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 APRIL 30, 2002
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: 14,534,410 shares at
May 31, 2002.
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 STATEMENTS OF OPERATIONS
(In Thousands, except per share amounts)
==========================================================================================================
Three Months Ended
April 30,
-------------------------
2002 2001
----------------------------------------------------------------------------------------------------------
NET SALES $ 6,003 $ 14,497
COST OF SALES 4,515 9,568
----------------------------------------------------------------------------------------------------------
GROSS PROFIT 1,488 4,929
----------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Selling and marketing 3,432 4,313
Engineering, research and development 2,534 3,301
General and administrative 1,863 2,750
Deferred stock compensation 106 201
Other operating expenses 97 93
----------------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 8,032 10,658
----------------------------------------------------------------------------------------------------------
LOSS FROM OPERATIONS (6,544) (5,729)
----------------------------------------------------------------------------------------------------------
OTHER INCOME (EXPENSES)
Investment income 94 100
Interest expense (1,310) (190)
Other income (Expenses) 80 51
Gain on sale of marketable securities 11,656 -
----------------------------------------------------------------------------------------------------------
TOTAL OTHER INCOME (EXPENSES) 10,520 (39)
----------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAX 3,976 (5,768)
NET INCOME (LOSS) $ 3,976 $ (5,768)
==========================================================================================================
EARNINGS (LOSS) PER SHARE:
PREFERRED STOCK DIVIDENDS - 180
NET GAIN (LOSS) APPLICABLE TO COMMON SHARES $ 3,976 $ (5,948)
BASIC WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 14,323 13,282
----------------------------------------------------------------------------------------------------------
BASIC NET INCOME (LOSS) PER COMMON SHARE $ 0.28 $ (0.45)
==========================================================================================================
DILUTED WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 18,913 13,282
----------------------------------------------------------------------------------------------------------
DILUTED NET INCOME (LOSS) PER COMMON SHARE $ (1.26) $ (0.45)
==========================================================================================================
COMPREHENSIVE INCOME AND ITS COMPONENTS CONSIST OF
THE FOLLOWING:
Net income (loss) $ 3,976 $ (5,768)
Unrealized losses from marketable securities:
Unrealized holding losses arising during the period (1,398) (21,636)
Reclassification adjustment for gains included in net income (11,656) -
----------------------------------------------------------------------------------------------------------
NET COMPREHENSIVE INCOME (LOSS) $ (9,078) $(27,404)
==========================================================================================================
See accompanying notes to consolidated financial statements.
1
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands, except per share amounts)
===========================================================================================================================
April 30, January 31,
2002 2002
---------------------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 21,492 $ 14,243
Accounts receivable, net 9,625 8,081
Inventory, net 17,384 18,810
Prepaid expenses and other current assets 947 1,252
Investment in marketable securities 13,148 28,120
---------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 62,596 70,506
---------------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT, NET 18,523 17,411
---------------------------------------------------------------------------------------------------------------------------
OTHER ASSETS
Purchased technology, net 559 652
Other assets 1,686 1,671
Investment in former subsidiary - 99
---------------------------------------------------------------------------------------------------------------------------
TOTAL OTHER ASSETS 2,245 2,422
---------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 83,364 $ 90,339
===========================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term debt $ 890 $ 1,043
Current maturities of long term debt 408 362
Accounts payable 6,661 5,575
Accrued liabilities and other current liabilities 8,768 8,887
Due on redeemption of preferred security of subsidiary 48,800 48,800
---------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 65,527 64,667
---------------------------------------------------------------------------------------------------------------------------
Long-term debt and capital lease obligations 3,797 3,867
Debentures payable, net of unamortized costs and discounts 3,923 3,489
Dividends payable 99 99
---------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 73,346 72,122
---------------------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; liquidation preference $1,353 1 1
Common stock, $.30 par value; 150,000,000 shares authorized; 14,543,298 shares issued
14,534,410 shares outstanding at April 30, 2002; 14,209,104 shares issued and
14,200,216 shares outstanding at January 31, 2002 4,363 4,263
Additional paid-in capital 152,161 151,443
Deferred stock compensation (194) (255)
Accumulated deficit (157,350) (161,326)
Accumulated unrealized gain on marketable securities 11,106 24,160
Treasury stock, at cost; 8,888 shares at April 30, 2002 and
January 31, 2002, respectively (69) (69)
---------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 10,018 18,217
---------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 83,364 $ 90,339
===========================================================================================================================
See accompanying notes to consolidated financial statements.
2
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In Thousands, except per share amounts)
================================================================================================================
Three Months Ended
April 30,
------------------------
2002 2001
----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) from continuing operations $ 3,976 $ (5,768)
----------------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization 1,358 611
Accounts receivable, option receivables and inventory reserves 716 1,071
(Gain) on sale of marketable securitites (11,656) -
Non-cash interest on debentures 774 -
Deferred and other stock compensation 106 201
Changes in assets and liabilities:
Increase in accounts receivable (1,638) (2,458)
(Increase) decrease in inventories 1,061 (12,817)
Decrease in other current assets 48 272
Increase in accounts payable 1,032 9,900
Increase (decrease) in accrued and other current liabilities 15 (362)
----------------------------------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES (4,208) (9,350)
----------------------------------------------------------------------------------------------------------------
CASH FLOWS PROVIDED BY (USED) IN INVESTING ACTIVITIES:
Purchase of property and equipment (1,944) (1,431)
Cash received from sale of marketable securities and other investments 13,574 -
Other assets 4 (438)
----------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED) IN INVESTING ACTIVITIES 11,634 (1,869)
----------------------------------------------------------------------------------------------------------------
CASH FLOWS PROVIDED BY (USED) IN FINANCING ACTIVITIES:
Payments of short-term debt, net (153) (185)
Proceeds from long-term debt - 384
Repayment of long-term debt (24) (9)
Proceeds from common stock - 9,645
Proceeds from stock option and warrant exercises - 338
----------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED) IN FINANCING ACTIVITIES (177) 10,173
----------------------------------------------------------------------------------------------------------------
INCREASE(DECREASE) IN CASH AND CASH EQUIVALENTS 7,249 (1,046)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 14,243 9,965
----------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 21,492 $ 8,919
================================================================================================================
See accompanying notes to consolidated financial statements.
3
Sorrento Networks 10Q 04/30/02
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 statement" within the meaning of the Private Securities
Litigation Reform Act of 1995. Readers are referred to the "Other Risk Factors"
section of this Quarterly Report on Form 10-Q 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, 2002.
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".
Results of Operations/Comparison of the Quarters ended April 30, 2002 and 2001.
Net sales. Our consolidated net sales decreased $8.5 million or 59% to
$6.0 million for the quarter ended April 30,2002 compared to net sales of $14.5
million for the quarter ended April 30, 2001. Net sales for our Sorrento
Networks Inc.("Sorrento"), the Company's primary operating subsidiary, decreased
$8.3 million or 64% to $4.8 million for the quarter ended April 30, 2002 as
compared to net sales of $13.1 million for the quarter ended April 30, 2001. The
reduction in sales volume reflects the continued weak telecommunications
industry volumes.
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. Gross
margin percent on a consolidated basis decreased to 25% for the quarter ended
April 30, 2002 from 34% in the quarter ended April 30, 2001. Consolidated gross
profit was $1.5 million, a decrease of 70% for the quarter ended April 30, 2002
from $4.9 million for the quarter ended April 30, 2001. Gross margin percent and
gross profit were negatively impacted by the substantially higher percentage of
fixed overhead allocated to cost of sales as a result of the lower revenue
volume for the quarter. Gross profit for Sorrento decreased to $1.0 million the
quarter ended April 30, 2002, as compared to $4.5 million in the quarter ended
April 30, 2001, a decrease of 77%.
Selling and marketing. Selling and marketing expenses consist
primarily of employee compensation and related costs, commissions to sales
representatives, tradeshow expenses and travel expenses. Selling and marketing
expenses decreased to $3.4 million or $57% of net sales, for the quarter ended
April 30, 2002 from $4.3 million, or 30% of net sales for the quarter ended
April 30, 2001. The decrease was primarily the result of cost reduction efforts
implemented and lower revenue volume for the quarter. We continue to manage our
expenditures for sales and marketing in relation with the expansion of our
domestic and international sales channels and the establishment of strategic
relationships. We expect sales commissions to increase as our sales volume
increases since many of our sales personnel earn a portion of their total
compensation from commissions based on sales volume.
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 expenses as incurred. We continue to manage our research and development
cost in relation to the changes in our sales volume and available capital
resources in our development efforts to enhance existing products and introduce
new products to our product offering. Our consolidated engineering, research and
development expenses decreased to $2.5 million, or 42% of net sales, for the
quarter ended April 30, 2002 from $3 million, or 22.8% of nets sales for the
quarter ended April 30, 2001. The decline can primarily be attributed to
decreases in product development material and personnel related costs reflecting
managements planned reduction in operating expense levels.
4
Sorrento Networks 10Q 04/30/02
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 decreased to $1.9 million, or 31% of net sales, for
the quarter ended April 30, 2002 from $2.8 million, or 19% of net sales, for the
quarter ended April 30, 2001. The decrease in general and administrative
expenses can be attributed to reductions in investment banking, professional
fees and personnel related costs due to our operating expense reduction efforts.
Other income (charges). Other income (charges) from continuing
operations was $10.5 million in income for the quarter ended April 30, 2002
versus a $39 charge for the quarter ended April 30, 2001. The current year
quarter includes an $11.7 million gain on the sale of marketable securities as a
result of the sale of 3,396,221 shares of NETsilicon, Inc common stock to Digi
International, Inc. for $13.6 million in cash. The remaining shares of
NETsilicon common stock was exchanged for Digi International common stock and is
accounted for under marketable securities. The Company obtained 2,324,683 shares
of Digi common stock on the exchange. The increase of $1.1 million in interest
expense for the quarter ended April 30, 2002 from the quarter ended April 30,
2001 was primarily due to cost associated with the Company's convertible
debenture which included interest of $766, paid in common stock, amortization of
issuance costs of $36 and amortization of the fair value of the warrants issued
to the purchasers and placement agent and the deemed beneficial conversion
feature of $398. In addition, to the foregoing interest expense was partially
offset by a decline in our short-term borrowings.
Income taxes. There was no provision for income taxes for the quarters
ended April 30, 2002 and 2001. 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 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 deferred tax assets will not be realized.
Sorrento Networks, Inc.
Net sales. Net sales decreased 64% to $4.8 million for the three months
ended April 30, 2002 from $13.1 million for the same comparable quarter last
year. During the three months ended April 30, 2002, we shipped product to ten
customers of which five customers represented a combined 88% of our net sales.
During the quarter ended April 30, 2001, we shipped product to twelve customers
of which five customers represented a combined 84% of our 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. Revenues continue to be negatively impacted by weak
telecommunication industry volumes.
Gross profit. Gross profit decreased 77% to $1.0 million for the
quarter ended April 30, 2002 from $4.5 million for the same comparable
quarter last year. Our gross margin decreased to 21% of net sales for the
quarter ended April 30, 2002 from 34% of net sales for the comparable quarter
last. Year. The gross margin and gross margin percentage decrease was primarily
the result of a significantly higher allocation of fixed manufacturing
overhead in the Company's cost of shipments for the quarter as a result of the
lower revenue volume. The Company has initiated cost cutting actions in
production due to the lower revenue volume and a continued slowdown in the
capital expenditure spending throughout the telecom industry.
Selling and marketing. Selling and marketing expenses decreased to $3.4
million, or 70% of net sales, for the quarter ended April 30, 2002 from $4.2
million, or 32% of net sales for the same comparable quarter last year. The
decrease in sales and marketing expenses resulted from cost reduction programs
initiated by the Company. Sales and marketing expenses showed decreases in
travel expenses, advertising expenses and reductions in personnel.
5
Sorrento Networks 10Q 04/30/02
Engineering, research and development. Engineering, research and
development expenses decreased to $2.4 million, or 50% of net sales, for the
quarter ended April 30, 2002 from $3.2 million, or 25% of net sales, for the
same comparable quarter last year. The decrease in engineering, research and
development expenses was the result of decreased expenditures associated with
the Company's cost reduction programs and included decreases in engineering
personnel, employee relocation and recruiting expenses and reduction in material
related development expenses. The number of engineering personnel decreased to
65 at April 30, 2002 from 99 at April 30, 2001.
General and administrative. General and administrative expenses
decreased to $869, or 18% of net sales for the quarter ended April 30, 2002 from
$1.5 million, or 11% of net sales, for the comparable quarter last year.
The decrease in general and administrative expenses reflects the reduction of
executive and administrative personnel and lower operating expenses, including
professional banking and other fees.
Deferred and other stock compensation. Deferred and other stock
compensation for the quarter ended April 30, 2002 includes $62 of amortization
of deferred stock compensation and $44 of expenses resulting from the
amortization of the value of stock options granted to consultants. 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 $1.2 million, or by 14% for
the quarter ended April 30, 2002 from $1.4 million for the comparable quarter
last year. Sales in our RF Synthesis product category decreased by 41% compared
to the same quarter last year reflecting lower demand for products in this
category. A portion of this decrease was offset by increased shipments of our
new Coarse Wavelength Division Multiplexing ("CWDM") products that contributed
approximated 13% of the revenue during the quarter. Shipments of our legacy
product remained relatively unchanged when compared to the quarter ended April
30, 2002 to the prior year.
Gross Profit. Gross profit increased to $463, or by 2%, for the quarter
ended April 30, 2002 from $456 for the comparable quarter last year. Meret's
gross margins increased to 39% for the quarter ended April 30, 2002 from 34% for
the comparable quarter last year. The positive change in gross margin was
primarily the result of better pricing of our legacy products when compared to
the prices that were sold at in the prior year. In addition, we made shipments
during the quarter of our new CWDM products which contributed to the increase in
the gross margin.
Selling and Marketing. Selling and marketing expenses decreased to $64
or 5% of net sales, for the quarter ended April 30, 2002 from $98, or 7% of net
sales, for the comparable period last year. The decrease during the quarter
ended April 30, 2002 compared to the same three month period last year resulted
from a decrease in internal commissions. Commissionable sales were down
significantly from the three months ended April 30, 2001. This combined with
changes in the commission structure resulted in lower commission expense during
the current quarter.
Engineering, Research and Development. Engineering, research and
development expenses increased to $137 or 11% of net sales, for the quarter
ended April 30, 2002 from $81 or 6% of net sales for the comparable quarter last
year. The increase during the quarter ended April 30, 2002 results from the
addition of four engineers to support the development of new products and the
enhancement of existing products.
General and Administrative. General and administrative expenses
increased to $147 or 12% of net sales for the quarter ended April 30, 2002 from
$73 or 5% of net sales for the comparable quarter last year. The increase in
general and administrative expenses during the quarter consisted primarily of
additions in
6
Sorrento Networks 10Q 04/30/02
the administration staff, costs associated with upgrades in our business
application software and, costs incurred to move the facilities to a new
location.
Liquidity and Capital Resources
We finance our operations through a combination of internal funds, investments
and debt and equity financing. At April 30, 2002, our working capital was $(3.0)
million and included $21.5 million in cash and cash equivalents and $13.1
million of investments in marketable securities. In addition, $48.8 million of
Series A Holder's obligation as a result of their exercised right of redemption
was re-classified at year end January 31, 2002 as a current liability as
compared to mezzanine in the Company's liability and owner's equity section of
the balance sheet in the prior year. The Series A redemption of securities can
only be made through lawfully available funds that would normally be generated
from SNI profitable operations, which the Company does not currently have
available, or foresee availability of, in the near future.
Our continuing operations used cash flows of $4.2 million during the quarter
ended April 30, 2002. During the quarter ended April 30, 2001 continuing
activities used cash flows of $9.3 million. The decrease in cash flows used by
operations resulted primarily from gains on the sale of marketable securities
and a decrease in our accounts receivable, offset by increases in inventory and
accounts payable.
The Company has incurred significant losses and negative cash flows from
operations for the past two years. Sorrento Networks, Inc., the Company's
principal operating subsidiary, has primarily been the operating entity
responsible for these losses and negative cash flows. The losses have been
generated as SNI continues to develop its technology, marketing, sales and
operations in its effort to become a major supplier of metro and regional
optical networks world-wide. The Company has funded its operations primarily by
the sale of securities and the issuance of debt. There can be no assurance that
similar funding will be available in the future. Further, with the downturn in
the economic environment and decreases in capital spending by telecom carriers,
the Company anticipates that its current and future revenues will be negatively
impacted. As a result, the Company will need to raise additional capital in the
future or continue to substantially decrease its operating costs and capital
spending in order to fund its 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 90 days. Receivables from
international customers have frequently taken longer to collect. For some of the
customers of our optical networking products, payment is required within 180
days from the date of shipment. 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 either current or future receivables will not be impacted negatively by
this economic environment.
Our investing activities during the quarter ended April 30, 2002 provided cash
flows of $11.6 million. We purchased property and equipment of $1.9 million and
received $13.6 million on the sale of marketable securities and other assets.
During the quarter ended April 30, 2001 the investing activities of our
continuing operations used cash flows of $1.9 million. This consisted primarily
of $1.4 million in purchases of capital equipment and $438 in other assets.
Our financing activities during the quarter ended April 30, 2002 used cash flows
of $177 which consisted primarily of repayment of debt. During the quarter ended
April 30, 2001 the financing activities of our continuing operations provided
cash flows of $10.2 million which consisted primarily of $9.6 million in net
proceeds from a private placement for issuance of our common stock, $338 in
proceeds from option and warrant exercised, $384 in proceeds from long term debt
offset by $194 in repayment of short and long term debt.
7
Sorrento Networks 10Q 04/30/02
In May, the Company terminated it's line of credit with Coast Savings. The line
of credit totaled $1.0 million with outstanding borrowings against this line of
credit was $890 at April 30, 2002. The line of credit was secured by a
collateral agreement against Meret's accounts receivables, inventory and other
assets.
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 Sorrento 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. In April 2001 a majority of Series A
Shareholders exercised their right to redeem the Series A Preferred Stock. Such
redemption can only be made out of funds deemed to be lawfully available or
from a sale pro rata portion as to which a lesser amount of lawfully available
funds would exist. The Company at the current time does not have such funds
which would normally be generated from operating profits of the subsidiary,
Sorrento Networks, Inc.
In September 2001, certain holders of SNI's Series A preferred stock obtained a
preliminary injunction for the Delaware Court of Chancery, which was affirmed by
the Delaware Supreme Court in January 2002. The injunction prohibits SNI from
issuing additional shares of Series A preferred stock and from incurring debt
without the consent of the holders of a majority of the outstanding shares of
Series A preferred stock. The Court of Chancery will decide whether to make this
injunction permanent at a trial that is not currently scheduled. We cannot
predict the outcome of that trial. The injunction against SNI, our principal
operating subsidiary, issuing Series A preferred stock, makes it very difficult
to fund SNI as its business operations require. The Company, however, does have
the right to make such capital contributions to SNI to fund its operations as
the Board may deem necessary. During the quarter ended April 30, 2002 the
Company made capital contributions that totaled $3,750 to SNI. Capital
contributions do not increase the Company's ownership interest in SNI, but
rather increases the basis of our ownership interest. The Board has authorized
capital contributions to be made when necessary to fund the SNI operations, but
there can be no assurance that the Board will continue to authorize such
contributions in the future should other funding methods continue to be
unavailable.
We anticipate that our available cash resources, and marketable securities
available for sale together with any necessary cost reductions will be
sufficient to meet our presently anticipated capital requirements for the
current fiscal year. Nonetheless, 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.
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 from these estimates under different
assumptions or conditions.
8
Sorrento Networks 10Q 04/30/02
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
o Inventory is evaluated on a continual basis and 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.
o Accounts receivable balances are evaluated on a continual basis and
allowances are provided for potentially uncollectable accounts based on
management's estimate of the collectability 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.
Impact of Recent Accounting Pronouncements
In October 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" effective for financial
statements issued for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years. Restatement of previously issued
annual financial statements is not permitted, however, comparative financial
information for earlier periods shall reflect required reclassifications in
presentation. SFAS 144 requires long-lived assets of continuing and discontinued
operations be measured at the lesser of carrying amount or fair value less
estimated selling costs. The assets and liabilities of discontinued operations
shall be presented separately in the asset and liability sections of the balance
rather than shown as net realizable value. We do not believe the adoption of
SFAS 144 will have a material effect on our financial position or results of
operations.
In August 2001, the Financial Accounting Standards Board issued SFAS 143,
"Accounting for Asset Retirement Obligations" effective for fiscal years
beginning after June 15, 2002. SFAS 143 requires the recognition of the fair
value of liabilities for asset retirement obligations to be recognized in the
period in which it is incurred if a reasonable estimate of fair value can be
made. The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset. We do not believe the adoption of SFAS
143 will have a material effect, if any, on our financial position or results of
operations.
In June 2001, the Financial Accounting Standards Board finalized SFAS
141, "Business Combinations", and SFAS 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 purpose 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 nine months from the date of adoption. We are also required to reassess the
useful lives of other intangible assets within the first interim quarter after
adoption of SFAS 142.
9
Sorrento Networks 10Q 04/30/02
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
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
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;
10
Sorrento Networks 10Q 04/30/02
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.
11
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 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 months ended April 30,
2002 and 2001 along with financial data for January 31, 2002, 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 generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. The January 31, 2002 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, 2002.
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 April 30, 2002
and for the quarter ended April 30, 2001, have been made. The results of
operations for the quarter ended April 30, 2002 are not necessarily indicative
of the operating results for the full year.
Digi International, Inc. And NETsilicon, Inc.
On September 15, 1999 NETsilicon, Inc. ("NSI") completed an initial
public offering in which 6,037,500 shares of its common stocks were sold
(3,537,500 shares by NSI and 2,500,000 shares by us). NSI received net proceeds
of $22,249 and we received net proceeds of $15,382. In addition, NSI repaid
advances due us of $5,884. In connection with the initial public offering by NSI
our remaining 55% interest became non-voting shares. Accordingly, our financial
statements reflected the results of operations of NSI through September 14, 1999
at which time our remaining interest were 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 included in the computation of
comprehensive income.
In October 2000, we sold 350,000 shares of our investment in NSI for
$4,219. The purchasers had the right to receive additional NSI shares from us if
the three day average high for the NSI common stock, as quoted on NASDAQ, at
December 31, 2000 was less than the price paid to us by the purchasers but not
less than $8.00 per share. We issued an additional 177,344 shares of NSI to the
purchasers, reducing the price per share we received to $8.00 per share. Our
12
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
------------------------------------------------------------------------------
former Chairman and CEO purchased 100,000 of these shares of NSI for $1,164 and
received an additional 45,546 shares pursuant to the price protection provision.
As a result of this transaction, our remaining interest was approximately 7.0
million shares of NSI, or 51% as of January 31, 2002 and continued to be
accounted for as a marked-to-market security.
On February 13, 2002 NSI completed a merger with Digi International,
Inc.("DIGI"). In connection with the merger, we exchanged our 6,972,656 shares
of NSI for 2,324,683 shares of DIGI and $13,574 in cash. More information
concerning DIGI is available in its public filings with the Securities and
Exchange Commission.
Entrada Networks, Inc.
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.
(ENI) . 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 ENI for $3,306. After these transactions and ENI's issuance
of additional shares to outside investors in connection with the merger we owned
49% of ENI. Accordingly, our financial statements reflected the results of
operations of ENI 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 ENI 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 ENI 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 ENI
shares. Prior to January 31, 2001 we distributed 20,182 of our ENI shares upon
the exercise of options and as of January 31, 2002 we have reserved 826,000
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 ENI shares
including the shares reserved for option and warrant holders has been accounted
for at our original cost of $5,122. In addition we have granted options to
purchase 410,000 of our ENI shares for $3.19 per share (the merger price) to
several of our then officers and consultants.
The remaining 326,034 ENI 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.
More information concerning ENI 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
13
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
------------------------------------------------------------------------------
our Sorrento subsidiary granted by it to its employees; during the three months
ended April 30, 2002 and 2001 it amortized $61 and $154, 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 three months ended April
30, 2002 and 2001 it recorded $44 and $47, respectively, for options granted to
consultants.
Recent Accounting Pronouncements
In October 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for
the Impairment or Disposal of Long Lived Assets" effective for financial
statement issued for fiscal years beginning after December 15, 2001 and interim
periods within those fiscal years. Restatements of previously issued annual
financial statements is not permitted, however, comparative financial
information for earlier periods shall reflect required reclassifications in
presentation. SFAS 144 requires long-lived assets of continuing and discontinued
operations be measured at the lesser of carrying amount or fair value less
estimated selling costs. The assets and liabilities of discontinued operations
shall be presented separately in the asset and liability sections of the balance
rather than shown as net realizable value. We do not believe the adoption of
SFAS 144 will have a material effect on our financial position or results of
operations.
In August 2001, the Financial Accounting Standards Board issued SFAS
143, "Accounting for Assets Retirement Obligations" effective for fiscal years
beginning after June 15, 2002. SFAS 143 requires the recognition of the fair
value of liabilities for asset retirement obligations to be recognized in the
period in which it is incurred if a reasonable estimate of fair value can be
made. The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset. We do not believe the adoption of SFAS
143 will have a material effect, if any, on our financial position or results of
operations..
In June 2001, the Financial Accounting Standards Board finalized SFAS
141, "Business Combinations", and SFAS 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 others 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 nine months from the date adoption. We are also required to reassess the
useful lives of other intangible assets within the first interim quarter after
adoption of SFAS 142.
14
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 April 30, 2002 and January 31, 2002 consist of:
April 30, 2002 January 31, 2002
-------------- ----------------
Raw material .............................................. $13,390 $14,593
Work in process ........................................... 2,093 879
Finished goods ............................................ 8,371 9,806
------- -------
23,854 25,278
Less: Valuation reserve ................................... (6,470) (6,468)
------- -------
$17,384 $18,810
======= =======
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 Digi, 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. At
April 30, 2002, and January 31, 2002 marketable securities were as follows:
Unrealized
Cost Gains Market Value
---- ----- ------------
April 30, 2002:
Digi ........................... $2,020 $11,076 $13,096
Entrada ........................ 22 30 52
------ ------- -------
$2,042 $11,106 $13,148
====== ======= =======
January 31, 2002:
NETsilicon ..................... $3,938 $24,142 $28,080
Entrada ........................ 22 18 40
------ ------- -------
$3,960 $24,160 $28,120
====== ======= =======
15
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
------------------------------------------------------------------------------
Debentures-During August 2001, we completed a private placement of our
9.75% convertible debentures receiving net proceeds of $29,749. The debentures,
due August 2, 2004, have a face value of $32,200 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 options of paying the interest on these
debentures in shares of our common stock. In addition, the purchaser received
four year warrants to acquire an additional 3,351,840 shares of our common stock
at $7.21 per share and the placement agent received five year warrants to
acquire 111,651 shares of our common stock, equity securities, options or
warrants at a price less than $7.21 per share or at a discount to the then
market price. The conversion price and warrant exercise are subject to
adjustment.
In accordance with Emerging Issues Task Force ("EITF") No. 00-27 we
have 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 results 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 will be amortized as additional interest expense over the period the
debentures are outstanding. Interest expense during the three months ended April
30, 2002 of $1.2 million at the stated 9.75% interest which is paid in common
stock, amortization of issuance costs of $36 and amortization of the fair value
of the warrants issued to the purchasers and placement agent and the deemed
beneficial conversion feature of $398. On April 1, 2002 the Company issued
303,579 shares of our common stock in payment of $774interest for the debenture
interest period ending March 31, 2002. At April 30, 2002 debentures payable
consists of:
Face Value .......................................................... $ 32,200
Issuance costs ...................................................... (2,451)
Value of warrants and deemed beneficial
conversion feature ............................................. (27,252)
--------
Debenture book value at issuance .......................... 2,497
Accumulated amortization of
Issuance costs ................................................. 117
Value of warrants and deemed beneficial conversion feature ..... 1,309
--------
$ 3,923
========
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
16
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
------------------------------------------------------------------------------
1,000,000 shares of Preferred Stock, Series E
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 quarters ended April 30, 2002 and
2001 consist of:
Three Months Ended April 30,
----------------------------
2002 2001
-------- --------
Deemed dividends (Sorrento Series A) $ - $180
= ====
OTHER CAPITAL STOCK TRANSACTIONS
On March 22, 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. For a period of 18 months
from the March 22, 2001 completion date in the event the Company were to issue
shares of common stock or equity securities convertible into our common stock at
a price less than $6.5531 per share the purchasers would be entitled to receive
additional shares of common stock.
During 2000, our Sorrento subsidiary 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. Subsequent to the purchase
of 2,697,248 of these shares an officer and director of the purchaser joined the
Board of Directors of Sorrento. One of our then outside directors purchased
45,872 shares and a then director of Sorrento purchased 91,744 in this
placement. One of our present outside directors, who was not a director at that
time, purchased 183,486 shares in this placement. In addition, he is a director
of Liberty Media Corporation which owns an 11% economic interest representing a
37% voting interest in UGC. The purchaser of 3,027,523 shares in this placement
is an indirect subsidiary of UGC. Liberty Media also holds convertible debt in
this Series A holder which debt it has agreed to exchange for shares in UGC.
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. If 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 to be redeemed at the shares then
adjusted liquidation preference. If such a request is made in writing, our
Sorrento subsidiary has the obligation to redeem the shares in cash, if funds
are lawfully available to such a
17
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
------------------------------------------------------------------------------
redemption, or for such pro rata portion as to which a lesser amount of lawfully
available funds would exist. The net proceeds from the issuance of these shares
has been classified as a minority interest in the accompanying financial
statements as of April 30, 2002 and January 31, 2001. The difference between the
net proceeds received on the sale of these shares and their liquidation
preference of $48,800 was recorded as a deemed dividend during the period
from issuance to March 31, 2001. During the years ended April 30, 2002 and 2001,
we recorded a deemed dividend of $0 and $180 with respect to the Sorrento Series
A shares. As of April 30, 2002 and January 31, 2002 the Series A Preferred Stock
has been reclassified as a current liability since the holders have exercised
their right to redeem the shares.
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 April 30, 2002 there were 4,610,540 shares
under option at prices varying from $3.00 to $69.13 per share.
In addition our Sorrento subsidiary adopted its 2000 Stock Option/Stock
Issuance Plan under which it has granted options to certain of its employees and
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, 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 April 30, 2002 there were 14,915,227 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.
EARNINGS PER SHARE CALCULATION
The following data show the amounts used in computing basic earnings
per share for the quarters ended April 30, 2002 and 2001.
Three Monthes Ended April 30,
-----------------------------
2,002 2,001
----- -----
Net income (loss) ....................... $ 3,976 $ (5,768)
Less: preferred dividends ............... -- (180)
------------ ------------
Net income (loss) available to common
shareholders used in basic EPS ..... $ 3,976 $ (5,948)
============ ============
Average number of common shares
used in basic EPS .................. 14,322,839 13,281,938
============ ============
18
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
------------------------------------------------------------------------------
We had a net loss for the quarter ended April 30, 2001. Accordingly,
the effect of dilutive securities including convertible preferred stock, vested
and non-vested stock options and warrants to acquire 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.
Net income (loss) available to common
shareholders used in basic EPS ............... $ 3,976 $ (5,948)
Less: Convertible debt issuance costs ............. (28,620) --
Plus: Convertible debt interest ................... 774 --
---------- ----------
Net loss available to common
shareholders used in diluted EPS ............. $ (23,870) $ (5,948)
========== ==========
Average number of common shares
used in basic EPS ............................ 14,322,839 13,281,938
---------- ----------
Effect of dilutive securitites:
Convertible debentures ............................ 4,466,021 --
Stock benefit plans ............................... -- 279,440
Stock benefit plan of subsidiary .................. -- 56,409
Warrant exercises ................................. 123,964 2,453
---------- ----------
Average number of common shares and dilutive
potential common stock used in diluted EPS ... 18,912,824 13,620,240
========== ==========
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 with exercise
prices in excess of the average market price for the period are excluded because
their effect would be antidilutive.
LITIGATION
On September 10, 2001, holders of a portion of the outstanding Series A
Preferred Stock of our Sorrento subsidiary obtained a preliminary injunction
from the Delaware Court of Chancery 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. On January 23, 2002, the Delaware Supreme Court
affirmed the granting of the preliminary injunction.
On October 19, 2001, an amended complaint was filed in the injunction
action, adding as named defendants, the Company, our Meret subsidiary, certain
present and former officers and directors of the Company and our
19
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
------------------------------------------------------------------------------
subsidiaries as well as our investment bankers. The amended complaint also
added, among other things, claims for fraud, securities fraud, breach of
fiduciary duty, conspiracy, and intentional interference with contract as well
as requesting the appointment of a receiver for our Sorrento subsidiary, all
which claims are based on alleged wrongs committed in connection with or since
the Series A placement. Our Sorrento subsidiary and the original individual
defendants have all answered this amended complaint denying all allegations of
wrongdoing.
The new defendants have all moved to dismiss the amended complaint. Management
believes the allegations contained in the amended complaint are without merit.
On December 14, 2001, plaintiffs filed motions to sequester the common
stock of our Sorrento subsidiary owned by Meret and the Sorrento Series A
preferred stock that we own, as an alternative method of obtaining jurisdiction
over us and Meret in the Delaware litigation. Management also believes that
these motions are without merit.
Currently, hearings on all pending motions have been taken off the
Court's calendar at the request of all parties, pending the resolution of
ongoing settlement discussions between the Company and the plaintiffs. While
the Company is encouraged at the progress of these negotiations, there can be
no assurance that a settlement will be reached.
During June 2000, we entered into various agreements with Par Chadha, our
former CEO and Chairman, which, among other matters, provides for payments of
$250,000 per year for three years of consulting services and loans by us for the
exercise of previously granted options to acquire 1,178,500 options at prices
varying from $7.03 to $49.25 per share. As the members of our Board of Directors
at the time of his resignation ceased to represent more than 50% of the Board in
October 2000, all payments for consulting services were accelerated and no
future consulting services are required. During October 2000, Mr. Chadha
exercised 71,112 options, applying the $500,000 accelerated payment to the
exercise. In addition, he exercised 507,388 options for which we are
contractually obligated to loan the $5,034,000 due on the exercise. During
September 2001, Mr. Chadha notified us that he does not have any obligations
under the agreements. We have notified him that we do not agree with his
interpretation of his repayment obligations under the terms of the agreements.
During December 2001, we entered into an agreement whereby the 507,388
option exercise was rescinded. Mr. Chadha returned the 507,388 shares to us for
cancellation and we cancelled the receivable due from him and restored the
original option agreements. In June, 2002, the Company filed with the Superior
Court of California, County of Los Angeles a Complaint for Declaratory Relief
regarding the interpretation of the agreement. Should Mr. Chadha prevail in
Court, the Company may be required to issue him 1,178,500 shares of the
Company's stock for no consideration.
In April 2002, our former Chairman and CEO, Dr. Xin Cheng, filed a claim
in arbitration seeking, among other things, payment of $500 and acceleration of
the vesting of options pursuant to alleged contractual obligations of our
Sorrento subsidiary. The Company is disputing these claims.
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 effect on our financial position, results of operations, or
cash flows.
SUBSEQUENT EVENTS
20
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
------------------------------------------------------------------------------
The Board of Directors of Osicom approved a two-year employment contract
with Mr. Sue ending May 2002, which provides for a salary of $168 per year and
the vesting of all his options to acquire our common stock granted prior to
February 1, 2000. This contract may be terminated for cause. However, should Mr.
Sue be terminated without cause or resign in certain circumstances prior to the
end of the contract term he will receive a continuation of his salary and
benefits for two years, vesting of all his options to acquire our common stock
and he is required to provide consulting services to us during that period, On
May 8, 2002 Mr. Sue resigned from his position effective May 17, 2002 alleging
entitlement to the foregoing salary continuation and other benefits. The Company
does not believe Mr. Sue is entitled to any such benefits.
The Board of Directors of Osicom entered into a two-year contact with
Anne Wallace, Director of Financial Reporting, ending May 22, 2002 which
provided her compensation of $200 per year, plus benefits and living expenses
while on location at the Company's Santa Monica facility. This contract may be
terminated for cause. However, should Ms. Wallace contract be terminated without
good reason, or if she resigns for good reason, she will receive a continuation
of compensation and benefits for two years, and vesting of all her options to
acquire our common stock. On May 8, 2002 Ms. Wallace gave notice to the Company
that she has resigned for good reason, thus alleging entitlement to the
foregoing compensation and benefits. The Company does not believe Ms. Wallace is
entitled to any such benefits.
The Board of Directors of Osicom entered into a two-year employment
contract with Mr. Nimrod Johnson, Corporate Controller, ending May 22, 2002,
which provides for a salary of $97 per year and the vesting of all his options
to acquire our common stock. This contract maybe terminated for cause. However,
should Mr. Johnson be terminated without cause or resign in certain
circumstances prior to the end of the contract term he will receive a
continuation of his salary and benefits for two years, vesting of all his
options to acquire our common stock and he is required to provide consulting
services to us during that period. On May 9, 2002 Mr. Johnson resigned from his
position effective May 17, 2002 alleging entitlement to the foregoing salary
continuation and other benefits. The Company does not believe Mr. Johnson is
entitled to any such benefits.
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 by reviewing the
financial strength and credit risks of the investments and financial
institutions that the Company places its cash investments. Such investments and
placements may include governmental or associated agency notes or bonds, liquid
money market investments with a high degree of credit rating and major national
or regional banks with excellent credit history and ratings. To date our risks
in these investments has been minimal.
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 April 30, 2002. 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.
21
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 consolidated receivables:
April 30, January 31,
--------- -----------
2002 2002
---- ----
Customer A ........................... 9.2% 30.9%
Customer B ........................... 25.0% 18.6%
Customer C ........................... -- 11.8%
Customer D ........................... 25.9% 8.4%
The following data shows the customers accounting for more than 10% of
net consolidated sales:
April 30, 2002 April 30, 2001
-------------- --------------
Customer A ........................... 17.4% 24.7%
Customer B ........................... 13.7% 19.8%
Customer C ........................... 13.2% 13.9%
Customer D ........................... 14.1% 20.4%
22
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
(In Thousands, except share and per share amounts)
------------------------------------------------------------------------------
SEGMENT INFORMATION
Sorrento Meret
Networks Optical Other Total
-------- ------- ----- -----
Three Months Ended April 30, 2002
Net Sales ........................................... $ 4,794 $ 1,209 -- $ 6,003
Cost of Sales ....................................... 3,769 746 -- 4,515
--------- --------- --------- ---------
Gross Profit .................................. 1,025 463 -- 1,488
--------- --------- --------- ---------
Operating income (loss) ............................. (5,719) 22 (847) (6,544)
Depreciation & amortization expense ................. 769 133 435 1,358
Valuation allowance additions ....................... 270 447 105 822
Capital asset additions ............................. 1,662 212 70 1,944
Total assets ........................................ 59,572 8,187 15,605 83,364
Three Months Ended April 30, 2001
Net Sales ........................................... $ 13,139 $ 1,358 $ -- $ 14,497
Intersegment sales .................................. -- -- --
--------- --------- --------- ---------
Total net sales ............................... 13,139 1,358 -- 14,497
Cost of Sales ....................................... 8,666 902 -- 9,568
--------- --------- --------- ---------
Gross Profit .................................. 4,473 456 -- 4,929
--------- --------- --------- ---------
Operating income (loss) ............................. (4,629) 112 (1,212) (5,729)
Depreciation & amortization expense ................. 397 136 78 611
Valuation allowance additionals ..................... 399 172 500 1,071
Capital asset additions ............................. 1,396 4 31 1,431
Total assets ........................................ 54,350 8,346 43,002 105,698
23
PART II
OTHER INFORMATION
Item 1: Legal Proceedings
On September 10, 2001, holders of a portion of the outstanding Series A
Preferred Stock of our Sorrento subsidiary obtained a preliminary injunction
from the Delaware Court of Chancery 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. On January 23, 2002, the Delaware Supreme Court
affirmed the granting of the preliminary injunction.
On October 19, 2001, an amended complaint was filed in the injunction
action, adding as named defendants, the Company, our Meret subsidiary, certain
present and former officers and directors of the Company and our subsidiaries as
well as our investment bankers. The amended complaint also added, among other
things, claims for fraud, securities fraud, breach of fiduciary duty,
conspiracy, and intentional interference with contract as well as requesting the
appointment of a receiver for our Sorrento subsidiary, all which claims are
based on alleged wrongs committed in connection with or since the Series A
placement. Our Sorrento subsidiary and the original individual defendants have
all answered this amended complaint denying all allegations of wrongdoing.
The new defendants have all moved to dismiss the amended complaint. Management
believes the allegations contained in the amended complaint are without merit.
On December 14, 2001, plaintiffs filed motions to sequester the common
stock of our Sorrento subsidiary owned by Meret and the Sorrento Series A
preferred stock that we own, as an alternative method of obtaining jurisdiction
over us and Meret in the Delaware litigation. Management also believes that
these motions are without merit.
Currently, hearings on all pending motions have been taken off calendar
at the request of all parties, pending the resolution of ongoing settlement
discussions between the Company and the plaintiffs. While the Company is
encouraged at the progress of these negotiations, there can be no assurance that
a settlement will be reached.
During June 2000, we entered into various agreements with Par Chadha, our
former CEO and Chairman, which, among other matters, provides for payments of
$250,000 per year for three years of consulting services and loans by us for the
exercise of previously granted options to acquire 1,178,500 options at prices
varying from $7.03 to $49.25 per share. As the members of our Board of Directors
at the time of his resignation ceased to represent more than 50% of the Board in
October 2000, all payments for consulting services were accelerated and no
future consulting services are required. During October 2000, Mr. Chadha
exercised 71,112 options, applying the $500,000 accelerated payment to the
exercise. In addition, he exercised 507,388 options for which we are
contractually obligated to loan the $5,034,000 due on the exercise. During
September 2001, Mr. Chadha notified us that he does not have any obligations
under the agreements. We have notified him that we do not agree with his
interpretation of his repayment obligations under the terms of the agreements.
During December 2001, we entered into an agreement whereby the 507,388
option exercise was rescinded. Mr. Chadha returned the 507,388 shares to us for
cancellation and we cancelled the receivable due from him and restored the
original option agreements. In June, 2002, the Company filed with the Superior
Court of California, County of Los Angeles a Complaint for Declaratory Relief
regarding the interpretation of the agreement. We have been advised by Mr.
Chadha's counsel that in June 2002, Mr. Chadha filed a lawsuit against the
Company in the Superior Court of California, County of Los Angeles, also seeking
declaratory relief and in addition, alleging breach of contract and fraud. The
Company has not as yet received a copy of this complaint and has no further
details regarding its contents. Should Mr. Chadha prevail in Court, in addition
to any other relief that may be granted, the Company may be required to issue
him 1,178,500 shares of the Company's stock for no consideration.
In April 2002, our former Chairman and CEO, Dr. Xin Cheng, filed a claim
in arbitration seeking, among other things, payment of $500 and acceleration of
the vesting of options pursuant to alleged contractual obligations of our
Sorrento subsidiary. The Company is disputing these claims.
24
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 effect on our financial position, results of operations, or
cash flows.
Item 2: Changes in Securities and Use of Proceeds
Not Applicable
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
Consolidated Financial Statements for the Quarter Ended April 30,
2002 (included in Part I, Item 1).
B. Reports on Form 8-K
March 6, 2002 Board Appointment of new Chairman and Chief Executive
Officer
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)
June 19, 2002 By: /s/ Joe R. Armstrong
----------------------------------
Joe R. Armstrong,
Chief Financial Officer
Principal Accounting Officer
25