SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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 JULY 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File number: 0-15810
SORRENTO NETWORKS CORPORATION
(Exact name of Registrant as specified in charter)
New Jersey 22-2367234
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
9990 Mesa Rim Road
San Diego, California
92121
(Address of principal executive offices)
(Zip Code)
(858) 558-3960
(Registrant's telephone number, including area code)
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, $.30 par value per share, Outstanding: 14,229,026 shares
at September 12, 2001.
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.
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands)
================================================================================
Unaudited
July 31, 2001 January 31, 2000
----------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 3,615 $ 9,965
Accounts receivable, net 12,675 16,000
Inventory, net 28,867 14,601
Prepaid expenses and other current assets 1,210 813
Investment in marketable securities 25,811 50,258
---------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 72,178 91,637
---------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT, NET 17,956 16,600
---------------------------------------------------------------------------------------------------------------
OTHER ASSETS
Purchased technology, net 838 1,023
Other assets 1,920 2,556
Investment in former subsidiary 1,266 1,307
---------------------------------------------------------------------------------------------------------------
TOTAL OTHER ASSETS 4,024 4,886
---------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 94,158 $ 113,123
===============================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term debt $ 1,180 $ 1,342
Current maturities of long term debt 524 422
Accounts payable 19,960 8,382
Accrued and other current liabilities 8,067 9,498
---------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 29,731 19,644
---------------------------------------------------------------------------------------------------------------
Long-term debt and capital lease obligations 3,922 3,819
Dividend payable 1,266 1,307
---------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 34,919 24,770
---------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST
Preferred stock of subsidiary; 8,954 shares issued and
outstanding; subsidiary liquidation preference $48,800 48,800 48,620
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; cumulative dividends; liquidation
preference $1,353 including accumulated dividends 1 1
Common stock, $.30 par value; 150,000 shares authorized; 14,238 shares
issued and 14,229 shares outstanding at July 31, 2001; 12,608 shares
issued and 12,599 shares outstanding at January 31, 2001 4,271 3,782
Additional paid-in capital 125,107 114,994
Notes receivable from option exercises (5,034) (5,034)
Deferred stock compensation (569) (880)
Accumulated deficit (134,919) (118,010)
Accumulated unrealized gain on marketable securities 21,651 44,949
Treasury stock, at cost; 9 shares at July 31, 2001 and January 31, 2001 (69) (69)
---------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 10,439 39,733
---------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 94,158 $ 113,123
===============================================================================================================
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 Ended Six Months Ended
July 31 July 31
------------------------- -----------------------
2001 2000 2001 2000
------------------------------------------------------------------------------------------------------------------------------
NET SALES $ 7,998 $ 11,376 $ 22,495 $ 21,424
COST OF SALES 6,702 7,534 16,270 15,727
------------------------------------------------------------------------------------------------------------------------------
GROSS PROFIT 1,296 3,842 6,225 5,697
------------------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Selling and marketing 3,836 5,512 8,149 9,226
Engineering, research and development 3,425 6,465 6,726 12,386
General and administrative 3,293 5,035 6,043 8,200
Deferred compensation 205 836 406 836
Other operating expenses 93 93 186 2,255
------------------------------------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 10,852 17,941 21,510 32,903
------------------------------------------------------------------------------------------------------------------------------
LOSS FROM OPERATIONS (9,556) (14,099) (15,285) (27,206)
------------------------------------------------------------------------------------------------------------------------------
OTHER INCOME (CHARGES)
Investment income 43 873 143 1,361
Interest expense (144) (289) (334) (512)
Other income (charges) (168) (9) (117) (4)
Losses on marketable securities (1,136) -- (1,136) --
------------------------------------------------------------------------------------------------------------------------------
TOTAL OTHER INCOME (CHARGES) (1,405) 575 (1,444) 845
------------------------------------------------------------------------------------------------------------------------------
LOSS BEFORE INCOME TAXES (10,961) (13,524) (16,729) (26,361)
Provision for Income Taxes -- -- -- --
------------------------------------------------------------------------------------------------------------------------------
NET LOSS $(10,961) $(13,524) $(16,729) $(26,361)
==============================================================================================================================
INCOME (LOSS) PER COMMON SHARE:
PREFERRED STOCK DIVIDENDS -- 579 180 976
NET LOSS APPLICABLE TO COMMON SHARES $(10,961) $(14,103) $(16,909) $(27,337)
==============================================================================================================================
BASIC
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (IN THOUSANDS) 14,184 11,609 13,740 11,563
NET LOSS PER COMMON SHARE $ (0.77) $ (1.21) $ (1.23) $ (2.36)
==============================================================================================================================
DILUTED
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (IN THOUSANDS) 14,184 11,609 13,740 11,563
NET LOSS PER COMMON SHARE $ (0.77) $ (1.21) $ (1.23) $ (2.36)
==============================================================================================================================
COMPREHENSIVE INCOME AND ITS COMPONENTS CONSIST OF THE FOLLOWING:
Net loss $(10,961) $(13,524) $(16,729) $(26,361)
Unrealized gains (losses) from marketable securities:
Unrealized holding gains (losses) arising during the period (2,798) 65,969 (24,434) 29,406
Reclassification adjustment for losses included in net income 1,136 -- 1,136 --
------------------------------------------------------------------------------------------------------------------------------
COMPREHENSIVE INCOME (LOSS) $(12,623) $ 52,445 $(40,027) $ 3,045
==============================================================================================================================
See accompanying notes to consolidated financial statements
3
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands)
================================================================================
Six Months Ended
July 31
--------------------------
2001 2000
-------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss from operations $(16,729) $(26,361)
-------------------------------------------------------------------------------------------------------
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 1,648 2,361
Accounts receivable and inventory reserves 5,104 5,366
Intangible assets valuation allowances -- 435
Losses on marketable securities 1,136 --
Deferred and other stock compensation 406 836
Changes in assets and liabilities net of effects of business entity
divestures:
Increase in accounts receivable (100) (5,720)
Increase in inventories (15,444) (3,742)
Increase in short-term commercial paper -- (8,559)
Decrease in other current assets 255 62
Increase (decrease) in accounts payable 11,654 (110)
Increase (decrease) in accrued and other current liabilities (1,507) 4,455
-------------------------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES (13,577) (30,977)
-------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (2,596) (7,121)
Proceeds from sale of marketable securities 13 --
Advances to affiliates, net of repayments -- 528
Other assets (517) (2,376)
-------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (3,100) (8,969)
-------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term debt, net of repayments (162) (807)
Repayment of long-term debt (17) (389)
Proceeds from preferred stock issued by subsidiary -- 46,638
Proceeds from common stock 9,645 --
Proceeds from stock option exercises 861 2,348
-------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 10,327 47,790
-------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (6,350) 7,844
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 9,965 13,511
-------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 3,615 $ 21,355
=======================================================================================================
See accompanying notes to consolidated financial statements.
4
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In Thousands, except share and per share amounts)
--------------------------------------------------------------------------------
Sorrento Networks Corporation (formerly Osicom Technologies, Inc.) (the
"Company," "We," "Our," or "Us") through its subsidiaries designs, manufactures
and markets integrated networking and bandwidth aggregation 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, California,
Santa Monica, California and Fremont, California. In addition, we have various
sales offices located in the United States, Europe and Asia. Our former
subsidiary, Entrada Networks is located in San Diego, California. 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 as of July 31, 2001 and January 31,
2001, for the three and six months ended July 31, 2001 and 2000, have 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 generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. The January 31, 2001 balance sheet was derived from
audited financial statements, but does not include all disclosures required by
generally accepted accounting principles. 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 financial statements and the notes thereto included in our
Annual Report on Form 10-K for the year ended January 31, 2001.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates that affect
the reported amounts of assets, liabilities, revenues and expenses, the
disclosure of contingent assets and liabilities. Actual results could differ
from these estimates. In the opinion of Management, all adjustments (which
include only normal recurring adjustments) necessary to present fairly the
financial position, results of operations and cash flows as of July 31, 2001 and
for the three and six months ended July 31, 2000, have been made. The results of
operations for the three and six months ended July 31, 2001 are not necessarily
indicative of the operating results for the full year.
On August 31, 2000, we completed a merger of Entrada Networks with Sync
Research, Inc. ("Sync"), a Nasdaq listed company in which we received 4,244,155
shares of the merged entity which changed its name to Entrada Networks, Inc. and
changed its symbol to ESAN. We purchased 93,900 shares of Sync in the open
market during June and July, 2000 for $388 and on August 31, 2000 purchased an
additional 1,001,818 shares directly from Entrada for $3,306. After these
transactions and Entrada's issuance of shares to outside investors in connection
with the merger we owned 48.9% of Entrada Networks. Accordingly, the
accompanying financial statements reflect the results of Entrada through August
31, 2000.
Pursuant to a plan adopted by our Board of Directors prior to the
merger we distributed 3,107,155 of our Entrada shares on December 1, 2000 to our
shareholders of record as of November 20, 2000. The distribution was made at the
rate of one-fourth (0.25) of an Entrada share for each of our outstanding
shares. At exercise, options and warrants to acquire our common shares which
were granted and unexercised as of November 20, 2000 will receive a similar
number of Entrada shares. Prior to July 31, 2001 we distributed 29,533 of our
Entrada shares upon the exercise of options and as of July 31, 2001 have
reserved 1,046,045 shares for future exercises of options and warrants. The cost
basis of these reserved shares and related liability to the option and warrant
holders is included in the investment in former subsidiary and dividends payable
in the accompanying balance sheet. The aggregate distribution of our Entrada
shares including the shares reserved for option and warrant holders has been
accounted
5
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
--------------------------------------------------------------------------------
for at our original cost of $5,122. In addition we have granted options to
purchase 410,000 of our Entrada shares for $3.19 per share (the merger price) to
several of our then officers and consultants.
The remaining 1,106,337 Entrada shares owned by us are accounted for as
an "available for sale security". Under this accounting, these shares are
marked-to-market at the end of each reporting period. The difference between our
basis and the fair market value, as reported on Nasdaq, is a separate element of
stockholders' equity and is included in the computation of comprehensive income.
During the quarter ended July 31, 2001, we recorded an impairment allowance of
$1,087 to reflect the decline in the market value of our Entrada shares. More
information concerning Entrada is available in its public filings with the
Securities and Exchange Commission.
NETsilicon, Inc.
On September 15, 1999 NETsilicon, Inc. ("NSI") completed an initial
public offering in which we sold 2,000,000 of our shares in NSI and in which our
remaining 55.4% interest became non-voting shares until sold to a non-affiliate.
Accordingly, the accompanying financial statements reflect the results of
operations of NSI through September 14, 1999 at which time our remaining
interest is accounted for as an "available for sale security." Under this
accounting, the 7.5 million shares of NSI held by us are marked-to-market at the
end of each reporting period with the difference between our basis and the fair
market value, as reported on Nasdaq, reported as a separate element of
stockholders' equity and is included in the computation of comprehensive income.
After our sale in October 2000 of 527,344 of our shares in NSI we own
6,972,656 shares of NSI, or 49.6% as of July 31, 2001. More information
concerning NSI is available in its public filings with the Securities and
Exchange Commission.
Deferred 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
Sorrento subsidiary granted by it to its employees. During the quarters ended
July 31, 2001 and 2000, and the six months ended July 31, 2001 and 2000 our
subsidiary Sorrento Networks "Sorrento" amortized $157, $678, $311 and $678
respectively of the total $2,604 initially recorded for deferred stock
compensation.
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 Sorrento
subsidiary granted by it to its consultants. During the quarters ended July 31,
2001 and 2000, and the six months ended July 31, 2001 and 2000 Sorrento recorded
$48, $158, $95 and $158, respectively, for options granted to consultants.
6
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
--------------------------------------------------------------------------------
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board finalized
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations", and No. 142, "Goodwill and Other Intangible Assets". SFAS 141
requires the use of the purchase method of accounting and prohibits the use
of the pooling-of-interests method of accounting for business combinations
initiated after June 30, 2001. SFAS 141 also requires that we recognize
acquired intangible assets apart from goodwill if the acquired intangible
assets meet certain criteria. SFAS 141 applies to all business combinations
initiated after June 30, 2001 and for purchase business combinations completed
on or after July 1, 2001. Upon adoption of SFAS 142, it requires that we
reclassify the carrying amounts of intangible assets and goodwill based on
the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer
amortize goodwill, but instead test goodwill for impairment at least annually.
In addition, SFAS 142 requires that we identify reporting units for the purposes
of assessing potential future impairments of goodwill, reassess the useful lives
of other existing recognized intangible assets, and cease amortization of
intangible assets with an indefinite useful life. An intangible asset with an
indefinite useful life should be tested for impairment in accordance with the
guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years
beginning after December 15, 2001 to all goodwill and other intangible assets
recognized at that date, regardless of when those assets were initially
recognized. SFAS 142 requires us to complete a transitional goodwill impairment
test six months from the date of adoption. The Company is also required to
reassess the useful lives of other intangible assets within the first interim
quarter after adoption of SFAS 142.
During the fiscal years ended January 31, 1997 we completed several
business combinations which were accounted for using the purchase method. As of
July 31, 2001, the net carrying amount of intangible assets is $837 all of which
pertain to our Meret Optical business segment. Amortization expense during the
quarters ended July 31, 2001 and 2000 was $93 and during the six months ended
July 31, 2001 and 2000 was $186. We are currently evaluating the effect, if any,
the adoption of SFAS 141 and 142 will have on our financial position and results
of operations.
SFAS 133, as amended by SFAS 137 and 138 "Accounting for Derivative
Instruments and Hedging Activities," is effective for financial statements
with fiscal quarters of all fiscal years beginning after June 15, 2000.
The Accounting Standards Executive Committee issued Statement of Position
("SOP") 98-1, "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use," and SOP 98-5, "Reporting on the Costs of Start-up
Activities," effective in the current or future periods. The adoption or future
adoption of these standards has had or will have no material effects, if any, on
our financial position or results of operations.
The Financial Accounting Standards Board issued Interpretation ("FIN")
No. 44, "Accounting for Certain Transactions involving Stock Compensation," an
Interpretation of APB Opinion No. 25. FIN 44 clarifies the application of
Opinion No. 25 for (a) the definition of an employee for purposes of applying
Opinion No. 25, (b) the criteria for determining whether a plan qualifies as a
non-compensatory plan, (c) the accounting consequences of various modifications
to the terms of a previously fixed stock option award, and (d) the accounting
for an exchange of stock compensation awards in a business combination. FIN 44
is effective July 2, 2000, but certain conclusions cover specific events that
occur after either December 15, 1998, or January 12, 2000. The adoption of this
standard had no material effect, if any, on our financial position or results of
operations.
The Securities and Exchange Commission issued Staff Accounting Bulletin
No. 101, Revenue Recognition ("SAB 101") which broadly addresses how companies
report revenues in their financial statements effective the fourth fiscal
quarter of years beginning after December 31, 1999. The adoption of this policy
had no effect on our financial position or results of operations.
7
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
--------------------------------------------------------------------------------
BALANCE SHEET DETAIL
Inventories at July 31, 2001 and January 31, 2001 consist of:
July 31, 2001 January 31, 2001
------------- ----------------
Raw material $ 19,582 $ 10,201
Work in process 4,519 4,310
Finished goods 8,533 2,882
----- -----
32,634 17,393
Less: Valuation reserve (3,767) (2,792)
-------- --------
$ 28,867 $ 14,601
======== ========
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. Investments not classified as held to
maturity, those for which we have the intent and ability to hold, are classified
as available for sale. Our investments in NETsilicon 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 and
during the quarter ended July 31, 2001 we recorded an impairment loss of $1,087
against our investment in Entrada. At July 31, 2001 and January 31, 2000
marketable securities were as follows:
Unrealized
Cost Gains Market Value
---- ------------- ------------
July 31, 2001:
NETsilicon $ 3,938 $ 21,651 $ 25,589
Entrada 222 - 222
------- -------- --------
$ 4,160 $ 21,651 $ 25,811
======= ======== ========
January 31, 2001:
NETsilicon $ 3,938 $ 42,303 $ 46,241
Entrada 1,371 2,646 4,017
------- -------- --------
$ 5,309 $ 44,949 $ 50,258
======= ======== ========
STOCKHOLDERS' EQUITY
We are authorized to issue the following shares of stock:
150,000,000 shares of Common Stock ($.30 par value)
2,000,000 shares of Preferred Stock ($.01 par value) of which
the following series have been designated:
2,500 shares of Preferred Stock, Series A 1,000 shares of
Preferred Stock, Series B 100,000 shares of Preferred
Stock, Series C 3,000 shares of Preferred Stock, Series D
1,000,000 shares of Preferred Stock, Series E
8
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
--------------------------------------------------------------------------------
We have outstanding the following shares of preferred stock:
Shares Par Liquidation
Outstanding Value Preference
----------- ----- ----------
Series D 1,353 $ 1 $ 1,353
===== === =======
Preferred stock dividends during the three and six months ended July
31, 2001 and 2000 consist of:
Three Months Ended July 31, Six Months Ended July 31,
--------------------------- -------------------------
2001 2000 2001 2000
-------- -------- -------- -------
Accrued, unpaid dividends (Series A) $ - $ 38 $ - $ 75
Deemed dividends (Sorrento Series A) - 541 180 901
---- ----- ----- -----
$ - $ 579 $ 180 $ 976
==== ===== ===== =====
OTHER CAPITAL STOCK TRANSACTIONS
In March, 2001 we completed a private placement of 1,525,995
unregistered shares of our common stock receiving net proceeds of $9,645. In
addition the purchasers received three year warrants to acquire an additional
381,499 shares of our common stock at $8.19 per share. In the event we issue
shares of our common stock or equity securities convertible into our common
stock at a price less than $6.5531 per share the purchasers are entitled to
receive additional shares of common stock.
During, 2000, our Sorrento completed a sale of 8,596,333 shares of
its Series A Convertible Preferred Stock receiving net proceeds of $46,638
from a group of investors. 1,467,891 shares were purchased by entities in
which our immediate past Chairman and CEO, who was an outside director at
that time, was a partner or member pursuant to a previously contracted
right of participation. In addition, Sorrento paid a finders fee of $1,950
through the issuance by Sorrento of an additional 357,799 shares of its
Series A Convertible Preferred Stock to an entity in which our immediate past
Chairman and CEO, who was an outside director at that time, was a partner. One
of our then outside directors purchased 45,872 shares and a then director of
Sorrento purchased 91,744 in this placement.
Each share of Sorrento's Series A Preferred Stock is convertible into
one share of Sorrento's common stock at the option of the holder, may vote on an
"as converted" basis except for election of directors, and has a liquidation
preference of $5.45 per share. The shares are automatically converted into
Sorrento's common stock upon an underwritten public offering by Sorrento with an
aggregate offering price of at least $50,000. Since Sorrento did not complete a
$50,000 public offering by March 1, 2001, the holders of more than 50% of the
then outstanding Series A shares may request a redemption at the current
liquidation preference of $48.8 million and Sorrento has received such written
notices. The requested redemption can only be made from specified categories of
funds, and our Sorrento subsidiary cannot legally redeem any of the Series A
shares at this time. We have engaged an investment banking firm to assist in
structuring an agreement between Sorrento and the Series A shareholders
regarding their redemption request. The net proceeds from the issuance of these
shares has been classified as a minority interest in the accompanying financial
statements. The difference between the net proceeds received on the sale of
these shares and their liquidation preference of $48,800 has been recorded as a
deemed dividend during the period from issuance to March 31, 2001. During the
six months ended July 31, 2001 and the quarter and six months ended July 31,
2000, we recorded a deemed dividend of $180, $541 and $901, respectively, with
respect to the Sorrento Series A shares.
9
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
--------------------------------------------------------------------------------
We made sales of products to subsidiaries of two of the purchasers of
Sorrento's Series A Preferred Stock. During the three and six months ended July
31, 2001 we made sales of $0 and $1,592, respectively, to the subsidiaries of
the purchaser of 33.8% of the shares and those customers had outstanding
receivables of $1,833 at July 31, 2001 under 180 days terms. During the three
and six months ended July 31, 2001 we made sales of $1,108 and $2,292,
respectively, to the subsidiaries of the purchaser of 6.2% of the shares and
those customers had outstanding receivables of $626 at July 31, 2001.
STOCK OPTION PLANS
We have four stock options plans in effect: 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. At July 31, 2001 there were 4,828,993 shares
under option at prices varying from $3.00 to $69.13 per share.
In addition Sorrento adopted its 2000 Stock Option/Stock Issuance
Plan under which it has granted options to certain of its employees,
directors at prices not less than fair value at the date of grant and generally
vest over four years. Eligible individuals may be issued shares of common stock
directly, when through immediate purchase of the shares at fair value or as a
bonus tied to performance milestones. No stock has been issued under the stock
issuance program and at July 31, 2001 there were 17,446,021 Sorrento shares
under option at prices varying from $2.00 to $6.85 per share.
The holders of these options may elect to convert all or a portion of
their options into options to acquire our stock at a ratio of 3.9 for one.
During the six months ended July 31, 2001 we issued options to acquire 5,718 of
our common stock exercisable at $7.80 to $21.55 per share upon conversions of
Sorrento options.
EARNINGS PER SHARE CALCULATION
The following data show the amounts used in computing basic earnings
per share for the three and six months ended July 31, 2001 and 2000.
Three Months Ended July 31, Six Months Ended July 31,
--------------------------- -------------------------
2001 2000 2001 2000
-------- -------- -------- --------
Net loss $ (10,961) $ (13,524) $ (16,729) $ (26,361)
Less: preferred dividends - (579) (180) (976)
--------- --------- --------- ---------
Net loss available to common
shareholders used in basic EPS $ (10,961) $ (14,103) $ (16,909) $ (27,337)
========= ========= ========= =========
Average number of common shares
used in basic EPS 14,183,611 11,608,562 13,740,247 11,563,083
========== ========== ========== ==========
We had a net loss for the three and six months ended July 31, 2001 and
2000. Accordingly, the effect of dilutive securities including convertible
preferred stock, vested and nonvested stock options and warrants to acquire
10
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
--------------------------------------------------------------------------------
common stock are not included in the calculation of EPS because their effect
would be antidilutive. The following data shows the effect on income and the
weighted average number of shares of dilutive potential common stock.
Three Months Ended July 31, Six Months Ended July 31,
--------------------------- -------------------------
2001 2000 2001 2000
-------- ------- -------- --------
Net loss available to common
shareholders used in basic EPS $ (10,961) $ (14,103) $ (16,909) $ (27,337)
Preferred stock dividends - - - -
--------- --------- --------- ---------
Net loss available to common
shareholders used in basic EPS $ (10,961) $ (14,103) $ (16,909) $ (27,337)
========= ========= ========= =========
Average number of common shares
used in basic EPS 14,183,611 11,608,562 13,740,247 11,563,083
Effect of dilutive securities:
Convertible preferred stock - - - -
Stock benefit plans 199,003 2,105,306 239,222 2,144,008
Stock benefit plan of Sorrento 39,230 - 47,820 -
Warrant exercises 61,486 106,190 31,970 118,391
--------- --------- --------- ---------
Average number of common shares
and dilutive potential common
stock used in diluted EPS 14,483,330 13,820,058 14,059,259 13,825,482
========== ========== ========== ==========
The shares issuable upon exercise of options and warrants represents
the quarterly average of the shares issuable at exercise net of the shares
assumed to have been purchased, at the average market price for the period, with
the assumed exercise proceeds. Accordingly, options and warrants to acquire
8,894,558 of our common stock with exercise prices in excess of the average
market price during the quarter ended July 31, 2001 are excluded because their
effect would be antidilutive.
RELATED PARTY TRANSACTIONS
During the year ended January 31, 2001 we made a 6.6% three year loan
in the amount of $300 to an officer in connection with his accepting employment
as our Senior Vice President, Legal. This is a full recourse loan and the
officer has pledged all his options to acquire our common stock and any options
he may receive from any of our subsidiaries as collateral. Accrued unpaid
interest on this loan at July 31, 2001 was $6.
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. At times such amounts may exceed the
F.D.I.C. limits. We limit the amount of credit exposure with any one financial
institution and believe that no significant concentration of credit exists with
respect to cash investments. No accounts at a single bank accounted for more
than 10% of our current assets.
Although we are directly affected by the economic well being of
significant customers listed in the following tables, management does not
believe that significant credit risk exist at July 31, 2001. We perform ongoing
evaluations of our customers and require letters of credit or other collateral
arrangements as appropriate. Accordingly, trade credit losses have not been
significant.
11
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
--------------------------------------------------------------------------------
The following data shows the customers accounting for more than 10% of
net receivables:
July 31, 2001 January 31, 2001
------------- ----------------
Customer A 14.7% 20.6%
Customer B 11.4 14.1
Customer C 4.9 15.6
Customer D 0.3 2.4
Customer E 10.0 -
Customer F 24.2 12.0
Customer G 14.5 20.5
Customer H 13.7 -
Customer I 13.2 -
The following data shows the customers accounting for more than 10% of
net sales:
Three Months Ended July 31, Six Months Ended July 31,
2001 2000 2001 2000
-------- -------- -------- --------
Customer A 22.4% - % 13.3% - %
Customer B 18.2 - 18.5 -
Customer C 13.9 12.8 10.2 6.8
Customer D 10.4 - 4.0 15.2
Customer E 3.0 - 3.1 -
Customer F - - 15.9 -
Customer G - 12.0 7.1 6.4
Customer H - - 7.0 -
SUBSEQUENT EVENTS
During August 200l, we completed a private placement of our 9.75% senior
convertible debentures receiving net proceeds of $29.7 million. The debentures,
due August 2, 2004, have a face value of $32.2 million which is convertible into
our common stock at $7.21 per share. At maturity we may elect to redeem the
debentures for cash and we have the option of paying the interest on these
debentures in shares of our common stock or cash. In addition the purchasers
received four year warrants to acquire an additional 3,351,840 shares of our
common stock at $7.21 per share. Subject to certain exceptions, if we issue
shares of our common stock, equity securities, options or warrants at a price
less than $7.21 per share the conversion price and warrant exercise price are
subject to adjustment.
12
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
--------------------------------------------------------------------------------
SEGMENT INFORMATION
Sorrento Meret Entrada
Networks Optical Networks Other Total
-------- ------- -------- ----- -----
Three months ended July 31, 2001:
Net sales to external customers $ 6,747 $ 1,251 $ - $ - $ 7,998
Intersegment sales - - - - -
-------- -------- ------ ------ --------
Total net sales 6,747 1,251 - - 7,998
Cost of goods sold 5,945 757 - - 6,702
-------- -------- ------ ------ --------
Gross profit 802 494 - - 1,296
-------- -------- ------ ------ --------
Operating income (loss) from
continuing operations (8,941) 135 - (750) (9,556)
Depreciation & amortization expense 816 136 - 85 1,037
Valuation allowance additions 3,957 75 - - 4,032
Capital asset additions 1,128 7 - 30 1,165
Total assets 51,483 7,861 n/a 34,814 94,158
Sorrento Meret Entrada
Networks Optical Networks Other Total
-------- ------- -------- ----- -----
Three months ended July 31, 2000:
Net sales to external customers $ 3,550 $ 1,785 $6,041 $ - $ 11,376
Intersegment sales - - - - -
-------- -------- ------ ------ --------
Total net sales 3,550 1,785 6,041 - 11,376
Cost of goods sold 2,782 1,057 3,695 - 7,534
-------- -------- ------ ------ --------
Gross profit 768 728 2,346 - 3,842
-------- -------- ------ ------ --------
Operating income (loss) from
continuing operations (12,533) 375 (622) (1,319) (14,099)
Depreciation & amortization expense 833 123 399 1 1,356
Valuation allowance additions 686 177 22 - 885
Capital asset additions 2,396 29 133 7 2,565
Total assets 25,624 8,853 11,893 232,590 278,960
13
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
--------------------------------------------------------------------------------
SEGMENT INFORMATION (continued)
Sorrento Meret Entrada
Networks Optical Networks Other Total
-------- ------- -------- ----- -----
Six months ended July 31, 2001:
Net sales to external customers $ 19,886 $ 2,609 $ - $ - $ 22,495
Intersegment sales - - - - -
-------- -------- ------ ------ --------
Total net sales 19,886 2,609 - - 22,495
Cost of goods sold 14,611 1,659 - - 16,270
-------- -------- ------ ------ --------
Gross profit 5,275 950 - - 6,225
-------- -------- ------ ------ --------
Operating income (loss) from
continuing operations (13,571) 247 - (1,961) (15,285)
Depreciation & amortization expense 1,213 272 - 163 1,648
Valuation allowance additions 4,356 247 - 500 5,103
Capital asset additions 2,524 11 - 61 2,596
Total assets 51,483 7,861 n/a 34,814 94,158
Sorrento Meret Entrada
Networks Optical Networks Other Total
-------- ------- -------- ----- -----
Six months ended July 31, 2000:
Net sales to external customers $ 8,234 $ 3,439 $9,751 $ - $ 21,424
Intersegment sales - - - - -
-------- -------- ------ ------ --------
Total net sales 8,234 3,439 9,751 - 21,424
Cost of goods sold 4,862 1,772 9,093 - 15,727
-------- -------- ------ ------ --------
Gross profit 3,372 1,667 658 - 5,697
-------- -------- ------ ------ --------
Operating income (loss) from
continuing operations (18,426) 972 (7,593) (2,159) (27,206)
Depreciation & amortization expense 1,232 246 881 2 2,361
Valuation allowance additions 748 300 4,753 - 5,801
Capital asset additions 4,544 51 184 2,342 7,121
Total assets 25,624 8,853 11,893 232,590 278,960
14
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Certain statements contained in this Quarterly Report on Form 10-Q, including,
without limitation, statements containing the words "believes", "anticipates",
"estimates", "expects", and words of similar import constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Readers are referred to the "Other Risk Factors" section of our Annual
Report on Form 10-K, as well as the "Financial Risk Management" and "Future
Growth Subject to Risks" sections contained therein, which identify important
risk factors that could cause actual results to differ from those contained in
the forward-looking statements.
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 for the year ended January 31, 2001.
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".
Entrada Networks
On August 31, 2000, we completed a merger of our Entrada subsidiary with Sync
Research, Inc. a Nasdaq listed company. After the merger, our purchase of Sync
shares prior to the merger and our purchase of shares for cash from Entrada we
owned 48.9% of the merged entity which changed its name to Entrada Networks.
Pursuant to our plans adopted prior to the merger, we distributed one-fourth
shares of an Entrada share for each of our outstanding shares and reserved a
similar number for each unexercised option and warrant to acquire our common
stock outstanding on the record date. After the distribution and reserve for
options and warrants we own approximately 10.1% of Entrada and account for this
remaining interest as an "available for sale security" which is marked to market
at the end of each period.
The amounts included in our fiscal 2002 year are not comparable to our fiscal
2000 year due to the inclusion of Entrada Networks only through the August 31,
2000 merger. Additional information regarding the Entrada is available from its
various filings with the Securities and Exchange Commission which are available
online at www.freeedgar.com and www.sec.gov or from the Securities and Exchange
Commission.
Results of Operations/Comparison of the Quarters and Six Months Ended July 31,
2001 and 2000
Net sales. Our consolidated net sales were $8.0 million for the quarter ended
July 31, 2001 compared to $11.4 million for the three months ended July 31,
2000, a decrease of 29.8%. This decrease in net sales reflects an increase of
$3.1 million at our subsidiary Sorrento Networks ("Sorrento") and a decrease of
$534,000 at Meret Optical Communications ("Meret"). The remaining decline was
related to Entrada Networks. During the six months ended July 31, 2001 our net
sales increased to $22.5 million from $21.4 million for the comparable six
months ended July 31, 2000, an increase of 5.1%. This increase in net sales
reflects a $11.7 million increase at Sorrento, and an $860,000 decrease at
Meret. The remaining decline was related to Entrada.
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 decreased to $1.3 million for the quarter ended July
31, 2001 from $3.8 million for the comparable quarter last year. This decrease
reflects a $34,000 increase at Sorrento offset by $234,000 decrease at Meret.
The remaining decline was related to Entrada. Consolidated gross profit
increased to $6.2 million, or by 8.7%, for the six months ended July 31, 2001
from $5.7 million for the six months ended July 31, 2000. This increase reflects
a $1.9 million increase at Sorrento, partially offset by a $747,000 decrease at
Meret and $658,000 for Entrada.
Selling and marketing. Selling and marketing expenses consist primarily of
employee compensation and related costs, commissions to sales representatives,
tradeshow expenses, facilities costs, and travel expenses. We will continue to
manage our expenditures for sales and marketing in relation with the expansion
of our domestic and
15
international sales channels and the establishment of strategic relationships.
Our consolidated selling and marketing expenses decreased to $3.8 million, or
47.5% of net sales, for quarter ended July 31, 2001 from $5.5 million, or 48.2%
of net sales for the comparable quarter last year. Approximately $400,000 of
this decrease was related to Sorrento. The remaining decrease was related to
Entrada. Our selling and marketing expenses decreased to $8.1 million, or 36.0%
of net sales, during the six months ended July 31, 2001 from $9.2 million, or
43.0% of net sales, for the comparable six month period last year. Sorrento's
selling expenses increased by $1.3 million for the six months ended July 31,
2001 from the comparable six month period last year which was offset by the
decrease related to Entrada.
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. We expect research and development costs to increase as our sales
increase. Our consolidated engineering, research and development expenses
decreased to $3.4 million, or 42.5% of net sales, for the quarter ended July 31,
2001 from $6.5 million, or 57.0% of net sales, for the comparable period last
year. Sorrento accounted for $1.8 million of this decrease. The remaining
decrease was related to Entrada. During the six months ended July 31, 2001, our
consolidated engineering, research and development expenses decreased to $6.7
million, or 29.8% of net sales, from $12.4 million, or 57.9% of net sales, for
the comparable six month period last year. Sorrento's engineering, research and
development expenses decreased $2.8 million for the six months ended July 31,
2001 from the comparable six month period last year and the remaining decrease
was related to Entrada.
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. Our consolidated general
and administrative expenses decreased to $3.3 million, or 41.3% of net sales,
for the quarter ended July 31, 2001 from $5.0 million, or 43.9 % of net sales,
for the comparable quarter ended last year. Approximately $900,000 of this
decrease was related to Sorrento. The remaining decrease related to Entrada. Our
consolidated general and administrative expenses decreased to $6.0 million, or
26.7% of net sales, for the six months ended July 31, 2001 from $8.2 million, or
38.3% of net sales, for the comparable period last year. Sorrento accounted for
$1.2 million of this decrease and the remaining decrease primarily related to
Entrada.
Other operating expenses. Other operating expenses for the quarters and six
months ended July 31, 2001 and 2000 include $93,000 and $186,000, respectively,
of amortization of purchased technology related to acquisitions included in
Meret. During the six months ended July 31, 2000, approximately $2.1 million of
these costs were attributable to the closure of one of Entrada's facilities and
valuation reserves recorded against distributor receivables and capitalized
software costs of Entrada.
Other income (charges). Other income (charges) decreased to $1.4 million charges
for the quarter ended July 31, 2001 from $575,000 income for the comparable
period last year. Investment income declined by $830,000 during the quarter
ended July 31, 2001 from the comparable period last year due to reduced
investments of our cash surplus cash in short-term investments as well as
reduced interest received on customer financing receivables. Our interest
expense decreased by $190,000 for the quarter ended July 31, 2001 from the
comparable quarter last year due to reductions in our short-term borrowings.
Other charges increased by $159,000 during the quarter ended July 31, 2001 from
the comparable period last year primarily as the result of foreign currency
exchanges. Losses on marketable securities during the quarter ended July 31,
2001 include a $1.1 million impairment allowance on our available for sale
investment in Entrada and realized losses on sales of Entrada shares. During the
six months ended July 31, 2001 other income (charges) decreased to $1.4 million
charges from $845,000 million income for the comparable six months last year.
The decrease reflects a decrease in investment income of $1.2 million related to
reduced investments of surplus cash in short term investments as well as reduced
interest received on customer financing receivables. Our interest expense
decreased by $178,000 for the six months ended July 31, 2001 from the comparable
six months last year due to reduced short-term borrowings. Other charges
increased by $113,000 during the six months ended July 31, 2001 from the
comparable period last year primarily as the result of foreign currency
exchanges.
Income taxes. There was no provision for income taxes for quarters and six
months ended July 31, 2001 and 2000. 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. However, due to potential adjustments to the net
operating loss carry forwards
16
as provided by the Internal Revenue Code with respect to future ownership
changes, 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 assets
will not be realized.
Sorrento Networks
Net sales. Net sales increased 91.4% to $6.7 million for the three months ended
July 31, 2001 from $3.6 million for the comparable quarter last year. During the
three months ended July 31, 2001, we shipped product to fourteen customers of
which four customers represented over 75% of our net sales. During the quarter
ended July 31, 2000, we shipped product to five customers of which two customers
represented over 75% of our net sales. Net sales increased by 142.7% to $19.9
million for the six months ended July 31, 2001 from $8.2 million for the
comparable period last year. During the six months ended July 31, 2001, we
shipped product to sixteen customers of which six customers represented over 75%
of our net sales. During the six months ended July 31, 2000, we shipped product
to eleven customers of which four customers represented over 75% of our net
sales. Sales to our international customers increased to 57.1% of our net sales
during the quarter ended July 31, 2001 from 38.5% during the comparable quarter
last year. For the six months ended July 31, 2001 sales to international
customers increased to 45.5% of our net sales from 24.7% during the comparable
period last year. 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. Gross profit increased by 4.4% to $802,000 for the quarter ended
July 31, 2001 from $768,000 for the comparable quarter last year. Our gross
margin decreased to 12.0% of net sales for the quarter ended July 31, 2001 from
21.3% of net sales for the comparable quarter last year. Gross profit for the
six months ended July 31, 2001 increased by 55.9% to $5.3 million from $3.4
million for the comparable period last year. Our gross margin for the six months
ended July 31, 2001 decreased to 26.6% of net sales from 41.5% for the
comparable period last year. The decline in gross margin for the quarter and six
months ended July 31, 2001 results from changes in our product mix, increases in
our obsolescence reserve and increases in manufacturing costs.
Selling and marketing. Selling and marketing expenses decreased to $3.7 million,
or 55.2% of net sales, for the quarter ended July 31, 2001 from $4.1 million, or
113.9% of net sales for the comparable quarter last year. For the six month
period ended July 31, 2001 selling and marketing expenses increased to $7.9
million, or 39.7% of net sales from $6.6 million, or 80.5% of net sales. The
decrease in sales and marketing expenses for the three months ended July 31,
2000 is primarily the result of decreases in trade show participation,
advertising and promotion and recruitment. The increase in sales and marketing
expenses for the six months ended July 31, 2001 is primarily the result of
increased operating expenses related to opening three foreign sales offices
located in Beijing, Singapore and the Netherlands and increased field service
expenses. We increased our sales and marketing personnel to 76 at July 31, 2001
from 57 at July 31, 2000. We are continually evaluating our resource
requirements and will plan accordingly for any additions necessary to expand our
domestic and international sales force and marketing efforts.
Engineering, research and development. Engineering, research and development
expenses decreased to $3.3 million, or 49.3% of net sales, for the quarter ended
July 31, 2001 from $5.1 million, or 141.7% of net sales, for the comparable
quarter last year. For the six months ended July 31, 2001 engineering, research
and development expenses decreased to $6.6 million, or 33.2% of net sales from
$9.4 million, or 114.6% of net sales. The decreases were primarily due to the
completion and conversion of an existing project into production and reduced
project material and consulting expenses. The decrease is also the result of
decreased relocation and travel expenses. We increased our research and
development personnel to 95 at July 31, 2001 from 88 at July 31, 2000. We expect
our research and development expenses to increase in future periods as sales
increase to support our efforts in our continued development of end-to-end
optical networking solutions for the metropolitan market.
General and administrative. General and administrative expenses decreased to
$2.5 million, or 37.3% of net sales, for the quarter ended July 31, 2001 from
$3.4 million, or 94.4% of net sales, for the comparable quarter last year. For
the six months ended July 31, 2001 general and administrative expenses decreased
to $4.0 million, or 20.1% of net sales from $5.2 million, or 63.4% of net sales.
During the three and six month periods, our legal and professional expenses
decreased in comparison to last year where substantially higher expenses were
incurred in anticipation of a public offering. This decrease was partially
offset by increases to our bad debt allowance as well as
17
increased personnel and personnel related expenses incurred to build our
infrastructure needed to support our planned growth. We have increased our
general and administrative personnel to 29 at July 31, 2001 from 24 at July 31,
2000.
Deferred and other stock compensation. Deferred and other stock compensation for
the quarter and six months ended July 31, 2001 includes $157,000 and $311,000 of
amortization of deferred stock compensation and $48,000 and $95,000 of
amortization of the value of stock options granted to consultants, respectively.
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 is being
amortized on an accelerated basis over the vesting period of the options.
Meret Optical Communications
Net sales. Net sales for Meret decreased to $1.3 million, or by 27.8%, for the
quarter ended July 31, 2001 from $1.8 million for the for the comparable quarter
last year. During the six months ended July 31, 2001 net sales decreased to $2.6
million, or by 23.5%, from $3.4 million for the comparable six months last year.
The decline in net sales results from the decrease in product demand for the
legacy product family.
Gross Profit. Gross profit decreased to $494,000, or by 32.1%, for the quarter
ended July 31, 2001 from $728,000 for the comparable quarter last year. Meret's
gross margins decreased to 38.0% for the quarter ended July 31, 2001 from 40.4%
for the comparable quarter last year. During the six months ended July 31, 2001
Meret's gross profit decreased to $950,000, or by 44.1%, from $1.7 million for
the six months ended July 31, 2000. Meret's gross margins decreased to 36.5% for
the six months ended July 31, 2000 from 50.0% for the six months ended July 31,
2000. The decrease in gross margin reflects a shift in Meret's product mix
towards shipments of lower margin products.
Selling and Marketing. Selling and marketing expenses increased to $122,000 or
9.4% of net sales, for the quarter ended July 31, 2001 from $105,000, or 5.8% of
net sales, for the comparable period last year. For the six months ended July
31, 2001, selling and marketing expenses decreased to $220,000, or 8.5% of net
sales, from $285,000, or 8.3% of net sales, for the six months ended July 31,
2000. The decrease results primarily from a decline in external sales
commissions directly related to the decrease in net sales from the comparable
period last year.
Engineering, Research and Development. Engineering, research and development
expenses increased to $88,000 or 6.8% of net sales, for the quarter ended July
31, 2001 from $59,000 or 3.3% of net sales for the comparable quarter last year.
During the six months ended July 31, 2001 engineering expenses increased to
$169,000 or 6.5% of net sales, from $87,000 for 2.6% of net sales for the
comparable six months last year. The increase is attributable to expenditures to
update existing products.
General and Administrative. General and administrative expenses decreased to
$54,000 or 4.2% of net sales for the quarter ended July 31, 2001 from $96,000 or
5.3% of net sales for the comparable quarter last year. The decrease is
primarily attributable to reductions in allowances for bad debts. During the six
months ended July 31, 2001, general and administrative expenses decreased
slightly to $127,000 from $138,000 for the comparable six months last year.
Other operating expenses. Other operating expenses of $93,000 and $186,000 for
the quarter and six months ended July 31, 2001 remained unchanged compared to
the comparable quarter and six months last year. These costs represent the
amortization of purchased technology related to prior acquisitions.
18
Liquidity and Capital Resources
We finance our operations through a combination of debt and equity financing. At
July 31, 2001, our working capital was $42.5 million including $3.6 million in
cash and cash equivalents.
The amounts included in our statement of cash flows for the six months ended
July 31, 2001 are not comparable to our six months ended July 31, 2000 amounts
due to the inclusion of Entrada for only the six months ended July 31, 2000.
Readers should refer to Entrada's quarterly reports on Form 10-Q for information
concerning Entrada.
Our operating activities used cash flows of $13.6 million during the six months
ended July 31, 2001. During the six months ended July 31, 2000 our operating
activities used cash flows of $31.0 million. The decreases in cash flows used by
operations results primarily from the decrease in our net loss and increases in
accounts payable partially offset by increases in inventory and decreases in
accrued and other current liabilities.
Our standard payment terms range from net 30 to net 90 days. Receivables from
international customers have frequently taken longer to collect. For some of the
Sorrento customers payment is required within 180 days from the date of
shipment.
Our investing activities during the six months ended July 31, 2001 used cash
flows of $3.1 million. We purchased property and equipment of $2.6 million and
$517,000 in other assets. During the six months ended July 31, 2000 the
investing activities used cash flows of $9.0 million. This consisted primarily
of $7.1 million in purchases of capital equipment, and $2.0 million invested in
a Sorrento customer. We expect our investments in property and equipment will
increase as sales increase.
Our financing activities during the six months ended July 31, 2001 provided cash
flows of $10.3 million which consisted of $9.6 million in net proceeds from a
private placement for issuance of our common stock and $861,000 in proceeds from
option and warrant exercises offset by repayments of short and long term debt.
During the six months ended July 31, 2000 the financing activities provided cash
flows of $47.8 million which consisted of $46.6 million in net proceeds from a
private placement by Sorrento of its convertible preferred stock and $2.3
million in proceeds from option and warrant exercises offset by repayments of
short and long term debt.
We have a line of credit which totals $8.0 million. Outstanding borrowings
against this line of credit was $1.2 million at July 31, 2001. Our credit line
is collateralized by accounts receivable, inventory and equipment.
During March 2000, our Sorrento subsidiary completed a private placement of
8,596,333 shares of its Series A Convertible Preferred Stock to a group of
investors receiving net proceeds of approximately $46.6 million. Each share of
our Sorrento subsidiary's Series A Preferred Stock is convertible into one share
of its common stock at the option of the holder, may vote on an "as converted"
basis except for election of directors, and has a liquidation preference of
$5.45 per share. The shares are automatically converted into Sorrento's common
stock upon an underwritten public offering by Sorrento with an aggregate
offering price of at least $50 million. Since our Sorrento subsidiary did not
complete a $50 million public offering by March 1, 2001, the holders of more
than 50% of the then outstanding Series A shares may request to be redeemed at
the shares then adjusted liquidation preference. Our Sorrento subsidiary has
received notice from the holders of more than 50% of its Series A Preferred
Stock requesting that Sorrento redeem the Series A Preferred Stock which has a
liquidation preference of $48.8 million. The requested redemption can only be
made from specified categories of funds, and our Sorrento subsidiary cannot
legally redeem any of the Series A Preferred Stock at this time. We have engaged
an investment banking firm to assist in structuring an agreement between our
Sorrento subsidiary and the Series A Preferred Shareholders regarding their
redemption request.
During August 200l, we completed a private placement of our 9.75% senior
convertible debentures receiving net proceeds of $29.7 million. The debentures,
due August 2, 2004, have a face value of $32.2 million which is convertible into
our common stock at $7.21 per share. At maturity we may elect to redeem the
debentures for cash and we have the option of paying the interest on these
debentures in shares of our common stock or cash. In addition the purchasers
received four year warrants to acquire an additional 3,351,840 shares of our
common stock at $7.21 per share. Subject to certain exceptions, if we issue
shares of our common stock, equity securities, options or warrants at a price
less than $7.21 per share the conversion price and warrant exercise price are
subject to adjustment.
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We anticipate that our available working capital, together with additional
financings including a line of credit at our Sorrento subsidiary, will be
sufficient to meet our presently anticipated capital requirements for the next
year. Nonetheless, our future capital requirements may vary materially from
those now planned including the need for additional working capital to
accommodate our future 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.
Impact of Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board finalized Statement of
Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", and
No. 142, "Goodwill and Other Intangible Assets". SFAS 141 requires the use of
the purchase method of accounting and prohibits the use of the
pooling-of-interests method of accounting for business combinations
initiated after June 30, 2001. SFAS 141 also requires that we recognize
acquired intangible assets apart from goodwill if the acquired intangible
assets meet certain criteria. SFAS 141 applies to all business combinations
initiated after June 30, 2001 and for purchase business combinations completed
on or after July 1, 2001. Upon adoption of SFAS 142, it requires that we
reclassify the carrying amounts of intangible assets and goodwill based
on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that we identify reporting units for the purposes of
assessing potential future impairments of goodwill, reassess the useful lives of
other existing recognized intangible assets, and cease amortization of
intangible assets with an indefinite useful life. An intangible asset with an
indefinite useful life should be tested for impairment in accordance with the
guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years
beginning after December 15, 2001 to all goodwill and other intangible assets
recognized at that date, regardless of when those assets were initially
recognized. SFAS 142 requires us to complete a transitional goodwill impairment
test six months from the date of adoption. The Company is also required to
reassess the useful lives of other intangible assets within the first interim
quarter after adoption of SFAS 142.
During the fiscal years ended January 31, 1997 we completed several business
combinations which were accounted for using the purchase method. As of July 31,
2001, the net carrying amount of intangible assets is $837 all of which pertain
to our Meret Optical business segment. Amortization expense during the quarters
ended July 31, 2001 and 2000 was $93 and during the six months ended July 31,
2001 and 2000 was $186. We are currently evaluating the effect, if any, the
adoption of SFAS 141 and 142 will have on our financial position and results of
operations.
SFAS 133 as amended by SFAS 137 and 138 "Accounting for Derivative Instruments
and Hedging Activities," is effective for financial statements with fiscal
quarters of all fiscal years beginning after June 15, 2000. The Accounting
Standards Executive Committee issued Statement of Position ("SOP") 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," and SOP 98-5, "Reporting on the Costs of Start-up Activities,"
effective in the current or future periods. The adoption or future adoption
of these standards has had or will have no material effects, if any, on
our financial position or results of operations.
The Financial Accounting Standards Board issued Interpretation ("FIN") No. 44,
"Accounting for Certain Transactions involving Stock Compensation," an
Interpretation of APB Opinion No. 25. FIN 44 clarifies the application of
Opinion No. 25 for (a) the definition of an employee for purposes of applying
Opinion No. 25, (b) the criteria for determining whether a plan qualifies as a
non-compensatory plan, (c) the accounting consequences of various modifications
to the terms of a previously fixed stock option award, and (d) the accounting
for an exchange of stock compensation awards in a business combination. FIN 44
is effective July 2, 2000, but certain conclusions cover specific events that
occur after either December 15, 1998, or January 12, 2000. The adoption of this
standard had no material effect, if any, on our financial position or results of
operations.
The Securities and Exchange Commission issued Staff Accounting Bulletin No. 101,
Revenue Recognition ("SAB 101") which broadly addresses how companies report
revenues in their financial statements effective the fourth fiscal
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quarter of years beginning after December 31, 1999. The adoption of this policy
had no effect 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
Our Sorrento subsidiary has received notice from the holders of more than 50% of
its Series A Preferred Stock requesting that Sorrento redeem the Series A
Preferred Stock. The requested redemption can only be made from specified
categories of funds, and our Sorrento subsidiary cannot legally redeem any of
the Series A Preferred Stock at this time. We have engaged an investment banking
firm to assist in structuring an agreement between our Sorrento subsidiary and
the Series A Preferred Shareholders regarding their redemption request.
On September 10, 2001, holders of outstanding Series A Preferred Stock of our
Sorrento subsidiary obtained a preliminary injunction prohibiting it from
issuing further shares of its Series A Preferred Stock or incurring any
additional debt without the consent of the holders of a majority of the
currently outstanding shares of such Series A Preferred Stock. We are requesting
such consent from the holders of these shares. Our management does not believe
that the preliminary injunction will prevent us from making capital
contributions to our Sorrento subsidiary.
Fluctuations in Revenue and Operating Results
The networking and bandwidth aggregation industry is 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.
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," "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
21
statements include without limitation: our ability to successfully develop, sell
and market our optical networking and other products; our expectations
concerning factors affecting the markets for our products, such as demand for
increased bandwidth; the scope and duration of the economic slowdown currently
being experienced by many of our existing and prospective customers; our ability
to compete successfully with companies who are much larger than we are and who
have much greater financial resources at their disposal; our ability, or
failure, to complete strategic alliances and strategic opportunities such as
sales or spin-offs of subsidiaries or business units on terms favorable to us
for reasons either within or outside our control; our ability successfully to
finance our current and future needs for working capital; changed market
conditions, new business opportunities or other factors that might affect our
decisions as to the best interest of our shareholders; and other risks detailed
from time to time in our reports filed with the 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. These risks and uncertainties are described in the
following section. 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.
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 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. Additionally, the interest rates charged by our present
lenders adjust on the basis of the lenders' prime rate.
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.
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PART II
OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
On September 10, 2001, holders of outstanding Series A Preferred Stock
of our Sorrento subsidiary obtained a preliminary injunction
prohibiting it from issuing further shares of its Series A Preferred
Stock or incurring any additional debt without the consent of the
holders of a majority of the currently outstanding shares of such
Series A Preferred Stock. We are requesting such consent from the
holders of these shares. Our management does not believe that the
preliminary injunction will prevent us from making capital
contribution to our Sorrento subsidiary.
From time to time, we are involved in various 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
effect on our financial position or results of operations or cash
flows.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
On March 26, 2001 we issued 1,525,995 of our common stock at $6.5531
per share to a group of three private institutional investors,
receiving $9,645,292 in net proceeds to be used for working capital
purposes. There were no underwriters in the transaction; however, we
paid of fee of $300,000 to a placement agent. In addition the
purchasers received three year warrants to acquire an additional
381,499 shares of our common stock at $8.19 per share. In the event we
issue shares of our common stock or equity securities convertible into
our common stock at a price less than $6.5531 per share the purchasers
are entitled to receive additional shares of common stock in order to
reduce their effective purchase price to such lower amount.
This sale was made without general solicitation or advertising and no
underwriters received fees in connection with this security sale. The
purchasers were accredited and sophisticated investors with access to
all relevant information necessary. The shares were issued pursuant to
exemptions from registration under Rule 506 of Regulation D and
Section 4(2) of the Securities Act of 1933 as a transaction not
involving any public offering. We have filed a Registration Statement
on Form S-3 covering the resale of these shares.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
ITEM 5: OTHER INFORMATION
Not Applicable
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
20 Consolidated Financial Statements for the Quarter Ended
July 31, 2001 (included in Part I, Item 1)
B. Reports on Form 8-K
June 1, 2001 Fiscal 2002 First Quarter Results
August 3, 2001 Convertible Debentures Placement
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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)
By: /s/ Joe R. Armstrong Date: September 14, 2001
-----------------------------------
Joe R. Armstrong,
Chief Financial Officer
Principal Accounting Officer
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