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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-15810
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SORRENTO NETWORKS CORPORATION
(Exact name of Registrant as specified in charter)
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Delaware 04-3757589
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
9990 Mesa Rim Road 92121
San Diego, California (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (858) 558-3960
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Common Stock, $0.001 par value per share, Outstanding: 10,477,217 shares at
December 1, 2003.
Indicate by check mark whether the registrant is an accelerated filer as
defined in rule 12-b2 of the Securities Exchange Act of 1934. Yes [ ] No [X]
This Form 10-Q, future filings of the registrant, and oral statements made
with the approval of an authorized executive officer of the Registrant may
contain forward looking statements. In connection therewith, please see the
cautionary statements and risk factors contained in Item 2. "Fluctuations in
Revenue and Operating Results" and "Forward Looking Statements--Cautionary
Statement", which identify important factors which could cause actual results to
differ materially from those in any such forward-looking statements.
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SORRENTO NETWORKS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
(In Thousands, except share information)
October 31, January 31,
2003 2003
----------- -----------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and equivalents......................................................... $ 4,826 $ 7,747
Accounts receivable, net..................................................... 4,574 5,576
Inventory, net............................................................... 13,562 13,934
Prepaid expenses and other current assets.................................... 1,294 741
Investment in marketable securities.......................................... 483 3,959
--------- ---------
TOTAL CURRENT ASSETS...................................................... 24,739 31,957
--------- ---------
PROPERTY AND EQUIPMENT, NET..................................................... 13,788 17,103
--------- ---------
OTHER ASSETS
Purchased technology, net.................................................... 987 430
Investment in non-marketable securities...................................... 5,025 5,025
Other assets................................................................. 864 1,290
--------- ---------
TOTAL OTHER ASSETS........................................................ 6,876 6,745
--------- ---------
TOTAL ASSETS.................................................................... $ 45,403 $ 55,805
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Current maturities of long term debt......................................... $ 137 $ 222
Accounts payable............................................................. 4,548 5,135
Deferred revenue............................................................. 648 3,700
Accrued professional fees.................................................... 3,488 4,324
Other accrued liabilities and current liabilities............................ 5,697 6,236
Due on redemption of preferred security of subsidiary........................ -- 48,800
Contingent Liabilities....................................................... 2,290 --
--------- ---------
TOTAL CURRENT LIABILITIES................................................. 16,808 68,417
--------- ---------
Long-term debt and capital lease obligations.................................... 3,550 3,644
Debentures payable.............................................................. 12,998 18,121
Dividends payable............................................................... -- 99
--------- ---------
TOTAL LIABILITIES......................................................... 33,356 90,281
--------- ---------
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; liquidation preference $1,353............... 1 1
Common stock, $.001 par value; 150,000,000 shares authorized; 10,477,661
shares issued 10,477,217 shares outstanding at October 31, 2003; 886,494
shares issued 886,050 shares outstanding at January 31, 2003.............. 10 5,318
Additional paid-in capital................................................... 198,012 144,887
Deferred stock compensation.................................................. -- (5)
Accumulated deficit.......................................................... (186,060) (187,536)
Accumulated other comprehensive income loss.................................. 153 2,928
Treasury stock, at cost; 444 shares at October 31, 2003 and January 31, 2003,
respectively.............................................................. (69) (69)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT)...................................... 12,047 (34,476)
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)............................ $ 45,403 $ 55,805
========= =========
See accompanying notes to consolidated financial statements.
2
SORRENTO NETWORKS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In Thousands, except per share amounts)
Three Months Nine Months
Ended October 31, Ended October 31,
----------------- -------------------
2003 2002 2003 2002
------- ------- -------- --------
NET SALES $ 6,726 $ 5,525 $ 19,063 $ 16,727
COST OF SALES 4,891 4,563 13,910 16,577
------- ------- -------- --------
GROSS PROFIT 1,835 962 5,153 150
------- ------- -------- --------
OPERATING EXPENSES
Selling and marketing 2,499 2,419 6,565 9,496
Engineering, research and development 2,530 1,980 5,725 6,853
General and administrative 1,247 1,613 4,758 9,387
Deferred stock compensation -- 109 51 324
Other operating expenses 103 133 309 323
------- ------- -------- --------
TOTAL OPERATING EXPENSES 6,379 6,254 17,408 26,383
------- ------- -------- --------
LOSS FROM OPERATIONS (4,544) (5,292) (12,255) (26,233)
------- ------- -------- --------
OTHER INCOME (EXPENSES)
Investment income 5 45 14 232
Interest expense (298) (1,738) (4,102) (4,589)
Other income (expenses) 20 63 13,793 182
Gain on sale of marketable securities -- -- 4,026 11,656
------- ------- -------- --------
TOTAL OTHER INCOME (EXPENSES) (273) (1,630) 13,731 7,481
------- ------- -------- --------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAX (4,817) (6,922) 1,476 (18,752)
PROVISION FOR INCOME TAXES -- -- -- --
------- ------- -------- --------
NET INCOME (LOSS) $(4,817) $(6,922) $ 1,476 $(18,752)
======= ======= ======== ========
EARNINGS (LOSS) PER SHARE:
BASIC WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 10,252 781 5,722 755
------- ------- -------- --------
BASIC NET INCOME (LOSS) PER COMMON SHARE $ (.47) $ (8.86) $ .26 $ (24.84)
======= ======= ======== ========
DILUTED WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING 10,252 1,004 5,722 978
------- ------- -------- --------
DILUTED NET INCOME (LOSS) PER COMMON SHARE $ (.47) $(34.54) $ .26 $ (45.97)
======= ======= ======== ========
COMPREHENSIVE LOSS AND ITS COMPONENTS
CONSIST OF THE FOLLOWING:
Net income (loss) $(4,817) $(6,922) $ 1,476 $(18,752)
Other components of comprehensive loss, net of tax:
Unrealized holding (losses) arising during the period (18) (1,590) 1,152 (9,800)
Reclassification adjustment for amounts included in
net income -- -- (4,026) (11,656)
------- ------- -------- --------
NET COMPREHENSIVE (LOSS) $(4,835) $(8,512) $ (1,398) $(40,208)
======= ======= ======== ========
See accompanying notes to consolidated financial statements.
3
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
For the nine months ended October 31, 2003
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited)
(In Thousands)
Common Stock Preferred Stock Additional Deferred
---------------- --------------- Paid in Stock Accumulated
Shares Amount Shares Amount Capital Compensation Deficit
------ ------- ------ ------ ---------- ------------ -----------
Balance at January 31, 2003 886 $ 5,318 2 $1 $144,887 $ (5) $(187,536)
Common stock par value re-
valuation (5,317) 5,317
Restructuring adjustment 436
Common stock issuance 9,564 9 47,255
Unrealized (losses) on
available for sale securities
Reclassification adjustment for
(gains) losses realized in net
income (loss)
Deferred stock compensation
of subsidiary 46 (46)
Expenses paid with stock
issuances 27 0 71
Amortization of deferred stock
compensation 51
------ ------- --- --- -------- ---- ---------
Net income 1,476
------ ------- --- --- -------- ---- ---------
Balance at October 31, 2003 10,477 $ 10 2 $1 $198,012 $ -- $(186,060)
====== ======= === === ======== ==== =========
Treasury Stock Other Total
--------------- Comprehensive Stockholders'
Shares Amount Income (Loss) Equity
------ ------ ------------- -------------
Balance at January 31, 2003 1 $(69) $ 2,928 $(34,476)
Common stock par value re-
valuation
Restructuring adjustment 436
Common stock issuance 47,264
Unrealized (losses) on
available for sale securities (2,874) (2,874)
Reclassification adjustment for
(gains) losses realized in net
income (loss) 99 99
Deferred stock compensation
of subsidiary --
Expenses paid with stock
issuances 71
Amortization of deferred stock
compensation 51
--- ----- ------- --------
Net income 1,476
--- ----- ------- --------
Balance at October 31, 2003 1 $(69) $ 153 $ 12,047
=== ===== ======= ========
See accompanying notes to consolidated financial statements.
4
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
For the nine months ended October 31, 2002
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited)
(In Thousands)
Common Stock Preferred Stock Additional Deferred
--------------- --------------- Paid in Stock Accumulated
Shares Amount Shares Amount Capital Compensation Deficit
------ ------ ------ ------ ---------- ------------ -----------
Balance at January 31, 2002 710 $4,263 2 $1 $143,705 $(255) $(161,326)
Stock option and warrant
exercises 1 9 (9)
Unrealized losses on available
for sale securities
Reclassification adjustment for
(gains) losses realized in
net income (loss)
Deferred stock compensation
of subsidiary 136 (136)
Expenses paid with stock
issuances 176 1,048 8,706
Amortization of deferred stock
compensation 322
--- ------ --- --- -------- ----- ---------
Net loss $ (18,752)
--- ------ --- --- -------- ----- ---------
Balance at October 31, 2002 887 $5,320 2 $1 $152,538 $ (69) $(180,078)
=== ====== === === ======== ===== =========
Treasury Stock Other Total
--------------- Comprehensive Stockholders'
Shares Amount Income (Loss) Equity
------ ------ -------------- -------------
Balance at January 31, 2002 1 $(69) $ 24,160 $ 10,479
Stock option and warrant
exercises --
Unrealized losses on available
for sale securities (9,800) (9,800)
Realized (gains) on available
for sale securities (11,656) (11,656)
Deferred stock compensation
of subsidiary --
Expenses paid with stock
issuances 9,754
Amortization of deferred stock
compensation 322
--- ---- -------- --------
Net loss (18,752)
--- ---- -------- --------
Balance at October 31, 2002 1 $(69) $ 2,704 $(19,653)
=== ==== ======== ========
See accompanying notes to consolidated financial statements.
5
SORRENTO NETWORKS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Thousands)
Nine Months Ended
October 31,
-------------------
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .................................................................. $ 1,476 $(18,752)
-------- --------
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization ................................................ 2,872 3,038
Accounts receivable and inventory reserves ................................... (1,333) 4,345
Expenses paid through issuance of securities ................................. 71 --
Gain on sale of marketable securities ........................................ (4,026) (11,656)
Non-cash interest on debentures .............................................. 2,715 4,091
Gain on restructuring ........................................................ (13,629) --
Deferred and other stock compensation ........................................ 51 187
Changes in assets and liabilities:
(Increase) decrease in accounts receivable ................................ 1,295 (1,024)
Decrease in inventories ................................................... 4,150 3,858
(Increase) decrease in other current assets ............................... (137) 793
Decrease in accounts payable .............................................. (1,028) (2,114)
Increase (decrease) in deferred revenue ................................... (3,342) 5,247
Increase (decrease) in accrued and other current liabilities .............. (985) 1,796
-------- --------
NET CASH USED IN OPERATING ACTIVITIES ........................................... (11,850) (10,191)
CASH FLOWS FROM INVESTING ACTIVITIES:
LuxN merger ........................................................................ 1,866 --
Capitalized fees on LuxN merger .................................................... (360) --
(Purchase) disposal of property and equipment ...................................... 949 (2,774)
Cash received from sale of marketable securities and other investments ............. 6,360 13,574
Other assets ....................................................................... 295 154
-------- --------
NET CASH PROVIDED BY INVESTING ACTIVITIES ....................................... 9,110 10,954
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of short-term debt, net ................................................... -- (808)
Repayment of long-term debt ........................................................ (180) (532)
Proceeds from common stock ......................................................... (1) --
-------- --------
NET CASH USED IN FINANCING ACTIVITIES ........................................... (181) (1,340)
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS .................................................. (2,921) (577)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD ........................................ 7,747 14,243
-------- --------
CASH AND CASH EQUIVALENTS - END OF PERIOD .............................................. $ 4,826 $ 13,666
======== ========
See accompanying notes to consolidated financial statements.
6
SORRENTO NETWORKS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED OCTOBER 31, 2003 AND 2002
The Company
Sorrento Networks Corporation (the "Company," "We," "Our," or "Us") through
its subsidiaries designs, manufactures and markets integrated networking and
bandwidth aggregation and optical access products for enhancing the performance
of data and telecommunications networks. Our products are deployed in telephone
companies, Internet Service Providers, governmental bodies and the
corporate/campus networks that make up the "enterprise" segment of the
networking marketplace. We have facilities in San Diego and Sunnyvale,
California and various sales offices located in the United States and Europe. We
market and sell our products and services through a broad array of channels
including worldwide distributors, value added resellers, local and long distance
carriers and governmental agencies.
Summary of Significant Accounting Policies
Basis of Presentation
The accompanying financial data for the three and nine months periods ended
October 31, 2003 and 2002, along with financial data for January 31, 2003, has
been prepared by us, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to such rules and regulations. The January 31,
2003 balance sheet was derived from audited financial statements, but does not
include all disclosures required by accounting principles generally accepted in
the United States of America. However, we believe that the disclosures we have
made are adequate to make the information presented not misleading. These
consolidated financial statements should be read in conjunction with the
consolidated financial statements and the notes thereto included in our Annual
Report on Form 10-K/A for the year ended January 31, 2003.
We have incurred significant losses and negative cash flows from operations
for the past two years. SNI, our principal operating subsidiary, has primarily
been the operating entity responsible for these losses and negative cash flows.
The losses have been generated as SNI, as well as our newly acquired LuxN
subsidiary, continue to develop their technology, marketing, sales and
operations in efforts to become major suppliers of metro and regional optical
networks worldwide. We fund our operations primarily through a combination of
internal funds, investments, and debt and equity financing. There can be no
assurance that similar funding will be available in the future. Further, with
the recent downturn in the economic environment and decreases in capital
spending by telecom carriers, we believe our current and future revenues could
be negatively impacted. As a result, future increases in working capital will be
required to both maintain and grow our business along with a continued and
substantial focus on reducing operating expenses. Given the uncertainty and/or
unpredictability of the telecom market and the limited amount of our existing
working capital there can be no assurance that our existing financial resources
will be sufficient to cover our operational needs for the next twelve months.
Our current cash resources provide for less than six months of working capital
based upon our historical losses. If however, our revenues show improvement, we
implement our plans on expense reductions and attract additional working capital
through the issuance of stock or debt, our balance sheet will be significantly
improved and will provide us with the necessary financial resources to meet our
operational plans for a period exceeding one year. Our future capital
requirements may vary materially from those now planned including the need for
additional working capital to accommodate planned growth, hiring and
infrastructure needs. There can be no assurances that our working capital
requirements will not exceed our ability to generate sufficient cash internally
to support our requirements and that external financing will be available or
that, if available, such financing can be obtained on terms favorable to us and
our shareholders. We are actively pursuing several alternatives and
opportunities in order to strengthen our financial condition.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates that affect the reported amounts of assets,
7
liabilities, revenues and expenses, the disclosure of contingent assets and
liabilities. Actual results could materially differ from these estimates. In the
opinion of Management, all adjustments (which include normal recurring
adjustments and charges described in the notes to the financial statements)
necessary to present fairly the financial position, results of operations and
cash flows for the three and nine months ended October 31, 2003 and 2002 have
been made. The results of operations for the three and nine months ended October
31, 2003 are not necessarily indicative of the operating results for the full
year.
Certain reclassifications have been made to prior year presentations to
conform to the fiscal year 2004 presentation.
Digi International, Inc. and NETsilicon, Inc.
The remaining 1,162,341 DIGI shares were sold on May 2, 2003 for $4.26 per
share. The purchaser of the stock was again DIGI. The proceeds from this sale,
in the amount of approximately $5.0 million, were deposited on May 7, 2003.
In accordance with a settlement agreement reached between Sorrento Networks
and our former Chairman and Founder, Par Chadha, 566,000 shares of ENI stock
were transferred to Mr. Chadha in exchange for mutual releases by the Company
and Mr. Chadha and certain of his affiliates. The stock transfer was completed
on July 1, 2003 and had a value of $88 thousand. In addition, we transferred
128,214 shares of ENI stock to settle a dispute between a former employee and
the Company. The value of the transfer was $20 thousand and was completed on
July 16, 2003.
Stock Compensation
We account for employee-based stock compensation utilizing the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." Accordingly, compensation cost for
stock options issued to employees is measured as the excess, if any, of the fair
market price of our common stock at the date of grant over the amount an
employee must pay to acquire the stock. This amount appears as a separate
component of stockholders' equity and is being amortized on an accelerated basis
by charges to operations over the vesting period of the options in accordance
with the method described in Financial Accounting Standards Board Interpretation
No. 28. All such amounts relate to options to acquire common stock of our
subsidiary Sorrento Networks, Inc. ("SNI") granted by it to its employees;
during the three and nine months ended October 31, 2003 and 2002 it amortized $0
and $62 thousand, and $5 thousand and $157 thousand, respectively, of the total
$2.6 million initially recorded for deferred stock compensation. As of April 30,
2003 the deferred stock compensation amount of $2.6 million has been fully
amortized.
For non-employees, we compute the fair value of stock-based compensation in
accordance with Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation," and Emerging Issues Tax Force (EITF) 96-18,
"Accounting for Equity Instruments that are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services." All such amounts
relate to options to acquire common stock of our subsidiary Sorrento Networks,
Inc. ("SNI") granted by it to its consultants; during the three and nine months
ended October 31, 2003 and 2002 it recorded $0 and $46 thousand, and $46
thousand and $45 thousand, respectively, for options granted to consultants.
As of April 30, 2003 the deferred stock compensation for non-employees was
fully amortized.
Recent Accounting Pronouncements
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 150. "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS 150"). SFAS 150 clarifies the accounting for certain financial
instruments with characteristics of both liabilities and equity and requires
that those instruments be classified as liabilities in the balance sheets.
Previously, many of those financial instruments were classified as equity. SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003 and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. We adopted this pronouncement with no material
impact on our results of operations and financial condition.
In April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No. 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and
clarifies accounting for derivative instruments,
8
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133"). In particular, it (1) clarifies under what
circumstances a contract with an initial net investment meets the characteristic
of a derivative as discussed in SFAS 133, (2) clarifies when a derivative
contains a financing component, (3) amends certain definitions to conform it to
the language used in FASB Interpretation No. ("FIN") 45, "Guarantor Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others" ("FIN 45") and (4) amends certain other existing
pronouncements. SFAS 149 will be effective for contracts entered into or
modified after June 30, 2003, except as stated below, and for hedging
relationships designated after June 30, 2003. The provisions of SFAS 149 that
relate to guidance in SFAS 133 Implementation Issues that have been effective
for fiscal quarters which began prior to June 15, 2003, will continue to be
applied in accordance with their respective effective dates. In addition,
certain provisions relating to forward purchases or sales of when-issued
securities or other securities that do not yet exist, will be applied to both
existing contracts as well as new contracts entered into after June 30, 2003 We
adopted this pronouncement with no material impact on our results of operations
and financial condition.
In November 2002, the FASB Emerging Issues Task Force ("EITF") reached a
consensus on Issue 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables" ("EITF 00-21"). In the absence of higher level accounting
literature, EITF 00-21 governs how to separate and allocate revenue to goods or
services or both that are to be delivered in a bundled sales arrangement. EITF
00-21 applies to revenue arrangements entered into after June 30, 2003 and
allows for either prospective application or cumulative adjustment upon
adoption. We have adopted the guidance of EITF 00-21 with no material effect on
our financial condition or results of operations.
Balance Sheet Detail
Inventories at October 31, 2003 and January 31, 2003 consist of:
(Thousands)
October 31, January 31,
2003 2003
----------- -----------
Raw material.............. $ 25,005 $10,767
Work in process........... 3,019 2,804
Finished goods............ 5,438 6,326
-------- -------
33,462 19,897
Less: Valuation reserve... (19,900) (5,963)
-------- -------
$ 13,562 $13,934
======== =======
Marketable Securities--Marketable securities, which consist of equity
securities that have a readily determinable fair value and do not have sale
restrictions lasting beyond one year from the balance sheet date, are classified
into categories based on our intent. Our investments in DIGI and Entrada are
classified as available for sale and are carried at fair value, based upon
quoted market prices, with net unrealized gains reported as a separate component
of stockholders' equity until realized. Unrealized losses are charged against
income when a decline in fair value is determined to be other than temporary. At
October 31, 2003, and January 31, 2003, marketable securities were as follows:
9
(thousands)
Unrealized Market
Cost Gains Value
------ ----------- ------
October 31, 2003:
Entrada....... 13 53 66
------ ------ ------
$ 13 $ 53 $ 66
====== ====== ======
January 31, 2003:
Digi.......... $1,009 $2,884 $3,893
Entrada....... 22 44 66
------ ------ ------
$1,031 $2,928 $3,959
====== ====== ======
Intangible Assets--Goodwill and indefinite life intangible assets are no
longer amortized but are subject to periodic impairment tests. We have no
goodwill or indefinite life intangible assets. Other intangible assets with
finite lives, such as our purchased technology, are amortized over their useful
lives.
The carrying value of finite life intangible assets, consisting of purchased
technology of our subsidiary Meret Optical, as of October 31, 2003, is
approximately $122 thousand, net of amortization. The change in the net carrying
amount of finite life intangible assets during the nine months ended October 31,
2003 is due to amortization of $309 thousand. The $122 thousand remaining book
value is expected to be amortized at approximately $102 in the fourth quarter
of Fiscal 2004 and $20 thousand in Fiscal 2005.
Non-marketable securities - consists of an investment we made into a
non-public or privately funded exchange carrier. Their principal business is
selling broadband services to enterprise customers and they principally use
networks that have deployed our equipment for WDM transport. Our investment in
this company reflects the price we paid for Series C Preferred Stock at that
time of the investment. The value of our investment is difficult to ascertain
and is subject to certain elements such as market conditions, revenue growth,
financial performance and future financings for their company. As of the end of
October 31, 2003, there can be no assurance that we could sell our securitiesr
for an amount equal to our investment.
Debentures - During August 2001, we completed a private placement of our
9.75% convertible debentures receiving net proceeds of $29.8 million. The
debentures, due August 2, 2004 had a face value of $32.2 million, which was
convertible into our common stock at $144.20 per share. At maturity, we could
have elected to redeem the debentures for cash and we had the option of paying
the interest on these debentures in shares of our common stock. In addition, the
purchasers received four year warrants to acquire an additional 167,592 shares
of our common stock at $144.20 per share and the placement agent received five
year warrants to acquire 5,583 shares of our common stock, equity securities,
options or warrants at a price less than $144.20 per share or at a discount to
the then market price. The conversion price and warrant exercise were subject to
adjustment.
In accordance with Emerging Issues Task Force ("EITF") No. 00-27 we
accounted for the fair value of warrants issued to the purchasers and placement
agent and the fair value of the deemed beneficial conversion feature, which
resulted solely as a result of the required accounting, of the debenture as a
reduction to the face value of the debentures with an offsetting increase to
additional paid in capital. These amounts, as well as the issuance costs paid in
cash, were amortized as additional interest expense over the period the
debentures were outstanding.
On March 6, 2003, we and our wholly-owned subsidiary Sorrento Networks,
Inc. entered into an Exchange Agreement with the holders of our 9.75% Senior
Convertible Debentures (the "9.75% Debentures") and the Series A Convertible
Preferred Stock (the "Preferred Stock") of Sorrento Networks, Inc. The Exchange
Agreement and associated documents contemplated an exchange (the "Exchange") of
the 9.75% Debentures and the Preferred Stock at closing into shares of common
stock and $12.5 million of our new 7.5% Secured Convertible Debentures (the
"7.5% Debentures"). Certain holders of the Preferred Stock would also receive
additional 7.5% Debentures of approximately $600 thousand to pay certain legal
fees.
The Exchange Agreement was approved by shareholders on May 29, 2003 and was
completed and became effective on June 4, 2003 pursuant to which we exchanged
current outstanding debentures and Series A Preferred Stock for common stock and
an issuance of a smaller principal amount of 7.5% Debentures.
10
Interest expense on the 9.75% Debentures thru the June 4, 2003 exchange
date of approximately $3.5 million included the stated 9.75% interest of
approximately $1 million, amortization of issuance costs of $275 thousand and
amortization of the fair value of the warrants issued to the purchasers and
placement agent and deemed beneficial conversion feature of approximately $2.2
million.
Interest expense on the 7.5% debentures during the three and nine months
ended October 31, 2003 was $248 thousand and $402 thousand, respectively.
11
At October 31, 2003 and January 31, 2003 debentures payable for the 9.75%
debentures consisted of:
(thousands)
October 31, January 31,
2003 2003
----------- -----------
Face value .......................................... $-- $ 32,200
Issuance costs ...................................... -- (2,451)
Value of warrants and deemed beneficial conversion
feature .......................................... -- (19,525)
--- --------
Debenture book value at issuance ................. -- 10,224
Accumulated amortization of issuance costs .......... -- 881
Accumulated amortization of the value of warrants and
deemed beneficial conversion feature ............. -- 7,016
--- --------
$-- $ 18,121
=== ========
The7.5% debentures are convertible at any time at the option of the holders
into shares of common stock at a conversion price of $5.42, the fair value on
the date of the exchange. The debentures mature on August 2, 2007 and are
secured by substantially all of our assets and those of our subsidiaries (with
certain exceptions).
At October 31, 2003 and January 31, 2003 debentures payable for the 7.5%
debentures consisted of:
(thousands)
October 31, January 31,
2003 2003
----------- -----------
Face value of 7.5% convertible debentures..... $12,398 $--
Face value of new debentures for legal fees... 600 --
------- ---
Book value of debentures at issuance $12,998 $--
======= ===
Stockholders' Equity
We are authorized to issue the following shares of stock:
150,000,000 shares of Common Stock ($0.001 par value)
2,000,000 shares of Preferred Stock ($.01 par value) of which the
following series have been designated:
3,000 shares of Preferred Stock, Series D
1,000,000 shares of Preferred Stock, Series F
As of October 31, 2003, we had outstanding the following shares of
preferred stock:
Shares Par Liquidation
Outstanding Value Preference
----------- ----- -----------
Series D... 1,353 $0.01 $1,353
----- ----- ------
1,353 $0.01 $1,353
===== ===== ======
Other Capital Stock Transactions
Stock Split - In October 2002, approval was granted for a one-for-twenty
reverse stock split effective October 28, 2002. The effect of this stock split
was reflected in the financial statements retroactively as if the stock split
occurred at the beginning of the earliest period reported.
Each share of SNI's Series A Convertible Preferred Stock was convertible
into one share of SNI's common stock at the option of the holder, voted on an
"as converted" basis except for election of directors, and had a liquidation
preference of $5.45 per share. The shares were automatically convertible into
SNI's common stock upon
12
an underwritten public offering by SNI with an aggregate offering price of at
least $50.0 million. As SNI did not complete a $50.0 million public offering by
March 1, 2001, the holders of more than 50% of the then outstanding Series A
shares had the right to request in writing that SNI redeem them at the adjusted
liquidation preference. On receipt of such a request, SNI had the obligation to
redeem the shares in cash, if funds were lawfully available for such redemption,
or to redeem such pro rata portion as to which a lesser amount of lawfully
available funds existed. In April 2001, SNI received written redemption requests
from holders of a majority of the Series A shares. The difference between the
net proceeds received on the sale of these shares and their liquidation
preference of $48.8 million was recorded as a deemed dividend during the period
from issuance to March 31, 2001.
On June 4, 2003, we consummated the Exchange Agreement and cancelled all
outstanding Series A Convertible Preferred Stock.
In connection to our capital and corporate restructuring plan, we issued
8,029,578 shares of common stock to the holders of the 9.75% debentures and the
Series A Convertible Preferred Stock upon consummation of the Exchange. The
Company's $32.2 million in convertible debentures were converted into common
shares of the Company and a portion of $12.5 million in secured convertible 7.5%
debentures that mature in August 2007. In addition, all Series A Convertible
Preferred Stock were converted into common shares of the Company and a portion
of the $12.5 million in secured convertible debentures. The outstanding Series A
Convertible Preferred Stock "put" of $48.8 million against SNI was withdrawn.
Certain Series A Convertible Preferred stockholders also received a total of
$600 thousand in additional secured convertible 7.5% debentures to pay certain
legal fees.
There was an aggregate gain, net of tax, on the capital restructuring
transaction of $13.8 million. The conversion of the SNI Series A Convertible
Preferred Stock into common stock and a portion of the $12.5 million 7.50%
convertible debenture resulted in a net gain of $48.8 million. The gain was
off-set by the loss on the value of the warrants and beneficial conversion
feature on the $32.2 million, 9.75% convertible debentures, converted to common
stock and a portion of the 7.50% convertible debenture. The consolidated net
gain on the capital restructuring transaction was $13.8 million or $2.35 per
share for the quarter ending July 31, 2003.
On August 8, 2003, we acquired LuxN Inc. for a combination of stock,
warrants, and cash. Stockholders of LuxN were given the option of exchanging
shares of LuxN stock for either their pro-rata portion of LuxN's net cash or
shares of Sorrento's common stock. In addition to the cash or Sorrento common
stock, stockholders of LuxN have the right to receive warrants to purchase an
aggregate of 400 thousand shares of Sorrento common stock, with an exercise
price of $3.05 per share, the fair market value on the date of the acquisition.
The warrants will be held in escrow for a period of six months to satisfy any
successful indemnification claims. At closing, Sorrento issued approximately 1.4
million shares of common stock with the remaining approximately 500 thousand
shares of common stock to be issued subject to stockholder approval.
13
LUXN ACQUISITION
On August 8, 2003, LuxN, Inc. was acquired by Sorrento Networks Corporation,
pursuant to an Agreement and Plan of Merger ("the Agreement"), dated as of June
25, 2003. LuxN develops, manufactures and markets optical transport and
switching solutions for metropolitan service providers and enterprise customers.
We acquired LuxN to expand our offerings of optical transport and switching
solutions to a segment of customers we were not currently servicing. As of
August 8, 2003, the results of operations from LuxN are shown in our
consolidated income statement.
The purchase consideration for the acquisition of LuxN amounted to
approximately $18 million consisting of cash paid and common stock issued. The
cash paid was approximately $14.8 million and was paid to LuxN's Series A-1
Preferred Stockholders who elected to receive cash in lieu of common stock. The
common stock was issued to LuxN shareholders who elected to exchange their
shares of LuxN stock for Sorrento Networks common stock. The Company issued
1,374,194 shares of its common stock at the per share fair value on the date of
issuance of $2.35 for an approximate value of $3.2 million. These shares were
issued August 8, 2003.
The purchase consideration excludes the value of 400,000 warrants issued in
connection with the purchase that are held in escrow until the expiration of an
indemnification period as per the Agreement. When and if the warrants are
released from escrow, the value of the warrants will be recorded as additional
purchase price consideration. The $900 thousand value of the 400,000 warrants
issued to LuxN shareholders who elected to exchange their shares of LuxN stock
for Sorrento Networks common stock was determined using the Black Scholes option
pricing model based on the following inputs: option price of $3.05, estimated
life of 5 years, volatility of 168% and no dividends. When released from escrow,
the fair value of these contingent warrants will be recorded as additional
purchase consideration.
The purchase consideration excludes the value of the future issuance of 505,153
shares of Sorrento Networks common stock to the LuxN shareholders who elected to
exchange their shares of LuxN stock for our common stock pursuant to the
Agreement. The shares will be issued upon shareholder approval and in return
$1.0 million of LuxN cash held in escrow will be released. The approximate value
of these shares is $1.2 million as of the acquisition date based upon the fair
market per share value of $2.35 on August 8, 2003. The fair value of these
contingent common shares will be recorded as additional purchase consideration.
On the accompanying consolidated balance sheet of the Company, the Company has
reflected contingent purchase consideration of approximately $2.3 million
arising from the contingently issuable warrants and common shares described
above and reimbursement for certain accounts receivable of approximately 200
thousand.
The accompanying balance sheet includes purchased technology of approximately
$864 thousand arising from the purchase of LuxN. The value assigned to the
purchased technology is based upon the Company's preliminary assessment of the
purchased technologies fair value. The Company is in the process of determining
the fair value of the purchased technology. The Company expects to complete the
valuation of the purchased technology in the near future and will make any
necessary adjustments to the purchase price as needed.
The balance sheet of LuxN as of August 8, 2003, is shown below reflecting the
preliminary application of purchase accounting.
14
[SORRENTO NETWORKS LOGO]
LUXN, INC.
BALANCE SHEETS AT DATE OF ACQUISITION (UNAUDITED)
(In Thousands, except per share amounts)
=========================================================================
August 8, 2003
-------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and equivalents $20,368
Restricted cash 1,000
Accounts receivable, net 225
Inventory, net 2,513
Prepaid expenses and other current assets 415
-------------------------------------------------------------------------
TOTAL CURRENT ASSETS 24,521
-------------------------------------------------------------------------
PROPERTY AND EQUIPMENT, NET 167
PURCHASED TECHNOLOGY, NET 864
-------------------------------------------------------------------------
TOTAL ASSETS $25,552
=========================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long term debt 2,923
Accounts payable 441
Deferred revenue 290
Accrued liabilities and other current liabilities 1,264
-------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 4,918
-------------------------------------------------------------------------
-------------------------------------------------------------------------
TOTAL NET ASSETS ACQUIRED 20,634
-------------------------------------------------------------------------
15
SORRENTO NETWORKS CORPORATION [SORRENTO NETWORKS LOGO]
AND SUBSIDIARIES
SUPPLEMENTAL PRO FORMA FINANCIAL DATA
(In Thousands)
Sorrento
Networks
Consolidated LuxN, Inc Total
------------ --------- -----
Three Months Ended October 31, 2003
Revenue $ 4,205 $ 2,521 $ 6,726
Net Income (Loss) (3,816) (1,001) (4,817)
Earnings per Share $ (0.37) $ (0.10) $ (0.47)
======== ======== ========
Three Months Ended October 31, 2002
Revenue $ 5,525 3,983 $ 9,508
Net Income (Loss) (6,922) (1,468) (8,390)
Earnings per Share $ (8.86) $ (1.88) $ (10.74)
======== ======== ========
Nine Months Ended October 31, 2003
Revenue $ 16,542 3,983 $ 20,525
Net Income (Loss) 2,477 (6,873) (4,396)
Earnings per Share $ 0.43 $ (1.20) $ (0.77)
======== ======== ========
Nine Months Ended October 31, 2002
Revenue $ 16,727 $ 2,969 $ 19,696
Net Income (Loss) (18,752) (20,494) (39,246)
Earnings per Share $ (24.84) $ (27.14) $ (51.98)
======== ======== ========
16
Stock Option Plans
We have five stock option plans in effect: The 2003 Equity Incentive Plan,
the 2000 Stock Incentive Plan, the 1988 Stock Option Plan, the 1997 Incentive
and Non-Qualified Stock Option Plan and the 1997 Director Stock Option Plan. The
stock options have been made available to certain employees and consultants. All
options are granted at not less than fair value at the date of grant and have
terms varying from 3 to 10 years. The purpose of these plans is to attract,
retain, motivate and reward our officers, directors, employees and consultants
to maximize their contribution towards our success. We account for these plans
under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under these plans had an exercise price equal to the market
value of the underlying common stock on the date of grant.
In order to provide more prominent and frequent disclosures about the
effects of stock-based compensation as required under SFAS 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure", the following table
summarizes the pro forma effect of stock-based compensation on net income and
earnings (loss) per share as if the optional expense recognition provisions of
SFAS 123 had been adopted.
The fair value of stock options used to compute pro forma net loss and pro
forma loss per share disclosures is estimated using the Black-Scholes
option-pricing model, which was developed for use in estimating the fair value
of traded options that have no vesting restrictions and are fully transferable.
In addition, this model requires the input of subjective assumptions, including
the expected price volatility of the underlying stock. Projected data for
expected volatility and expected life of stock options is based upon historical
and other data. Changes in these
17
subjective assumptions can materially affect the fair value estimate, and
therefore the existing valuation models may not provide a reliable single
measure of the fair value of the Company's employee stock options.
18
Net Earnings Per Share Table
For the three months ended, For the nine months ended,
October 31, October 31,
--------------------------- --------------------------
2003 2002 2003 2002
------- ------- ------- --------
Net earnings (loss):
As reported (4,817) (6,922) 1,476 (18,752)
Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects -- 51 109 324
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects (1,220) (1,428) (2,486) (4,321)
------- ------- ------- --------
Pro forma (6,037) (8,299) (901) (22,749)
======= ======= ======= ========
Earnings (loss) per share:
Basic EPS as reported $ (0.47) $ (8.86) $ 0.26 $ (24.84)
======= ======= ======= ========
Pro forma basic EPS $ (0.59) $(10.70) $ (0.18) $ (30.58)
======= ======= ======= ========
Diluted EPS as reported $ (0.47) $(34.54) $ 0.26 $ (45.97)
======= ======= ======= ========
Pro forma diluted EPS $ (0.59) $(35.96) $ (0.18) $ (50.39)
======= ======= ======= ========
Earnings Per Share Calculation
The following data show the amounts used in computing basic earnings per
share for the three and nine months ended October 31, 2003 and 2002.
(thousands, except per share amounts)
Three Months Ended Nine Months Ended
October 31, October 31,
---------------------- ---------------------
Earnings Per Share Calculation 2003 2002 2003 2002
----------- -------- ---------- --------
Net income (loss) available to common shareholders used
in basic EPS $ (4,817) $ (6,922) $ 1,476 $(18,752)
=========== ======== ========== ========
Average number of common shares used in basic EPS 10,252,445 780,555 5,721,644 754,519
=========== ======== ========== ========
Basic income (loss) per common share is calculated by dividing the net
income (loss) by the weighted average number of common shares outstanding during
the period. Diluted income (loss) per common share is calculated by dividing the
applicable net income (loss) by the sum of the weighted average number of common
shares outstanding and all additional common shares that would have been
outstanding if potentially dilutive common shares had been issued during the
period. The following data shows the effect on income and the weighted average
number of shares of dilutive potential common stock.
19
(thousands, except per share amounts)
Three Months Ended October 31, Nine Months Ended October 31,
------------------------------ -----------------------------
2003 2002 2003 2002
----------- ------------ ---------- ------------
Net income (loss) available for common shareholders
used in basic EPS $ (4,817) $ (6,922) $ 1,476 $ (18,752)
Less: Convertible debt issuance costs (28,622) (28,622)
Plus: Convertible debt interest 248 783 402 1,557
----------- ------------ ---------- ------------
Net gain (loss) available to common shareholders used
in diluted EPS $ (4,569) $(34,673,439) $ 1,878 $(44,946,439)
=========== ============ ========== ============
Average number of common shares used in basic EPS 10,252,445 780,555 5,721,644 728,535
----------- ------------ ---------- ------------
Effect of dilutive securities:
Convertible debentures -- 223,301 -- 223,301
----------- ------------ ---------- ------------
Average number of common shares and dilutive
potential common stock used in diluted EPS 10,252,445 1,003,856 5,721,644 951,836
=========== ============ ========== ============
Common stock options and warrants of 1,298,112 and 2,398,165 and 1,308,889
shares of common stock for convertible debentures, for the three and nine month
period respectively, are excluded from the computation, as the effect was
anti-dilutive.
Litigation
On June 4, 2003, we consummated the exchange transaction and cancelled all
outstanding Series A Convertible Preferred Stock and 9.75% Senior Convertible
Debentures. The Exchange Agreement provides that the litigation instituted by
the former holders of Series A stock be dismissed without prejudice against the
Company, its subsidiaries, its current officers and directors, and other
defendants who execute an appropriate release, and without prejudice against all
other defendants. This dismissal will require court approval, which is in the
process of being obtained by counsel for all parties.
In addition, claims in arbitration were filed by two of our former
financial officers and employees who worked in our former Santa Monica office,
which has since been closed, alleging that their resignations in May 2002 were
for "good reason" as defined in their employment agreements, all of which were
to expire on May 22, 2002. One of the claims was settled in May 2003 for $45
thousand. The other claim was resolved by an arbitrator in August 2003 whom
ruled in our favor.
A former officer of our SNI subsidiary brought suit alleging breach of a
consulting agreement we entered into with him in March 2002, following his
resignation "for good reason" as defined in his employment agreement. He was
seeking acceleration of consulting fees due to him under his consulting
agreement in the amount of $229 thousand. This suit was settled on December 1,
2003 for $15 thousand and $150 thousand worth of Sorrento common stock that was
distributed to him June 4, 2003.
From time to time, we are involved in various other legal proceedings and
claims incidental to the conduct of our business. Although it is impossible to
predict the outcome of any outstanding legal proceedings, we believe that such
legal proceedings and claims, individually and in the aggregate, are not likely
to have a material adverse effect on our financial position, results of
operations, or cash flows.
Contingent Liabilities
On August 8, 2003 we acquired LuxN for a combination of stock, warrants,
and cash previously held by LuxN. At October 31, 2003 Sorrento's balance sheet
contains a $2.3 million contingent liability. This contingent liability is made
up of $1.0 million in restricted cash, $242 thousand in accounts receivable and
the value of the 400,000 FIBR warrants held in escrow. This contingent liability
will be eliminated upon shareholder approval of the issuance of the remaining
approximately 500 thousand shares of Sorrento common stock to complete the
acquisition transaction.
In 1996 we acquired a business from Cray Computers that eventually became
the basis of Entrada Networks, a subsidiary of ours that was spun-off in August
2003 through a merger agreement with Sync Research, a then
20
publicly traded NASDAQ company. Upon the purchase of the business from Cray
Computers, which subsequently was acquired by Anite Corporation, they assumed
the obligation of the pension plan and the right to terminate it within five
years from the date of purchase. If however after five years the plan had not
been terminated, the parties agreed to agree as to what to do with the plan on a
going forward basis. They did not terminate the plan during this five-year
period. In the third quarter of fiscal 2004, we were advised by a consultant
retained by us and by the successor corporation that the cost of termination
of the pension plan in question could be in excess of $2.0 million. While we do
not believe that we are liable for this cost, it is possible that the successor
corporation may try to seek a substantial contribution from us towards this
liability. We have not been involved with the plan for these periods and have no
employees that are participants or covered by the plan.
Concentration Of Credit Risk
Financial instruments that potentially subject us to concentrations of
credit risk consist primarily of temporary cash investments and trade
receivables. As regards the former, we place our temporary cash investments with
high credit financial institutions and limits. At times such amounts may exceed
the F.D.I.C. limits. We limit the amount of exposure with any one financial
institution and believe that no significant concentration of credit risk exists
with respect to cash investments.
Although we are directly affected by the economic well being of significant
customers listed in the following tables, we do not believe that significant
credit risk exists at October 31, 2003. We perform ongoing evaluations of our
customers and require letters of credit or other collateral arrangements as
appropriate. Accordingly, trade receivable credit losses have not been
significant.
The following data shows the customers accounting for more than 10% of net
consolidated receivables:
October 31, January 31,
2003 2003
----------- -----------
Customer A.......................................... 30.0% 0.0%
Customer B.......................................... 26.7% 29.6%
Customer C.......................................... 17.3% 0.0%
Customer D.......................................... 13.1% 16.1%
The following data shows the customers accounting for more than 10% of net
consolidated sales:
Three Months Ended Nine Months Ended
October 31, October 31,
------------------ -----------------
2003 2002 2003 2002
---- ---- ---- ----
Customer A 26.0% 0.0% 9.2% 0.0%
Customer B 16.6% 1.2% 7.8% 1.7%
Customer C 11.1% 0.0% 15.6% 1.5%
Customer D 10.8% 21.6% 14.4% 22.1%
Customer E 0.0% 21.3% 14.3% 16.5%
21
Segment Information
Sorrento Meret LuxN
Networks Optical Inc. Other Total
-------- ------- ------- ------- --------
Three Months Ended October 31, 2003
Revenues from external customers $ 3,766 $ 439 $ 2,521 $ $ 6,726
Cost of goods sold 3,048 194 1,649 4,891
-------- ------- ------- ------- --------
Gross Profit $ 718 $ 245 $ 872 $ -- $ 1,835
======== ======= ======= ======= ========
Segment income (loss) from operations (3,368) 205 (1,014) (367) (4,544)
Depreciation and amortization expense 701 125 -- 24 850
Valuation allowance additions (reductions): --
Receivables and inventory (316) -- 86 (230)
Capital asset additions (disposals), net (52) -- 561 509
Total assets 22,803 4,929 5,702 11,969 45,403
Three Months Ended October 31, 2002
Net sales $ 5,151 $ 374 $ -- $ -- $ 5,525
Cost of sales 4,110 453 -- -- 4,563
-------- ------- ------- ------- --------
Gross Profit $ 1,041 $ (79) $ -- $ -- $ 962
======== ======= ======= ======= ========
Segment income (loss) from operations (3,983) (538) -- (771) (5,292)
Depreciation and amortization expense 813 311 -- 24 1,148
Valuation allowance additions (reductions): --
Receivables and inventory (333) (860) -- -- (1,193)
Capital asset additions (disposals), net 766 18 -- -- 784
Total assets 33,205 5,784 -- 19,008 57,997
Nine Months Ended October 31, 2003
Net sales $ 14,533 $ 2,009 $ 2,521 $ -- $ 19,063
Cost of sales 10,980 1,282 1,849 -- 13,911
-------- ------- ------- ------- --------
Gross Profit $ 3,553 $ 727 $ 872 $ -- $ 5,152
======== ======= ======= ======= ========
Segment income (loss) from operations (9,344) 517 (1,014) (2,413) (12,254)
Depreciation and amortization expense 2,416 383 -- 73 2,872
Valuation allowance additions (reductions): --
Receivables and inventory (1,113) (469) 86 -- (1,496)
Capital asset additions (disposals), net (1,510) -- 561 -- (949)
Total assets 22,803 4,929 5,702 11,969 45,403
Nine Months Ended October 31, 2002
Net sales $ 14,491 $ 2,236 $ -- $ -- $ 16,727
Cost of sales 14,101 2,476 -- -- 16,577
-------- ------- ------- ------- --------
Gross Profit $ 390 $ (240) $ -- $ -- $ 150
======== ======= ======= ======= ========
Segment income (loss) from operations (21,825) (1,559) -- (2,849) (26,233)
Depreciation and amortization expense 2,386 573 -- 79 3,038
Valuation allowance additions (reductions): --
Receivables and inventory 2,638 188 -- -- 2,826
Capital asset additions (disposals), net 1,927 75 -- 70 2,072
Total assets 33,205 5,784 -- 19,008 57,997
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the consolidated unaudited
financial statements and related notes thereto. Further reference should be made
to our Form 10-K/A for the year ended January 31, 2003, including the
consolidated audited financial statements and notes thereto.
The results of operations reflect our activities and our wholly owned
subsidiaries; this consolidated group is referred to individually and
collectively as "We" and "Our".
Forward-Looking Statements--Cautionary Statement
All statements other than statements of historical fact contained in this
Form 10-Q, in our future filings with the Securities and Exchange Commission, in
our press releases and in our oral statements made with the approval of an
authorized executive officer are forward-looking statements. Words such as
"propose," "anticipate," "believe," "estimate," "expect," "plan", "intend,"
"may," "should", "could," "will" and similar expressions are intended to
identify such forward-looking statements. These forward-looking statements are
made pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Although we believe that our expectations reflected in these
forward-looking statements are based on reasonable assumptions, such statements
involve risk and uncertainties and no assurance can be given that actual results
will be consistent with these forward-looking statements. Important factors that
could cause actual results to differ materially from those forward-looking
statements include without limitation: (1) our ability to fund our operations
until such time that revenue and orders improve, including our ability to raise
additional equity or debt financing; (2) unanticipated technical problems
relating to our products; (3) our ability, or lack thereof, to make, market and
sell optical networking products that meet with market approval and acceptance;
(4) the greater financial, technical and other resources of our many, larger
competitors in the marketplace for optical networking products; (5) changed
market conditions, new business opportunities or other factors that might affect
our decisions as to the best interests of our shareholders; (6) other risks
detailed from time to time in our reports filed with the U.S. Securities and
Exchange Commission.
We wish to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made. Such
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. We specifically decline any obligation to publicly
release the result of any revisions, which may be made to any forward-looking
statements to reflect anticipated or unanticipated events or circumstances
occurring after the date of such statements, or to update the reasons why actual
results could differ from those projected in the forward-looking statements.
Results of Operations/Comparison of the Three and Nine Months ended October 31,
2003 and 2002.
Net sales. Our consolidated net sales increased $1.2 million or 22% to $6.7
million for the quarter ended October 31, 2003 compared to net sales of $5.5
million for the quarter ended October 31, 2002. The August 8, 2003 acquisition
of LuxN added $2.5 million in net sales to the quarter. Excluding LuxN, net
sales declined $1.2 million compared to prior year with Sorrento Networks Inc.
("SNI"), the Company's primary operating subsidiary, down $1.4 million or 27% to
$3.8 million for the quarter ended October 31, 2003, as compared to net sales of
$5.2 million for the prior year period. This decrease is attributable to the
slow uneven pace of recovery in the telecommunications industry resulting in
reduced capital expenditures amongst our core customer base. During the nine
months ended October 31, 2003 our net sales increased to $19.1 million from
$16.7 million for the comparable prior year period, an increase of $2.4 million
or 14%. This increase reflects the $2.5 million in additional net sales of LuxN.
Net sales for our Meret subsidiary declined by $200 thousand and $500 thousand
for the quarter and nine month periods compared to prior year due to the
transfer of one of Meret's product lines to SNI. This transfer was done for
conformity of products within the two segments.
During the three months ended October 31, 2003, product shipments to four
customers represented a combined $4.3 million or 65% of consolidated net sales.
During the quarter ended October 31, 2002, product shipments to three customers
represented a combined $3.9 million or 71% of consolidated net sales. During
the nine months ended October 31, 2003, product shipments to six customers
represented $13.4 million or 70% of consolidated net sales. For the comparable
nine months ended October 31, 2002, product shipments to four
23
customers represented $10.6 million or 63% of consolidated net sales. We expect
to continue experiencing significant fluctuations in our quarterly revenues as a
result of our long and variable sales cycle as well as our highly concentrated
customer base.
Gross profit. Cost of sales consists principally of the costs of
components, subcontract assembly from outside manufacturers, and in-house system
integration, quality control, final testing and configuration costs.
Consolidated gross profit was $1.8 million, or 27%, for the quarter ended
October 31, 2003 versus $1 million, or 17%, for the prior year quarter. SNI's
gross margin for the quarter increased by 5-points from the prior year's 14%
reflecting competitive pricing pressure. Meret's 56% gross margin for the
quarter improved by 19 points from the prior year's 37% due principally to lower
overhead costs resulting from relocation and consolidation of Meret's
manufacturing. LuxN contributed $872 thousand of gross profit, at a 35% gross
margin, for the quarter.
Consolidated gross profit for the nine months ended October 31, 2003 was
$5.2 million, or 27%, versus $150 thousand, or 1%, for the prior year period.
SNI's gross profit for the nine months was $3.6 million versus $95 thousand in
the prior year. Meret's gross profit for the nine months was $727 thousand
versus $55 thousand in the prior year. In July 2002, we adjusted the market
prices on many of our inventory components and took a write down for obsolete
and slow-moving inventories. These adjustments to SNI's and Meret's inventories
negatively impacted gross profit by $4 million. Excluding these adjustments, the
prior year gross margin would have been $4.2 million or 25%. The current year
nine-month period also includes $872 thousand of gross profit, at a 35% gross
margin, for LuxN.
Selling and marketing. Selling and marketing expenses consist primarily of
employee compensation and related costs, commissions to sales representatives,
tradeshow expenses and travel expenses. Consolidated selling and marketing
expenses increased $80 thousand to $2.5 million, or 37% of net sales, for the
quarter ended October 31, 2003 from $2.4 million, or 44% of net sales, for the
prior year quarter. Excluding LuxN's $557 thousand, selling and marketing costs
were down by $477 thousand compared to the prior year. Comparative percentages
of net sales, excluding LuxN, reveal a 2-point increase from 44% last year to
46% this year reflecting our ongoing efforts to minimize operating expenses
thru tight cost controls and reduced personnel costs.
Consolidated selling and marketing expenses of $6.5 million, or 34% of net
sales, for the nine months ended October 31, 2003 were $2.9 million lower than
the $9.5 million, or 57% of net sales, in the prior year period. This reduction
in expenses was attributable to implemented cost reductions heavily influenced
by reduced headcount and lower personnel related costs such as employee benefits
and travel. In addition, there were no LuxN expenses in the prior year period.
Engineering, research and development. Engineering, research and
development expenses consist primarily of compensation related costs for
engineering personnel, facilities costs and materials used in the design,
development and support of our technologies. All research and development costs
are expensed as incurred. Our consolidated engineering, research and development
expenses increased to $2.5 million, or 38% of net sales, for the quarter ended
October 31, 2003, from $2 million, or 36% of net sales, for the prior year
quarter. Excluding LuxN's $1.2 million, engineering, research and development
expenses were down by $659 thousand compared to the prior year. Comparative
percentages to sales, excluding LuxN, show a 16-point decline from 36% last
year to 20% this year due primarily to reduced personnel costs.
Consolidated engineering, research and development expenses of $5.7
million, or 30% of net sales, for the nine months ended October 31, 2003 were
$1.1 million lower than the $6.8 million, or 41% of net sales, in the prior year
period. This reduction in expenses was attributable to implemented cost
reductions heavily influenced by reduced headcount and lower personnel related
costs. In addition, there were no LuxN expenses in the prior year period.
General and administrative. General and administrative expenses consist
primarily of employee compensation and related costs, legal and accounting fees,
public company costs and allocable occupancy costs. Consolidated general and
administrative expenses were $1.2 million in the quarter ended October 31, 2003
versus $1.6 million in the comparable prior year period. Excluding LuxN's $118
thousand, general and administrative expenses declined by $484 thousand from
the prior year due primarily to lower personnel related expense and
professional fees.
Consolidated general and administrative expenses of $4.8 million, or 25% of
net sales, for the nine months ended October 31, 2003 were $4.6 million lower
than the $9.4 million, or 56% of net sales, in the prior year period. This
reduction in expenses primarily reflects a significantly lower level of costs
incurred in our corporate
24
restructuring program during the current year versus last year. In addition,
there were no LuxN expenses in the prior year period.
Deferred stock compensation. Deferred stock compensation was $0 and $109
thousand in the quarters ended October 31, 2003 and 2002, respectively. For the
nine month period ended October 31, 2003 and 2002, deferred compensation costs
were $51 thousand and $324 thousand, respectively. These costs were incurred in
connection with the grants of stock options with exercise prices determined to
be below the fair value of Sorrento's common stock on the date of grant,
Sorrento recorded deferred stock compensation of $2.6 million, which amount
was fully amortized at April 30, 2003.
Other income (charges). Other income (charges) from operations for the
quarter ended October 31, 2003 was comprised mainly of $286 thousand interest on
the Company's 7.5% debentures while the prior year quarter was comprised mainly
of $1.7 million of costs associated with the Company's 9.75% debentures. During
the nine months ended October 31, 2003, other income (charges) was $13.8 million
compared to $182 thousand for the same period in the prior year. This increase
reflects a net gain on the capital restructuring of $13.7 million, partially
offset by $3.5 million in costs associated with the Company's 9.75% convertible
debentures and $400 thousand interest on the Company's 7.5% debentures, and a
$4 million gain on the sale of marketable securities. Prior year other income
was comprised of a gain on the sale of marketable securities of $11.7 million
partially offset by $4.3 million in costs associated with the Company's 9.75%
debentures.
Income taxes. There was no provision for income taxes for the quarters and
nine months ended October 31, 2003 and 2002, respectively. We have carry
forwards of domestic federal net operating losses, which may be available, in
part, to reduce future taxable income in the United States. These carry forwards
have been adjusted due to the capital restructuring that occurred in June 2003.
However, due to potential adjustments to the net operating loss carry forwards
as provided by the Internal Revenue Code with respect to ownership changes made
as a result of the Exchange Agreement dated June 4, 2003, future availability of
the tax benefits is not assured. In addition, we provided a valuation allowance
in full for our deferred tax assets, as it is our opinion that it is more likely
than not that some portion or all of the deferred tax assets will not be
realized.
Liquidity and Capital Resources
We finance our operations through a combination of internal funds,
investments and debt and equity financing. At October 31, 2003, our working
capital was $10.2 million and including $4.8 million in cash and cash
equivalents and $483 thousand of investments in marketable securities.
Operations
Our operations used cash flows of $11.9 million during the nine months
ended October 31, 2003. During the quarter ended October 31, 2002, operations
used cash flows of $10.2 million. Significant items impacting the change in cash
flows used by operations were: positive earnings versus the prior year loss, the
gain on restructuring, decrease in accounts receivable and inventory reserves,
decrease in the gain on sales of marketable securities and the decline in
deferred revenues.
We have incurred significant losses and negative cash flows from operations
for the past two years. Sorrento Networks, Inc., ("SNI") our principal operating
subsidiary, has primarily been the operating entity responsible for these high
losses and negative cash flows. The losses have been generated as SNI continues
to develop its technology, marketing and sales and operations in its effort to
become a major supplier of metro and regional optical networks worldwide.
We have funded our operations primarily through a combination of internal
funds, the sale of investments and debt and equity financing. There can be no
assurance that similar funding will be available in the future. In addition, now
that our capital restructuring efforts are completed, there are certain
restrictions on us in both the amount of debt we can incur in future periods and
the types of securities that we can issue to raise additional capital in future
periods. Both of these restrictions could have a negative impact on our ability
to raise the additional working capital that we will require in future periods.
Further, with the downturn in the economic environment and decreases in capital
spending by telecom carriers, our revenue has been negatively impacted and our
future revenues could also be negatively impacted. As a result, our need for
additional working capital is crucial for future operations. We are actively
pursuing several alternatives and opportunities in order to strengthen our
financial condition. If we could successfully complete a financing transaction,
and there can be no assurance of that, we would expect to have
25
sufficient capital to operate our business for at least the next twelve months.
However, based upon the historical losses and negative cash flows we have
incurred in the past we estimate that we have less than six months of working
capital to finance our operations unless significant increases in revenue or
reduction in expenses are made. If such capital is not available, we will need
to substantially and immediately decrease our operating costs and capital
spending in order to fund operations. There can be no assurance that our
available cash, future funding or reduction in operating costs will be
sufficient to fund our operations in the future.
Our standard payment terms range from net 30 to net 60 days. Receivables
from international customers have frequently taken longer to collect. In
addition, the downturn in the telecom market has impacted many of the telecom
carriers ability to purchase or pay for outstanding commitments within standard
payment terms. There can be no assurance that this continued economic
environment will not impact either current or future receivables negatively, or
our ability to control inventory levels. We do not provide long-term financing
to customers buying our equipment.
Investing Activities
Our investing activities during the nine months ended October 31, 2003
provided cash flows of $12.0 million primarily from the sale of $6.4 million in
marketable securities, $1.9 million of net investing transactions related to the
LuxN merger and the disposal of $900 property and equipment. During the nine
months ended October 31, 2002, investing activities provided cash flows of $12.1
million primarily from $13.6 million on the sale of marketable securities offset
by purchased property and equipment of $2.8 million.
Financing Activities
Our financing activities during the nine months ended October 31, 2003 and
2002 used cash of $181 thousand and $1.3 million, respectively, consisting
primarily of the repayment of debt. We anticipate that we will need additional
working capital to fulfill our capital working requirements for the next year.
While we have made significant cost reductions to bring our losses more in line
with our anticipated or projected revenues, there is no assurance the volume of
future revenues will be sufficient to allow us to meet our financial obligations
for future periods. We continue to reduce our operating costs and have initiated
activities to raise additional working capital. If revenues do not continue to
improve in the future and expenses are not significantly reduced, we anticipate
that we will not have sufficient working capital to finance our operations for
the next twelve months. Our future capital requirements may vary materially from
those now planned including the need for working capital to accommodate planned
growth, hiring and infrastructure needs. There can be no assurances that our
working capital requirements will not exceed our ability to generate sufficient
cash internally to support our requirements and that external financing will be
available or that, if available, such financing can be obtained on terms
favorable to us and our shareholders.
Contractual Cash Obligations
The following tables quantify our future contractual obligations and
commercial commitments as of October 31, 2003:
Contractual Obligations
Payments due in fiscal years
---------------------------------------------------------------
Remainder
Total 2004 2005 2006 2007 2008 Thereafter
------- --------- ---- ---- ------- ---- ----------
Long-term Debt ................ $ 3,597 $ 11 $ 49 $ 54 $ 58 $63 $3,362
Capital Leases ................ 90 37 53 -- -- -- --
Operating Leases .............. 493 144 158 131 42 18 --
7.5% Convertible Debentures ... 12,998 -- -- -- 12,998 -- --
------- ---- ---- ---- ------- --- ------
Total ......................... $17,178 $192 $260 $185 $13,098 $81 $3,362
======= ==== ==== ==== ======= === ======
26
The table above does not include our trade accounts payable and accrued
liabilities at October 31, 2003 as disclosed on the accompanying consolidated
balance sheet.
Securities Authorized For Issuance Under Equity Compensation Plans
The following table provides information as of October 31, 2003
regarding compensation plans (including individual compensation arrangements)
under which equity securities are authorized for issuance.
Number of Securities To Number of Securities
Be Issued Upon Remaining Available for
Exercise Weighted-Average Exercise Future Issuance Under Equity
Of Outstanding Price of Outstanding Compensation Plans
Options, Options, (Excluding Securities
Warrants and Rights Warrants and Rights Reflected in Column (a))
----------------------- ------------------------- ----------------------------
Plan Category (a) (b) (c)
----------------------- ------------------------- ----------------------------
Equity Compensation Plans Approved
by security Holders *(FIBR) 1,263,011 $92.50 1,395,989
--------- ------ ----------
Equity Compensation Plans not Approved
by Security Holders (SNI) 2,737,847 $ 5.27 20,558,153
--------- ------ ----------
Total 4,000,858 $32.81 21,954,142
--------- ------ ----------
* As adjusted for stock splits
See the Stock Option Plans note in the financial statements included in this
quarterly report for information regarding the material features of the above
plans. Each of the above plans provides that the number of shares with respect
to which options may be granted, and the number of shares of Common Stock
subject to an outstanding option, shall be proportionally adjusted in the event
of a subdivision or consolidation of shares or the payment of a stock dividend
on Common Stock, and the purchase price per share of outstanding options shall
be proportionately revised.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of
operations are based upon our 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 us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosures of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to our valuation of inventory and our allowance for uncollectable
accounts receivable. We base our estimates on historical experience and on
various other assumptions 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 materially from these estimates under
different assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
o Revenue recognition. Revenue is generally recognized when the
products are shipped, all substantial contractual obligations, if
any, have been satisfied, and the collections of the resulting
receivable is reasonably assured. When title does not pass to the
customer at time of shipment, revenue is not recognized until all
contractual requirements are met and title has transferred.
During this transition period, the amount of the sale and/or
installation is shown in deferred revenue.
Revenue from installation is recognized as the services are
performed to the extent of the direct costs incurred. To date,
installation revenue has not been material. Revenue from service
obligations, if any, is deferred and recognized over the life of
the contract. Inventory or demonstration equipment shipped to
potential customers for field trials is not recorded as
27
revenue. We accrue for warranty costs, sales returns and other
allowances at the time of shipment. Although our products contain
a software component, the software is not sold separately and we
are not contractually obligated to provide software upgrades to
our customers.
o Inventory. Inventory is evaluated on a continual basis and
management must make estimates about the future customer demand
for our products, taking into account both the economic
conditions and growth potential of our customers. Reserve
adjustments are made based on management's estimate of future
sales value, if any, of specific inventory items. Reserve
adjustments are made for the difference between the cost of the
inventory and the estimated market value and charged to
operations in the period in which the facts that give rise to the
adjustments become known. A misinterpretation or misunderstanding
of these conditions or uncertainty in the future outlook of our
industry or the economy, or the failure to estimate correctly,
could result in inventory losses in excess of the provisions
determined to be appropriate at the time of the balance sheet.
o Accounts receivable. Accounts receivable balances are evaluated
on a continual basis and management regularly reviews the
financial stability of individual customers. This analysis
involves a judgment of the customer's current and projected
financial condition and the positive or negative effects of the
current and projected industry outlook, as well as that of the
economy in general. Allowances are provided for potentially
uncollectable accounts based on management's estimate of the
collectability and the probability of default of customer
accounts. If the financial condition of a customer were to
deteriorate, resulting in an impairment of their ability to make
payments, an additional allowance may be required. Allowance
adjustments are charged to operations in the period in which the
facts that give rise to the adjustments become known.
o Intangible assets. We currently have intangible assets that
include assets with finite lives, such as our purchased
technology. The determination of related estimated useful lives
and whether these assets are impaired involves judgments based
upon short and long-term projections of future performance. We
have no goodwill or indefinite life intangible assets. Other
intangible assets with finite lives continue to be amortized over
their useful lives.
o Legal contingencies. We are subject to proceedings, lawsuits and
other claims, including proceedings under laws and government
regulations related to securities, environmental, labor, product
and other matters. We are required to assess the likelihood of
any adverse judgments or outcomes to these matters, as well as
potential ranges of probable losses. A determination of the
amount of reserves required, if any, for the contingencies is
based on a careful analysis of each individual issue with the
assistance of outside legal counsel. Our reserves may change in
the future due to new developments in each matter or changes in
approach such as a change in settlement strategy in dealing with
these matters.
o Income taxes. We currently have no provisions for income taxes.
We have carry forward domestic federal net operating losses,
which may be available, in part, to reduce future taxable income
in the United States. However, due to potential adjustments to
the net operating loss carry forwards as provided by the Internal
Revenue Code with respect to ownership changes made as a result
of the Exchange Agreement dated June 4, 2003, future availability
of the tax benefits is not assured. In addition, we provided a
valuation allowance in full for our deferred tax assets, as it is
our opinion that it is more likely than not that some portion or
all of the deferred tax assets will not be realized.
Impact of Recent Accounting Pronouncements
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 150. "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity" ("SFAS 150"). SFAS 150 clarifies the accounting for certain financial
instruments with characteristics of both liabilities and equity and requires
that those instruments be classified as liabilities in the balance sheets.
Previously, many of those financial instruments were classified as equity. SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003 and otherwise is effective at the beginning of the first
28
interim period beginning after June 15, 2003. We adopted this pronouncement with
no material impact on our results of operations and financial condition.
In April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No. 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities under SFAS
No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). In particular, it (1) clarifies under what circumstances a contract with
an initial net investment meets the characteristic of a derivative as discussed
in SFAS 133, (2) clarifies when a derivative contains a financing component, (3)
amends a definition to conform it to the language used in FASB Interpretation
No. ("FIN") 45, "Guarantor Accounting and Disclosure Requirements for
Guarantees, including Indirect Guarantees of Indebtedness of Others" ("FIN 45")
and (4) amends certain other existing pronouncements. SFAS 149 will be effective
for contracts entered into or modified after June 30, 2003, except as stated
below, and for hedging relationships designated after June 30, 2003. The
provisions of SFAS 149 that relate to guidance in SFAS 133 Implementation Issues
that have been effective for fiscal quarters which began prior to June 15, 2003,
will continue to be applied in accordance with their respective effective dates.
In addition, certain provisions relating to forward purchases or sales of
when-issued securities or other securities that do not yet exist, will be
applied to both existing contracts as well as new contracts entered into after
June 30, 2003. We will apply the provision of SFAS 149 on a prospective basis to
contracts entered into or modified after June 30, 2003 and expect that this
pronouncement will not have a material impact on our results of operations and
financial condition.
In November 2002, the FASB Emerging Issues Task Force ("EITF") reached a
consensus on Issue 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables" ("EITF 00-21"). In the absence of higher level accounting
literature, EITF 00-21 governs how to separate and allocate revenue to goods or
services or both that are to be delivered in a bundled sales arrangement. EITF
00-21 applies to revenue arrangements entered into after June 30, 2003 and
allows for either prospective application or cumulative adjustment upon
adoption. We adopted this pronouncement with no material impact on our financial
position or results of operations.
Effects of Inflation and Currency Exchange Rates
We believe that the relatively moderate rate of inflation in the United
States over the past few years has not had a significant impact on our sales or
operating results or on the prices of raw materials. There can be no assurance,
however, that inflation will not have a material adverse effect on our operating
results in the future.
The majority of our sales and expenses are currently denominated in U.S.
dollars and to date our business has not been significantly affected by currency
fluctuations. However, we conduct business in several different countries and
thus fluctuations in currency exchange rates could cause our products to become
relatively more expensive in particular countries, leading to a reduction in
sales in that country. In addition, inflation in such countries could increase
our expenses. In the future, we may engage in foreign currency denominated sales
or pay material amounts of expenses in foreign currencies and, in such event,
may experience gains and losses due to currency fluctuations. Our operating
results could be adversely affected by such fluctuations.
Other Matters
See Part II, Item 1, "Other Information--Legal Proceedings".
Fluctuations in Revenue and Operating Results
Sales of our products to the telecommunications industry are subject to
fluctuation and the declines and increases recently experienced by us are not
necessarily indicative of the operating results for any future periods. Our
operating results may fluctuate as a result of a number of factors, including
the timing of orders from, and shipments to, customers; the timing of new
product introductions and the market acceptance of those products; increased
competition; changes in manufacturing costs; availability of parts; changes in
the mix of product sales; the rate of end user adoption and carrier and private
network deployment of WAN data, video and audio communication services; factors
associated with international operations; and changes in world economic
conditions.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to financial market risks, including changes in interest
rates and foreign currency rates. Our exposure to interest rate risk is the
result of our need for periodic additional financing for our large operating
losses
29
and capital expenditures associated with establishing and expanding our
operations. The interest rate that we will be able to obtain on debt financing
will depend on market conditions at that time, and may differ from the rates we
have secured on our current debt.
Almost all of our sales have been denominated in U.S. dollars. A portion of
our expenses are denominated in currencies other than the U.S. dollar and in the
future a larger portion of our sales could also be denominated in non-U.S.
currencies. As a result, currency fluctuations between the U.S. dollar and the
currencies in which we do business could cause foreign currency translation
gains or losses that we would recognize in the period incurred. We cannot
predict the effect of exchange rate fluctuations on our future operating results
because of the number of currencies involved, the variability of currency
exposure and the potential volatility of currency exchange rates. We attempt to
minimize our currency exposure risk through working capital management and do
not hedge our exposure to translation gains and losses related to foreign
currency net asset exposures.
We do not hold or issue derivative, derivative commodity instruments or
other financial instruments for trading purposes. Investments held for other
than trading purposes do not impose a material market risk.
We believe that the relatively moderate rate of inflation in the United
States over the past few years and the relatively stable interest rates incurred
on short-term financing have not had a significant impact on our sales,
operating results or prices of raw materials. There can be no assurance,
however, that inflation or an upward trend in short-term interest rates will not
have a material adverse effect on our operating results in the future should we
require debt financing in the future.
Item 4. Controls and Procedures
Evaluation of Controls and Procedures
The Company maintains disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) designed to ensure that it is able
to collect the information it is required to disclose in the reports it files
with the SEC, and to process, summarize and disclose this information within the
time periods specified in the rules of the SEC. These disclosure controls and
procedures are designed and maintained by or under the supervision of the
Company's Chief Executive Officer and Chief Financial Officer, as required by
the rules of the SEC. The Company's Chief Executive Officer and Chief Financial
Officer are responsible for evaluating the effectiveness of the disclosure
controls and procedures. Based on their evaluation of the Company's disclosure
controls and procedures which took place as of the end of the period covered by
this report, the Chief Executive and Chief Financial Officers believe that these
controls and procedures are effective to ensure that the Company is able to
collect, process and disclose the information it is required to disclose in the
reports it files with the SEC within the required time periods. During the
period covered by this report, there have been no changes in the Company's
internal controls over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
Changes in Controls and Procedures
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these internal controls after the
date of our most recent evaluation.
30
PART II
OTHER INFORMATION
Item 1: Legal Proceedings
On June 4, 2003, we consummated the exchange transaction and cancelled all
outstanding Series A Convertible Preferred Stock and 9.75% Senior Convertible
Debentures. The Exchange Agreement provides that the litigation instituted by
the former holders of Series A stock be dismissed without prejudice against the
Company, its subsidiaries, its current officers and directors, and other
defendants who execute an appropriate release, and without prejudice against all
other defendants. This dismissal will require court approval, which is in the
process of being obtained by counsel for all parties.
In accordance with a settlement agreement reached between us and our former
Chairman and Founder, Par Chadha, 566,000 shares of ENI stock were transferred
to Mr. Chadha in exchange for mutual releases by the Company and Mr. Chadha and
certain of his affiliates. The stock transfer was completed on July 1, 2003 and
had a value of $88 thousand.
In addition, claims in arbitration were filed by two of our former
financial officers and employees who worked in our Santa Monica office, which
has since been closed, alleging that their resignations in May 2002 were for
"good reason" as defined in their employment agreements, all of which were to
expire on May 22, 2002. One of the claims has was settled in May 2003 for $45
thousand. The other claim was resolved by an arbitrator in August 2003 whom
ruled in our favor.
A former officer of our SNI subsidiary brought suit alleging breach of a
consulting agreement we entered into with him in March 2002, following his
resignation "for good reason" as defined in his employment agreement. He was
seeking acceleration of consulting fees due to him under his consulting
agreement in the amount of $229 thousand. This suit was settled on December 1,
2003 for $15 thousand and $150 thousand of Sorrento common stock that was
distributed to him June 4, 2004.
From time to time, we are involved in various other legal proceedings and
claims incidental to the conduct of our business. Although it is impossible to
predict the outcome of any outstanding legal proceedings, we believe that such
legal proceedings and claims, individually and in the aggregate, are not likely
to have a material adverse effect on our financial position, results of
operations, or cash flows.
Item 2: Changes in Securities and Use of Proceeds
On August 8, 2003, we acquired LuxN for a combination of stock, warrants,
and cash previously held by LuxN. Stockholders of LuxN were given the option of
exchanging shares of LuxN stock for either their pro-rata portion of LuxN's net
cash or shares of Sorrento's common stock. In addition to the cash or common
stock, stockholders of LuxN have the right to receive warrants to purchase an
aggregate of 400 thousand shares of Sorrento common stock, with an exercise
price of $3.05 per share, the fair market value on the date of acquisition. The
warrants will be held in escrow for a period of six months to satisfy any
successful indemnification claims. At closing, Sorrento issued approximately 1.4
million shares of common stock with the remaining approximately 500 thousand
shares of common stock to be issued subject to stockholder approval.
Item 3: Defaults Upon Senior Securities
Not Applicable
Item 4: Submission of Matters to a Vote of Security Holders
Not Applicable.
31
Item 5: Other Information
Not Applicable
Item 6: Exhibits and Reports on Form 8-K
(a). Exhibits
1. Consolidated Financial Statements for the Quarter and Nine Months
Ended October 31, 2003 (included in Part I, Item 1).
2. Exhibits:
2.1 Agreement and Plan of Merger with LuxN, Inc. (J).
3.1 Certificate of Incorporation of the Registrant (G).
3.2 By-Laws of the Registrant (G).
3.3 Series D Preferred Stock Certificate of Designation (G).
4.1 1988 Stock Option Plan (B).
4.2 Amended and Restated 1997 Incentive and Non-Qualified Stock
Option Plan (A).
4.3 1997 Directors Stock Option Plan (C).
4.4 2000 Stock Incentive Plan (E).
4.5 2000 Employee Stock Purchase Plan (D).
4.6 2000 Stock Option/Stock Issuance Plan of Sorrento Networks,
Inc. (E).
4.7 Form of 7.5% Convertible Debenture Due August 2, 2007 (G).
4.8 Form of Warrant, expiry date August 2, 2007 (G).
4.9 Sorrento Networks Corporation 2003 Equity Incentive Plan
(G).
5. Opinion of Greenbaum, Rowe, Smith, Ravin, Davis & Himmel
LLP.
10.1 Agreement dated July 12, 2000 with Richard L. Jacobson (E).
10.2 Agreement dated March 1, 2002, with Phillip W. Arneson (F).
10.3 Exchange Agreement dated March 6, 2003 (G).
10.4 Form of Registration Rights Agreement with Exchanging
Holders (G).
10.5 Agreement dated May 17, 2002 with Joe R. Armstrong (H).
10.6 Agreement dated July 3, 2002 with Richard L. Jacobson (H).
10.7 Agreement dated February 1, 2003 with Robert L. Hibbard (H).
10.8 First Amendment to Exchange Agreement (I).
21. Subsidiaries of the Registrant (H).
23.1 Consent of BDO Seidman LLP - filed herewith.
----------
The foregoing are incorporated by reference from the Registrant's filings
indicated:
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Accounting Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32
32.1 Certifications of Chief Executive Officer and Principal
Accounting Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
(A) Proxy Statement dated December 1, 1999.
(B) Proxy Statement dated May 13, 1998.
(C) Proxy Statement dated November 21, 1997.
(D) Proxy Statement dated December 11, 2000.
(E) Form 10-K for the year ended January 31, 2001.
(F) Form 10-K for the year ended January 31, 2002.
(G) Proxy Statement filed with the SEC on April 16, 2003.
(H) Form 10-K for the year ended January 31, 2003.
(I) Form 8-K dated May 30, 2003.
(J) Form 8-K/A dated August 25, 2003.
NOTE: Certain previously filed exhibits are no longer being incorporated by
reference (and therefore not numerically listed) as the underlying
documents have either expired or are no longer material or relevant.
(b). Reports on Form 8-K
August 13, 2003 Q2 Results of Operations and Financial Condition
August 22, 2003 Acquisition of Assets
August 25, 2003 Acquisition of Assets
September 10, 2003 Q2 Earnings Conference Call Transcript
October 23, 2003 Acquisition of Assets and Pro-forma Financial
Statements
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SORRENTO NETWORKS CORPORATION
(REGISTRANT)
December 17, 2003 By: /s/ JOE R. ARMSTRONG
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Joe R. Armstrong,
Chief Financial Officer
Principal Accounting Officer
34
STATEMENT OF DIFFERENCES
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The section symbol shall be expressed as................................ 'SS'