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 requires recording costs associated with exit or disposal
activities at their fair values when a liability has been incurred. Under
previous guidance, certain exit costs were accrued upon management's commitment
to an exit plan, which is generally before an actual liability has been
incurred. Adoption of SFAS 146 is required with the beginning of fiscal year
2003. The Company does not anticipate a significant impact on its results of
operations from adopting this Statement.
22
ITEM 7A. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We are exposed to market risk from changes in interest rates. We have a risk
management control process to monitor our interest rate risk. The risk
management process uses analytical techniques, including market value,
sensitivity analysis, and value at risk estimates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements listed below are included on pages F-1
through F-22 following the signature page to this report:
Page
----
Independent Auditors' Reports F-1
Consolidated Financial Statements:
Balance Sheets as of December 31, 2002 and 2001 F-3
Statements of Income for the Years Ended December
31, 2002, 2001 and 2000 F-4
Statements of Stockholders' Equity (Deficit) and Comprehensive
Income (Loss) for the Years Ended December 31, 2002, 2001 and 2000 F-5
Statements of Cash Flows for the Years Ended December 31, 2002,
2001 and 2000 F-6
Notes to Consolidated Financial Statements F-7
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
In connection with the reverse acquisition of Mcglen in March 2002, the Board of
Directors of Northgate changed accountants to Corbin & Wertz replacing Mcglen's
prior accountants, BDO Seidman, LLP, and Lan Plus' prior accountants, Singer,
Lewak, Greenbaum and Goldstein LLP. Such change was reported on Form 8-K filed
May 15, 2002. On January 9, 2003, in connection with a reorganization of Corbin
& Wertz, the Company filed another Form 8-K reporting a change in accountants to
Corbin & Company, LLP. There were no disagreements with the Company's current or
prior accountants.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
INFORMATION RELATING TO EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information relating to our current
executive officers and directors*:
Name Age Position
---- --- --------
Andy Teng 49 Chairman of the Board, Chief Executive Officer and
Secretary
Richard Shyu 37 President and Director
Mike Chen 30 Director
Grant Trexler 41 Chief Financial Officer
23
ANDY TENG was elected our Chairman of the Board, Chief Executive Officer and
Secretary on March 20, 2002. He has served as Chairman of the Board and Chief
Executive Officer of Lan Plus Corporation since March 1992. From March 1992 to
September 2000, Mr. Teng also served as Lan Plus' President. Prior to purchasing
Lan Plus, Mr. Teng was the President and principal shareholder of Syntax
Computers, Inc. from 1987 to 1992. From 1985 to 1987, Mr. Teng was the President
and principal shareholder of Anncoa Chemical Company. Mr. Teng holds Masters and
Bachelor of Science degrees from Texas A&M University.
RICHARD SHYU was elected our President and to our board of directors on March
20, 2002. He has served as President of Lan Plus Corporation since September
2000, and as Lan Plus' Vice President of Sales and Marketing since 1996. Prior
to joining Lan Plus in August 1992, Mr. Shyu served as the General Manager of
DTC, Inc., a mainboard distributor located in Pico Rivera, California, servicing
VARs, instructional buyers and regional retail chain stores for two years. From
1988 to 1990, Mr. Shyu co-owned and managed a real estate development company
and also worked for Unisys Corporation designing Fault Tolerant SCSI Storage
Systems for the financial industry. Mr. Shyu holds a Bachelor of Science degree
in Electrical Engineering from California Polytechnic State University - Pomona
and later continued his post graduate studies in Computer Engineering at the
University of Southern California.
MIKE CHEN is one of our founders and served as our Chief Executive Officer from
January 2001 until the election of Mr. Teng in March 2002. Mr. Chen has served
as our President, Chief Technology Officer, and Secretary from May 1996 to March
2002. Mr. Chen has served as a director of the Company since May 1996. Prior to
founding the Company in 1996, he was an independent software programmer. Mr.
Chen received his Bachelor of Science in Electrical Engineering and Computer
Science in 1995 from the University of California at Berkeley.
GRANT TREXLER has served as our Chief Financial Officer since January 2000.
Prior to this, Mr. Trexler served as the Director of Finance and Administration
for El Monte RV, the nation's second largest motor home rental dealer, beginning
in July 1996. From August 1994 through May 1996, Mr. Trexler was the CFO of
Creative Computers, which completed its initial public offering and one
follow-on offering during this period. At Creative Computers, he was responsible
for implementing internal accounting and budgeting systems, financial reporting,
and financial due diligence. Prior to joining Creative, Mr. Trexler spent nine
years at PricewaterhouseCoopers, most recently as a Senior Manager in its
Mergers and Acquisitions group. Mr. Trexler holds Masters in Business
Administration and Bachelor of Arts degrees from California Polytechnic State
University - San Luis Obispo, and is a Certified Public Accountant.
* There are no family relationships among any of our directors or executive
officers.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Our board does not currently have a compensation committee or a committee
performing similar functions. Our board of directors as a whole performs all
functions relating to executive compensation. None of our executive officers
serves as a member of the board of directors or compensation committee of any
entity that has one or more executive officers serving on our board of
directors.
SECTION 16(a) REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's executive officers and
directors, among others, to file certain beneficial ownership reports with the
Securities and Exchange Commission. The Company believes that no late filings
were made, or that there have been any failures to file any required reports, by
its executive officers and directors.
ITEM 11. EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth the names, positions and
annual compensation paid by the Company for the years ended December 31, 2002,
2001,and 2000, to Andy Teng, our Chairman and Chief Executive Officer, Richard
Shyu, our President, and Grant Trexler, our Chief Financial Officer.
24
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM
COMPENSATION
AWARDS
Fiscal All Other Securities Underlying
Name and Position Year Salary ($) Bonus ($) Compensation ($) Options (#)(1)
- ----------------- ---- ---------- --------- ---------------- --------------
Andy Teng, Chief Executive Officer 2002 154,000 - - -
2001 106,000 1,200 - -
2000 173,000 - - -
Richard Shyu, President 2002 153,000 - 7,000(2) -
2001 60,000 2,000 5,000(2) -
2000 57,000 - 6,000(2) -
Grant Trexler, Chief Financial Officer 2002 120,000 - 3,000(3) 25,000
2001 123,900 25,000 12,200(3) -
2000 122,200 - 10,150(3) 15,000
(1) Reflects the Company's 10:1 reverse stock split in March 2002.
(2) Reflects an automobile allowance paid by the Company on Mr. Shyu's behalf.
(3) Reflects a health insurance allowance and an automobile allowance paid by
the Company to Mr. Trexler.
The following table sets forth certain information with respect to all stock
options granted by the Company during the last fiscal year to Messrs. Teng, Shyu
and Trexler:
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
% of Total Options
Number of Securities Granted to Exercise
Fiscal Underlying Options Employees Price Expiration
Name Year Granted in Fiscal Year ($/Sh) Date
---- ---- ------- -------------- ------ ----
Andy Teng 2002 - - - -
Richard Shyu 2002 - - - -
Grant Trexler 2002 25,000 4.9% $0.35 6/20/07
(1) Reflects the Company's 10:1 reverse stock split in March 2002.
The following table sets forth certain information with respect to the exercise
of stock options during the last fiscal year and the value of unexercised stock
options held by Messrs. Teng, Shyu and Trexler at December 31, 2002:
AGGREGATED OPTION EXERCISES IN LAST
YEAR AND YEAR-END (YE) OPTION VALUES
Number of Securities
Underlying Unexercised Value of Unexercised
Fiscal Shares Acquired Value Options at YE In-the-Money Options YE ($)
Name Year On Exercise (#) Realized Exercisable/Unexercisable Exercisable/Unexercisable
---- ---- --------------- -------- ------------------------- -------------------------
Andy Teng 2002 None N/A None -
Richard Shyu 2002 None N/A None -
Grant Trexler 2002 None N/A 15,000/25,000 -
25
DIRECTORS' COMPENSATION
Non-employee directors receive a fee of $750 for each meeting of the Board
attended, no additional fees for any meetings of any committee of the Board
attended, and reimbursement of their actual expenses. Directors who are also our
employees are not paid any fees or additional remuneration for their service as
members of the Board of Directors.
EXECUTIVE OFFICER EMPLOYMENT CONTRACTS
On January 17, 2000 we entered into a three-year employment agreement with Grant
Trexler. Mr. Trexler terminated his employment contract upon completion of the
merger with Lan Plus Corporation.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The following table sets forth, as of March 31, 2003, the number of shares of
our Common Stock (after consideration of the Company's 10:1 reverse stock split
that was effective with the close of the merger with Lan Plus) held of record or
beneficially: (i) by each person who held of record, or was known by Mcglen to
own beneficially, more than 5% of the outstanding shares of the our Common
Stock; (ii) by each of our current executive officers and directors; and (iii)
by all of our current executive officers and directors as a group:
NAME AND ADDRESS OF NUMBER OF PERCENT OF OUTSTANDING
BENEFICIAL OWNER SHARES OWNED(1) SHARES OF COMMON STOCK
Andy Teng 12,857,450(2) 67.8%
16700 Gale Avenue
City of Industry, CA 91745
Richard Shyu 1,285,323 6.8%
16700 Gale Avenue
City of Industry, CA 91745
Mike Chen 408,295 2.2%
16700 Gale Avenue
City of Industry, CA 91745
Grant Trexler 115,252(3) *
16700 Gale Avenue
City of Industry, CA 91745
All current executive officers and 14,666,320(3) 76.8%
directors as a group (4 persons)
* Less than 1%.
(1) Except as otherwise indicated and subject to applicable community
property and similar statutes, the persons listed as beneficial owners
of the shares of our common stock have sole voting and dispositive
power with respect to such shares.
(2) Includes 4,223,182 shares issuable upon conversion of the Lan Plus
Corporation Employee Stock Ownership Plan (ESOP) Preferred Stock into
common stock. Mr. Teng is the Trustee of the ESOP.
(3) Includes 15,000 shares purchasable by Mr. Trexler within 60 days upon
exercise of outstanding stock options, the remaining 25,000 shares
become exercisable beginning in June 2003.
26
The Company currently maintains the following equity compensation plans: (1) the
1999 Stock Option Plan of Mcglen Micro, Inc., as amended, and (2) the Mcglen
Internet Group, Inc. 2000 Stock Option Plan. Each of these plans was approved by
the Company's stockholders. The Company maintains no equity compensation plans
that were not approved by stockholders. The following table sets forth, for each
of these plans, the number of shares of the Company's common stock subject to
outstanding options and rights, the weighted-average exercise price of
outstanding options, and the number of shares remaining available for future
award grants as of December 31, 2002.
Number of shares Number of shares of
of Company Company common stock
common stock to Weighted- remaining available for
be issued upon average exercise future issuance under
exercise of price of equity compensation
outstanding outstanding plans (excluding shares
options and options and reflected in the first
Plan category warrants warrants column)
- ----------------------------- -------------- ------------ -------------------------
Equity compensation plans
approved by stockholders 599,500 $1.53 1,400,500
Equity compensation plans
not approved by stockholders 235,500 $5.65 N/A
Total 834,000 $2.69 1,400,500
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
BRIDGE LOAN FROM AMRO INTERNATIONAL, S.A.
On April 10, 2000, we received a bridge loan in the amount of $1,500,000 from
AMRO International, S.A. (AMRO), and simultaneously issued a 10% Convertible
Debenture (the "Debenture"). On January 26, 2001, AMRO converted $508,000 of
principal into 3,445,710 shares of our common stock. These shares have been
registered under the Company's SB-2 registration statement that went effective
March 21, 2001. In February 2002, AMRO agreed to convert the rema