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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K/A
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended January 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File number: 0-15810
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SORRENTO NETWORKS CORPORATION
(Exact name of Registrant as specified in charter)
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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)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $6.00 Nasdaq
Title of each class Name of exchange on which registered
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in a definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. _________
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes ___ No X_.
The Registrant's revenues for its most recent fiscal year were $25,137,000
The aggregate market value of voting stock based upon the bid and ask price held
by non-affiliates of the Registrant on March 31, 2003 was $6,193,054.
Number of shares outstanding of the Registrant's only class of common stock as
of March 31, 2003 (the latest practicable date): 886,050.
DOCUMENTS INCORPORATED BY REFERENCE:
None.
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PART I
Item 1. Business
Introduction
This Annual Report on Form 10-K may contain forward-looking statements
that involve risks and uncertainties. Such statements include, but are not
limited to, statements containing the words "believes, "anticipates," "expects,"
"estimates" and words of similar import. Our actual results could differ
materially from any forward-looking statements, which reflect, management's
opinions only as of the date of this report, as a result of such risks and
uncertainties. We undertake no obligation to revise or publicly release the
results of any revisions to these forward-looking statements. Readers should
carefully review the risk factors set forth below in "Factors That May Affect
Future Results" and in other documents the company files from time to time with
the Securities and Exchange Commission, including its quarterly reports on Form
10-Q.
We are a leading supplier of intelligent optical networking solutions
for metropolitan and regional applications worldwide. Our solutions enable
communication carriers and service providers to offer broadband networking
services over optical fibers for metropolitan and regional applications. Our
technologies permit telecommunications service providers to increase fiber
capacity and fiber bandwidth utilization, reduce network costs and complexity
over scalable and efficient networking platforms. Our optical networking systems
support a wide variety of protocols, mixed speeds of traffic and accommodate
changing traffic patterns directly over optical networks.
Our product solutions include optical transport, optical access, and
network management solutions optimized for metro and regional markets, and
combine to create powerful, cost-effective, and easy-to-manage optical networks.
Our dense wavelength division multiplexing, or DWDM, and course wavelength
division multiplexing, or CWDM, platforms can be used in both metropolitan and
regional network applications. DWDM and CWDM technology allows many optical
signals to be transmitted simultaneously on the same optical fiber by using
different wavelengths of light to distinguish the signals. This technology
increases optical network capacity and flexibility.
Our comprehensive suite of optical networking interfaces and optical
access multiplexers allow us to also address broadband applications in the
optical access market including data center fail-over recovery, storage area
networking and internet connectivity applications. In addition, our CWDM product
is a lower cost, entry level solution that can be used for enterprise and
carrier customer access that complements our DWDM product line. Multiplexing is
a process that combines a number of lower speed data transmissions into one
high-speed data transmission.
We also have two powerful network management solutions for our DWDM
product line. Addressing all key management aspects - fault, configuration,
performance, and security - these systems conform to North American and
international standards and are simple to learn and use. We have a robust,
carrier-class management system that offers broad functionality, including
equipment/facilities management, fault management, performance monitoring,
security control, alarm filtering, and remote download. We also have an
enterprise network management solution that provides an intuitive graphical
interface and covers operations, administration, maintenance, and provisioning
functionality for our DWDM networks.
We currently have an installed base with over 20 communications service
providers and system integrators worldwide, including AT&T Broadband, now
Comcast Corporation, Deutsche Telekom, Cox Communications, United Pan-Europe
Communications, El Paso Global Networks and Edison Carrier Solutions.
Understanding Our Market
Definitions of technical terms used throughout this document can be
found at the end of this Item 1.
Rapid Growth in Bandwidth Demand
2
Fueled by the growth of the Internet, the volume of data traffic
transmitted across telecommunications networks now exceeds voice traffic. The
growth of data traffic is attributable to increased Internet usage, increased
access speeds and greater use of bandwidth intensive applications. Bandwidth
means the capacity to move information down a communications channel. Bandwidth
is defined by the highest data rates that can be transmitted by that channel and
is commonly measured in bits per second. According to Ryan, Hankin & Kent,
Internet traffic is projected to increase at a rate exceeding 40% per year for
the next five years.
Migration of Network Infrastructure
Traditional copper-based and SONET/SDH based telecommunications
infrastructures were originally designed for voice traffic. These
infrastructures do not scale effectively to provide the bandwidth needed to
support the growth in high-speed data traffic. In addition, these
infrastructures need network-wide upgrades in order to accommodate growing
traffic thus resulting in long delays for provisioning new services.
DWDM and CWDM technologies are more flexible, more efficient and more
scalable networking alternatives for meeting the growing demand for bandwidth
and new broadband services. Broadband means technologies or networks that have
the ability to transmit high data rates. DWDM means dense wavelength division
multiplexing, which is a sophisticated opto-electronics technology that uses
multiple wavelengths of light very efficiently to greatly increase the number of
video, data or voice channels of information that can be sent on a single
optical fiber. SONET means a transmission protocol for high-speed transmission
over fiber optic cable, which was introduced by Bell Communications in 1984 and
quickly accepted by American National Standards Institute. SDH means Synchronous
Digital Hierarchy, which is transmission protocol for high-speed transmission
over fiber optic cable published in 1988 by the Consultative Committee for
International Telegraph and Telephony. It is a transmission protocol used
outside the United States that is similar to SONET .
DWDM networks for long-haul applications were the first to be deployed,
and optical solutions specifically designed to address the challenges faced by
metropolitan markets have significantly lagged in deployment. Accordingly, metro
networks are considered to be traffic bottlenecks in the fast and efficient
transmission of data.
Enhanced Competition in the Service Provider Market
Worldwide deregulation in the telecommunications industry has led to an
increase in the number of service providers seeking to address the growing
demand for bandwidth. In the U.S. and internationally, traditional service
providers such as incumbent local exchange carriers (ILECs), inter-exchange
carriers (IXCs) and post, telephone and telegraph companies (PTTs) are seeing
new entrants in the broadband networking market seeking to capitalize on the
growing demand for bandwidth. A number of competitors to these incumbents are
building new data-centric networks to address the present bandwidth bottlenecks
in the metropolitan markets, including utilities and cable television companies
which are upgrading their current networks and are leveraging existing
investments in fiber optic infrastructure to deliver high-speed data services in
both the local and regional markets. This enhanced competition in the carrier
and service provider markets is driving increased capital expenditures on
network infrastructure that is focused on delivering scalable high-speed data
services in a cost efficient manner.
Network Topography
The following describes each of the network segments within the optical
network hierarchy:
o Long-haul networks are high capacity networks that connect
service providers and carry voice and data across large
geographic regions, typically spanning distances up to 4,000
kilometers. Long-haul networks are relatively simple networks,
built around SONET/SDH technology and are primarily designed only
to satisfy service provider long haul network capacity
requirements.
o Metropolitan core (metro-core) networks connect the central
offices of service providers in a metropolitan area and
facilitate the transport and switching of traffic within extended
metropolitan areas and between the network edge and long-haul
networks. Metropolitan core networks are typically implemented in
ring configurations and reach ring circumferences up to 300
kilometers. In order to efficiently use the optical network,
sub-rate multiplexing devices aggregate traffic into wavelengths
carrying higher speed aggregate
3
bit rates across telecommunications networks. Regional networks
typically transport voice and data traffic between cities across
distances of 200 to 600 kilometers or more.
o Access networks connect enterprises or traffic aggregation nodes,
in multiple locations throughout metropolitan areas, to service
providers' central offices or connect different end-user
locations to each other. In order to efficiently use the optical
network, optical access devices aggregate traffic from end users
into wavelengths or wavelength bands for transport across
telecommunications networks. Because access networks must support
the varying demands of end users, these networks tend to be very
complex.
Metropolitan area optical network opportunity
Although optical technologies are being deployed in long-haul networks
to relieve capacity constraints, these solutions are not specifically designed
to address the issues inherent in metropolitan and regional optical networks.
Data is normally mapped into the voice multiplexing hierarchy for transport over
the long-haul network. Metropolitan optical networks are characterized by
varying traffic patterns and protocols as well as varied topologies and end-user
requirements, making them more complex and difficult to manage than long haul
networks. As a result, service providers have only recently begun to exploit the
benefits of optical technologies in metropolitan optical networks.
The optical networking market has seen a substantial downturn in 2002
from 2001 levels. The metro WDM market, which was expected to increase, has also
experienced a slowdown as capital spending has declined throughout the
telecommunications industry. While we believe that the metro WDM world-wide
market will grow significantly in the years to come, such growth is not likely
to occur until capital spending resumes in the markets we serve, and we are
unable to assess at present when this might take place. According to industry
analysts, including Ryan, Hankin and Kent and others, the metro WDM market in
2001 was about $1.2 billion worldwide and is expected to grow to $3.6 billion by
2005.
Regional optical network opportunity
In addition to the metropolitan market, recent engineering enhancements
have permitted the use of DWDM networking platforms for regional optical
networking applications. This development opens up the opportunity to address a
portion of the substantial long haul market. In some regions, e.g., Europe,
regional solutions apply to the majority of the networks installed. Industry
researchers recently started looking at reclassifying the regional market
opportunity, although statistical data for this market are not available.
Specific challenges facing metropolitan optical networks
Service providers face numerous specific challenges in addressing
metropolitan and regional optical networks:
o Scalability Limitations. Originally constructed for voice
traffic, the current network infrastructure based on SONET/SDH
technology does not allow for the network efficiencies necessary
to address the shift to a predominantly data-driven network. Due
to its inherent lack of scalability, the current network
infrastructure may require service providers to undertake the
expensive and tedious process of replacing network equipment or
adding new layers of similar equipment in response to changes or
increases in bandwidth demand. Alternative approaches to WDM are
being developed by other vendors to address the scalability of
the SONET/SDH networks. These nonstandard solutions are called
next generation SONET/SDH and can minimize the wasted bandwidth
of legacy SONET/SDH. While these solutions allow carriers to
combine voice and data on the same network, such solutions do
not, however, expand the amount of bandwidth available and are,
therefore, unable to accommodate the need for large amounts of
bandwidth.
o Need to Support Multiple Protocols. Metropolitan optical networks
are characterized by a wide variety of protocols. The inability
to support multiple protocols and services from a single platform
further increases the cost and complexity of the metropolitan
networks. Alternative approaches to WDM are being developed by
other vendors to address the requirement for support of multiple
services. These nonstandard solutions are called multi-service
provisioning platforms. These solutions generally carry out
protocol conversions and are much more complex than WDM
solutions.
4
o Market Downturn. Virtually all telecom related market segments
have suffered a decline in demand in the current economic
downturn. What was once viewed as only a long-haul decline in
market demand has now affected the regional and metropolitan
networks as both enterprise and carrier business have cut back
capital spending. Although we expect that demand in the regional
and metropolitan markets will be strong in future periods, there
are no assurances that capital spending will resume within this
sector in the near term.
o Several Stages of Conversion. Present solutions require several
conversions to transport data through a metropolitan network. In
the access networks, aggregation of traffic often requires
protocol conversions into a common protocol before optical
transmission. In the central office, data is often demultiplexed
and converted into electrical signals for regeneration, switching
or further aggregation into higher capacity links and then
reconverted into optical signals for transmission in the
metro-core network.
o Inefficient Bandwidth Utilization. Within metropolitan optical
networks, service providers must cater to end-users with varying
access speeds. Current optical access solutions do not make
efficient use of scarce wavelength resources. Service providers
must assign a full wavelength to each signal, whether or not the
end-user requires the full bandwidth potential of each
wavelength.
o Difficulty of Network Management. Multiple protocols and
services, coupled with the lack of standards that exist in
metropolitan optical networks, make network management functions,
such as performance monitoring and configuration, exceedingly
difficult. Lack of a robust network management platform further
adds to the cost and complexity of metropolitan optical networks.
o Need for New, Enhanced Service Offerings to Generate New Revenue
Opportunities. Service providers are searching for
next-generation solutions that will enable them to generate
additional sources of revenue from offering new or enhanced
services to their customers. Current solutions typically require
the service provider to deploy equipment that is specifically
designed for a particular service and transmission rate.
Next-generation solutions must be able to offer enhanced
features, wavelength provisioning and bandwidth-on-demand, that
end-users will increasingly request from service providers.
Our Solutions
Our solutions feature products designed to specifically address the
shortcomings of legacy SONET/SDH networks and to facilitate offering new
services throughout metropolitan and regional optical networks. We enable our
customers to meet the rapidly growing demand for bandwidth by offering
end-to-end metropolitan and regional optical networking solutions for the
aggregation, transport and management of traffic. Our current products,
including our GigaMux'r' DWDM transport system, our EPC'TM' sub-rate
multiplexing modules, our JumpStart'TM' CWDM transport system, as well as the
network management product line that includes GigaView, TeraManager'TM' and
TeraConfigurator'TM', are specifically designed to meet the unique requirements
of the metropolitan and regional markets.
Our optical networking solutions offer numerous benefits including:
o Cost Effective Entry-Level Access Solution. Our Jumpstart CWDM
platform allows low cost multiplexing of up to four wavelengths
carrying a mix of protocols and signals for access applications.
CWDM means coarse wavelength division multiplexing, which is a
sophisticated opto-electronics technology that uses multiple
wavelengths of light to increase the number of video, data or
voice channels of information that can be sent on a single
optical fiber.
o Scalable Architecture. We have created an optical networking
solution that simultaneously transmits voice, data, and video
over optimized fiber channels. The modular architecture of our
solution enables service providers to incrementally expand
capacity as their bandwidth needs increase. This simple,
scaleable, and functional solution solves short and long-term
service provider problems, which enhances their ability to reduce
costs and offer value-added services. For example, a service
provider can begin deployment with a single channel and later
expand up to 64 channels, providing up to 640 gigabits per
second, or Gbps, of transmission capacity without interrupting
existing traffic. A fiber channel is a serial data transfer
architecture standard conceived for new mass storage devices and
other peripheral devices that require very high bandwidth
connections. Bit rates for fiber channels are either 1.06 Gbps or
2.1 Gbps.
5
o Protocol and Signal Transparency. Our suite of solutions
transports a mix of protocols and signals, including SONET/SDH,
Asynchronous Transfer Mode (ATM) over SONET, Internet Protocol
(IP) over SONET, Gigabit Ethernet, Fibre Channel and Enterprise
System Connectivity in their native formats over numerous
wavelengths in the same fiber. This transparency provides
operational simplicity in that the service provider can offer
networking connectivity without having to worry about protocol
conversions. This is particularly important in metropolitan areas
where multiple protocols are utilized and data transmission rates
change often. The transparency of our solution eliminates the
unnecessary conversions from optical to electrical and back to
optical, as well as eliminates several layers of equipment that
would otherwise be required in the transport and switching of
traffic, thus reducing network complexity and signal latency.
o Protocol Aggregation. Our EPC'TM' optical access multiplexer
aggregates traffic, of varied rates utilizing a wavelength per
direction of transmission, from businesses and network points of
presence for transport throughout optical networks. This
aggregation allows better utilization of wavelengths and lowers
capital expenditures of telecom service providers by reducing
investments in excess network capacity.
o Manageability. The design of our end-to-end optical networking
solution will allow service providers to perform network
management from a single platform with our TeraManager'TM'
product. This intelligent optical network element management
software platform provides fault, configuration, performance, and
security management utilizing an easy-to-use graphical user
interface that allows point and click network provisioning and
monitoring.
o Regional optical transport. Our solution permits service
providers to expand beyond the confines of metropolitan networks
using the same platform for metropolitan and regional
applications. Regional networks can now be built using the lower
cost solutions developed for the metropolitan environment
Our Strategy
Our objective is to become a leading supplier of intelligent optical
networking solutions for metro and regional applications worldwide. The key
elements of our strategy are to:
o Enhance and complete our metropolitan/regional optical networking
solutions
We intend to continue to enhance our existing family of metropolitan
and regional optical networking products and to introduce new products that
increase the functionality of our end-to-end optical solution. We introduced
TeraManager'TM' and TeraConfigurator'TM' in our management solution portfolio in
fiscal 2003. We also introduced JumpStart'TM', our CWDM solution, in fiscal year
2002. The combination of our GigaMux'r' optical transport products, with the
EPC'TM' sub-rate multiplexer, the JumpStart'TM' CWDM, and TeraManager'TM', our
carrier class network management product, creates an intelligent all-optical
transport solution.
o Leverage our engineering leadership
We intend to leverage our engineering expertise in the areas of
optical, mechanical, electrical and network management design to continue to
provide leading end-to-end metropolitan and regional optical networking systems
and to expand our market share. We believe we were the first company to
commercially ship a metropolitan optical networking product using DWDM
technology. As of January 31, 2003, we had a skilled team of 29 engineers that
continually focus on developing products for the metropolitan and regional
optical transport market. We believe that our technological leadership has been
the key to our success and will enable us to rapidly develop new product
offerings and end-to-end optical solutions for the metropolitan and regional
markets.
o Allow our customers to leverage their fiber assets by offering
revenue-generating services
The majority of our existing customers and targeted customers have a
large amount of fiber assets in the metropolitan and regional network
infrastructure. We intend to continue to develop and provide solutions that will
enable our customers to leverage their existing fiber infrastructure to deliver
revenue-generating services, while reducing their overall network costs. In
addition, we believe our existing customer base provides us with an advantage
when competing for new customers. We intend to continue to work closely with our
customers and invest
6
in sales and marketing resources to maintain our high level of customer service
and remain responsive to our customers' changing needs.
o Aggressively pursue expense reduction initiatives
We plan to aggressively pursue cost reduction initiatives to bring our
expenses in line with current and future anticipated revenues. Such reductions
may affect the size of our workforce, and may require decreasing our operating
expenses and capital spending. During the past two fiscal years we have
concentrated on implementing initiatives that have lowered our operating costs
and anticipate the need for continued cost reductions if sales volume does not
increase in the near future.
o Maintain our sales, service and support
organizations worldwide
We intend to continue to market our products worldwide. We currently
have sales, service and support teams in North America, Europe and Asia. We
believe that sales, service and support efforts on a customer-by-customer basis
are most effective due to the technical evaluation and significant investments
that are made by our customers.
Products
Our family of optical networking systems is designed to provide our
customers with end-to-end solutions for the metropolitan and regional optical
networking markets. Our transport, access, switching and network management
systems include the following products, some of which are still in development.
GigaMux'r' - DWDM Optical Transport
Our GigaMux'r' optical transport product utilizes DWDM technology to
expand the capacity of new and existing fibers and enable traffic to travel
throughout metropolitan optical networks without optical to electrical to
optical conversions at each intermediate node. Our GigaMux'r' features
wavelength translation, wavelength multiplexing, optical amplification, optical
add-drop multiplexing, protection switching and performance monitoring. The
scalable and modular architecture of our GigaMux'r' product enables service
providers to easily and cost-effectively expand their existing networks as
bandwidth requirements increase. GigaMux'r' can simultaneously transport
multiple protocols bi-directionally over one or more fibers, which reduces the
cost and complexity of the network.
Our GigaMux'r' product is Network Equipment Building Standards, or
NEBS, level III certified. As of January 31, 2003, we have shipped our
GigaMux'r' product to over 20 direct carrier customers or resellers worldwide.
Our GigaMux'r' product includes the following key features:
o Scalability: the system can grow from 1 to 64 protected channels
(640 Gbps/fiber) without a major upgrade or service interruption.
o Protocol transparency: the system can aggregate and transport
SONET/SDH (OC-3/STM-1 through OC-192/STM-64 carrying voice, IP or
ATM traffic), ESCON, Fibre Channel, Fast Ethernet, Gigabit
Ethernet and video.
o Modular protection: the system's modular protection system allows
redundancy to be implemented at any point in the network.
o Add/drop channels: the system is equipped with add/drop modules
that allow specific channels to be added or dropped while all
other channels pass through. Our filter subsystem can add or drop
from single channels to larger wavelength bands.
o Reach: Up to 600 kilometers with optical amplifiers and up to
1000 km with the addition of dispersion compensation.
EPC'TM' - Sub-Rate Access Multiplexer
Electric Photonic Concentrator, or EPC'TM', is our sub-rate access
multiplexer product that aggregates a wide variety of traffic from businesses
and network points of presence for high-speed transport throughout optical
7
networks. The traffic is aggregated and effectively shares a wavelength per
direction of transmission and can be ported directly into the DWDM stage of our
GigaMux'r'. EPC'TM' is designed to lower the cost and increase the efficiency of
bandwidth delivery within optical networks.
Our EPC'TM' products include the following key features:
o Support for asynchronous or synchronous (SONET/SDH) time division
multiplexing of data
o Provisionable bit rates and protocol and overhead transparency
JumpStart'TM' -- CWDM Transport
JumpStart is our entry level solution for multiplexing up to 4
bi-directional data channels using coarse wavelength division multiplexing
technology on a single fiber. The product is very compact and can be stacked to
provide additional capacity -- 4 channels per fiber.
TeraManager'TM' -- Element Management System
TeraManager'TM' is our TL1-based intelligent element management
software platform that provides fault, configuration, performance and security
management for all the Sorrento networks products and for networks built with
such products. Service providers can operate our network management platform
through an easy-to-use graphical user interface, which gives users a complete
network view and enables point and click provisioning and monitoring.
Our TeraManager'TM' product includes the following features:
o Fault, configuration, security and performance management
o Carrier class performance
o Interface with higher layer operation support systems
Customers
Our target customer base includes wholesale and retail broadband
service providers, such as inter-exchange carriers, local and foreign telephone
companies, the telecom affiliates of utility companies (utilicoms), cable
television service providers, system integrators and distributors.
Our customers generally fit the following customer profiles:
o Wholesale Network Providers -- these customers provide wavelength
and broadband services to communication service providers and
include telecommunication carriers, cable companies and
utilicoms.
o Managed Services Providers -- these customers provide wavelength
and broadband services to enterprises and include
telecommunication carriers, cable companies, utilicoms and
Internet Service Providers.
o System Integrators -- companies that specialize in providing
turnkey networking solutions for enterprise networks and
applications such as data-center connectivity and storage area
networks.
o Major Enterprises -- major enterprise customers are generally
large organizations with complex networking needs, usually
spanning multiple locations and difficult types of network
requirements. Enterprise customers include industrial
corporations, government agencies, and utilities.
o Small and Medium Businesses -- these customers have a need for
networks as well as connection to the Internet and/or to their
business partners. However, they generally have limited
resources. Therefore, we provide product through systems
integrators or Value Added Resellers.
During fiscal 2003, the majority of our sales were to relatively few
customers, and we expect this customer concentration to continue for the
foreseeable future. For fiscal 2003, we shipped our optical networking products
to a total of 23 customers worldwide. Three customers, AT&T Broadband, now
Comcast Corporation, Cox
8
Communications and Deutsche Telekom each represented more than 10% of our net
sales for fiscal 2003 and for fiscal 2002.
Key Relationships
We have entered into long-term agreements with some of our customers
and strategic allies, including:
AT&T Broadband Network Solutions (Now Comcast Business Communications)
In February 2000, we entered into a strategic alliance agreement with
AT&T Broadband Network Solutions (now Comcast Business Communications, or AT&T
Broadband. Under the terms of this agreement, we and AT&T Broadband agreed to
negotiate in good faith concerning the implementation of a number of joint sales
and marketing initiatives. AT&T Broadband also agreed to help introduce our
technology to individuals at other AT&T divisions and to provide feedback
concerning our products' performance. The initial term of this agreement expired
in February 2002 and was automatically renewed for an additional one-year term
in February 2002 and in February 2003. Similar automatic renewals will occur in
each succeeding February. Either we or AT&T Broadband may terminate the
agreement for any reason upon ninety days notice. In addition, we concurrently
entered into an equipment purchase agreement. The equipment purchase agreement
expired in February 2002 and was automatically renewed for an additional
one-year term in February 2002 and in February 2003. Similar automatic renewals
will occur in each succeeding February. Either we or AT&T Broadband may
terminate the agreement for any reason upon ninety days notice. We started
shipping our products to AT&T Broadband in the second quarter of fiscal year
2001.
In November 2002, we entered into a separate exclusive supplier
agreement with AT&T Broadband. Under this agreement, we become AT&T Broadband's
exclusive supplier, subject to certain exceptions, of dense and course
wavelength division multiplexing equipment that AT&T Broadband uses to provide
UFO Communications, Inc., a private service provider, with certain services on
certain AT&T Broadband networks. The initial term of this agreement is five
years and continues after the initial term until either party gives 90 days
written notice terminating the agreement.
UFO Communications, Inc.
In November 2002, we entered into an exclusive supplier agreement with
UFO Communications, Inc., or UFO. Under this agreement, we become UFO's
exclusive supplier of dense and course wavelength division multiplexing
equipment, subject to certain exceptions, for networks owned, leased or operated
by UFO. The initial term of this agreement is five years and can be renewed at
any time by the written agreement of both parties for additional terms of one
year or longer.
Looking Glass Networks
In August 2001, we entered into an equipment purchase agreement with
Looking Glass Networks, or LGN. Under the terms of this agreement, LGN agreed to
purchase metro DWDM optical networking equipment from Sorrento as the primary
supplier. LGN also agreed to receive early adopter access to new and emerging
Sorrento technologies, and to serve as a beta tester for new and emerging
equipment and to provide feedback concerning our products' performance. The
initial term of this agreement expires in August 2004 and will be automatically
renewed for additional one-year terms. Either LGN or Sorrento may terminate the
agreement at the end of the initial or any renewal term upon ninety days notice.
We started shipping our products to LGN in the third quarter of fiscal year
2002.
Sales and Marketing
Our sales effort is currently focused on North America, Europe and
Asia. As of January 31, 2003, our sales and marketing organization included 39
employees, including account managers, sales engineers, support personnel,
product managers and marketing personnel. In North America, Europe and Asia, we
sell our products through our direct sales force as well as through system
integrators. Our international direct sales force is located in the United
Kingdom, France, Belgium, Germany, Singapore and China.
In support of our worldwide selling efforts, our marketing team targets
potential customers through in-depth market analysis. Our marketing objectives
include building market awareness and acceptance of our products as
9
well as expanding our customer base. Our customer acquisition strategy has
focused on targeting customers who are aggressively building network
infrastructure and are looking to leverage existing fiber assets to generate
additional revenue from broadband services. This focus has led to strategic
supply agreements with several MSOs, utilities, and to a lesser extent CLECs. We
also plan to target incumbent carriers as they expand the development of their
metropolitan and regional fiber networks. Marketing personnel coordinate our
participation in trade shows, seminars and industry events and conduct media
relation's activities with trade and general business publications. We
participate in many industry organizations responsible for developing standards
that are used in optical networks.
Customer Service and Support
Our customer service and support team provide a critical component of
our customer satisfaction initiative. This team provides support to our
customers allowing them to successfully design and implement their optical
networks. All services can be customized to meet the needs our customers. Our
staff is experienced, and has the equipment necessary to support both
installation and problem resolution. A variety of installation service packages
supports the implementation from start up to upgrades and maintenance.
Specialists are available 7 days a week, 24 hours a day. We offer a Technical
Assistance Center as well as field services support. Multiple technical support
service agreements allow our customers to define the level of support they
require. Our customer service and support team provides installation,
maintenance and training programs addressing the product, installation and
maintenance processes and can be delivered at the customer location or at our
training facility.
We currently provide service and support to our international customers
on a direct basis and are establishing service and support agreements throughout
the world. To date revenues from service and support agreements have not been
material. We intend to continue to develop our internal team to meet the needs
of our customers and will utilize strategic partners to allow us to provide
greater value when appropriate.
We provide a total service solution. Our hardware products are
warranted against defects for a period of 12 to 36 months dependent on purchase
agreements, including technical support and parts repair/replacement. We also
offer support contracts for a fee to our customer base, thereby allowing our
customers to select a service plan tailored to their own particular needs.
Engineering, Research and Development
We have assembled a team of highly skilled engineers with extensive
experience in the fields of optical, mechanical, electrical and network
management design. We believe that our success in introducing DWDM optical
technology for use in the metropolitan and regional markets was a result of our
strength in research and development. As of January 31, 2003, 29 employees were
engaged in engineering, research and development efforts. Our research and
development efforts are focused on new product development as well as enhancing
performance and reliability of our existing products. We believe that our
research and development efforts are key in maintaining technical
competitiveness, delivering innovative products, and addressing the needs of the
regional and metropolitan market.
Our engineering, research and development expenses were $9.0 million,
$13.7 million and $23.9 million for the years ended January 31, 2003, 2002 and
2001, respectively. The decrease in our engineering, research and development
expenses was primarily due to headcount reduction and product rationalizations
under our cost reduction program.
Manufacturing and Quality
We outsource the manufacturing of our products. We design our products
and perform system integration, quality control, final testing and configuration
at our San Diego, California location. Our San Diego facility is ISO-9002
certified and we have begun the process of becoming ISO9000/2000. By meeting
such standards, we assure our customers that we meet internationally recognized
standards for quality, customer care and sound management practices. We believe
that outsourcing our manufacturing allows us to conserve working capital,
flexibly respond to changes in market demand and more quickly deliver products
to our customers.
We currently purchase products from our contract manufacturers and
other suppliers on a purchase order basis. We generally do not enter long-term
contracts with our contract manufacturers or suppliers, and they are not
obligated to perform services for us for any specific period or at any specified
price, except as may be provided in a particular purchase order. We purchase a
limited number of key components used in the manufacturing of our
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products from a limited number of suppliers and some of our components are
purchased exclusively from a single supplier on a purchase order basis.
Patent, Trademarks and Licenses
We currently hold approximately 36 patents and have several patent
applications pending. Although we attempt to protect our intellectual property
rights through patents, trademarks, and copyrights, maintaining certain
technology as trade secrets and other measures, we cannot assure that any
patent, trademark, copyright or other intellectual property rights owned by us
will not be invalidated, circumvented or challenged, that such intellectual
property rights will provide competitive advantages to us or that any of our
pending or future patent applications will be issued with the scope of the
claims sought by us, if at all. We cannot assure that others will not develop
technologies that are similar or superior to our technology, duplicate our
technology or design around the patents that we own. In addition, effective
patent, copyright and trade secret protection may be unavailable or limited in
certain foreign countries in which we do business or intend to do business in
the future. We also have licensed and may in the future license technologies
from other companies on a non-exclusive basis. For example, our CWDM product
incorporates technology purchased from Entrada Networks, Inc., our former
affiliate, that we then enhanced to complete a commercially feasible product.
We believe that the future success of our business will depend on our
ability to translate the technological expertise and innovation of our personnel
into new and enhanced products. We cannot assure that the steps taken by us will
prevent misappropriation of our technology. In the future, we may take legal
action to enforce our patents and other intellectual property rights, to protect
our trade secrets, to determine the validity and scope of the proprietary rights
of others, or to defend against claims of infringement or invalidity. Such
litigation could result in substantial costs and diversion of resources and
could harm our business and operating results.
As is common in our industry, we have from time to time received
notification from other companies of intellectual property rights held by those
companies upon which our products may infringe. Any claim or litigation, with or
without merit, could be costly, time consuming and could result in a diversion
of management's attention, which could harm our business. If we were found to be
infringing on the intellectual property rights of any third party, we could be
subject to liabilities for such infringement, which could be material, and could
be required to seek licenses from other companies or to refrain from using,
manufacturing or selling certain products or using certain processes. Although
holders of patents and other intellectual property rights often offer licenses
to their patent or other intellectual property rights, no assurance can be given
that licenses would be offered, that the terms of any offered license would be
acceptable to us or that failure to obtain a license would not cause our
operating results to suffer.
Working Capital Practices
We have historically maintained high levels of inventories to meet
output requirements of our customers and to ensure an uninterrupted flow of
inputs from suppliers. It is not our standard policy to grant customers the
right to return merchandise that performs according to specifications. Typical
payment terms require payment within thirty to sixty days from the date of
shipment.
We perform ongoing credit evaluations of each customer's financial
condition and extend unsecured credit related to the sales of various products.
From time to time we receive financial instruments such as letters of credit for
payments for international customers. At January 31, 2003, accounts receivable
due from AT&T Broadband, Cox Communications, DeltaNet and iNOC accounted for
31%, 16%, 19% and 30% respectively, of net receivables.
Our Backlog
At January 31, 2003, we had backlog that totaled over $5.0 million
compared to slightly over $200 thousand at January 31, 2002. Our backlog
consists of orders confirmed with a purchase order for products to be shipped
within twelve months to customers with approved credit status. We do not believe
that backlog, as of any particular date, should be used as an indication of
sales for any future period for two reasons. First, orders are increasingly
being booked and shipped in a short period of time and therefore may never be
calculated in the backlog amount at the end of any particular quarter. Second,
customers have and can change delivery schedules or cancel orders without a
significant penalty.
11
Competition
The market for optical networking equipment is extremely competitive
and subject to rapid technological change. We expect competition to continue to
be significant in the future. Our primary competitors in the DWDM market include
vendors of optical networking and infrastructure equipment such as Nortel
Networks, CIENA Corporation, Cisco Systems, and Lucent Technologies, as well as
private companies that have been or will be focusing on our target markets. Our
primary competitors for our CWDM products include Adva AG Optical Networking,
and CIENA Corporation. Many of our competitors have significantly greater
financial resources and are able to devote these greater resources to the
development, promotion, sales and support of their products. In addition, many
of our competitors have more extensive customer relationships than we do,
including relationships with our potential customers. We believe each of our
competitors has optical networking products in various stages of development.
We believe the principal competitive factors in the optical networking
market are:
o product performance, features, functionality and reliability;
o price/performance characteristics;
o timeliness of new product introductions;
o relationships with existing customers;
o service, support and financing; and
o financial stability and strength of company.
We believe our products compete favorably with our competition within
our marketplace.
The competitors for Meret's legacy products include Pesa, Artel, RGB
Spectrum, Utah Scientific, and many other companies.
Increased competition may result in further price reductions, reduced
gross margins and loss of market share, any of which could materially and
adversely affect our business, operating results and financial condition. There
can be no assurance that we will be able to compete successfully against current
and future competitors, or that competitive factors will not have a material
adverse effect on our business, operating results and financial condition.
Environmental Compliance
We are required to file environmental compliance reports with the
Federal Food and Drug Administration regarding the emissions levels of our
laser-based products, which are used in fiber optics communications. All of our
products comply with required safety level standards.
Employees
As of January 31, 2003, we had 115 employees of which 29 were in
engineering, research and development, 39 in sales and marketing, and the
remainder in manufacturing and in general and administrative functions. Of the
29 employees in research and development 15 have masters degrees and 11 have
doctorate degrees. We also employ a number of part-time and temporary personnel
from time to time in various departments. Our future success will depend in part
on our ability to attract, retain and motivate highly qualified technical and
management personnel, for whom competition is intense. None of our employees are
covered by a collective bargaining agreement and we believe that our relations
with our employees are good.
Forward-Looking Statements -- Cautionary Statement
All statements other than statements of historical fact contained in this
Form 10-K, 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
12
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 consummate our proposed capital restructuring; our
ability successfully to finance our current and future needs for working
capital; our ability to keep our common stock listed on the Nasdaq Stock Market;
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;
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.
Factors That May Affect Future Results
In connection with the safe harbor contained in the Private Securities
Reform Act of 1995 we are hereby identifying important factors that could cause
actual results to differ materially from those contained in any forward-looking
statements made by us or on our behalf. Any such statement is qualified by
reference to the following cautionary statements:
The telecom industry has experienced a significant downturn in the past
year and continues to stay at a low capital spending level for carriers with
whom we depend upon our revenues. Current world turmoil, economic uncertainty
and an equity market that is essentially closed or extremely difficult to raise
new capital, could cause our future revenues to decrease. A significant downturn
in our revenues would drain our existing working capital and have a very
negative impact on our stock price. In addition, we would be faced with the need
to raise additional working capital of which there is no certainty would be
available.
In order to continue to support planned operations, enhance and expand
our product offerings and to penetrate additional market share in the regional
and metropolitan marketplace we will need additional funds in the future. If
we are unable to obtain new investment, we will have to reduce or cease
operations, or attempt to sell some or all of our operations or to merge with
another entity.
The continued development of our products as well as the expansion of
manufacturing capabilities or the establishment of additional sales, marketing
and distribution capabilities will require the commitment of substantial funds.
Our existing working capital is not sufficient to meet these expansion plans.
Potential sources of additional funds include public or private offerings of
equity securities and bank lines of credit. Additional financing may not be
available on terms favorable to us, or at all. Insufficient funds may require us
to delay, scale back or eliminate certain product development programs, or
attempt to merge with another entity or otherwise reduce our existing operations
or cease operations. We also expect that, as a result of the slowdown in capital
spending in the telecom industry, we will need to continue to reduce our
expenses in the future to bring them in line with reduced revenues in order to
conserve our financial resources. Moreover, without adequate financing,
potential customers who otherwise would select our products to purchase may
decide to buy from other vendors who they perceive to have greater financial
stability.
On March 6, 2003, we, SNI, and the holders of our outstanding 9.75%
debentures and Series A Preferred Stock executed an Exchange Agreement, pursuant
to which we have agreed to exchange the outstanding 9.75% debentures and Series
A Preferred Stock for shares of our common stock and new 7.5% debentures in an
aggregate
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principal amount of $13.1 million. The closing of the restructuring transaction
will occur as soon as is practicable after we receive shareholder approval of
the exchange and related transactions, subject to the satisfaction or waiver of
the conditions set forth in the Exchange Agreement. We currently expect the
closing to be on or about May 21, 2003.
An aggregate of approximately 10,440,000 shares of our common stock
will be issued at the closing of the restructuring transaction or will be
issuable upon conversion of the new 7.5% debentures. The new 7.5% debentures
that will be issued in the restructuring transaction, excluding the debentures
to be issued to certain Series A stockholders for certain legal fees, will be
convertible into between approximately 1,034,000 and approximately 3,101,000
shares (representing approximately 8.75% and 26.25% respectively of our shares
outstanding on a diluted basis), depending on the conversion price. The new
7.5% debentures that will be issued to certain Series A stockholders for
certain legal fees will be convertible into approximately 100,000 shares,
depending on the conversion price. The conversion price of the new 7.5%
debentures will depend upon the closing price of our stock prior to the
closing of the restructuring transaction. Because we will not know the
conversion price until shortly before closing the restructuring transaction, we
cannot now determine the precise number of shares of our common stock that will
be issued to the holders of the outstanding 9.75% debentures and Series A
Preferred Stock at the closing of the restructuring transaction and the precise
number of shares of our common stock that will be issuable upon conversion of
the new 7.5% debentures. "Diluted basis" is a concept that is used in the
Exchange Agreement, and means the total number of shares of our common stock
issued and outstanding immediately after the closing of the restructuring
transaction, after giving effect to (i) the issuance of shares of common stock
as part of the restructuring transaction, (ii) shares of our common stock
issuable upon conversion of $12.5 million principal amount of the New
Debentures, and (iii) shares of our common stock issuable upon exercise of the
New Warrants. "Diluted basis" does not give effect to (i) the shares of our
common stock issuable under the 2003 Equity Incentive Plan, (ii) shares of
common stock issuable upon conversion of the Fee Amount Debentures, (iii)
shares of our common stock issuable upon conversion of our Series D Preferred
Stock, and (iv) shares of our common stock issuable upon exercise of existing
options or warrants.
We are in the process of restructuring both our Senior Convertible
Debentures of $32.2 million and Series A Preferred Stock issued by our
subsidiary Sorrento Networks Inc., with a payback obligation of $48.8 million
from that subsidiary. If approved by our shareholders, the proposed
restructuring would result in the exchange of our outstanding Senior
Convertible Debentures Due August 2, 2004, and associated warrants, (together,
the "Outstanding Debentures"), and shares of the Series A Preferred Stock
issued by our subsidiary, Sorrento Networks, Inc. (the "Series A"), into
shares of our common stock and an aggregate principal amount of $12.5 million
(the "Exchange Debentures") of new 7.5% Secured Convertible Debentures (the
"New Debentures"). We will also issue $600 thousand aggregate principal amount
of New Debentures (the "Fee Amount Debentures") to some of the holders of the
Series A Preferred Stock for payment of certain legal fees. In order to effect
the proposed restructuring, our shareholders must vote to approve the exchange
transaction and the issuance of new shares of our common stock and new
convertible debentures, a change in our state of incorporation from New Jersey
to Delaware, and the adoption of a new employee equity incentive plan.
The restructuring is being done for several reasons. The primary reason
is to allow us to restructure our approximately $81 million in obligations due
to the holders of the Outstanding Debentures and Series A obligation. We believe
that the successful restructuring of these obligations into common equity and a
much smaller amount of convertible debentures will strengthen our balance sheet,
allow us to compete more effectively in our industry, permit us to meet the
minimum equity requirements for our principal trading market, Nasdaq, and allow
us an opportunity to raise additional working capital in the future. In addition
to the restructuring of our debt obligations, we plan to simplify our corporate
structure by rolling-up and merging various subsidiaries into one principal
corporation, although this may not happen until after the consummation of the
financial restructuring. This simplification of our corporate structure should
enable us to continue to improve our cost reduction efforts in an industry that
has experienced severe revenue and capital expenditure reductions. There is no
certainty the proposed restructuring will be approved by our shareholders.
Further, because of certain provisions in the Exchange Agreement that govern the
terms and conditions of the restructuring and closing, there is the possibility
that the Debenture Holders or Series A Preferred Stock could elect not to close
on the transaction, even after we have gained shareholder approval and incurred
significant costs associated with the proposed restructuring. If the
restructuring does not close, we would likely be forced to seek protection from
the large liabilities that would become due if defaults under our Debenture
Agreements were triggered.
As part of our proposed restructuring the lawsuits and pending
litigation with the Series A shareholders issued by our Subsidiary Sorrento
Networks, Inc. our subsidiary have been stayed until completion of the proposed
restructuring.
14
The Series A Preferred Stock issued by our Sorrento Networks, Inc. subsidiary
("SNI"), and a preliminary injunction obtained by some of the holders of that
stock, could have a material adverse effect on our ability to raise the capital
that we need.
Certain holders of SNI's Series A preferred stock obtained a
preliminary injunction in September 2001 from 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. As part of our proposed
restructuring the lawsuits and pending litigation with the Series A Shareholders
have been stayed until completion of the proposed restructuring. However, should
the restructuring not occur, the stay will not continue in effect. The Court of
Chancery would then decide whether to make this injunction permanent at a trial
that is not currently scheduled. We cannot predict the outcome of that trial,
if it occurs. 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. We, however, have the right to make such capital
contributions to SNI to fund its operations as the Board may deem necessary.
Capital contributions do not increase our 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 our Board will continue to authorize such contributions
in the future should other funding methods continue to be unavailable. In
addition, our Exchange Agreement with our Convertible Debenture Holders and
Series A shareholders place certain restrictions on funding SNI until completion
of the restructuring.
The redemption rights of the Series A Preferred Stock of SNI, and
limitations on funding SNI could have a negative impact on our business.
In April 2001, holders of the Series A Preferred Stock exercised
their right to ask SNI to redeem their shares for approximately $49 million in
cash. Such request can only be paid from lawfully available funds of which SNI
has none available and would normally be generated from operating profits of the
business. SNI does not foresee any such profits in the near future. While the
Series A shareholders have agreed to the proposed restructuring, there is no
assurance the restructuring will close. Such uncertainty could impact the
business negatively on both a short and long-term basis.
If the proposed restructuring agreement is approved by the shareholders
and completed, all pending legal actions relating to the Series A will be
dismissed. If the restructuring is not completed, we will be forced to consider
an alternative plan of reorganization. (Please refer to Item 3. Legal
Proceedings, for more information).
We may not be able to obtain the additional financing we anticipate we will need
in the near future to continue our business.
We will need additional funds to support operations in the near future
in order to continue to enhance and expand our product offerings and to increase
our market share in the regional and metropolitan marketplace. If we are unable
to obtain new investment, we may have to reduce or cease operations, or attempt
to sell some or all of our operations or to merge with another entity. We cannot
be sure that we will be able to obtain this new financing.
The further development of our products as well as the expansion of
manufacturing capabilities or the establishment of additional sales, marketing
and distribution capabilities will likely require the commitment of substantial
funds. Our existing working capital is not likely to be sufficient to meet these
expansion plans. Potential sources of additional funds include public or private
offerings of debt or equity securities, bank lines of credit or extensions of
existing arrangements by us. Additional financing may not be available on terms
favorable to us, or at all. Insufficient funds may require us to delay, scale
back or eliminate certain product development programs, or attempt to merge with
another entity or otherwise reduce or cease operations. We also expect that, as
a result of the slowdown in capital spending in the optical networking and
telecommunications industries, we will need to continue to reduce our expenses
in the near future to bring them in line with reduced revenues in order to
conserve our working capital. Moreover, without adequate financing, potential
customers who otherwise would select our products to purchase may decide to buy
from other vendors whom the customers perceive to have greater financial
stability.
15
We have a history of losses and expect to incur future losses.
We have incurred operating losses during the years ended January 31,
2003, 2002 and 2001 of $31.3 million, $37.2 million and $50.4 million,
respectively, and as of January 31, 2003, we had an accumulated deficit of
$187.5 million. We expect to continue to incur losses in the future. If we do
not become profitable, the value of our stock will decrease. We have large
expenses in the areas of sales and marketing, research and development,
manufacturing, and general and administrative expenses that are not covered by
our current sales volume and resulting gross margin. Currently, the majority of
revenues are from shipments of our optical networking product lines. In order
for us to become profitable, we will need to generate and sustain higher
revenue, improve our gross margins on products while maintaining reasonable
expense levels.
Our history of losses and future losses could have an impact on our ability to
finance our business and risk our ability to continue operating.
We have incurred significant losses and may incur significant losses in
the future. Such losses could cause our equity balance to fall below necessary
levels even after the restructuring so that we would again be in violation of
minimum listing requirements for our publicly traded stock on the Nasdaq
National Market, which could cause significant decline in shareholder value and
stock price.
If Nasdaq delists our common stock from the Nasdaq National Market, the market
liquidity for our common stock could be severely and adversely effected.
On September 18, 2002, the Nasdaq Stock Market informed us that we were
not in compliance with its listing maintenance standards regarding minimum net
tangible assets or minimum shareholder's equity. We believe that if our
capital-restructuring plan is approved by our shareholders and is consummated,
we will regain compliance with Nasdaq listing standards. However, on January 23,
2003, the Nasdaq staff determined that our stock should be delisted from Nasdaq
because of concerns regarding the length of time it was taking to complete the
restructuring transaction, and about our ability to remain in compliance for a
long enough period of time even if the restructuring transaction was completed.
We appealed this determination to a Nasdaq Listing Qualifications Panel, and our
stock remains listed on Nasdaq pending the decision of the Panel.
On March 6, 2003 we presented before the Nasdaq Panel our reasons for
requesting an extension of time to complete our restructuring plans.
On April 4, 2003, the Panel issued a decision extending until May 16,
2003, our time to demonstrate compliance with the minimum shareholder equity
standard. As our current plan is to close the capital restructuring, subject to
shareholder approval, on or about May 21, 2003, we are asking the Panel for a
short extension of the May 16 deadline. While there can be no assurance that the
Panel will grant this extension, our understanding is that Panels customarily
grant such short extensions under circumstances such as these.
If our stock is delisted from Nasdaq, the ability of holders of our
common stock to sell our stock could be adversely affected, our ability to
secure future funding might be severely impacted, and there could be a material
adverse effect on our financial condition. If we are not successful in the
restructuring we will be delisted from Nasdaq, this delisting would constitute
a triggering event that would allow our debenture holders to request accelerated
payment of their debentures at 125% of the face value. If such an event were to
occur, we would not have the financial resources to repay such a request, thus
resulting in a default under the debenture agreement.
If our common stock is delisted from the Nasdaq market system, it may be subject
to the "penny stock" regulations, which may affect the ability of our
shareholders to sell their shares.
Regulations of the SEC define "penny stock" to be any non-Nasdaq equity
security that has a market price as therein defined of less than $5.00 per share
or which has an exercise price of less than $5.00 per share, subject to certain
exceptions. For any transaction involving a penny stock, unless exempt, the
rules require delivery, prior to any transaction of any penny stock, of a
disclosure schedule prepared by the SEC relating to the penny stock market. The
SEC also requires disclosure of our commissions payable to both the
broker/dealer and its registered representative and information regarding
current quotations of the securities. Finally, the SEC requires that monthly
statements be sent disclosing recent price information for the penny stock held
in the account and information on the limited market in penny stocks.
Your percentage of ownership and voting power, and the price of our common stock
may decrease because we may issue a substantial number of shares of common
stock, or securities convertible or exercisable into our common stock.
16
We have the authority to issue up to 7.5 million shares of our common
stock and 2.0 million shares of our preferred stock without shareholder
approval. We may also issue additional warrants and options to purchase shares
of our common stock. These future issuances could be at values substantially
below the price paid for our common stock by current shareholders. We may
conduct additional future offerings of our common stock, preferred stock, or
other securities with rights to convert the securities into shares of our common
stock, which may result in a decrease in the value, or market price of our
common stock. Further, the issuance of preferred stock could have the effect of
delaying, deferring or preventing a change of ownership without further vote or
action by the shareholders and may adversely affect the voting and other rights
of holders of common stock.
Our industry is highly competitive, and we may not have the resources required
to compete successfully.
The market for optical networking equipment is extremely competitive.
We expect competition to intensify in the future. Our primary sources of
competition include vendors of optical networking and infrastructure equipment
such as CIENA Corporation, Cisco Systems, Lucent Technologies, Nortel Networks,
and ADVA AG Optical Networking as well as private companies that have been or
will be focusing on our target markets. The competitors for Meret's legacy
products include Pesa, Artel, RGB Spectrum, Utah Scientific, and many other
companies. We may also face competition from a number of other companies that
have announced plans for new products to address the same network problems that
our products address. Many of our current and potential competitors have
significantly greater sales and marketing, technical, manufacturing, financial
and other resources than we do. Our competitors also may have more extensive
customer relationships than us, including relationships with our current and
potential customers. If we are unable to compete successfully against our
current and future competitors, we could experience pricing pressures, reduced
gross margins and order cancellations, any one of which could seriously harm our
business.
Our business may be seriously harmed if the market for optical
networking products in metropolitan and regional areas does not see a recovery
from the downturn in telecom capital spending and develop as we expect.
Our business may be seriously harmed if the market for optical networking
products in metropolitan and regional areas does not develop as we expect.
Our current and future product offerings are focused on the needs of
providers that service regional and metropolitan areas. The market for optical
networking products in regional and metropolitan areas is not yet mature, and we
cannot be certain that a feasible market for our products will develop or be
sustainable. In addition, the market has suffered a cutback in capital spending
from both enterprise and carrier customers as a result of poor economic
conditions. If this market does not develop, or develops more slowly than we
expect or continues to be impacted by the reduction in capital spending, our
business may be seriously harmed. Furthermore, the optical networking industry
is subject to rapid technological change, and newer technology or products
developed by others could render our products less competitive or obsolete. In
developing our products, we have made, and will continue to make, assumptions
about the optical networking standards that our customers and competitors may
adopt. If the standards adopted are different from those which we have chosen to
support, market acceptance of our product would be significantly reduced and our
business will be seriously harmed.
Our future growth depends on our ability to attract new customers, and on our
customers' ability to sell additional services to their own customers.
Most of our potential customers evaluate optical networking products
for deployment in large telecommunications systems that they are installing.
There are only a relatively limited number of potential customers for our
products. If we are not selected by a potential customer, our revenues and
ability to grow our business may be seriously harmed. Similarly, our growth
depends on our customers' success in selling communications services based on
our products and complementary products from others. Our success will depend on
our ability to effectively anticipate and adapt to customer requirements and
offer products and services that meet customer demands. Any failure of our
current or prospective customers to purchase products from us for any reason,
including a downturn in their business, would seriously harm our ability to grow
our business.
If we fail to establish and successfully maintain strategic alliances, long-term
contracts and relationships with distributors and system integrators, our
ability to grow and be profitable may be seriously harmed.
17
Strategic alliances and long-term contracts are an important part of
our effort to expand our sales opportunities and technological capabilities. To
date, we have entered into strategic alliances with AT&T Broadband, now Comcast
Corporation, UFO Communications, Inc. and Looking Glass Networks. In addition we
have a long-term contract with Cox Communications. We cannot be certain that our
existing alliances and long-term contracts will not be cancelled or that we will
be able to enter additional strategic alliances on terms that are favorable to
us. With the exception of two agreements we recently entered into with TCI
Network Solutions, Inc., d/b/a AT&T Broadband Network Solutions, and UFO
Communications, Inc., our agreements to date with our strategic allies are
non-exclusive, and we anticipate that future agreements will also be on a
non-exclusive basis. These agreements are generally short term, have no minimum
financial commitments on either side and can be cancelled without significant
financial consequence. In addition, we cannot be certain that our existing and
any future strategic alliances will be successful. As we expand internationally,
we will increasingly depend upon distributors and system integrators. Our
ability to grow and be profitable may be seriously harmed if we fail to
establish and maintain strategic alliances, long-term contracts and
relationships with distributors and system integrators. Our five-year agreement
with AT&T Broadband Network Solutions provides that we will be AT&T Broadband
Network Solutions' exclusive supplier, subject to certain exceptions, of dense
and course wavelength division multiplexing equipment. We also recently
contracted with UFO to be its exclusive supplier of equipment, subject to
certain exceptions, for networks owned, leased or operated by UFO.
We rely on a small number of customers for most of our revenues and any loss,
cancellation, reduction or delay in sales to, or collections from, any single
customer could seriously harm our business.
Our customer base is highly concentrated. Historically, orders from a
relatively limited number of customers accounted for most of our net sales. For
the fiscal year ended January 31, 2003, five customers accounted for 84% of net
sales, during the fiscal year ended January 31, 2002, five customers accounted
for 62% of net sales and in fiscal year 2001 five customers accounted for 44% of
our net sales. We expect that, for the foreseeable future, sales to a limited
number of customers will continue to account for a high percentage of our net
sales. We currently do not have any long-term purchase commitments with any of
our customers, and we are subject to the varying purchase cycles of our
customers. Our concentrated customer base significantly increases the credit
risks associated with slow payments or non-payments by our customers. The loss
or delay of orders or slow or non-payment from, any of our largest customers
could adversely impact our business.
Our backlog at any point may not be a good indicator of expected revenues.
Our backlog at the beginning of each quarter typically is not
sufficient to achieve expected sales for the quarter. To achieve our sales
objective, we are dependent upon obtaining orders during each quarter for
shipment during that quarter. Furthermore, our agreements with our customers
typically provide that they may change delivery schedules and cancel orders
within specified times which are typically 30 days or more prior to the
scheduled shipment date, without significant penalty. Our customers have in the
past built, and may in the future build, significant inventory in order to
facilitate more rapid deployment of anticipated major projects or for other
reasons. Decisions by such customers to reduce their inventory levels have led
and could lead to reductions in purchases from us. These reductions, in turn,
have and could cause fluctuations in our operating results and have had and
could have caused an adverse effect on our business, financial condition and
results of operations in periods in which the inventory is reduced.
Our operating results are likely to fluctuate significantly and may fail to meet
or exceed the expectations of securities analysts or investors, causing our
stock price to decline.
Our revenues and operating results will vary significantly from quarter
to quarter and year to year due to a number of factors, many of which are
outside of our control and any of which may cause our stock price to fluctuate.
Some of the factors that may affect us include changes in market demand for our
optical networking products, the cost and availability of components used in our
products, the timing and amount of customer orders, the length and
unpredictability of the sales and deployment cycles of our products, the timing
of new product introductions and enhancements by our competitors and ourselves,
changes in our pricing or the pricing of our competitors, our ability to attain
and maintain production volumes and quality levels of our products, and general
economic conditions as well as those specific to the telecommunications and
related industries.
18
If we are unable to comply with regulations affecting our customers' industries,
our revenues may be seriously harmed.
Our customers are involved in industries that are subject to extensive
regulation by domestic and foreign governments. If we fail to conform our
products to these regulatory requirements, we could lose sales and our business
could be seriously harmed. Additionally, any failure of our products to comply
with relevant regulations could delay their introduction and require costly and
time-consuming engineering changes.
The time that our customers and potential customers require for testing and
qualification before purchasing our products can be long and variable, and may
require us to invest significant resources without any assurances of sales,
which may cause our results of operations to be unpredictable.
Before purchasing our products, potential customers typically undertake
a lengthy evaluation, testing and product qualification process. In addition,
potential customers often require time-consuming field trials of our products.
Our sales effort requires the effective demonstration of the benefits of our
products to, and significant training of, potential customers. In addition, even
after deciding to purchase our products, our customers may take several years to
deploy our products. The timing of deployment depends on many factors, including
the sophistication of a customer and the complexity and size of a customer's
networks. Our sales cycle, which is the period from the time a sales lead is
generated until the recognition of revenue, can often be longer than one year.
The length and variability of our sales cycle is influenced by a variety of
factors beyond our control, including our customers' buildout and deployment
schedules, our customers' access to product purchase financing, our customers'
needs for functional demonstration and field trials, and the manufacturing lead
time for our products. Because our sales cycles are long and variable and may
require us to invest significant resources without any assurances of sales, our
results of operations may be unpredictable.
The GigaMux'r', EPC'TM', TeraManager'TM' and JumpStart'TM' are our only
currently available significant products, and if they are not commercially
successful, our revenue will not grow and we may not achieve profitability.
If our customers and potential customers do not adopt, purchase and
successfully deploy our GigaMux'r',EPC'TM', TeraManager and JumpStart products
in large numbers, our revenue may not grow and our business, financial condition
and results of operations will be seriously harmed. Because the market for our
products is relatively new, future demand for our products is uncertain and will
depend on the speed of adoption of optical networking, in general, and optical
equipment in metro and regional networks, in particular.
If we are not able to develop and commercialize new or enhanced products, our
operating results and competitive position will be seriously harmed.
Our growth depends on our ability to successfully fund and develop new
and enhanced products. The development of new or enhanced products is a costly,
complex and uncertain process that requires us to anticipate accurately future
technological and market trends. Our next generation of transport and network
management products is currently under development. We cannot be sure whether
these or other new products will be successfully developed and introduced to the
market on a timely basis, or at all. We will need to complete each of the
following steps to successfully commercialize these and any other new products,
complete product development, qualify and establish component suppliers,
validate manufacturing methods, conduct extensive quality assurance and
reliability testing, complete software validation, and demonstrate systems
interoperability.
Each of these steps presents serious risks of failure, rework or delay,
any one of which could adversely affect the rate at which we are able to
introduce and market our products. If we do not develop these products in a
timely manner, our competitive position and financial condition could be
adversely affected.
In addition, as we introduce new or enhanced products, we must also
manage the transition from older products to newer products. If we fail to do
so, we may disrupt customer ordering patterns or may not be able to ensure that
adequate supplies of new products can be delivered to meet anticipated customer
demand. Any failure to effectively manage this transition may cause us to lose
current and prospective customers.
If our products do not interoperate with our customers' networks, installations
will be delayed or cancelled or our products could be returned.
Many of our customers require that we design products to interoperate
with their existing networks, each of which may have different specifications
and utilize a variety of protocols. Our customers' networks contain multiple
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generations of products that have been added over time as these networks have
grown and evolved. Our products must interoperate with all of the products
within these networks as well as future products in order to meet our customers'
requirements. If we are required to modify our product design to be compatible
with our customers' systems to achieve a sale, it may result in a longer sales
cycle, increased research and development expense and reduced margins on our
products. If our products do not interoperate with those of our customers'
networks, installations could be delayed, orders for our products could be
cancelled or our products could be returned, any of which could seriously harm
our business.
Our products may have errors or defects that we find only after deployment,
which could seriously harm our relationship with our customers and our
reputation.
Our customers may discover errors or defects in our products, and our
products may not operate as expected. If we are unable to fix errors or other
problems that may be identified on a timely basis, we could experience losses of
or delays in revenues and loss of market share, loss of customers, failure to
attract new customers or achieve market acceptance, diversion of engineering
resources, increased service and warranty costs, and legal actions by our
customers. Any failure of our current or planned products to operate as expected
could delay or prevent their adoption and seriously harm our relationship with
our customers and our reputation.
We depend upon contract manufacturers and any disruption in these relationships
may cause us to fail to meet the demands of our customers and damage our
customer relationships.
We use contract manufacturers to manufacture and assemble some of our
products in accordance with our specifications. We currently have three
U.S.-based contract manufacturers. We do not have long-term contracts with any
of them, and none of them is obligated to perform services for us for any
specific period or at any specified price, except as may be provided in a
particular purchase order. We may not be able to effectively manage our
relationships with these manufacturers and they may not meet our future
requirements for timely delivery or provide us with the quality of products that
we and our customers require.
Each of our contract manufacturers also builds products for other
companies. We cannot be certain that they will always have sufficient quantities
of inventory available to fill our orders, or that they will allocate their
internal resources to fill these orders on a timely basis. Qualifying a new
contract manufacturer and commencing volume production is expensive and time
consuming and could result in a significant interruption in the supply of our
products. If we are required to change contract manufacturers, we may suffer
delays that could lead to the loss of revenue and damage our customer
relationships.
We rely on a limited number of suppliers and single suppliers for some of our
components, and our sales and operating results may be seriously harmed if our
supply of any of these components is disrupted.
We and our contract manufacturers currently purchase several key
components of our products from single and limited sources. We purchase each of
these components on a purchase order basis and have no long-term contracts for
these components. In the event of a disruption in supply or if we receive an
unexpectedly high level of purchase orders, we may not be able to develop an
alternate source in a timely manner or at favorable prices. Any of these events
could hurt our ability to deliver our products to our customers and negatively
affect our operating margins. In addition, our reliance on our suppliers exposes
us to potential supplier production difficulties or quality variations. Any such
disruption in supply would seriously affect our present and future sales.
We expect the average selling prices of our products to decline, which may
reduce gross margins and revenue.
Our industry has experienced significant erosion of average product
selling prices. We anticipate that the average selling prices of our products
will decline in response to competitive pressures, increased sales discounts,
and new product introductions by our competitors or other factors. Such reduced
sales prices require us to reduce our costs in order to maintain or improve our
existing gross margins. If we are unable to achieve sufficient cost reductions
and increases in sales volumes, the decline in average selling prices will
reduce our gross margins and revenue.
If we are unable to hire or retain highly skilled personnel, we may not be able
to operate our business successfully.
20
Our future success depends upon the continued services of our key
management, sales and marketing, and engineering personnel, many of whom have
significant industry experience and relationships. Many of our personnel could
be difficult to replace. We do not have "key person" life insurance policies
covering any of our personnel. The loss of the services of any of our key
personnel could delay the development and introduction of, and negatively impact
our ability to sell, our products. Competition for highly skilled personnel is
intense in our industry, and we may not be able to attract and retain qualified
personnel, which could seriously harm our business.
If we become subject to unfair hiring claims, we could incur substantial costs
in defending ourselves.
Companies in our industry whose employees accept positions with
competitors frequently claim that their competitors have engaged in unfair
hiring practices. We cannot assure you that we will not receive claims of this
kind in the future as we seek to hire qualified personnel or that those claims
will not result in material litigation. We could incur substantial costs in
defending ourselves or our employees against such claims, regardless of their
merits. In addition, defending ourselves from such claims could divert the
attention of our management away from our operations.
We may be unable to protect our intellectual property, which could limit our
ability to compete.
We rely on a combination of patent, copyright, trademark and trade
secret laws and restrictions on disclosure to protect our intellectual property
rights. We also enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and control access to, and
distribution of, our software, documentation and other proprietary information.
Despite our efforts to protect our proprietary rights, unauthorized parties may
attempt to copy or otherwise obtain and use our products or technology.
Monitoring unauthorized use of our products is difficult, and we cannot be
certain that the steps we have taken will prevent unauthorized use of our
technology, particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States. If competitors gain access
to our technology, our ability to compete could be harmed.
We could become subject to litigation regarding intellectual property rights,
which could seriously harm our business and require us to incur significant
costs.
In recent years, there has been significant litigation in the United
States involving patents and other intellectual property rights. We may be a
party to litigation in the future to protect our intellectual property or as a
result of an allegation that we infringe upon others' intellectual property
rights. Any parties asserting that our products infringe upon their proprietary
rights would force us to defend ourselves and possibly our customers or
manufacturers against the alleged infringement. These claims and any resulting
lawsuits, if successful, could subject us to significant liability for damages
and invalidation of our proprietary rights. Additionally, any claims and
lawsuits, regardless of their merits, would likely be time-consuming and
expensive to resolve and would divert management time and attention.
Any claims of infringement on the intellectual property rights of
others could also force us to do one or more of the following: stop selling,
incorporating or using our products that use the challenged intellectual
property, obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology, which may not be available to us
on reasonable terms, or at all, or redesign those products that use such
technology. If we are forced to take any of the foregoing actions, our business
may be seriously harmed. However, we intend to vigorously protect our
intellectual property against all material challenges.
If necessary licenses of third-party technology are not available to us or are
very expensive, our products could become obsolete.
We have been licensing, and may be required to, license technology from
third parties to develop new products or product enhancements. We cannot assure
you that third-party licenses will be available to us on commercially reasonable
terms, if at all. If we are required to obtain any third-party licenses to
develop new products and product enhancements, we could be required to obtain
substitute technology, which could result in lower performance or greater cost,
either of which could seriously harm the competitiveness of our products.
Our international operations are subject to a number of risks,
including changes in foreign government regulations and telecommunications
standards, import and export license requirements, tariffs, taxes and other
trade barriers, fluctuations in currency exchange rates, difficulty in
collecting accounts receivable, the burden of
21
complying with a wide variety of foreign laws, treaties and technical standards,
difficulty in staffing and managing foreign operations, and political and
economic instability.
The majority of our sales and expenses have been denominated in U.S.
dollars. However, in the future a larger portion of our sales and expenses may
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 do not currently engage in foreign exchange hedging
transactions to manage our foreign currency exposure.
If we do not effectively manage our growth, we may not be able to successfully
expand our business.
Our business has experienced wide fluctuations in sales volume from
quarter to quarter, which places a significant strain on our management systems
and resources. Our ability to successfully offer our products and implement our
business plan in a rapidly evolving market requires an effective planning and
management process. We will need to continue to improve our financial,
managerial and manufacturing processes and reporting systems, and will need to
continue to expand, train and manage our workforce worldwide. If we fail to
effectively manage our growth and address the above requirements, our ability to
pursue business opportunities and expand our business could be harmed.
Our stock price may be volatile which may affect your ability to sell shares at
or above the offering price or result in securities litigation against us.
The stock market in general, the Nasdaq Stock Market and the stock of
optical networking companies in particular, have experienced extreme price and
volume fluctuations that have often been unrelated or disproportionate to a
company's operating performance. We expect the price of our common stock to
fluctuate. The offering price may not be indicative of the prices that will
prevail in the public market after the offering. The trading price of our common
stock could fluctuate in response to factors including those described elsewhere
in the prospectus and:
o General market conditions;
o Announcements of technological innovations or new products;
o Publicity regarding actual or potential results with respect to
technologies or products under development; and
o Other events or factors, many of which are beyond our control
These broad market and industry factors may cause our stock price to
decline, regardless of our actual operating performance. In the past, following
periods of volatility in the market price of a company's securities, securities
class-action litigation has often been instituted against that company.
Securities class-action litigation, if instituted, could result in substantial
costs and a diversion of management's attention and resources, which would harm
our profitability.
We have incurred, and continue to incur, extremely high legal expenses
in connection with our capital restructuring and litigation with former officers
and personnel, which could be ongoing and lessen our available working capital.
The extraordinary and extremely high legal costs associated with our
capital restructuring and defense of legal claims against us brought by prior
officers, directors and other personnel have depleted our existing working
capital. If we continue to incur such expenses, our existing working capital may
be depleted sufficiently that our business may be seriously harmed. We cannot
assure you that we will be able to reduce such costs in the immediate future.
Definitions
As used in this Annual Report on Form 10-K, the following terms have the
meanings indicated:
22
"ATM" means Asynchronous Transfer Mode, which is a type of networking technology
based on transferring data in cells or packets of a fixed size. The small,
constant cell size allows ATM equipment to transmit video, audio, and data over
the same network, and assure that no single type of data overtakes the line.
Current implementations of ATM support data transfer rates of 25 Mbps to 2.48
Gbps.
"Backbone" means a main segment of a network carrying large amounts of traffic.
Individual metro and interoffice rings are attached to the backbone.
"Bandwidth" means the capacity to move information down a communications
channel. Bandwidth is defined by the highest data rates that can be transmitted
by that channel and is commonly measured in bits per second (bps). For example,
Ethernet has a 10 Mbps bandwidth and OC-192 has 10 gigabits per second
bandwidth.
"Bridge" means a device that connects two or more networks of the same access
method (Ethernet to Ethernet or Token Ring to Token Ring) by making simple
forward/don't forward decisions on each data packet received from any of the
networks to which it is connected.
"Broadband" means technologies or networks that have the ability to transmit
high data rates.
"CLEC" means a Competitive Local Exchange Carrier.
"Concentrator" means the connection point, more sophisticated than a hub,
incorporating different types of cable connections, back-up power supply,
data-gathering capability for management purposes and possibly even bridge and
router features as well.
"CWDM" means Coarse Wavelength Division Multiplexing, which is a sophisticated
optoelectronics technology that uses multiple wavelengths of light spaced at
least 400 Ghz apart to increase the number of video, data or voice channels of
information that can be sent on a single optical fiber in a transmission system.
"DWDM" means Dense Wavelength Division Multiplexing, which is a sophisticated
optoelectronics technology that uses multiple wavelengths of light very
efficiently to greatly increase the number of video, data or voice channels of
information that can be sent on a single optical fiber in a transmission system.
"ESCON" -- Enterprise System Connectivity -- means a protocol for 200 Mbps
signal transmission speed over fiber optic cable.
"Ethernet" means a 10 Mbps speed network that runs over thick coaxial cable
(10BASE5), thin coaxial cable (10BASE2), twisted-pair (10BASE-T), and
fiber-optic cable. It is the most widely used LAN technology and the most
popular form of Ethernet is 10BASE-T. Ethernet is a network specification that
was developed at Xerox Corp's Palo Alto Research Center, and made into a network
standard by Digital, Intel, and Xerox.
"Fast Ethernet" means a 100 Mbps speed network that runs over thick coaxial,
twisted-pair, and fiber-optic cable. Fast Ethernet is 10 times faster than
Ethernet.
"FDDI" means a Fiber Distributed Data Interface and is a fiber optic network
that supports transmission speeds up to 100 Mbps.
"Fibre Channel" means a serial data transfer architecture standard conceived for
new mass storage devices and other peripheral devices that require very high
bandwidth connections. Bit rates for Fibre channel are either 1.06 Gbps or 2.1
Gbps.
"Gigabit Ethernet" means a 1000 Mbps speed network that runs fiber-optic cable
for wide area network connections.
"HDTV" means high definition television, which is a new type of television that
provides much better resolution than current television. HDTV is slowly being
implemented into the broadcast networks.
"Hub" means a central connection device to which many network tributaries are
connected.
"ILEC" means Incumbent Local Exchange Carrier and is a telephone company that
provides local services and does not offer long distance services. All the
regional operating companies after the break-up of AT&T became ILECs.
23
"ISDN" means an Integrated Services Digital Network and is an all-digital
communications network that provides a wide range of services on a switched
basis. Voice, data and video can be simultaneously transmitted on one line from
a source.
"ISO" means International Standards Organization. Founded in 1946, ISO is an
international organization composed of national standards bodies from over 75
countries. ISO has defined a number of important computer standards, the most
significant of which is perhaps is OSI (Open Systems Interconnection), a
standardized architecture for designing networks.
"ISP" means an Internet Service Provider.
"ITU" means International Telecommunications Union, which is an
intergovernmental organization through which private and public organizations
develop telecommunications. The ITU was founded in 1865 and became a United
Nations agency in 1947 and it is responsible for adopting international tax
treaties, regulations and standards governing telecommunications.
"IXC" means an inter-exchange carrier, a long distance telephone company or a
carrier that specializes in connecting central offices of local service
providers. This carrier typically does not offer services to end users. AT&T,
MCI and Sprint are IXCs. A carrier that provides the backbone of competitive
local exchange carriers can also be considered as an IXC. Therefore, an IXC can
provide service in both metropolitan and in long haul networks.
"LAN" means a Local Area Network and is a high-speed communications system
designed to link computers for the purpose of sharing files, programs and
various devices such as printers and high-speed modems within a small geographic
area such as a workgroup, department or single floor of a multi-story building.
LANs may include dedicated computers or file servers that provide a centralized
source of shared files and programs.
"MSO" means a Multiple Service Operator which is typically a cable TV operator
that offers multiple services such as video, voice and data.
"Multiplexing" means a process that combines a number of lower speed data
transmissions into one high-speed data transmission by splitting that total
available bandwidth into narrower bands (frequency division) or by allotting a
common channel to several different transmitting devices one at a time in
sequence (time division). The opposite function of separating the data channels
into their original format is called demultiplexing.
"OC-1, OC-3, OC-12, OC-48, OC-192" means the SONET bit rates of 51.85Mbps, 155
Mbps, 622 Mbps, 2.5 Gbps and 10Gbps transmission speeds for signals over fiber
optic cables. The number in the end of the term corresponds to the equivalent
multiple of OC-1 capacity (e.g., OC-192 means equivalent to 192 times OC-1)
"OEMs" means original equipment manufacturers.
"Opto-Electro-Optical" means Optical-Electrical-Optical which describes the
conversion of optical signals to electric and back to optical. Typically,
devices performing this function in the electrical domain and the signals need
to be converted back to optical for transmission over optical fibers.
"Packet" means the "envelope" in which the network software places a message
being sent from one station to another station in a network. One of the key
features of a packet is that it contains the destination address in addition to
the data.
"POTS" means "plain old telephone service" which refers to the standard
telephone service over copper lines that most homes use. In contrast, telephone
services based on high-speed, digital communications lines, such as ISDN and
FDDI, are not POTS. The main distinction between POTS and non-POTS services is
speed and bandwidth. POTS is generally restricted to about 52Kbps.
"Protocol" means a standard developed by international standards bodies,
individual equipment vendors, and ad hoc groups of interested parties to define
how to implement a group of services in one or more layers of the OSI model. The
Open Systems Interconnect ("OSI") reference model was developed by the ISO to
define all the services a LAN should provide. Ethernet and Token Ring, for
example, are both protocols that define different ways to provide the services
called for in the Physical and Data Link Layers of the OSI model.
24
"PTT" means Postal, Telephone and Telegraph, and refers to a generic telephone
company outside the United States. Typically, a PTT is state owned and can
operate both local and long distance services.
"RBOC" means a Regional Bell Operating Company.
"Router" means a network translator that reads network-addressing information
within packets to provide greater selectivity in directing traffic over multiple
network segments. It is a more complex inter-networking device.
"SDH" means Synchronous Digital Hierarchy which is transmission protocol for
high speed transmission over fiber optic cable published in 1988 by the
Consultative Committee for International Telegraph and Telephony. It a hierarchy
similar to SONET but in this case the lowest bit rate channel is STM-1 (155
Mbps).
"SONET" means a transmission protocol for high-speed transmission over fiber
optic cable, which was introduced by Bell Communications in 1984 and quickly
accepted by American National Standards Institute.
"Switch" means a device that allows the network operator to vary and select
connections between network nodes at very high speeds.
"T-1" means a dedicated phone connection supporting data rates of 1.544 Mbps. A
T-1 line actually consists of 24 individual channels, each of which supports
64Kbps and can be configured to carry voice or data traffic. T-1 lines are
sometimes referred to as DS-1 lines.
"TCP/IP" means Transmission Control Protocol/Internet Protocol, which is a suite
of protocols used for communications between two or more devices.
"TDM" means time division multiplexing which is a multiplexing process that
combines a number of lower speed data transmissions into one high-speed data
transmission by allotting a common channel to several different transmitting
devices one at a time in sequence.
"Token Ring" means a 4 Mbps or 16 Mbps speed network that uses different
technology than Ethernet to co-ordinate the transmission of data among nodes.
"WAN" means a Wide Area Network and is a communications network that connects
geographically dispersed users. Typically, a WAN consists of two or more LANs.
The largest WAN in existence is the Internet.
Item 2. Properties.
We recently moved our headquarters to the San Diego, California facility
that we own consisting of approximately 36,000 square feet used for offices,
research and development and manufacturing. We also own a 47,000 square foot
facility in San Diego, California adjacent to our headquarters that is used for
offices, manufacturing and customer support.
For the fiscal year 2003 we occupied an additional 19,240 square feet
used for office, research and development and manufacturing activities under
lease as detailed below:
Location Square Footage Facility Type Expiration Date
--------- --------------- ------------------------------ ---------------------
Santa Monica, California 6,000 Office April 30, 2003
Fremont, California 5,000 Office/Manufacturing July 31, 2003
Richardson, Texas 2,860 Office September 30, 2003
Stuttgart, Germany 5,380 Office December 31, 2005
As we move to bring our expenses in line with our revenue, we have
completed, or are in the process of completing, the relocation of the Santa
Monica, California, Fremont, California and Richardson, Texas offices to our San
Diego, California facility. In addition, we have closed down our overseas
facilities in The Netherlands, Belgium, China and Singapore.
We believe our facilities are suitable and adequate to meet our current
needs. See Note E to the Consolidated Financial Statements contained in Part II
herein for terms and amounts of mortgages on the facility we own.
25
Item 3. 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, our company, our Meret subsidiary, certain
of our present and former officers and directors and of 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 our company and the plaintiffs. Section 8.3 of the Exchange
Agreement entered into in connection with our proposed capital restructuring
provides that this litigation will be dismissed with prejudice against our
company, our subsidiaries, and our current officers and directors, and without
prejudice against all other defendants, at the closing of the Agreement.
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 thousand per year for three years of consulting services and loans by us
for the exercise of previously granted options to acquire 58,925 options at
prices varying from $140.60 to $985.00 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 3,556 options, applying the $500 thousand accelerated payment to the
exercise. In addition, he exercised 25,369 options for which we were
contractually obligated to loan the $5.0 million due on the exercise. Mr. Chadha
provided us with written notification dated in September 2001 that he does not
have any obligations under the agreements. We 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 25,369
option exercise was rescinded. Mr. Chadha returned the 25,369 shares to us for
cancellation and we cancelled the receivable due from him and restored the
original option agreements. In June 2002, we filed with the Superior Court of
California, County of Los Angeles a Complaint for Declaratory Relief regarding
the interpretation of the agreement. Also in June 2002, Mr. Chadha filed a
lawsuit against us in the Superior Court of California, County of Los Angeles,
seeking declaratory relief with respect to the interpretation of his separation
agreement and in addition, alleging breach of contract with respect to his
option exercise rights and fraud in connection with his rescission agreement. In
February 2003, both of these lawsuits were dismissed without prejudice to
facilitate settlement negotiations, but they can be refiled at any time. In
April 2003, an agreement in principle to settle these lawsuits was reached,
subject to the execution of a definitive agreement. There can be no assurance
that such a definitive settlement agreement will be executed. Should the cases
be refiled, and should Mr. Chadha prevail in Court, in addition to any other
relief that may be granted, we may be required to issue him 58,925 shares of our
stock for no consideration, and/or pay him cash damages, which he alleges to be
in excess of $4 million.
In April 2002, our former Chairman and CEO, Dr. Xin Cheng, who was
terminated without cause, filed a claim in arbitration seeking, among other
things, payment of $500 thousand and acceleration of the vesting of options
pursuant to alleged contractual obligations of our Sorrento subsidiary. The
arbitrator has issued a decision favorable to Dr. Cheng, and having exhausted
our legal remedies, we have paid Dr. Cheng $610 thousand in full satisfaction of
the arbitration award.
26
In addition, claims in arbitration have been filed by two of our former
financial officers and employees who worked in our Santa Monica office, which
has now been closed, alleging that their resignations in May 8,2002 were for
"good reason" as defined in their employment agreements, all of which were to
expire on May 22, 2002. We are disputing these claims, and have filed
counterclaims in one of the arbitrations. The aggregate amount of these claims
is in excess of $490 thousand.
We have also filed a lawsuit against United Pan Europe Communications,
N.V., one of our customers and a related party to one of Sorrento's Series A
shareholders, in connection with a past due receivable in the amount of $1.6
million for equipment shipped in 2000. The defendant has filed for protection
under the federal bankruptcy laws, and pursuant to the Exchange Agreement
entered into in connection with our capital restructuring, we have executed a
definitive settlement agreement and a stipulation of dismissal with prejudice
resolving this lawsuit in return for a payment of $350 and the return of certain
of the equipment previously shipped. We have received the payment of $350 from
UPC and, in accordance with the terms of the Exchange Agreement, have paid that
same amount to certain Series A Preferred Stock holders to defray legal costs
incurred by them. The equipment has also been returned.
We have also been sued by a former officer of our Sorrento subsidiary
alleging breach of a consulting agreement we entered into with him in March
2002, following his resignation "for good reason" as defined in his employment
agreement. Our execution of the consulting agreement, upon resignation "for a
good reason" was required by the employment agent, which had been approved by
our then Board of Directors in the Summer of 2000. The former officer is seeking
acceleration of consulting fees due to him under his consulting agreement in the
amount of $229 thousand. We feel these claims are without merit and are
vigorously defending the claims. We have also filed counterclaims. Currently,
the matter is in the early stages of discovery.
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 4. Submission of Matters to a Vote of Security Holders
Special Shareholders Meeting
In connection with our proposed financial restructuring of our company
we filed a Preliminary Special Notice and Proxy Statement with the Securities
and Exchange Commission on March 6, 2003 and expect to file the Definitive
Special Notice and Proxy Statement with the Securities and Exchange Commission
on or about April 15, 2003. The Special Shareholders meeting will be held May
19, 2003.
This restructuring is a crucial step in the continuing viability of
our company. If we are unable to consummate the restructuring transaction, we
will be forced to consider an alternative plan of reorganization or liquidation
which may result in our shareholders receiving little or nothing for their
shares.
The restructuring plan involves the exchange of our outstanding 9.75%
Senior Convertible Debentures due August 2, 2004 and associated warrants, and
shares of the Series A Convertible Preferred Stock issued by our subsidiary,
Sorrento Networks, Inc., into shares of our common stock and new secured
convertible debentures.
On the closing date, the exchanging holders (the Debenture holders and
the Series A Preferred Stock holders) "shall exchange their Debentures and
Series A Preferred Stock for new Exchange Debentures in the aggregate principal
amount of $12.5 million shares of our common stock (the "Exchange Shares"), in
an amount sufficient such that the Exchange Shares and shares of our common
stock into which the Exchange Debentures are convertible, represent 87.5% of our
outstanding common stock on a Diluted Basis. Exchanging Holders of Debentures
and Series A Preferred Stock will receive their respective pro rata share of the
Exchange Shares and the Exchange Debentures, with the amounts to be received by
each Exchanging Holder to be based upon such holder's respective ownership
percentage of Debentures and Series A Preferred Stock. None of the debentures
referred to are publicly traded (within the meaning of Sections 1273:1274).
"Diluted basis" is a concept that is used in the Exchange Agreement,
and means the total number of shares of our common stock issued and outstanding
immediately after the closing of the restructuring transaction, after giving
effect to (i) the issuance of shares of common stock as part of the
restructuring transaction, (ii) shares of our common stock issuable upon
conversion of $12.5 million principal amount of the New Debentures, and (iii)
shares of our common stock issuable upon exercise of the New Warrants. "Diluted
basis" does not give effect to (i) the
27
shares of our common stock issuable under the 2003 Equity Incentive Plan, (ii)
shares of common stock issuable upon conversion of the Fee Amount Debentures,
(iii) shares of our common stock issuable upon conversion of our Series D
Preferred Stock, and (iv) shares of our common stock issuable upon exercise of
existing options or warrants.
The Series A Preferred Stock holders that were parties to the
litigation in Delaware against SNC will be issued debentures in the aggregate
principal amount of $600,000.
Our existing common shareholders, representing 7.5% of our outstanding
common stock on a diluted basis upon the consummation of the restructuring
transaction, will receive non-transferable Warrants to purchase in the
aggregate that number of shares of Common Stock equal to five percent (5%) of
the Common Stock on a Diluted Basis as of the Closing Date.
Additionally, we will reincorporate in the state of Delaware from New
Jersey, in connection with the restructuring and the requirements of the
Exchange Agreement. We will also adopt a new employee equity plan, the Sorrento
Networks Corporation 2003 Equity Incentive Plan.
UNAUDITED PRO FORMA FINANCIAL STATEMENTS
The pro forma unaudited consolidated balance sheet reflects the effect
of the anticipated exchange of SNI's Series A and our Outstanding Debentures as
of January 31, 2003, into shares of our common stock and the New Debentures
The January 31, 2003 consolidated balance sheet prior to restructuring
shows that $48.8 million of Series A classified as a current liability at SNI
and $18.1 million of $32.2 million in our Outstanding Debentures classified as a
long term liability would result in a reduction in total liabilities of $53.8
million after restructuring. In addition, shareholders' equity would increase by
the same amount from a negative $34.5 million to a positive $19.3 million after
the consummation of the restructuring transaction and restructuring of our
balance sheet. Our debt obligations associated with the Series A, which has been
`put' back to us, of $48.8 million and Outstanding Debentures in the principal
amount of $32.2 million would be reduced to $12.5 million, after the exchange.
We would also have outstanding an aggregate principal amount of $600,000 of Fee
Amount Debentures. The maturity date of the New Debentures would be August 2,
2007.
The consolidated statement of operations for the year ended January
31, 2003 shows a decrease in interest expense of $6.9 million. This reduction in
interest expense results from the amortization of the warrants, beneficial
conversion feature and debt issuance costs on the Outstanding Debentures. This
loss is attributable to the expense associated with the issuance of the New
Warrants and new shares of common stock partially offset by the gain associated
with the elimination of our current Series A and Outstanding Debentures.
The New Debentures, which will mature on August 2, 2007, will bear
interest at the rate of 7.5% per annum, which is cumulative, accrues daily from
the date of issuance, is calculated on the basis of a year composed of twelve
thirty-day months, and is due and payable on the first business day of each
calendar quarter following the date of issuance of the New Debentures. Subject
to certain limitations, interest on the New Debentures may be paid, at our
option, in cash, in additional New Debentures or in shares of our common stock.
Unpaid interest that is not paid within two business days of its due date, shall
bear interest at the lesser of 10.5% or the maximum amount allowed to be charged
by law.
At any time prior to the maturity date of the New Debentures, we may
redeem for cash on a pro rata basis some or all of the New Debentures at par,
plus accrued interest. We are also required to redeem the New Debentures on a
pro rata basis under certain circumstances upon the sale of certain of our
assets or those of our subsidiaries. The holders of the New Debentures have the
right at any time prior to the maturity date to convert the New Debentures into
shares of our common stock at the conversion price, which will be determined at
the closing of the restructuring transaction. If any New Debentures remain
outstanding on the maturity date, we will redeem them in cash. We are not
obligated, and the New Debenture holders are not entitled, to convert the New
Debentures if such conversion would mean that the New Debenture holder
beneficially owns 9.99% or greater of the number of shares of our common stock
which are then issued and outstanding.
The unaudited pro forma financial data and the notes thereto should be
read in conjunction with our historical financial statements. The unaudited pro
forma financial data is based upon certain assumptions and estimates of
management that are subject to change. The unaudited pro forma financial data is
presented for illustrative purposes only and is not necessarily indicative of
any future results of operations or the results that might have occurred if the
restructuring transaction had actually occurred on the indicated date.
PRO FORMA CONSOLIDATED BALANCE SHEET (UNAUDITED)
(In Thousands)
Historical Pro Forma Pro Forma
January 31, 2003 Adjustments January 31, 2003
ASSETS
CURRENT ASSETS
Cash and Securities $ 11,706 $ 11,706
28
Historical Pro Forma Pro Forma
January 31, 2003 Adjustments January 31, 2003
Accounts Receivable, net 5,576 5,576
Inventory, net 13,934 13,934
Other Current Assets 741 741
TOTAL CURRENT ASSETS 31,957 31,957
PROPERTY AND EQUIPMENT NET 17,103 17,103
OTHER ASSETS 6,745 6,745
-----------------------------------------------------------------------
TOTAL ASSETS $ 55,805 $ 55,805
=======================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long term debt $ 222 $ 222
accounts payable, accruals and other 19,395 19,395
Preferred Stock 48,800 (48,800) A (0)
-----------------------------------------------------------------------
TOTAL CURRENT LIABILITIES $ 68,417 (48,800) $ 19,617
=======================================================================
Debentures payable, net of unamortized 18,121 (32,200) B
costs and discounts
10,961 B
3,117 B
13,100 C 13,100
Other long Term liabilities 3,743 3,743
-----------------------------------------------------------------------
TOTAL LIABILITIES $ 90,281 (53,822) $ 36,459
=======================================================================
STOCKHOLDERS' EQUITY
$ 1 $ 1
Preferred Stock $.01 par value;
liquidation preference $1,353
Common Stock 5,318 49,616 D 54,934
Additional Paid in Capital 144,887 3,362 E
(10,961) B 137,287
Accumulated Deficit (187,536) (3,362) E
(3,117) B
18,284 B (175,730)
Other 2,854 2,854
-----------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY $(34,476) 53,822 $ 19,346
=======================================================================
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $ 55,805 $ 55,805
=======================================================================
29
PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS)
HISTORICAL PRO FORMA
YEAR ENDED PRO FORMA YEAR ENDED
JANUARY 31, 2003 ADJUSTMENTS JANUARY 31, 2003
NET SALES $25,137 $25,137
COST OF SALES 21,818 21,818
----------------------------------------------------------------
GROSS PROFIT 3,320 3,320
----------------------------------------------------------------
OPERATING EXPENSES
Selling and marketing 12,021 12,021
Engineering, research and development 8,990 8,990
General and administrative 13,638 13,638
----------------------------------------------------------------
TOTAL OPERATING EXPENSES 34,649 34,649
----------------------------------------------------------------
LOSS FROM OPERATIONS (31,329) (31,329)
----------------------------------------------------------------
OTHER INCOME (CHARGES)
Interest expense (9,619) 9,252F (367)
Other 14,738 14,738
----------------------------------------------------------------
TOTAL OTHER INCOME (CHARGES) 5,119 9,252 14,371
----------------------------------------------------------------
LOSS BEFORE INCOME TAXES (26,210) 9,252 (16,958)
----------------------------------------------------------------
Provision for Income taxes
----------------------------------------------------------------
NET INCOME (LOSS) $(26,210) 9,252 $(16,958)
================================================================
Loss per shares - basic $ (33.29) G $ (21.55)
----------------------------------------------------------------
Loss per share - Diluted $ (33.29) $ (21.55)
----------------------------------------------------------------
30
Proforma Balance Sheet Reconciling Footnotes:
(A) To record the retirement of the Series A shares.
(B) To record reacquisition of the Outstanding Debentures, including the
reacquisition of the beneficial conversion option associated with
the convertible debt. An entry of $10.9 million is recorded to
additional paid in capital to reflect the estimated value of the
beneficial conversion option at the date of extinguishment. An
additional $3.1 million representing the unamortized balance of the
previously issued debt costs and incremental value of the beneficial
conversion feature not reacquired will be recorded as part of the
gain on extinguishment.
(C) To record the issuance of the Exchange Debentures and the Fee Amount
Debentures, Exchange Debentures are in the amount of $12.5 million
and the Fee Amount Debentures are in the amount of $600 thousand.
(D) To record the value of the new shares of common stock issued to
holders of the Outstanding Debentures and Series A. Amount is
estimated at 8,268,322 shares at a per share price of $6.00
(E) To record the issuance of the New Warrants to existing shareholders.
The value of the New Warrants was determined using the Black Scholes
option pricing model based on the following inputs: Option price of
$6.60, estimated life of 4.5 years, volatility of 183%, no dividends
and a risk free rate of return of 3%.
(F) Entry to record adjustment to interest expense. Amount is calculated
as follows:
Historical Pro Forma
Year Ended Pro Forma Year Ended
January 31, 2003 Adjustments January 31, 2003
---------------- ----------- ----------------
Debt and capital lease obligations 367 367
Outstanding debentures 9,252 (9,252) 0
9,619 (9,252) 367
===== ======= ===
(G) Pro Forma loss per share is determined as follows:
Year Ended
January 31, 2003
----------------
Pro forma net loss (16,958)
Pro forma weighted average shares outstanding 787
For financial statement presentation, the proforma numbers on the
Balance Sheet assume the restructuring transaction occurred on January 31,
2003. The Statement of Operations assumes the restructuring transaction occurred
on the first day of the year ended January 31, 2003.
Excluded from the foregoing condensed consolidated pro forma statement
of operations is the anticipated gain on debt extinguishment of $18.2 million
and the expense related to the issuance of the New Warrants in the amount of
$3.4 million. The anticipated gain on debt extinguishment and expenses related
to the issuance of the New Warrants are based on a stock price of $6.00 on the
day of closing. For each $1.00 increase or decrease in stock price, this gain is
affected by $8.3 million. Given a range of closing stock prices of $4.00, $6.00
and $8.00 this gain would be $34.8 million, $18.2 million or $1.7 million
respectively.
31
PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters.
Our common stock traded on the Nasdaq Small Cap Market under the symbol
FIBR since 1994. On December 16, 1998, we commenced trading on the Nasdaq
National Market System under the same symbol.
Effective as of October 28, 2002 we implemented a one-for-twenty
reverse split of our outstanding shares of common stock. No fractional shares
were issued in connection with the reverse stock split. In lieu of fractional
shares, stockholders received a cash payment based on the market price, after
adjustment for the effect of the stock combination. The par value of the common
stock changed to $6.00 per share and the number of authorized shares decreased
from 150 million to 7.5 million shares of common stock. The reverse stock split
also affects options, warrants and other securities convertible into or
exchangeable for shares of our common stock that were issued and outstanding
immediately prior to the effective time of the stock combination. Preferred
stock was not affected.
The following table sets forth the high and low closing bid prices for
our common stock in the over-the-counter market from February 1, 2001 to January
31, 2003, based upon information obtained from Nasdaq. Quotations represent
inter-dealer prices; they do not include retail markups, markdowns, or
commissions; and, they may not represent actual transactions.
Fiscal
2001-2002 High Low
---------------- ---------- ---------
Quarter from February 1, 2001 to April 30, 2001.............................. $ 510.00 $ 78.20
Quarter from May 1, 2001 to July 31, 2001.................................... $ 323.80 $ 110.60
Quarter from August 1, 2001 to October 31, 2001.............................. $ 160.40 $ 33.40
Quarter from November 1, 2001 to January 31, 2002............................ $ 101.20 $ 64.20
Fiscal
2002-2003
----------------
Quarter from February 1, 2002 to April 30, 2002.............................. $ 73.20 $ 40.00
Quarter from May 1, 2002 to July 31, 2002.................................... $ 53.00 $ 13.20
Quarter from August 1, 2002 to October 31, 2002.............................. $ 14.80 $ 2.40
Quarter from November 1, 2002 to January 31, 2003............................ $ 15.07 $ 4.15
On March 31, 2003, the average of the high and low bid quotation for
our common stock was $7.00 per share. There is no assurance that a market in our
common stock will continue.
Approximate Number of Holders of Common Stock
As of March 31, 2003, (the latest practicable date) there were
approximately 756 shareholders of record, including brokerage firms and
nominees, of our common stock.
Dividends
We have never paid any cash dividends on our common stock. The present
policy of the Board of Directors is to retain all available funds to finance the
planned level of operations. In light of the anticipated cash needs of our
business, it is not anticipated that any cash dividends will be paid to the
holders of our common or preferred stock in the foreseeable future.
Sale of Unregistered Securities
During fiscal year 2003 we did not issue any shares of our common stock
that was not registered under the Securities Act of 1933.
Securities Authorized For Issuance Under Equity Compensation Plans
32
The following table provides information as of January 31, 2003
regarding compensation plans (including individual compensation arrangements)
under which equity securities of Sorrento are authorized for issuance.
Number of Securities To Number of Securities
Be Issued Upon Remaining Available for
Exercise Future Issuance Under Equity
Of Outstanding Weighted-Average Exercise Compensation Plans
Options, Price of Outstanding Options, (Excluding Securities
Warrants and Rights Warrants and Rights Reflected in Column (a))
--------------------------------------------------------------------------------------------------------------------------
Plan Category (a) (b) (c)
--------------------------------------------------------------------------------------------------------------------------
Equity Compensation
Plans Approved by 294,277 $387.53 260,723
security Holders *
(FIBR)
--------------------------------------------------------------------------------------------------------------------------
Equity Compensation
Plans not Approved by 3,296,003 $4.93 20,000,000
Security Holders
(SNI)
--------------------------------------------------------------------------------------------------------------------------
Total 3,590,280 $36.29 20,260,723
--------------------------------------------------------------------------------------------------------------------------
* As adjusted for stock splits.
See Note K to the Consolidated Financial Statements for information regarding
the material features of the above plans. Each of the above plans provides that
the number of shares with respect to which options may be granted, and the
number of shares of Common Stock subject to an outstanding option, shall be
proportionally adjusted in the event of a subdivision or consolidation of shares
or the payment of a stock dividend on Common Stock, and the purchase price per
share of outstanding options shall be proportionately revised.
Item 6. Selected Financial Data
The following table sets forth selected consolidated financial data
with respect to our five most recent fiscal years ended January 31. The selected
consolidated statement of operations data set forth below for each of our three
most recent fiscal years, and the selected consolidated balance sheet data set
forth at January 31, 2003 and 2002, are derived from our consolidated financial
statements which have been audited by BDO Seidman, LLP, independent certified
public accountants, as indicated in their report which is included elsewhere in
this annual report. The selected consolidated statement of operations data set
forth below for each of the two fiscal years ended January 31, 2000 and 1999,
and the consolidated balance sheet data set forth below at January 31, 2001,
2000 and 1999 are derived from our audited consolidated financial statements not
included in this annual report. The selected consolidated financial data should
be read in conjunction with our consolidated financial statements, and the notes
thereto including Note A which discusses our significant acquisitions,
dispositions and discontinued operations, included elsewhere in this annual
report, and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in Item 7.
Fiscal Year Ended January 31,
-------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
Statement of Operations Data: (a) (a)(b) (a)(b)
Net sales........................................ $ 25,137 $ 40,827 $ 44,641 $68,372 $ 58,362
Gross margin..................................... $ 3,320 $ 9,320 $ 13,171 $31,782 $ 25,885
Operating loss................................... $(31,329) $(37,154) $(50,415) $(9,951) $(10,060)
Net loss from continuing operations.............. $(26,210) $(43,136) $(41,905) $ 2,410 $(11,069)
Net income (loss) per share from continuing
operations:
Basic....................................... $ (33.29) $ (62.00) $ (74.20) $ 3.40 $ (33.80)
33
Fiscal Year Ended January 31,
-------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
Diluted..................................... $ (33.29) $ (76.32) $ (74.20) $ 3.00 $(33.80)
Balance Sheet Data:
Cash and cash equivalents................... $ 7,747 $ 14,243 $ 9,965 $ 13,511 $ 3,480
Working capital (deficit)................... $(36,460) $ 5,839 $ 71,993 $189,486 $11,399
Total assets................................ $ 55,805 $ 90,339 $ 113,123 $223,265 $66,796
Total debt (including short-term debt)...... $ 90,281 $ 72,122 $ 24,770 $ 20,727 $27,938
Stockholders' equity (deficit).............. $(34,476) $ 18,217 $ 39,733 $202,538 $38,858
The Consolidated Statement of Operations and Balance Sheet data shown above
include financial results from the following subsidiaries which have since been
disposed of:
(a) Entrada Networks, Inc. is reflected through August 31, 2001.
(b) NETsilicon is reflected through September 14, 1999.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Certain statements contained in this Annual Report on Form 10-K,
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 this Annual Report on Form 10-K, as well as the "Financial Risk
Management" and "Future Growth Subject to Risks" sections contained herein,
which identify important risk factors that could cause actual results to differ
from those contained in the forward-looking statements.
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".
Overview
Beginning in fiscal 2002, the global telecommunications market
deteriorated, reflecting a significant reduction in capital spending by
established service providers. This trend intensified during fiscal 2003.
Reasons for this reduction include the general economic slowdown, network
overcapacity, customer bankruptcies, network build-out delays and limited
capital availability. As a result, our sales and results of operations have been
and may continue to be adversely affected. The significant slowdown in capital
spending has created uncertainty as to the level of demand in our target
markets. In addition, the level of demand can change quickly and can vary over
short periods of time. As a result of the uncertainty and variations in our
markets, accurately forecasting future results, earnings and cash flow is
increasingly difficult.
As discussed in more detail throughout our MD&A:
34
o Our consolidated results of operations during the past two years
were adversely affected by the rapid and sustained deterioration
of the telecommunications market. After several years of
significant growth, our revenues declined during fiscal 2003 and
2002 by 38% and 8.5% respectively, as compared to the respective
prior year. The significant reduction in capital spending by
service providers, among other factors, contributed to this
decline;
o Our gross margin rates, which historically had been at least 40%,
declined to 13% and 23% during fiscal 2003 and 2002, respectively.
The significant and rapid decline in revenue from decreased market
demand led to significant inventory charges and high-unabsorbed
fixed cost, which, among other factors, adversely affected our
gross margin rates;
o We were able to reduce our operating expenses during fiscal 2003
and 2002 as a result of a cost reduction plan implemented, by 25%
and 27%, respectively as a result of a cost reduction plan
implemented. The reduction in operating expenses for fiscal 2003
were partially off-set by legal and professional fees of $2.8
million associated with our capital restructuring plan;
o We recorded significant provisions for bad debts of $1.5 million
and $1.6 million during fiscal 2003 and 2002, respectively, as a
result of the significant deterioration of the financial health or
bankruptcy of certain customers.
These factors contributed significantly to our loss from continuing
operations of $31.3 million and $37.1 million respectively for fiscal 2003 and
2002, respectively.
During this prolonged market downturn, we have worked closely with our
customers to position the full breadth of our products and services and
significantly reduced our cost structure. If capital investment levels continue
to decline, or if the telecommunications market does not improve or improves at
a slower pace than we anticipate, our revenues and profitability will continue
to be adversely affected. However, we believe our results could improve by
realizing higher gross margin rates and lower operating expenses resulting from
improved product mix, cost reductions relating to our capital restructuring plan
and reduced operating expenses, lower inventory-related charges and lower
provisions for bad debts.
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.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
o Revenue recognition. Revenue is generally recognized when the
products are shipped, all substantial contractual obligations, if
any, have been satisfied, and the collections of the resulting
receivable is reasonably assured. When title does not pass to
the customer at time of shipment, revenue is not recognized until
all contractual requirements are met and title has transferred.
During this transition period, the amount of the sale and/or
installation is shown in deferred revenue.
Revenue from installation is recognized as the services are
performed to the extent of the direct costs incurred. To date,
installation revenue has not been material. Revenue from service
obligations, if any, is deferred and recognized over the life of
the contract. Inventory or demonstration equipment shipped to
potential customers for field trials is not recorded as revenue.
We accrue for warranty costs, sales returns and other allowances
at the time of shipment. Although our products contain a software
component, the software is not sold separately and we are not
contractually obligated to provide software upgrades to our
customers.
o Inventory. Inventory is evaluated on a continual basis and
management must make estimates about the future customer demand
for our products, taking into account both the economic conditions
and growth potential of our customers. Reserve adjustments are
made based on management's estimate of future sales value, if
any, of
35
specific inventory items. Reserve adjustments are made for the
difference between the cost of the inventory and the estimated
market value and charged to operations in the period in which the
facts that give rise to the adjustments become known. A
misinterpretation or misunderstanding of these conditions or
uncertainty in the future outlook of our industry or the economy,
or the failure to estimate correctly, could result in inventory
losses in excess of the provisions determined to be appropriate at
the time of the balance sheet.
o Accounts receivable. Accounts receivable balances are evaluated on
a continual basis and management regularly reviews the financial
stability of individual customers. This analysis involves a
judgment of the customers current and projected financial
condition and the positive or negative effects of the current and
projected industry outlook, as well as that of the economy in
general. Allowances are provided for potentially uncollectable
accounts based on management's estimate of the collectability and
the probability of default of customer accounts. If the financial
condition of a customer were to deteriorate, resulting in an
impairment of their ability to make payments, an additional
allowance may be required. Allowance adjustments are charged to
operations in the period in which the facts that give rise to the
adjustments become known.
o Intangible assets. We currently have intangible assets that
include assets with finite lives, such as our purchased
technology. The determination of related estimated useful lives
and whether these assets are impaired involves judgments based
upon short and long-term projections of future performance. We
have no goodwill or indefinite life intangible assets. Other
intangible assets with finite lives continue to be amortized over
their useful lives.
o Legal contingencies. We are subject to proceedings, lawsuits and
other claims, including proceedings under laws and government
regulations related to securities, environmental, labor, product
and other matters. We are required to assess the likelihood of any
adverse judgments or outcomes to these matters, as well as
potential ranges of probable losses. A determination of the amount
of reserves required, if any, for the contingencies is based on a
careful analysis of each individual issue with the assistance of
outside legal counsel. Our reserves may change in the future due
to new developments in each matter or changes in approach such as
a change in settlement strategy in dealing with these matters. For
more information, see Note H to the consolidated financial
statements.
o Income taxes. We currently have no provisions for income taxes. We
have carry forward domestic federal net operating losses, which
may be available, in part, to reduce future taxable income in the
United States. However, due to potential adjustments to the net
operating loss carry forwards as provided by the Internal Revenue
Code with respect to 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.
Entrada Networks
On August 31, 2000, we completed a merger of our then subsidiary
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 $3.3 million. 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.
Results of Operations: Comparison of the Years Ended January 31, 2003
and January 31, 2002
Net sales. Our consolidated net sales decreased $15.7 million or 38% to
$25.1 million for fiscal 2003 when compared to net sales of $40.8 million for
fiscal 2002. Net sales for Sorrento Networks Inc., our primary operating
subsidiary, decreased $13.6 million or 38% to $22.4 million for fiscal 2003 as
compared to net sales of $36.0 million in fiscal 2002. Net sales for our Meret
Optical segment decreased $1.7 million or 35% in fiscal 2003 to $3.1 million of
which $296 thousand was intercompany sales as compared to net sales of $4.8
million in fiscal year 2002.
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 13% for fiscal 2003 from 23%
in fiscal 2002. Consolidated gross profit was $3.3 million, a decrease of 65%
for fiscal 2003 from $9.3 million for fiscal 2002. Gross margin percent and
36
gross profit were impacted negatively by increases in inventory reserves and
sales that were made at lower gross profit margins than the prior year. Gross
profit for our Sorrento subsidiary decreased to $3.1 million in fiscal 2003, as
compared to $7.7 million in fiscal 2002, a decrease of 60%. An increase in our
inventory reserves taken in the second quarter, accounted for $3.0 million of
the decrease in gross profit for SNI. The gross profit of our Meret Optical
segment decline to $204 thousand in fiscal 2003, as compared to $1.7 million in
fiscal 2002, a decrease of 88%. This decline was primarily the result of an
increase in our inventory reserve of $1.0 million, taken in the second quarter
and a decrease in revenue volume.
Selling and marketing. Selling and marketing expenses consist primarily
of employee compensation and related costs, commissions to sales
representatives, tradeshow expenses and travel expenses. Our consolidated
selling and marketing expenses decreased to $12.0 million, or 48% of net sales,
for fiscal 2003 from $16.2 million, or 40% or net sales for fiscal 2002. The
decline was primarily the result of cost reduction efforts implemented, a
reduction in both our U.S. and foreign sales offices and lower revenue volume
for the year..
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 continue to manage our research and development
costs 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 $9.0 million, or 36% of net sales, for fiscal
2003 from $13.7 million, or 34% of net sales, for fiscal 2002. The decrease can
primarily be attributed to decreases in product development material and
personnel related costs.
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 remained consistent at $12.8 million, or 51% of net
sales, for fiscal 2003 compared to 31% of net sales, for fiscal 2002. The
increase in general and administrative expenses as a percentage of net sales can
be attributed to an increase in professional fees associated with the capital
restructuring partially offset by a decrease in personnel related costs.
Other operating expenses. Other operating expenses for both fiscal 2003
and 2002 included approximately $400 thousand of amortization of purchased
technology related to acquisitions included in Meret. During the fiscal year
ended January 31, 2002, we recorded a $2.7 million valuation allowance against
option receivables from our former CEO and Chairman.
Other income (expenses). Other income (expenses) from continuing
operations increased to $5.1 million in income for fiscal 2003 from $6.0 million
in expense for fiscal 2002. Investment income increased by $1.6 million during
the fiscal year ended January 31, 2003 from the comparable period last year due
to increased investments of our cash surplus in short-term investments. The
increase of $6.3 million in interest expense for the fiscal year ended January
31, 2003 from the prior fiscal year is primarily due to the interest incurred on
our convertible debentures and an adjustment relating to the amortization of
both the beneficial conversion feature of the value allocated to the issuance of
warrants on our senior convertible debentures. The $5.5 million of interest on
these debentures includes the stated 9.75% interest of $2.3 million of which
$2.0 million was paid in common stock and $292 thousand was paid in cash,
amortization of issuance costs of $259 thousand, and amortization of the fair
value of the warrants issued to the purchasers and placement agent and the
deemed beneficial conversion feature of $2.9 million. Other income increased by
$313 thousand during the fiscal year ended January 31, 2003 from the prior
fiscal year resulting primarily from favorable gains on foreign currency
exchanges. Gains on marketable securities increased by $15.5 million for the
fiscal year ended January 31, 2003 from the prior fiscal year. $11.7 million of
this increase relates to the realized gain on our 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. We
obtained 2,324,683 shares of Digi common stock on the exchange, of which
1,162,342 shares were later sold back to Digi for $3.6 million in cash and a
gain of $2.6 million. The remaining $1.2 million increase results from an
impairment allowance taken on our available for sale investment in Entrada and
$1.0 million in realized losses on the sale of 1,051,000 shares of Entrada in
the prior fiscal year.
Income taxes. There was no provision for income taxes for fiscal years
2003 and 2002. We have carry forwards of domestic federal net operating losses,
which may be available, in part, to reduce future taxable income
37
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 assets will not be realized. Our prior management did not
file our tax returns for over six years. We had losses during each of these
years and do not believe there is tax liability for any of them, other than a
nominal penalty for failure to file a return. We have filed our federal returns
and are in the process of preparing and filing all our delinquent state tax
returns.
Sorrento Networks
Net sales. Net sales decreased to $22.4 million, or 38%, for fiscal
2003 from $36.0 million for fiscal 2002. In fiscal 2003, eighteen customers
accounted for 92% of our net sales compared with eleven customers, which
accounted for 94% in fiscal 2002. We expect to continue experiencing significant
fluctuations in our annual revenues as a result of our long and variable sales
cycle as well as our highly concentrated customer base. Revenue continues to be
negatively impacted by weak telecommunication industry volumes and management
determination to not pursue low gross margin projects.
Gross profit. Gross profit was $3.1 million for fiscal 2003, a decrease
of 59% from $7.7 million for fiscal 2002. Gross margin decreased to 14% of net
sales for fiscal 2003 from 21% for fiscal 2002. The declines were due primarily
to the increases in our obsolescence and inventory value reserves taken in the
second quarter and of a significantly higher fixed manufacturing overhead in our
cost of shipments for the year as a result of the lower revenue volume. We have
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. Sales and marketing expenses decreased to $11.7
million, or 52% of net sales, for fiscal 2003 from $15.7 million, or 44% of net
sales, for fiscal 2002. The decrease in sales and marketing expenses resulted
primarily from a reduction in personnel and related costs, decreased travel
expenses, trade show participation, and advertising expenses. The number of
sales and marketing personnel decreased to 36 at January 31, 2003 from 38 at
January 31, 2002.
Engineering, research and development. Engineering, research and
development expenses decreased to $8.5 million, or 38% of net sales, for fiscal
2003 from $13.2 million, or 37% of net sales, for fiscal 2002. The decrease in
engineering, research and development expenses was the result of decreased
expenditures associated with the decrease in engineering personnel and related
costs and a reduction in material related development expenses. The number of
engineering personnel decreased to 29 at January 31, 2003 from 67 at January 31,
2002.
General and administrative. General and administrative expenses
decreased to $7.6 million, or 34% of net sales, for fiscal 2003 from $6.9
million, or 19% of net sales, for fiscal 2002. The decrease in general and
administrative expenses reflects the reduction of executive and administrative
personnel and lower operating expenses. The number of general and administrative
personnel decreased to 11 at January 31, 2003 from 15 at January 31, 2002.
Deferred and other stock compensation. Deferred and other stock
compensation for the fiscal year ended January 31, 2003 includes $433 thousand
of amortization of deferred stock compensation resulting from the value of stock
options granted to consultants compared to $812 thousand for the prior fiscal
year. In connection with the grants of stock options with exercise prices
determined to be below the fair value of our common stock on the date of grant,
SNI 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 decreased to $3.1 million, or 36%, for fiscal 2003
of which $296 thousand was inter-company sales, from $4.8 million for fiscal
2002. The reduction in sales volume reflects the continued weak industry
volumes.
Gross profit. Gross profit decreased to $204 thousand, or 88%, for
fiscal 2003 from $1.7 million for fiscal 2002. Gross margin as a percentage of
net sales decreased to 7% for fiscal 2003 compared to 35% for the comparable
period last year. These declines were due primarily to the increases in our
obsolescence reserves taken
38
in the second quarter and a higher fixed manufacturing overhead in our cost of
shipments for the quarter as a result of the lower revenue volume.
Selling and marketing. Sales and marketing expenses decreased to $315
thousand, or 10% of net sales, for fiscal 2003, compared to $435 thousand, or 9%
of net sales, for fiscal 2002. This decrease was a direct result of reduced
internal commissions, due primarily to lower revenue volume and changes in the
commission structure, resulting in lower commission expense for the year.
Engineering, research and development. Engineering, research and
development expenses increased to $514 thousand, or 17% of net sales compared to
$417 thousand, or 9% of net sales, for fiscal 2002. This increase 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 $283 thousand, or 9% of net sales during fiscal 2003 from $200
thousand, or 4% of net sales, for fiscal 2002. The increase in general and
administrative expenses during fiscal 2003 resulted primarily from additions in
the administration staff, costs associated with upgrades in our business
application software and costs incurred to move the facilities to a new
location.
Other operation expenses. Other operating expenses increased to $421
thousand, or 14% of net sales for fiscal 2003 from $372 thousand, or 8% of net
sales, for fiscal 2002. These costs represent the amortization of purchased
technology related to prior acquisitions. The increase represents and adjustment
made to record amortization not previously recorded on purchased technology.
Results of Operations: Comparison of the Years Ended January 31, 2002 and
January 31, 2001.
Net sales. Our consolidated net sales decreased $3.8 million or 9% to
$40.8 million for fiscal 2002 when compared to net sales of $44.6 million for
fiscal 2001. Net sales of SNI, increased $9.6 million or 36% to $36.0 million
for fiscal 2002 as compared to net sales of $26.4 million in fiscal 2001. Net
sales for Meret Optical segment decreased $1.5 million or 24% in fiscal 2002 to
$4.8 million as compared to net sales of $6.3 million in fiscal year 2001.
Entrada Networks, an operating subsidiary which we spun-off in August 2000, had
a revenues of $11.9 million in fiscal 2001 whereas no revenues were reported for
Entrada Networks in fiscal year 2002.
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 23% for fiscal 2002 from 30%
in fiscal 2001. Consolidated gross profit was $9.3 million, a decrease of 29%
for fiscal 2002 from $13.2 million for fiscal 2001. Gross margin percent and
gross profit were impacted negatively by increases in inventory reserves and
sales that were made at lower gross profit than the prior year. Gross profit of
SNI decreased to $7.7 million in fiscal 2002, as compared to $9.1 million in
fiscal 2001, a decrease of 16%. An increase in inventory reserves accounts for
$3.7 million of the decrease in gross profit. The gross profit of our Meret
Optical segment decreased by $941 thousand from the prior fiscal year and was
primarily the result of the revenue volume decrease. The remaining change in
gross profit related to Entrada Networks.
Selling and marketing. Selling and marketing expenses consist primarily
of employee compensation and related costs, commissions to sales
representatives, tradeshow expenses and travel expenses. 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. Our consolidated selling and marketing expenses decreased to
$16.2 million, or 40% of net sales, for fiscal 2002 from $17.2 million, or 39%
or net sales for fiscal 2001.
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 continue to manage our research and development
costs 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 $13.7 million, or 33% of net sales, for fiscal
2002 from $23.9 million, or 54% of net sales, for fiscal 2001. The decrease can
primarily be attributed to decreases in product development material and
personnel related costs.
39
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 $12.7 million, or 31% of net sales, for
fiscal 2002 from $18.1 million, or 41% of net sales, for fiscal 2001. The
decrease in general and administrative expenses can be attributed to reductions
in investment banking, professional fees and personnel related costs.
Other operating expenses. Other operating expenses for both fiscal 2002
and 2001 included approximately $400 thousand of amortization of purchased
technology related to acquisitions included in Meret. During the fiscal year
ended January 31, 2002, we recorded a $2.7 million valuation allowance against
option receivables from our former CEO and Chairman. During the fiscal year
ended January 31, 2001, 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 (expenses). Other income (expenses) from continuing
operations decreased to $6.0 million charges for fiscal 2002 from $8.5 million
income for fiscal 2001. Investment income declined by $6.9 million during the
fiscal year ended January 31, 2002 from the comparable period last year due to
reduced investments of our cash surplus in short-term investments, lower
interest rates as well as reduced interest received on customer financing
receivables. The increase of $2.4 million in interest expense for the fiscal
year ended January 31, 2002 from the prior fiscal year is primarily due to the
interest incurred on our newly issued convertible debentures which was partially
offset by a decline in our short term borrowings. The $2.6 million of interest
on these debentures included the stated 9.75% interest of $1.6 million which was
paid in common stock, amortization of issuance costs of $82 thousand and
amortization of the fair value of the warrants issued to the purchasers and
placement agent and the deemed beneficial conversion feature of $911 thousand.
Other expenses increased by $99 thousand during the fiscal year ended January
31, 2002 from the prior fiscal year resulting primarily from unfavorable losses
on foreign currency exchanges. Gains on marketable securities decreased by $5.1
million for the fiscal year ended January 31, 2002 from the prior fiscal year.
Approximately $4.0 million of this decrease relates to the gain on our sale of
NSI shares during the prior fiscal year. The remaining $1.1 million decrease
results from an impairment allowance of $178 thousand on our available for sale
investment in Entrada and $1.0 million in realized losses on the sale of
1,051,000 shares of Entrada.
Income taxes. There was no provision for income taxes for fiscal years
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 assets will not be realized.
Sorrento Networks
Net sales. Net sales increased to $36.0 million, or 36%, for fiscal
2002 from $26.5 million for fiscal 2001. The increase in net sales was primarily
due to an increase in the number of deployments of systems to both new and
existing customers. In fiscal 2002, eleven customers accounted for 94% of our
net sales compared with seven customers which accounted for 91% in fiscal 2001.
In addition to the number of new customer and existing customer orders achieved
in fiscal year 2002, we continued to increase its product offering by
enhancements to existing products and the introduction of new products which
also contributed to the increase in net sales in fiscal year 2002. We plan to
continue to enhance our existing product line and develop new products to
increase sales. Our ability to achieve this goal will depend on continued sales
and available working capital that can be allocated to our development efforts.
Gross profit. Gross profit was $7.7 million for fiscal 2002, a decrease
of 16% from $9.1 million for fiscal 2001. Gross margin decreased to 21% of net
sales for fiscal 2002 from 34% for fiscal 2001. The gross margin percentage
decrease resulted from the shipment of lower margin products to multiple
customers with long-term purchase commitments or strategic alliance agreements
in fiscal 2002 as well as an increase in the valuation allowance recorded
against inventory of $4.0 million.
Selling and marketing. Sales and marketing expenses increased to $15.7
million, or 44% of net sales, for fiscal 2002 from $14.0 million, or 53% of net
sales, for fiscal 2001. The increase in sales and marketing expenses
40
resulted from increased travel expenses, trade show participation, and
advertising expenses. The number of sales and marketing personnel decreased to
38 at January 31, 2002 from 65 at January 31, 2001.
Engineering, research and development. Engineering, research and
development expenses decreased to $13.2 million, or 37% of net sales, for fiscal
2002 from $20.4 million, or 77% of net sales, for fiscal 2001. The decrease in
engineering, research and development expenses was the result of decreased
expenditures associated with the decrease in engineering personnel and decreases
in employee relocation and recruiting expenses and reduction in material related
development expenses. The number of engineering personnel decreased to 67 at
January 31, 2002 from 91 at January 31, 2001.
General and administrative. General and administrative expenses
decreased to $6.9 million, or 19% of net sales, for fiscal 2002 from $9.0
million, or 34% of net sales, for fiscal 2001. The decrease in general and
administrative expenses reflects the reduction of executive and administrative
personnel and lower operating expenses. The number of general and administrative
personnel decreased to 15 at January 31, 2002 from 32 at January 31, 2001.
Deferred and other stock compensation. Deferred and other stock
compensation for the fiscal year ended January 31, 2002 includes $812 thousand
of amortization of deferred stock compensation resulting from the value of stock
options granted to consultants compared to $1.9 million for the prior fiscal
year. In connection with the grants of stock options with exercise prices
determined to be below the fair value of our 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 decreased to $4.8 million, or 24%, for fiscal 2002 from
$6.3 million for fiscal 2001. The decrease in net sales was primarily due to
changes in product demand in the RF Synthesis product family. The majority of
this decrease was recognized in the fourth quarter of this year.
Gross profit. Gross profit decreased to $1.7 million, or 35%, for fiscal 2002
from $2.6 million for fiscal 2001. Gross margin as a percentage of net sales
decreased to 35% for fiscal 2002 compared to 42% for the comparable period last
year. The decrease in the gross margin percentage from the prior year resulted
from the reduction is RF Synthesis sales which generates a higher gross margin.
Selling and marketing. Sales and marketing expenses remained basically unchanged
at $435 thousand, or 9% of net sales, for fiscal 2002, compared to $437
thousand, or 7% of net sales, for fiscal 2001. Major expense changes by category
within the sales and marketing function included an increase in commissions to
external sales representatives that was offset by reduced personnel costs as a
result of reductions in the sales force.
Engineering, research and development. Meret incurred engineering expenses
during fiscal 2002 of $417 thousand, or 9% of net sales compared to $177
thousand, or 3% for the comparable period last year. The increase for the fiscal
year ended January 31, 2002 relates to the addition of three engineers to
support our development of our new coarse wavelength division multiplexing
products and the enhancement of existing products.
General and administrative. General and administrative expenses decreased to
$200 thousand, or 4% of net sales during fiscal 2002 from $595 thousand, or 9%
of net sales for the comparable period last year. The decrease in general and
administrative expenses during fiscal 2002 resulted from reductions in bad debt
allowances and bank fees.
Liquidity and Capital Resources
We finance our operations through a combination of internal funds,
investments and debt and equity financing. At January 31, 2003, our working
capital was a negative $36.5 million including $4.0 million of investments in
marketable securities and $7.7 million in cash and cash equivalents. The primary
reason for our negative working capital condition is that $48.8 million,
reflecting the obligation due to Series A Holders obligation as a result of
their right of redemption, was classified at year end January 31, 2003 and
January 31, 2002, as a current liability. This obligation had been clarified as
mezzanine in the Company's liability and owner's equity for the period ended
January 31, 2001. The Series A liability can only be paid through lawfully
available funds that would normally be generated from SNI profitable operations,
which we do not currently have available or foresee
41
the availability of in the near future. As previously discussed, we are in the
process of restructuring both our Senior Convertible Debentures of $32.2 million
and the SNI Series A Preferred liability of $48.8 million.
Cash Flow for the Years Ended January 31, 2003, 2002 and 2001
Continuing Operations
Our operations used cash flows of $14.2 million during fiscal 2003 as
compared to $31.8 million in fiscal 2002. The decrease in cash flows used by
operations in fiscal 2003 was primarily the result of lower accounts receivable
and inventories, combined with the increase in reserves for inventory and
accounts receivable, the use of stock for the payment of interest on debentures
and the gain on sale of marketable securities. This favorable impact on cash
used for operations was partially offset by the negative cash impact of the
Company's larger net operating loss and the use of cash to decrease our accounts
payable. In addition to the foregoing there were less significant changes
associated with changes in amortization and depreciation and other current
liabilities.
We have incurred significant losses and negative cash flows from
operations for the past two years. Sorrento Networks, Inc., our principal
operating subsidiary has primarily been the operating entity responsible for
these high losses and negative cash flows. The losses have been generated as SNI
continues to develop its technology, marketing and sales and operations in its
effort to become a major supplier of metro and regional optical networks
world-wide. In addition, we have incurred significant restructuring costs of
approximately $2.8 million in 2003 associated with restructuring of our
obligations under our Senior Convertible Debentures and Series A Holders
obligations. While we feel these restructuring costs are beneficial to our
long-term survival in a depressed telecom market, there is no certainty the
restructuring will be approved by the shareholders or will close even with
Shareholder approval.
We have funded our 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. In addition, if our restructuring efforts are
successful, there will be certain restrictions on us in both the amount of debt
we can incur in future periods and the types of securities that we will be able
to issue to raise additional capital in future periods. Both of these
restrictions could have a negative impact on our ability to raise the additional
working capital that we will require in future periods. Further, with the
downturn in the economic environment and decreases in capital spending by
telecom carriers, our revenue has been negatively impacted and we anticipate
that our future revenues will also be negatively impacted. As a result, our need
for additional working capital may be accelerated in the future. If such capital
is not available, we will need to substantially decrease our operating costs and
capital spending in order to fund operations. There can be no assurance that our
available cash, future funding or reduction in operating costs will be
sufficient to fund our operations in the future.
Our standard payment terms range from net 30 to net 60 days.
Receivables from international customers have frequently taken longer to
collect. In addition, the downturn in the telecom market has impacted many of
the telecom carriers ability to purchase or pay for outstanding commitments
within standard payment terms. There can be no assurance that this continued
economic environment will not impact either current or future receivables
negatively. We do not provide long-term financing to customers buying our
equipment.
Investing Activities
Our investing activities during fiscal 2003 provided for cash flows of
$9.1 million. Cash used in investing activities during fiscal year 2003 included
purchases of property and equipment of $3.3 million and $280 thousand in
purchases of other assets. We also made a $5.0 million investment in UFO
Communications, Inc. a private service provider, as part of a strategic
relationship. This was offset by $17.2 million of cash received from the sale of
marketable securities and other investments. In fiscal 2002 our investing
activities used $4.0 million. Cash used in investing activities during fiscal
2002 included purchases of property and equipment of $3.2 million and $900
thousand in other assets, which was offset by $144 thousand of cash received
from the sale of marketable securities and other investments.
In fiscal 2001 we used cash flows in investing activities of $12.5
million including $7.0 million in cash balances at Entrada as of August 31, 2000
when it ceased to be a subsidiary, following the merger with Sync Research. We
purchased property and equipment of $14.4 million, invested $3.3 million in
Entrada and $3.2 million in one of Sorrento's customers. During fiscal 2001, we
received $4.2 million from the sale of 350,000 of our NSI
42
shares and $819 thousand from the purchasers of our discontinued operations. We
received $9.2 million offset by our investment of $3.2 million from the
investment in one of Sorrento's customers and payment of $1.8 million on a note
receivable.
Financing Activities
In fiscal 2003 our financing activities used cash of $1.4 million and
consisted primarily of repayment of our line of credit and long-term debt. Our
financing activities during fiscal 2002 provided us $40.1 million and consisted
primarily of financing activities from the sale of common stock in March, 2001
of 76,300 shares which generated proceeds of $9.6 million and a convertible
debenture financing in August, 2001 which raised $29.7 million. As previously
mentioned, we are in the process of restructuring both our convertible debenture
financing completed in August, 2001 and the SNI Series A obligation of $48.8
million. In addition to the sale of common stock and convertible debentures, we
received $1.1 million from proceeds of stock option and warrant exercises of
$900 thousand and long term debt of $20 thousand. Offsetting these amounts were
repayments of short-term and long-term debt of $300 thousand.
In fiscal 2001 our financing activities provided cash flows of $60.6
million which consisted primarily of $46.6 million in net proceeds from a
private placement by SNI of its convertible preferred stock, $7.9 million in net
proceeds from a private placement by Entrada of its common stock, $3.9 million
in proceeds from option and warrant exercises, $2.4 million in proceeds from
long term debt offset by repayments of short and long term debt.
During March 2000, SNI 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 the SNI
Series A Preferred Stock is convertible into one share of SNI common stock at
the option of the holder and 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 our common stock upon an underwritten
public offering by SNI with an aggregate offering price of at least $50 million.
Since SNI 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 had the right
to request SNI redeem their shares at the 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 for such pro rata portion as to which a
lesser amount of lawful available funds would exist. At the current time, SNI
does not have such funds, which would normally be generated from operating
profits of our subsidiary. As previously mentioned, we are attempting to
restructure this outstanding obligation.
On August 31, 2000, we completed a merger of Entrada with Sync
Research, Inc., 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 we
owned 48.9% of Entrada Networks and we have accounted for our interest on our
balance sheet at cost as of January 31, 2001.
On December 1, 2000, we distributed 3,107,155 of our Entrada shares 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 January 31, 2001 we distributed 20,182 of our
Entrada shares upon the exercise of options and as of January 31, 2001 have
reserved 1,080,283 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 for at our original cost of $5.1 million. 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. In April 2003 our
Board of Directors determined that our ENT should be made available for general
corporate purposes, and we are no longer reserving any for distribution to
option and warrant holders as of November 20, 2000.
We anticipate that we will need additional working capital to fulfill
our capital working requirements for the next year. While we have made
significant cost reductions to bring our losses more in line with our
anticipated or projected revenues, there is no assurance the volume of future
revenues will be sufficient to allow us to meet our
43
financial obligations for future periods. Further, we anticipate we will need to
sell our marketable securities to finance our working capital needs for future
periods. Our holdings of marketable securities are highly volatile and do not
trade in large volume. There can be no assurance that when we need to sell our
holdings in marketable securities we will be able to obtain a market value price
for the securities without negatively impacting the price of such securities. We
continue to reduce our operating costs and have initiated activities to raise
additional working capital. Our future capital requirements may vary materially
from those now planned including the need for working capital to accommodate
planned growth, hiring and infrastructure needs. There can be no assurances that
our working capital requirements will not exceed our ability to generate
sufficient cash internally to support our requirements and that external
financing will be available or that, if available, such financing can be
obtained on terms favorable to us and our shareholders. In addition our auditors
have issued a going concern qualification to their opinion regarding the
successful approval and completion of our Capital Restructuring Plan anticipated
to close on or about the end of May 2003.
Contractual Cash Obligations
The following tables quantify our future contractual obligations and
commercial commitments as of January 31, 2003 (dollars in thousands):
Contractual Obligations
Payments due in fiscal years
---------------------------------------------------------------------------------
Total 2004 2005 2006 2007 2008 Thereafter
------------ ---------- ------------ ---------- ----------- --------- ----------
Long-term Debt $3,630 $ 38 $ 57 $ 54 $ 58 $63 $3,360
Capital Leases 253 198 55 -- -- -- --
Operating Leases 650 301 158 131 42 18 --
7.75% convertible debentures (a) 32,200 -- 32,200 -- -- -- --
Series A, preferred stock put (b) 48,800 48,800 -- -- -- -- --
---------------------------------------------------------------------------------
Total $85,533 $49,337 $32,470 $185 $100 $81 $3,360
=================================================================================
(a) Maturity date, August 2, 2004
(b) The Series A has a liquidation preference, with the holders having
a right to have the outstanding shares repurchased in the event an
initial public offering did not take place at our subsidiary, SNI,
by March 1, 2001. The IPO did not take place and a majority of
Series A holders exercised their redemption right. SNI has not
repurchased those shares because it does not have legally
available funds to do so. Applicable law prohibits a repurchase of
equity securities when the capital of the corporation is impaired
or when such repurchase would cause an impairment of the capital
of the corporation. SNI has not had funds legally available to
repurchase any of its equity securities since April 2001, and most
likely will not in the foreseeable future.
Note: If the capital restructuring is approved by the shareholders on
May 19, 2003,and the capital restructuring is completed, the debt
obligations to our convertible debenture holders of $32,200 and Series
A preferred stock holders of $48,800, will be eliminated and a new
convertible debenture of $12,500 will become effective, with a maturity
date of August 2, 2007.
Possible Effects Of Extinguishment of Debt Relating to Restructuring
As discussed in the unaudited proforma financial statements section of
part 1, there is an anticipated gain on debt extinguishment of $18.2 million and
the expense related to the issuance of the New Warrants in the amount of $3.4
million. The anticipated gain on debt extinguishment and expenses related to the
issuance of the New Warrants is based on a stock price of $6.00 at the time of
closing. For each $1.00 increase or decrease in stock price, this gain is
affected by $8.3 million. Given a range of closing stock prices of $4.00, $6.00
and $8.00 this gain would be $34.8 million, $18.2 million or $1.7 million
respectively.
Contingent Liabilities
44
One of our component suppliers is contending that our efforts to
reschedule shipments of certain components constitutes an anticipatory breach of
the purchase order by which the components were ordered, and has informed us
that they believe they are entitled to damages approximately $950 thousand,
despite the fact none of the goods have as yet been shipped. We do not believe
that our supplier can support the amount of the alleged cancellation fee. Our
supplier has threatened litigation if the dispute is not satisfactorily resolved
and while we believe that our defenses to both liability and damages are strong,
we can give no assurance that our position in such litigation would prevail.
In the merger agreement between our predecessor corporation and Sync
Research, we agreed to indemnify and hold our former subsidiary, Entrada,
harmless against any liability arising after the merger in connection with the
termination of a certain pension plan previously maintained by Entrada. In the
third quarter, we were advised by a consultant retained by us and by the
successor corporation to the entity from whom we originally purchased the
company that became Entrada that the cost of termination of the pension plan in
question is in excess of $3 million. While we do not believe that we are liable
for this cost, it is possible that the successor corporation, which has been
funding the pension plan since 1996, may seek a substantial contribution from us
towards this liability.
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.
Impact of Recent Accounting Pronouncements
In January 2003, the FASB issued FASB Interpretation ("FIN") No. 46,
"Consolidation of Variable Interest Entities", and interpretation of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements", FIN No. 46
explains how to identify variable interest entities and how an enterprise
assesses its interests in a variable interest entity to decide whether to
consolidate that entity. This Interpretation requires existing unconsolidated
variable interest entities to be consolidated by their primary beneficiaries if
the entities do not effectively disperse risks among parties involved. FIN No.
46 is effective immediately for variable interest entities created after January
31, 2003, and to variable interest entities in which an enterprise obtains an
interest after that date. The Interpretation applies in the first fiscal year or
interim period beginning after June 15, 2003, to variable interest entities in
which an enterprise holds a variable interest that is acquired before February
1, 2003. We do not anticipate that the adoption of FIN No. 46 will have a
material effect on our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," which amended SFAS No.
123, "Accounting for Stock-Based Compensation." The new standard proves
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. Additionally, the
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in the annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. This statement is effective for financial
statements for fiscal years ending after December 15, 2002. In compliance with
SFAS No. 148, we have elected to continue to follow the intrinsic value method
in accounting for its stock-based employee compensation arrangement as defined
by Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock
Issued to Employees, and has made the applicable disclosures in note K to the
consolidated financial statements.
45
In November 2002, the FASB issued FIN 45, which expands previously
issued accounting guidance and disclosure requirements for certain guarantees.
FIN 45 requires us to recognize an initial liability for the fair value of an
obligation assumed by issuing a guarantee. The provision for initial recognition
and measurement of the liability will be applied on a prospective basis to
guarantees issued or modified after December 31, 2002. The adoption of FIN 45 is
not expected to materially affect our consolidated financial statements.
In June 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities", which addresses accounting
for restructuring and similar costs. SFAS No. 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force ("EITF") Issue No. 94-3. We
will adopt the provisions of SFAS 146 for restructuring activities initiated
after December 31, 2002. SFAS 146 requires that the liability for costs
associated with an exit or disposal activity be recognized when the liability is
incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at
the date of a company's commitment to an exit plan. SFAS 146 also establishes
that the liability should initially be measured and recorded at fair value.
Accordingly, SFAS 146 may affect the timing of recognizing future restructuring
costs as well as the amount recognized. Adoption of this standard will not have
any immediate effect on our consolidated financial statements. We will apply
this guidance prospectively.
In April 2002, the Financial Accounting Standards Board issued SFAS No.
145, "Rescission of FASB Statements No. 4,44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections". This statement eliminates the
current requirement that gains and losses on debt extinguishment must be
classified as extraordinary items in the income statement. Instead, such gains
and losses will be classified as extraordinary items only if they are deemed to
be unusual and infrequent, in accordance with the current GAAP criteria for
extraordinary classification. In addition, SFAS 145 eliminates an inconsistency
in lease accounting by requiring that modifications of capital leases that
result in reclassification as operating leases be accounted for consistent with
sale-leaseback accounting rules. The statement also contains other
nonsubstantive corrections to authoritative accounting literature. The changes
related to debt extinguishment will be effective for fiscal years beginning
after May 15, 2002, and the changes related to lease accounting will be
effective for transactions occurring after May 15, 2002. Adoption of this
standard will not have any immediate effect on our consolidated financial
statements. We will apply this guidance prospectively.
In August 2001, the Financial Accounting Standards Board issued SFAS
No. 143, Accounting for Asset Retirement Obligations. This Statement is
effective for fiscal years beginning after June 15, 2002. SFAS 143 provides
accounting requirements for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. Under the
Statement, the asset retirement obligation is recorded at fair value in the
period in which it is incurred by increasing the carrying amount of the related
long-lived asset. The liability is accreted to its present value in each
subsequent period and the capitalized cost is depreciated over the useful life
of the related 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.
Other Matters
See Item 3. "Legal Proceedings" contained herein.
Item 7A. 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.
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
46
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.
47
Item 8. Five-Year Summary of Selected Financial Data.
(Amounts in thousands, except per share amounts) Years ended January 31,
----------------------------------------------------------------------------------------------------------------------
Results of Operations 2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------------------------
Revenues $25,137 $40,827 $44,641 $68,372 $58,362
Gross Margin (a) 3,320 9,320 13,171 31,782 25,885
Operating income (loss) (a) (31,329) (37,154) (50,415) (9,951) (10,060)
Operating income (loss) from continuing
operations (26,210) (43,136) (41,905) 2,410 (11,069)
Earnings (loss) per common share from
continuing operations: (b)
Basic (33.29) (62.00) (74.20) 3.40 (33.80)
Diluted (33.29) (76.32) (74.20) 3.00 (33.80)
Dividends per common share -- -- -- -- --
-----------------------------------------------------------------------
Financial Position
Cash, cash equivalents and short-tem $7,747 $14,243 $9,965 $13,511 $3,480
investments
Total assets 55,805 90,339 113,123 223,265 66,796
Total debt (c) (d) 70,787 65,299 5,583 7,934 12,710
Total liabilities (c) (d) 90,281 79,860 24,770 20,727 27,938
Shareholders' equity (deficit) (34,476) 10,479 39,733 202,538 38,858
=======================================================================
(a) Operating income (loss) and Income (loss) from continuing operations
includes net capital restructuring charges of approximately $1,800 in
fiscal year 2003 and inventory reserves taken of $4,152, $4,038, $3,689,
$1,600 and $1,624 which affected gross margin in fiscal year 2003, 2002,
2001, 2000 and 1999, respectively.
(b) All per share data have been restated to reflect the twenty-for-one split
of our common stock that became effective on October 28, 2002.
(c) Includes the effect of our Series A Preferred Stock obligation, at our SNI
subsidiary, for fiscal year 2003 and 2002.
(d) Includes 7.75% convertible debentures.
48
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Company
On March 31, 2003, our directors and executive officers were:
Name Age Position
---- --- --------
Phillip W. Arneson 66 Chief Executive Officer, President, and Chairman of the Board (ii)
Donne F. Fisher 64 Director (i), (ii)
Robert L. Hibbard 50 Director (ii)
Larry J. Matthews 75 Director (i)
Gary M. Parsons 53 Director (i)
Joe R. Armstrong 54 Chief Financial Officer
Richard L. Jacobson 60 Sr. Vice President, Legal and Secretary
--------------
(i) member of the Audit Committee
(ii) member of the Compensation Committee
Our By-Laws provide that the members of the Board of Directors be elected
annually by our Shareholders for one-year terms. Each director who is not an
employee of our company or our subsidiaries receives $1,000 for each Board of
Directors or committee meeting attended. Directors who serve as the chairman of
a committee receive an additional $500 for each committee meeting attended. The
Board of Directors has two committees: Audit and Compensation. There are no
family relationships between any directors and officers.
Phillip W. Arneson, has been our Chairman and Chief Executive Officer
of the Company since March 2002. He previously served as our President and Chief
Operating Officer from October 2001 until his appointment as Chairman and Chief
Executive Officer. He also has served as one of our directors since October 2000
and currently serves on the Meret Communications, Inc. and Sorrento Networks,
Inc. Boards of Directors. From 1996 to 2001, Mr. Arneson held the position of
Executive Vice President for privately held Frandsen Corporation, a diversified
financial and manufacturing company where he was responsible for growing the
enterprise through acquisitions, internal growth, and strategic partnerships.
Additionally, he served as President of two of its operating companies. Mr.
Arneson has served several public and private technology companies in executive
management, holding positions as Chief Executive Officer, President and Group
Vice President as well as having extensive experience as a director of such
companies. From 1982 to 1986, he served as Executive Vice President of Allied
49
Signal's Electronic Sector and as Chief Executive Officer of its subsidiary,
Amphenol Corp. In 1986, Mr. Arneson's technology group garnered the prestigious
IR-100 award for the development of an integrated fiber optics phase modulator.
Mr. Arneson holds a B.S. in Electrical Engineering from the University of
Minnesota's Institute of Technology and is a veteran, U.S. Marine Corps.
Donne F. Fisher, has served as one of our directors since November 2001
and is chairman of our Audit Committee. Mr. Fisher is currently President of
Fisher Capital Partners, Ltd., a private venture capital and investment company
he founded in 1991. From 1982 to 1996, Mr. Fisher held various executive officer
positions with Tele-Communications, Inc. ("TCI") and its subsidiaries including
Executive Vice President and Treasurer. He was a TCI director from 1980 until
1999 when TCI merged into AT&T Corporation. Since his retirement in 1996, Mr.
Fisher has been a consultant to TCI (now AT&T Broadband). Mr. Fisher also serves
as a director of Liberty Media Corporation, a former subsidiary of AT&T, and
General Communications, Inc., a diversified telecommunications provider.
Robert L. Hibbard, has served as one of our directors since November
2001 and is chairman of our Compensation Committee. Mr. Hibbard is an attorney
and management consultant in private practice in which he handles a wide variety
of commercial matters including technology licensing and the structuring of
merger and acquisitions transactions. From 1997 to 1999, Mr. Hibbard was Chief
Executive Officer of Kim Technologies International, Inc., a privately held
developer of electromechanical "super" capacitors for wireless applications.
From 1994 to 1997, Mr. Hibbard was Vice President and General Counsel at Allied
Signal Engines, and from 1987 to 1994, Assistant General Counsel at Allied
Signal Aerospace. Mr. Hibbard holds a bachelors degree from Gustavus Adolphus
College and a J.D. from Marquette University Law School, where he was a member
of the Marquette Law Review.
Gary M. Parsons, has served on our Board of Directors since October
2000. Since 1996, Mr. Parsons has held the position of Chairman of the Board for
XM Satellite Radio Holdings, Inc., and in October 2001 was named Chairman and
Chief Executive Officer of Mobile Satellite Ventures, LLP. From 1996 to April
2002, Mr. Parsons served as Chairman of Motient Corporation, a wireless data
firm. On January 10, 2002, Motient filed a voluntary bankruptcy petition in
connection with a prearranged restructuring of its debt and emerged from
bankruptcy on May 1, 2002. From 1990 to 1996, Mr. Parsons held a number of
executive positions at MCI Communications, Inc., including Executive Vice
President, Chief Executive Officer of MCI Metro, Inc., and President of MCI's
Southern Division. From 1984 to 1990, Mr. Parsons held the responsibilities of
Executive Vice President at Telecom*USA, a fiber-optic and long distance venture
subsequently acquired by MCI. Mr. Parsons holds a B.S. in Electrical and
Computer Engineering from Clemson University and a MBA from the University of
South Carolina.
Larry J. Matthews, has served on our Board of Directors since August
2002. Mr. Matthews was a co-founder of Zytec Corporation, a manufacturer of high
performance electronics for the telecommunications and computer industries. Mr.
Matthews served as an officer and director of Zytec which grew from a start-up
operation to a public company with revenues exceeding $250 million annually
during his tenure. In 1992, Zytec won the National Baldridge Quality Award. A
public offering of Zytec was completed in 1994. In 1997, Zytec merged with
Computer Products Corporation to form Artesyn Technologies (ATSN, NASDAQ). Mr.
Matthews currently serves on Artesyn's board as a director. He also serves on
the Board of Veritec, Inc. (VRTC.OB, OTC BB), a seller of microprocessor-based
encoding and decoding systems products. From January 1999 to June 2000, Mr.
Matthews served as Veritec's Acting President and Chief Executive Officer. Mr.
Matthews holds a Bachelor of Engineering degree from Iowa State University, and
serves on the boards of several privately held companies.
Joe R. Armstrong, has served as our Chief Financial Officer since
January 2001. He brings over 25 years of corporate finance, investor relations,
treasury, legal and management experience to the Company, having spent 15 years
with State Of The Art, a leading provider of accounting software. As chief
financial officer, vice president, finance and secretary of State Of The Art, he
managed two rounds of venture capital financing, the company's initial public
offering and several significant acquisitions and mergers. Prior to joining us,
Mr. Armstrong most recently served as CFO for The Bohlin Company. Previously, he
was director of marketing finance and financial planning for MAI Basic Four
Corporation and a certified public accountant for Vicenti, Lloyd and Stutzman, a
regional public accounting firm. Mr. Armstrong holds both bachelors and masters
degrees in business from Utah State University.
Richard L. Jacobson, has been our Senior Vice President, Legal and
Secretary since July 2000. Mr. Jacobson was a partner with the law firm of
Fulbright & Jaworski, LLP from 1990 to 2000 where his practice
50
consisted primarily of securities litigation and SEC enforcement matters. Prior
to joining Fulbright in 1988 he was in private practice in Palo Alto,
California, from 1986 to 1988, and in Washington, D.C., from 1980 to 1986. From
1977 to 1979, Mr. Jacobson worked for the SEC, where he was a member of the
Trial Unit in the Enforcement Division and served as Special Counsel to the
Chairman. He served as a law clerk for Ninth Circuit Judge Walter Ely from 1970
to 1971 and then clerked for Associate United States Supreme Court Justice
William O. Douglas from 1971 to 1972. Mr. Jacobson holds a J.D. from the
University of Southern California and a S.B. from the University of Chicago.
Our other key employees include:
Name Age Position
---- --- --------
Darin L. Clause 34 Vice President, Strategic Sales
Subrata Datta 40 Vice President, Engineering
Demetri Elias, Ph.D. 59 Vice President, Marketing
Susan L. Hamlin 40 Vice President, Sales (North America)
Mary A. Lay 46 Vice President, Finance
Jeff S. Phillips 33 Vice President, Corporate Development
Mark W. Thurman 53 Vice President, Operations
Mitchell R. Truelock 34 Vice President, Sales & Marketing
Li-Ran Wu 50 Vice President, Management Software
Darin L. Clause has served as Sorrento's Vice President, Strategic
Sales since September 2000 and joined us in December 1999 as Director, Sales
Development. Prior to joining us, Mr. Clause was employed with Pirelli as a
Senior Product Manager from 1996 to 1999, where he was responsible for
implementation of indoor cabling and connectivity business lines for the CATV,
CLEC, Utility and IXC markets and multiple channels. From 1994 to 1996, Mr.
Clause was a Project and Sales Engineer for Sumitomo Electric Lightwave, where
he was responsible for fiber optic passive component sales. Mr. Clause holds a
B.S. in Mechanical Engineering from Clemson University.
Subrata Datta has served as Sorrento's Vice President, Engineering
since November 2000 and joined Sorrento upon our acquisition of Distributed
Systems International, Inc. in 1996. From 1996 to 1999 he was responsible for
all engineering development for the LAN adapter and hub/switch products. Prior
to joining Sorrento, Mr. Datta helped develop the ANSI FDDI and FDDI-II
standards and design network components and system-level products for DSI. Prior
to DSI, Mr. Datta had extensive design experience while working at AT&T Bell
Laboratories on the 3B20 Duplex computer system, based on highly fault tolerant
architectures, high-reliability and stringent up-time requirements. Before
working for AT&T Bell Laboratories, Mr. Datta worked for IBM's Yorktown Research
Center where he focused on FDDI development for their RS6000 workstation
systems. Mr. Datta holds a M.S. and B.S. in Electrical Engineering from the
Cooper Union School of Engineering.
Demetri Elias, Ph.D. has served as Sorrento's Vice President, Marketing
since October 2000 and joined Sorrento in April 2000 as Director, Product Line
Management. Prior to joining Sorrento, Dr. Elias was with Nortel Networks, a
leading optical equipment developer, for over 22 years holding positions in
research and development, consulting, product management and marketing. In his
most recent Nortel Networks assignments he served as Director, Product Line
Management and Director, Strategic Marketing on optical networking products. Dr.
Elias holds a Ph.D. in Electrical Engineering from McGill University, Montreal,
Canada.
Susan L. Hamlin has served as Sorrento's Vice President, Sales (North
America) since September 2000 and joined Sorrento in November 1999 as Regional
Vice President of Sales. Ms. Hamlin is also responsible for Sorrento's customer
service group. During her tenure at Pirelli Cables and Systems, Ms. Hamlin was
Director of Sales from 1998 to 1999 and responsible for overseeing sales to
CATV, CLEC, Utility and IXC markets. From 1997 to 1998, Ms. Hamlin was National
Sales Manager - Distribution at Pirelli where she established and implemented
Pirelli's sales efforts into the distribution and OEM markets. From 1985 to
1996, Ms. Hamlin held a succession of sales and marketing management positions
with AT&T/Lucent Technologies where she was responsible for strategic planning,
market development and sales to the Regional Bell Operating Companies. Ms.
Hamlin holds a B.S. in Management Information Systems from Bradley University in
Peoria, Illinois and completed executive management
51
programs at Harvard University and the Wharton School of Business. As of March
2003, Ms. Hamlin is no longer with the Company.
Mary A. Lay has served as Sorrento's Vice President, Finance since July
2002 and joined us in March 2002 as Controller. Ms. Lay has also served as
Meret's Chief Financial Officer since July 2002. Prior to joining Sorrento, Ms.
Lay brings over 20 years of corporate finance, treasury and management
experience to the Company. Ms. Lay's previous experience includes contract and
permanent position as Corporate Controller and Chief Financial Officer at
several companies including On-Point Technology Systems, Inc., Curtis Coleman
Company and Nexergy Tauber. Ms. Lay holds a B.A. in Financial Accounting from
National University, a M.B.A from the University of Phoenix and is a certified
public accountant.
Jeff S. Phillips has served as Sorrento's Vice President, Corporate
Development since January 2001. From 1995 to 2000, Mr. Phillips was a Vice
President at US Bancorp where he focused on financing for telecom related
technology concerns and advisory assignments. Prior to joining US Bancorp, Mr.
Phillips was a financial analyst/strategist with Hillebrand GmbH, a European
investment group. Mr. Phillips began his career as a floor trader at the London
International Financial and Futures and Options Exchange (LIFFE) where he
focused on Deutsche Mark denominated financial derivatives. Mr. Phillips holds a
B.A. in Economics from the University of California at Berkeley.
Marc W. Thurman has served as Sorrento's Vice President, Operations
since April 2001. Mr. Thurman oversees our manufacturing and operations, supply
chain management, and quality assurance functions. He brings to us nearly 25
years of manufacturing operations, supply chain management and quality assurance
experience on leading edge technologies and products for the computer and
telecommunication markets. Mr. Thurman's previous experience includes service
since 1971, in various functions at Packard Bell NEC, ComCrypt Systems, IDEA
Courier, Inc., Sidereal Corporation, Intel Corporation, RTE Corporation, and
Western Electric. In his most recent position, Mr. Thurman had manufacturing
responsibilities including internal production, contract manufacturing (EMS) and
third party manufacturing (TPM), supporting revenues of $2 billion. Mr. Thurman
holds a B.S. in Electrical Engineering from Oregon State University as well as
an M.B.A. degree from University of Portland.
Mitchell R. Truelock, has served as Sorrento's Vice President, Sales
and Marketing since February 2003 and is responsible for North American and Asia
Pacific sales, marketing, product management and customer support. Mr. Truelock
joined Sorrento in January 2003 as Vice President, Strategic Planning after
having consulted with Sorrento since August 2002. Prior to working with
Sorrento, from February 2000 to November 2001, Mr. Truelock was a Vice President
in the communications equipment group at Robertson Stephens, a technology
investment bank. From June 1998 to February 2000, Mr. Truelock was a Vice
President in the technology group at Dain Rauscher Wessels, a technology
investment bank. From September 1995 to June 1998, Mr. Truelock was a corporate
attorney at Cooley Godward LLP where he focused on mergers and acquisitions,
private financings and initial public offerings for technology companies. Mr.
Truelock holds a L.L.M. in corporate securities at Georgetown University Law, a
J.D. from Southern Methodist University, and a BBA in accounting from the
University of Texas at Austin.
Li-Ran Wu has served as Sorrento's Vice President, Management Software
since November 2000 and joined Sorrento in October 1999. Before joining
Sorrento, Mr. Wu was a senior consultant and Lead Systems Engineer at Hitachi
Telecom where he developed second-generation SONET equipment to complement WDM
and OXC products within the OTN. He also developed the WDM information model
that was published in 1998. Prior to working at Hitachi, Mr. Wu was with Nortel
Networks, Racal Datacom and Taiwan Telecom. While at Nortel he developed a SONET
UPSR-based communication messaging protocol. Mr. Wu holds an M.S. in Electrical
Engineering from North Carolina State University and a B.S. in Computer Science
from Chiao Tung University. He has also completed work on his doctoral thesis at
the Georgia Institute of Technology.
Item 11. Executive Compensation
The following tables set forth the annual compensation for the
Company's Chief Executive Officer ("CEO") for the fiscal year ended January 31,
2003, and for the four most highly compensated executive officers of the
Company, other than the CEO, who were serving as executive officers at the end
of our fiscal year and whose salary and bonus exceeded $100,000.
52
Summary Compensation Table
Annual Compensation
-----------------------------
Other All
Annual Other
Name and Salary Bonus Compensation Compensation
Principal Position Year ($) ($)(A) ($) ($)(B)(C)(D)(E)(F)
------------------- ---- ------- ------- ------------ ------------------
Phillip W. Arneson, Chairman .... 2003 245,387 205,000 -- 72,066
Chief Executive Officer....... 2002 60,582 25,000 -- 12,547
-- --
Joe R. Armstrong ................ 2003 191,927 165,000 -- 20,962
Chief Financial Officer ...... 2002 175,011 -- -- --
Richard L. Jacobson, Sr. VP...... 2003 250,000 150,000 -- 19,231
Legal and Secretary........... 2002 251,802 -- -- --
2001 140,850 -- -- 42,746
Jeff S. Phillips, VP ............ 2003 170,019 68,000 -- 37,918
Corporate Development......... 2002 170,019 10,000 62,339
Darin L. Clause. VP.............. 2003 160,014 -- 79,393 8,400
Strategic Sales .............. 2002 160,014 -- 158,399 77,211
2001 145,181 -- 51,101 51,740
(A) Bonus compensation represents performance and retention bonuses paid in
fiscal year 2003 and 2002. In fiscal year 2003 Mr. Arneson received the
final payment of $5,000 of his $30,000 signing bonus per his employment
contract which took effect October 2001, a performance bonus of
$125,000 and a retention bonus of $75,000. Mr. Armstrong received a
performance bonus of $105,000 and a retention bonus of $60,000. Mr.
Jacobson received a $75,000 performance bonus and a $75,000 retention
bonus. Mr. Phillips received a $51,000 performance bonus and a $17,000
retention bonus.
In fiscal year 2002, Mr. Arneson received a signing bonus per his
employment contract which took effect October 2001 of $25,000 and
Mr. Phillips received a $10,000 performance bonus.
(B) Other compensation for Mr. Arneson for fiscal year 2003 consists of
temporary living expenses paid by the company of $48,930 and vacation
accrual buy-out of $23,237. In fiscal year 2002 Mr. Arneson had
temporary living expenses of $12,547.
(C) Other compensation for Mr. Armstrong represents vacation accrual
buy-out.
(D) Other compensation for Mr. Jacobson represents vacation accrual buy-out
in fiscal year 2003 and relocation related expenses reimbursed by us in
fiscal year 2001.
(E) Other compensation for Mr. Phillips represents living expenses of
$37,918 and $55,800 for fiscal years 2003 and 2002 respectively,
and vacation accrual buy-out of $6,539 in fiscal year 2002.
(F) Other compensation for Mr. Clause represents car allowance of $8,400,
$7,200 and $2,400 for fiscal years 2003, 2002 and 2001 respectively.
Mr. Clause had relocation expenses reimbursed by us of $70,011 and
$49,340 for fiscal years 2002 and 2001 respectively.
53
Key Employee Retention and Incentive Plan:
In November 2002, our Board of Directors, acting on a recommendation of
the Compensation Committee and in consultation with Towers Perrin, a national
executive compensation accounting firm, approved our "Key Employee Retention and
Incentive Plan." The purpose of this plan is to provide a means whereby the
Company could achieve the ongoing retention of certain key employees and certain
management personnel. In addition, the Plan also provides for granting incentive
based awards for the achievement of Company goals and objectives along with
recognition for the participant's continued contributions to the Company. In the
past we had no such formal plan.
A portion of the retention plan approved by the Board provides for
certain economic benefits to be paid to participants upon a change of control or
merger of the Company. Management participants in the retention plan include our
CEO, CFO and Senior Legal Counsel, each of whom have waived their rights to
compensation benefits that could or would be triggered under this plan related
to the capital restructuring efforts soon to be placed before our shareholders
for approval.
Long-Term Incentive Plans
We have has no long-term incentive plans other than our various stock option
plans.
Option Grants -- Year Ended January 31, 2003
There were no option grants exercised for the year ended January 31, 2003
for any of the Named Executive Officers.
The following table sets forth information concerning each exercise of stock
options during the year ended January 31, 2003 by each of the Named Executive
Officers and the January 31, 2003, value of unexercised options.
Aggregated Option Exercises in Fiscal Year 2003 and January 31, 2003
Option Values
Number of
Shares Securities Underlying Value of Unexercised
Acquired Unexercised Options In-the-Money Options
On Value at Fiscal Year-End ($) at Fiscal Year-End (#)(A)
Exercise Realized --------------------------- ---------------------------
Name (#) ($) Exercisable Unexercisable Exercisable Unexercisable
---- -------- -------- ----------- ------------- ----------- -------------
Phillip W. Arneson.............. -- -- 16,833 13,750 -- --
Joe R. Armstrong ............... -- -- 8,875 9,125 -- --
Richard L. Jacobson ............ -- -- 10,760 5,940 -- --
Jeff S. Phillips ............... -- -- 4,805 2,695 -- --
Darin L. Clause ................ -- -- 2,021 2,021 -- --
(A) Options are "in-the-money" if, on January 31, 2003, the market price of
the Common Stock ($6.33) exceeded the exercise price of such options. The
value of such options is calculated by determining the difference between
the aggregate market price of the Common Stock covered by such options on
January 31, 2003, and the aggregate exercise price of such options. As of
January 31, 2003 there were no options held by executive officers or
management that were exercisable at $6.33 or less.
Employment Agreements
On March 1, 2002 Mr. Arneson assumed the role of Chairman, President and
Chief Executive Officer of the Company. On April 30, 2002, our Board of
Directors approved an employment agreement with Mr. Arneson regarding the terms
of his employment as Chairman, Chief Executive Officer and President and which
superseded his August 2002 contract. The agreement provides for an annual
compensation of $250,000. The agreement also calls for the vesting, as of March
1, 2002, of the 6,250 options granted Mr. Arneson on September 17, 2001, and the
granting of 23,750 additional stock options (adjusted for the 1-for-20 reverse
split) at a strike price equal to the
54
closing price of the Company's common stock on Nasdaq on March 1, 2002, which
shares are to vest at the rate of 1,000 shares per month beginning on April 1,
2002, continuing for 12 months, when 5,000 additional shares vest, and beginning
on May 1, 2003, 1,125 shares will vest each month. The employment is at will;
however, if Mr. Arneson should be terminated without cause or resign in certain
circumstances, he would receive a lump sum severance payment of two years' base
salary and vesting of all stock options, and health and life benefits; he would
be required to provide exclusive consulting services for two years following his
termination. The agreement also calls for the reimbursement of living expenses
in San Diego at the rate of $2,750.00 per month while Mr. Arneson remains
employed.
In May 2002, we entered into an employment agreement with Mr. Armstrong,
our CFO, which provides for an annual salary of $200,000 per year plus bonus of
$20,000 to paid in on lump-sum, June 2002, and 10,500 options (adjusted for the
1-for-20 reverse split) to acquire our common stock vesting over two years. The
contract is for no specified term and Mr. Armstrong is an at-will employee such
that the Company or Mr. Armstrong may terminate employment at any time, with or
without cause or notice, and with or without reason, subject to the rights and
obligations as provided in the contract. However, should Mr. Armstrong be
terminated without cause he will receive a lump-sum severance payment of one
year's salary, health and life benefits for one year and vesting of all his
options. In the event of a change of control, merger or sale of the Company, Mr.
Armstrong is entitled to receive an immediate payment equal to one year's
salary, health and life benefits for one year and vesting of all his options.
In July 2002, we entered into an employment agreement with Mr. Jacobson
which provides for an annual salary of $250,000 per year and 9,000 options
(adjusted for the 1-for-20 reverse split) to acquire our common stock vesting
over two years. The contract is for no specified term and Mr. Jacobson is an
at-will employee, such that either the Company or Mr. Jacobson may terminate
employment at any time, with, or without cause or notice, and with or without
reason, subject to the rights and obligations as provided in the contract.
However, should Mr. Jacobson be terminated without cause he will receive a
lump-sum severance payment of six month's salary and vesting of all his options.
In the event of a change of control, merger or sale of the Company, Mr. Jacobson
is entitled to receive an immediate payment equal to six month's salary and
vesting of all his options.
On January 25, 2002, the Directors of Meret Optical Communications, who
then were Mr. Cheng and Mr. Sue, approved an employment agreement with Mr.
Rajadhyksha appointing him President of Meret and raising his annual salary to
$210,000 per year. In addition to the increase in salary there were provisions
for severance benefits based upon termination without cause or change in control
of the Company. Severance benefits for termination without cause or change in
control provisions allow Mr. Rajadhyksha to receive a lump sum payment of up to
one year's salary and the vesting of all his options to acquire our common
stock. As of August 27, 2002 Mr. Rajadhyksha was no longer with the Company and
he was paid severance benefits of $28,270 in full settlement.
Our then Board of Directors approved a two-year employment contract with
Mr. Mason ending May 2002, which provided for a base salary of $130,900 per year
and vesting of all his options to acquire our common stock granted prior to
February 1, 2000. This contract could be terminated for cause. However, were Mr.
Mason to be terminated without cause or resign in certain circumstances prior to
the end of the contract term he was entitled to receive a continuation of his
base salary and benefits for two years, vesting of all his options to acquire
our common stock, and he would be contractually required to provide consulting
services to us during the two years following his termination. In March 2002 Mr.
Mason notified the Company that he was resigning with cause, relying on an
agreement between Mr. Mason and Dr. Cheng in April 2001 that allowed him to
resign for cause at any time prior to the expiration of his employment agreement
as a result of having been relocated more than 35 miles from his prior
employment location. Mr. Mason's resignation under these circumstances entitled
him to receive two year salary and benefit continuation and immediate stock
vesting which the Company agreed to provide on the condition that Mr. Mason sign
the Company's standard employee confidentially, proprietary and invention
agreement. Mr. Mason refused to sign the confidentiality agreement and also
refused to return valuable company property in his possession. As a result we
stopped payments to Mr. Mason and have sought recovery of sums already paid to
Mr. Mason under his consulting agreement. Mr. Mason is seeking acceleration of
his extended employment benefits.
Our then Board of Directors approved a two-year employment contract with
Mr. Sue ending May 2002, which provides for a salary of $168,500 per year and
the vesting of all his options to acquire our common stock granted prior to
February 1, 2000. This contract could be terminated for cause. However, were Mr.
Sue to be terminated without cause or resign in certain circumstances prior to
the end of the contract term he was entitled to receive a continuation of his
salary and benefits for two years, vesting of all his options to acquire our
common stock and could be contractually required to provide consulting services
to us during that period. On May 8, 2002
55
Mr. Sue resigned from his position effective May 17, 2002 alleging entitlement
to the foregoing salary continuation and other benefits. We do not believe Mr.
Sue is entitled to any such benefits. In June, 2002 Mr. Sue filed a complaint in
arbitration against the Company to seek entitlement to his salary continuation.
We are opposing the complaint and have filed counter claims against Mr. Sue for
certain breaches of his duties as an officer and employee of the Company.
Our then Board of Directors entered into a two-year employment contract
with Mr. Nimrod Johnson, Corporate Controller, ending May 22, 2002, which
provided for a salary of $97,307 per year and the vesting of all his options to
acquire our common stock. This contract could be terminated for cause. However,
were Mr. Johnson to be terminated without cause or resign in certain
circumstances prior to the end of the contract term he was entitled to receive a
continuation of his salary and benefits for two years, vesting of all his
options to acquire our common stock and could be contractually 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. We do not believe Mr. Johnson
is entitled to any such benefits. In June, 2002 Mr. Johnson filed a complaint in
arbitration against the Company seeking entitlement to his salary continuation
and benefits.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange Act")
requires our directors and executive officers and persons who own more than ten
percent of a registered class of our equity securities to file reports of
beneficial ownership and changes in beneficial ownership with the Securities and
Exchange Commission (the "Commission"). The rules promulgated by the Commission
under Section 16(a) of the Exchange Act require those persons to furnish us with
copies of all reports filed with the Commission pursuant to Section 16(a).
During the fiscal year ended January 31, 2003, the following directors
and executive officers received stock option grants that were not reported on
Form 5 by the required March 17, 2003, filing date. Phillip W. Arneson, CEO and
Chairman, Joe R. Armstrong, CFO, Richard L. Jacobson, Senior Vice President
Legal and Corporate Secretary, Donne F. Fisher, Director, Gary M. Parsons,
Director, Robert L. Hibbard, Director and Larry J. Matthews, Director. These
directors and executive officers are in the process of filing their Form 5 as
required under Section 16(a) of the Exchange Act. Such reports are expected to
be filed within 5 days from the filing of this Form 10K.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information as of January 31,
2003, regarding the ownership of our common stock by (i) each of our directors;
(ii) each of the present executive officers; (iii) each person known to us to
beneficially own 5% or more of our common stock; and (iv) all our directors and
executive officers as a group. Except as indicated, all persons named as
beneficial owners of common stock have sole voting and investment power with
respect to the shares indicated as beneficially owned by them. All persons named
have an address at c/o Sorrento Networks Corporation, 9990 Mesa Rim Road, San
Diego, California 92121, unless otherwise indicated. All numbers give effect to
our 1-for-20 reverse stock split, which took effect on October 28, 2002.
Common Stock
------------
Number of Percentage of
Name of Beneficial Owner (A) Shares Outstanding (J)
---------------------------- ------ ---------------
Phillip W. Arneson (B) 19,083 2.1%
Donne F. Fisher (C) 1,750 *
Robert L. Hibbard (D) 4,300 *
Gary M. Parsons (E) 1,834 *
Larry J. Matthews (F) 0
Joe R. Armstrong (G) 10,138 1.1%
Richard L. Jacobson (H) 12,000 1.3%
Quila, LLC (I) 55,369 6.2%
15332 Antioch Street
Pacific Palisades, CA 90272
All Directors, Nominees and
Executive Officers as a Group 49,104 5.5%
56
-------------------
* Less than 1%
(A) All information with respect to beneficial ownership of the shares is
based upon filings made by the respective beneficial owners with the
Securities and Exchange Commission or information provided by such
beneficial owners to us.
(B) Includes exercisable options held by Mr. Arneson to acquire 16,833 shares
of common stock, 2,000 options to acquire common stock that becomes
exercisable in 60 days and 250 shares of common stock purchased in June
2002.
(C) Includes exercisable options held by Mr. Fisher to acquire 1,750 shares
of common stock. On March 7, 2000, Mr. Fisher was granted options to
acquire 100,000 shares of SNI's common stock at $5.45 under its option
plan for his services as an advisor to it. Pursuant to an outstanding
conversion offer, Mr. Fisher may elect to convert the SNI options into
options to acquire our common stock at a ratio of 78 for 1. Mr. Fisher is
President of Fisher Capital Partners which holds 183,486 shares of the
Series A. Mr. Fisher is a director of Liberty Media Corporation which
owns an approximate 74% economic interest representing an approximate 94%
voting interest in UnitedGlobalCom, Inc. ("UGC"). Belmarken Holding,
B.V., an indirect subsidiary of UGC, holds 3,027,523 shares of the Series
A. Liberty Media also holds convertible debt of United Pan-Europe
Communications, N.V., a subsidiary of UGC, which it has agreed to
exchange for additional shares in UGC.
(D) Includes exercisable options held by Mr. Hibbard to acquire 4,250 shares
of common stock and 50 shares of common stock purchased in July 2002.
(E) Includes exercisable options held by Mr. Parsons to acquire 1,834 shares
of common stock.
(F) Options to acquire shares of our common stock have been granted to Mr.
Matthews consistent with, and upon the same terms, conditions and vesting
schedules as, option grants made to other members of our board of
directors.
(G) Includes exercisable options held by Mr. Armstrong to acquire 8,875
shares of common stock, 1,113 options to acquire shares of common stock
that that become exercisable within 60 days and 150 shares of common
stock purchased in June 2002.
(H) Includes exercisable options held by Mr. Jacobson to acquire 10,760
shares of common stock, 594 options to acquire common stock that become
exercisable within 60 days and 646 shares of common stock, as of December
31, 2002, held in a 401K plan.
(I) Represents holdings reported by Qila, LLC and RII Partners, Inc. on
September 20, 2002 on Form 13-D, "General Statement of Beneficial
Ownership". Includes exercisable options to acquire 55,369 shares of
common stock held by RT Investments, Inc. Mr. And Mrs. Chadha disclaim
ownership in all these shares.
(J) For each beneficial owner, the "Percentage of Outstanding" equals each
owner's actual holdings of shares plus shares represented by vested,
unexercised options and warrants held, divided by our total shares
outstanding at December 31, 2002 plus the unexercised options and
warrants detailed above of the referenced holder only. In other words,
individual percentages of the listed holders will not add to the group
total because the calculations are made separately for each holder.
Item 13. Certain Relationships and Related Transactions.
In February 2003 we entered into a consulting agreement with Mr. Robert
Hibbard, to provide services to the Board of Directors and management of the
company at a consulting rate of $175 per hour and a retainer of $20,000 per
month for six months. Mr. Hibbard agrees to make himself available to the
Company for not less than 20 hours per week. The term of this agreement is for
twelve months, but may be terminated after six months by either party,
57
with or without cause, upon 5 days written notice. This agreement supersedes his
August 2002 consulting agreement. Nearly all of Mr. Hibbard's consulting work
for us has involved matters being considered or reviewed by the board or by
committees of the board. His work has included structuring and implementing our
2003 Equity Incentive Plan for employees, participation in settlement
negotiations for pending litigation, assistance in our capital restructuring and
improving our intellectual property policies and procedures, among other
matters. In fiscal year 2003 Mr. Hibbard was paid $91,836 in consulting fees.
During July 2000 we agreed to loan $300,000 for three years at the
applicable federal rate provided for in Internal Revenue Code Section 1274 to
Mr. Jacobson in connection with accepting employment as our Senior Vice
President, Legal. This is a full recourse loan and Mr. Jacobson has pledged his
options to acquire our common stock and any options he may receive from any of
our subsidiaries as collateral. Mr. Jacobson has received $300,000 in advances
under this loan agreement for which the interest rate is 6.6%. On July 3, 2002 a
new note covering the $300,000 was incorporated in Mr. Jacobson's employment
contract. The term remained the same as the July 2000 note, with all unpaid,
accrued interest and principal due and payable on August 30, 2003. In December
2002, Mr. Jacobson paid $39,330 on his loan that included payment of all prior
interest due and the remainder applied to his principal balance. As of January
31, 2003 Mr. Jacobson's loan outstanding to the Company totaled $297,961.
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 thousand per year for three years of consulting services and loans by us
for the exercise of previously granted options to acquire 58,925 options at
prices varying from $140.60 to $985.00 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 3,556 options, applying the $500 thousand accelerated payment to the
exercise. In addition, he exercised 25,369 options for which we were
contractually obligated to loan the $5.0 million due on the exercise. Mr. Chadha
provided us with written notification dated in September 2001 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 25,369
option exercise was rescinded. Mr. Chadha returned the 25,369 shares to us for
cancellation and we cancelled the receivable due from him and restored the
original option agreements. In June 2002, we filed with the Superior Court of
California, County of Los Angeles a Complaint for Declaratory Relief regarding
the interpretation of the agreement. Also in June 2002, Mr. Chadha filed a
lawsuit against us in the Superior Court of California, County of Los Angeles,
seeking declaratory relief with respect to the interpretation of his separation
agreement and in addition, alleging breach of contract with respect to his
option exercise rights and fraud in connection with his rescission agreement. In
February 2003, both of these lawsuits were dismissed without prejudice to
facilitate settlement negotiations, but they can be refiled at any time. In
April 2003, an agreement in principle to settle these lawsuits was reached,
subject to the execution of a definitive agreement. There can be no assurance
that such a definitive settlement agreement will be executed. Should the cases
be refiled, and should Mr. Chadha prevail in Court, in addition to any other
relief that may be granted, we may be required to issue him 58,925 shares of our
stock for no consideration, and/or pay him cash damages, which he alleges to be
in excess of $4 million.
On September 30, 2001, our then Chairman and CEO executed a two year
consulting agreement with Leonard Hecht whereby Mr. Hecht is to be paid a salary
at $250,000 per year plus benefits and the vesting of all his options to acquire
our common stock. We have since stopped making payments under this agreement,
and have been notified by Mr. Hecht that he believes we have thereby breached
this agreement.
In September 2000, our then Board of Directors approved a two year
consulting agreement with Rohit Phansalkar whereby he is paid a salary of
$250,000 per year plus benefits and the vesting of all his options to acquire
our commons stock. This contract was amended July 21, 2001.
58
Item 14. Controls and Procedures.
Disclosure Controls and Procedures
The Company maintains controls and procedures designed to ensure that it
is able to collect the information it is required to disclose in the reports it
files with the SEC, and to process, summarize and disclose this information
within the time periods specified in the rules of the SEC. The Company's Chief
Executive and Chief Financial Officers are responsible for establishing and
maintaining these procedures, and, as required by the rules of the SEC, evaluate
their effectiveness. Based on their evaluation of the Company's disclosure
controls and procedures which took place as of a date within 90 days of the
filing date of this report, the Chief Executive and Chief Financial Officers
believe that these procedures are effective to ensure that the Company is able
to collect, process and disclose the information it is required to disclose in
the reports it files with the SEC within the required time periods.
Internal Controls
The Company maintains a system of internal controls designed to provide
reasonable assurance that; transactions are executed in accordance with
management's general or specific authorization; transactions are recorded as
necessary (1) to permit preparation of financial statements in conformity with
accounting principles generally accepted in the United States, and (2) to
maintain accountability for assets; access to assets is permitted only in
accordance with management's general or specific authorization; and the recorded
accountability for assets is compared with the existing assets at reasonable
intervals and appropriate action is taken with respect to any differences.
Since the date of the most recent evaluation of the Company's internal
controls by the Chief Executive and Chief Financial Officers, there have been no
significant changes in such controls or in other factors that could have
significantly affected those controls including any corrective actions with
regard to significant deficiencies and material weaknesses.
59
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Exhibits and Consolidated Financial Statement Schedules
1. Financial Statements: (see index to financial statements at page F-1)
Independent Certified Public Accountants' Reports
Consolidated Balance Sheets at January 31, 2003 and 2002
Consolidated Statements of Operations for the Years Ended January 31, 2003, 2002 and 2001
Consolidated Statements Comprehensive Income for the Years Ended January 31, 2003, 2002 and 2001
Consolidated Statement of Stockholders' Equity for the Years Ended January 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the Years Ended January 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements
2. Exhibits:
3.1 Restated Certificate of Incorporation dated June 14, 1988 (A).
3.2 Amended and Restated By-Laws of the Registrant (B).
3.3 Certificate of Amendment to the Certificate of Incorporation dated January 16, 1998(D).
3.4 Amendment to the By-Laws dated January 30, 1998 (D).
3.5 Corrected Certificate of Incorporation of Sorrento Networks, Inc. (K).
3.6 Certificate of Amendment to the Certificate of Incorporation dated October 15, 2002(M).
3.7 Certificate of Correction to the Certificate of Amendment to the Certificate of
Incorporation dated November 6, 2002 (O).
4.1 1988 Stock Option Plan (E).
4.2 Amended and restated 1997 Incentive and Non-Qualified Stock Option Plan (D).
4.3 1997 Directors Stock Option Plan (F).
4.4 2000 Stock Incentive Plan (J).
4.5 2000 Employee Stock Purchase Plan (G).
4.6 2000 Stock Option/Stock Issuance Plan of Sorrento Networks, Inc. (J).
4.7 Form of Senior Convertible 9.75% Debenture due August 2, 2004 (K).
4.8 Form of Warrant dated August 2, 2001 (K).
4.9 Form of 7.5% Convertible Debenture Due August 2, 2007 (N).
4.10 Form of Warrant, expiry date August 2, 2007 (N).
4.11 Sorrento Networks Corporation 2003 Equity Incentive Plan (N).
4.12 Series D Preferred Stock Certificate of Designation (N).
4.13 Series F Preferred Stock Certificate of Designation (K).
10.1 Line of Credit Agreement with Coast Business Credit dated May 28, 1995 and
Modification dated January 31, 1996 (H).
10.2 Agreement dated June 12, 2000 with Par Chadha (I).
10.3 Agreement dated May 22, 2000 with Rohit Phansalkar (I).
10.4 Agreement dated May 22, 2000 with Christopher E. Sue (I).
60
10.5 Agreement dated August 22, 2000 with Leonard N. Hecht (J).
10.6 Agreement dated May 22, 2000 with John A. Mason (J).
10.7 Agreement dated July 12, 2000 with Richard L. Jacobson (J).
10.8 Securities Purchase Agreement dated as of August 1, 2001 (K).
10.9 Escrow Agreement dated as of August 1, 2001 (K).
10.10 Registration Rights Agreement dated as of August 2, 2001 (K).
10.11 Agreement dated March 1, 2002, with Phillip W. Arneson (L).
10.12 Exchange Agreement dated March 6, 2003 (N).
10.13 Form of Registration Rights Agreement with Exchanging Holders (N).
10.14 Agreement dated May 17, 2002 with Joe R. Armstrong, filed herewith.
10.15 Agreement dated July 3, 2003 with Richard L. Jacobson, filed herewith.
10.16 Agreement dated February 1, 2003 with Robert L. Hibbard, wiled herewith.
21.0 Subsidiaries of the Registrant (L).
23.0 Consent of BDO Seidman LLP-- filed herewith
99.1 Certification of Phillip W. Arneson, Chief Executive
Officer, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
filed herewith.
99.2 Certification of Joe R. Armstrong, Chief Financial Officer,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, filed
herewith.
______________
The foregoing are incorporated by reference from the Registrant's filings
as indicated:
(A) Form 10-QSB for the quarter ended July 31, 1996
(B) Form 10-K for the year ended January 31, 1988
(C) Form S-3 dated February 25, 1997
(D) Proxy Statement dated December 1, 1999
(E) Proxy Statement dated May 13, 1988
(F) Proxy Statement dated November 21, 1997
(G) Proxy Statement dated December 11, 2000
(H) Form 10-KSB for year ended January 31, 1996
(I) Form 10-Q for the quarter ended October 31, 2000
(J) Form 10-K for the year ended January 31, 2001
(K) Form 8-K dated August 3, 2001
(L) Form 10-K for the year ended January 31, 2002
(M) Form 8-K dated October 25, 2002
(N) Preliminary Proxy Statement filed with the SEC on March 6, 2003.
(O) Registration Statement on Form S-3, filed with the SEC on March 20, 2003.
--------------
NOTE: Certain previously filed exhibits are no longer being incorporated by
reference (and therefore not numerically listed) as the underlying
documents have either expired or are no longer material or relevant.
(b) Reports on Form 8-K
January 24, 2002 Delaware Supreme Court ruling
61
November 5, 2002 Non-compliance with Nasdaq listing requirements
November 12, 2002 Five-year supply agreement
December 10, 2002 Restructuring Letter of Intent and term sheet
March 12, 2003 Exchange Agreement and associated documents
April 11, 2003 Results of Operations and Financial Condition
62
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Certified Public Accountants................................................ F-2
Consolidated Balance Sheets as of January 31, 2003 and 2002....................................... F-3
Consolidated Statements of Operations and Comprehensive Loss for the years ended January 31,
2003, 2002 and 2001............................................................................. F-4
Consolidated Statements of Shareholders' Equity (Deficit) for the years ended January 31, 2003,
2002 and 2001................................................................................... F-5 to F-7
Consolidated Statements of Cash Flows for the years ended January 31, 2003, 2002 and 2001......... F-8 to F-9
Notes to Consolidated Financial Statements........................................................ F-10 TO F-36
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Shareholders of Sorrento Networks Corporation
9990 Mesa Rim Road
San Diego, CA 92121
We have audited the accompanying consolidated balance sheets of Sorrento
Networks Corporation (a New Jersey corporation) and subsidiaries (collectively
the "Company") as of January 31, 2003 and 2002 and the related consolidated
statements of operations and comprehensive loss, stockholders' equity (deficit)
and cash flows for each of the three years in the period ended January 31, 2002.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. These standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company as of January 31, 2003 and 2002, and the results of their operations and
their cash flows for each of the three years in the period ended January 31,
2003 in conformity with accounting principles generally in the United States of
America.
The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern. As discussed in the Note R, the
Company is in the process of completing a restructuring plan that is subject to
shareholder approval. If the Company is not successful in the restructuring it
will be delisted from Nasdaq, this delisting would constitute a triggering event
that would allow their debenture holders to request accelerated payment of their
debentures at 125% of the face value, this condition gives rise to substantial
doubt about the Company's ability to continue as a going concern. The
consolidated financial statements do not include any adjustments that might
arise from this uncertainty.
As discussed in Note F, the 2002 Financial Statements have been restated to
reflect a change in the calculation of the beneficial conversion feature of the
Company's debentures.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
Los Angeles, California
April 11, 2003
F-2
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands)
January 31, 2003 January 31, 2002
(Restated)
---------------- -----------------
ASSETS
CURRENT ASSETS
Cash and equivalents ................................................ $ 7,747 $ 14,243
Accounts receivable, net (Notes D, J and S) ......................... 5,576 8,081
Inventory, net (Notes B, D and S) ................................... 13,934 18,810
Prepaid expenses and other current assets (Note N) .................. 741 1,252
Investment in marketable securities (Note B) ........................ 3,959 28,120
--------- ---------
TOTAL CURRENT ASSETS .............................................. 31,957 70,506
--------- ---------
PROPERTY AND EQUIPMENT, NET (Notes C, D and E) ......................... 17,103 17,411
--------- ---------
OTHER ASSETS
Purchased technology, net (Note B) .................................. 430 852
Investment in non-marketable securities (Note B)..................... 5,025 --
Other assets (Notes A, B and N) ..................................... 1,290 1,471
Investment in former subsidiary (Note A) ............................ -- 99
--------- ---------
TOTAL OTHER ASSETS ................................................ 6,745 2,422
--------- ---------
TOTAL ASSETS ........................................................... $ 55,805 $ 90,339
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Short-term debt (Note D) ............................................ $ -- $ 1,043
Current maturities of long term debt (Note E) ....................... 222 362
Accounts payable .................................................... 5,135 5,575
Deferred revenue .................................................... 3,700 63
Accrued professional fees ........................................... 4,324 2,103
Other accrued liabilities and current liabilities ................... 6,236 6,721
Due on redemption of preferred security of subsidiary (Note J) ...... 48,800 48,800
--------- ---------
TOTAL CURRENT LIABILITIES ......................................... 68,417 64,667
--------- ---------
Long-term debt and capital lease obligations (Note E) .................. 3,644 3,867
Debentures payable, face amount of $32,200, net of unamortized costs and
discounts (Note F) .................................................. 18,121 11,227
Dividends payable (Note A) ............................................. 99 99
--------- ---------
TOTAL LIABILITIES ................................................. 90,281 79,860
--------- ---------
COMMITMENTS AND CONTINGENCIES (Notes F, G and H)
STOCKHOLDERS' EQUITY (DEFICIT) (Note I)
Preferred stock, $.01 par value; liquidation preference $1,353 ...... 1 1
Common stock, $6.00 par value; 7,500 shares authorized; 887 shares
issued and 886 shares outstanding at January 31, 2003; 711 shares
issued and 710 shares outstanding at January 31, 2002 ............. 5,318 4,263
Additional paid-in capital .......................................... 144,887 143,705
Deferred stock compensation ......................................... (5) (255)
Accumulated deficit ................................................. (187,536) (161,326)
Accumulated other comprehensive loss ................................ 2,928 24,160
Treasury stock, at cost; 1 share at January 31, 2003 and January 31,
2002, respectively ................................................ (69) (69)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) .............................. (34,476) 10,479
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............................. $ 55,805 $ 90,339
========= =========
See accompanying notes to consolidated financial statements.
F-3
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In Thousands, except per share amounts)
Twelve Months Ended
January 31
----------------------------------------
2003 2002 2001
----------- ------------ -------------
NET SALES (Notes B and J)................................................. $ 25,137 $ 40,827 $ 44,641
COST OF SALES............................................................. 21,817 31,507 31,470
----------- ------------ -------------
GROSS PROFIT......................................................... 3,320 9,320 13,171
----------- ------------ -------------
OPERATING EXPENSES
Selling and marketing.................................................. 12,021 16,165 17,200
Engineering, research and development.................................. 8,990 13,656 23,928
General and administrative............................................. 12,779 12,770 18,110
Deferred compensation.................................................. 433 812 1,908
Other operating expenses............................................... 426 3,071 2,440
----------- ------------ -------------
TOTAL OPERATING EXPENSES............................................. 34,649 46,474 63,586
----------- ------------ -------------
LOSS FROM OPERATIONS...................................................... (31,329) (37,154) (50,415)
----------- ------------ -------------
OTHER INCOME (EXPENSES)
Investment income (loss)............................................... 275 (1,368) 5,507
Interest expense....................................................... (9,619) (3,311) (918)
Other income (expenses)................................................ 214 (99) --
Gain (loss) on sale of marketable securities (Note A).................. 14,249 (1,204) 3,921
----------- ------------ -------------
TOTAL OTHER INCOME (EXPENSES)........................................ 5,119 (5,982) 8,510
----------- ------------ -------------
NET LOSS.................................................................. $ (26,210) $ (43,136) $ (41,905)
=========== ============ =============
LOSS PER COMMON SHARE (Note M)
BASIC
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (IN THOUSANDS)............ 787 698 593
NET LOSS PER COMMON SHARE:
----------- ------------ -------------
BASIC NET LOSS PER COMMON SHARE........................................... (33.29) $ (62.00) $ (74.20)
=========== ============ =============
DILUTED
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (IN THOUSANDS)............ 787 809 593
NET LOSS PER COMMON SHARE:
----------- ------------ -------------
DILUTED NET LOSS PER COMMON SHARE......................................... (33.29) $ (76.32) $ (74.20)
=========== ============ =============
COMPREHENSIVE LOSS AND ITS COMPONENTS CONSIST OF THE FOLLOWING:
Net loss............................................................. $ (26,210) $ (43,136) $ (41,905)
Unrealized gains (losses) from marketable securities:
Unrealized holding losses arising during the period................ (6,983) (21,993) (123,486)
Reclassification adjustment for gains (losses) included in net loss (14,249) 1,204 3,921
----------- ------------ -------------
NET COMPREHENSIVE LOSS.................................................... $ (47,442) $ (63,925) $ (161,470)
=========== ============ =============
See accompanying notes to consolidated financial statements.
F-4
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
For the Year Ended January 31, 2003
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In Thousands)
COMMON PREFERRED
STOCK STOCK ADDITIONAL NOTES DEFERRED
---------------- --------------- PAID IN RECEIVABLE STOCK
Shares Amount Shares Amount CAPITAL OPTIONS COMPENSATION
------ ------ ------ ------ ---------- ---------- ------------
Balance at
January 31, 2002.... 710 $4,263 2 $1 $143,705 $ -- $(255)
Stock option and
warrant exercises
(Notes I, J and M).. 1 9 (9)
Unrealized losses on
available for sale
securities (Note B).
Deferred stock
compensation
of subsidiary
(Note B)............ 183 (183)
Expenses paid with
stock issuances
(Note I)............ 175 1,046 1,008
Amortization of
deferred stock
compensation
(Note B)............ 433
------ ------ ------ ------ ---------- ---------- ------------
Net loss..............
------ ------ ------ ------ ---------- ---------- ------------
BALANCE AT
JANUARY 31, 2003.... 886 $5,318 2 $1 $144,887 $ -- $ (5)
====== ====== ====== ====== ========== ========== ============
TREASURY
STOCK OTHER TOTAL
ACCUMULATED --------------- COMPREHENSIVE STOCKHOLDERS'
DEFICIT Shares Amount LOSS EQUITY
----------- ------ ------ ------------- -------------
Balance at
January 31, 2002..... $(161,326) 1 $(69) $24,160 $10,479
Stock option and
warrant exercises
(Notes I, J and M)... 0
Unrealized losses on
available for sale
securities (Note B).. (21,232) (21,232)
Deferred stock
compensation
of subsidiary
(Note B)............. 0
Expenses paid with
stock issuances
(Note I)............. 2,054
Amortization of
deferred stock
compensation
(Note B)............. 433
conversion amount
related to debentures
(Note F).............
----------- ------ ------ ----------- ------------
Net loss............... (26,210) (26,210)
----------- ------ ------ ----------- ------------
BALANCE AT
JANUARY 31, 2003.... $(187,536) 1 $(69) $2,928 $(34,476)
=========== ====== ====== =========== ============
See accompanying notes to consolidated financial statements.
F-5
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
For the Year Ended January 31, 2002
(Restated)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In Thousands)
COMMON PREFERRED
STOCK STOCK ADDITIONAL NOTES DEFERRED
---------------- ---------------- PAID IN RECEIVABLE STOCK
Shares Amount Shares Amount CAPITAL OPTIONS COMPENSATION
------ ------ ------ ------ ---------- ---------- ------------
Balance at
January 31, 2001...... 630 $3,782 2 $1 $114,994 $(5,034) $(880)
Debentures
private placement
(Notes F)............. 24 20,676
Stock option and
warrant exercises
(Notes I, J and M).... (20) 23 (1,321) 5,034
Unrealized losses on
available for sale
securities (Note B)...
Deferred stock
compensation
of subsidiary
(Note B).............. 187 (187)
Expenses paid with
stock issuances
(Note I).............. (18)
Amortization of
deferred stock
compensation
(Note B).............. 812
Private placement
subsidiary (Note J)... 76 458 9,187
Deemed dividend
(Note I)..............
Net loss................
------ ------ ------ ------ ---------- ---------- ------------
BALANCE AT
JANUARY 31, 2002...... 710 $4,263 2 $1 $143,705 $-- $(255)
====== ====== ====== ====== ========== ========== ============
TREASURY
STOCK OTHER TOTAL
ACCUMULATED --------------- COMPREHENSIVE STOCKHOLDERS'
DEFICIT Shares Amount LOSS EQUITY
----------- ------ ------ ------------- ------------
Balance at
January 31, 2001...... $(118,010) 1 $(69) $44,949 (39,773)
Debentures
private placement
(Notes F)............. $20,676
Stock option and
warrant exercises
(Notes I, J and M).... 3,736
Unrealized losses on
available for sale
securities (Note B)... (20,789) (20,789)
Deferred stock
compensation
of subsidiary
(Note B)..............
Expenses paid with
stock issuances
(Note I).............. (18)
Amortization of
deferred stock
compensation
(Note B).............. 812
Private placement
subsidiary (Note J)... 9,645
Deemed dividend
(Note I).............. (180) (180)
Net loss................ (43,136) (43,136)
----------- ------ ------ ----------- ------------
BALANCE AT
JANUARY 31, 2002...... $(161,326) 1 $(69) $24,160 $10,479
=========== ====== ====== =========== ============
See accompanying notes to consolidated financial statements.
F-6
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
For the Year Ended January 31, 2001
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In Thousands)
COMMON PREFERRED
STOCK STOCK ADDITIONAL NOTES DEFERRED
----------------- ------------------ PAID IN RECEIVABLE STOCK
Shares Amount Shares Amount CAPITAL OPTIONS COMPENSATION
----------------- ------------------ ---------- ----------- --------------
Balance at
January 31, 2000 574 $3,445 5 $1 $102,418 $-- $--
Preferred stock
conversions
(Note I)............ 8 50 (3) -- (50)
Stock option and
warrant exercises
(Notes J, K and M).. 46 276 8,619 (5,034)
Unrealized losses on
available for sale
securities
(Note B)............
Deferred stock
compensation
of subsidiary
(Note B)............ 2,788 (2,788)
Amortization of
deferred stock
compensation
(Note B)............ -- 1,908
Distribution of
shares of
subsidiary
(Note A)............
Deemed dividend
(Note J)............
Dividends paid
(Note I)............ 2 11 1,219
Net loss..............
--- ------ --- ---- -------- ------- -----
BALANCE AT
JANUARY 31, 2001..... 630 $3,782 2 $ 1 $114,994 $(5,034) $(880)
=== ====== === ==== ======== ======= =====
TREASURY
STOCK OTHER TOTAL
ACCUMULATED ---------------------------- COMPREHENSIVE STOCKHOLDERS'
DEFICIT Shares Amount LOSS EQUITY
----------- ------------ ------------ ------------- ------------
Balance at
January 31, 2000.... $(67,771) 1 $(69) $164,514 $202,538
Preferred stock
conversions
(Note I)............ --
Stock option and
warrant exercises
(Notes J, K and M).. 3,861
Unrealized losses on
available for sale
securities
(Note B)............ (119,565) (119,565)
Deferred stock
compensation
of subsidiary
(Note B)............ --
Amortization of
deferred stock
compensation
(Note B)............ 1,908
Distribution of
shares of
subsidiary
(Note A)............ (5,122) (5,122)
Deemed dividend
(Note J)............ (1,982) (1,982)
Dividends paid
(Note I)............ (1,230) --
Net loss.............. (41,905) (41,905)
--------- --- ---- ------- -------
BALANCE AT
JANUARY 31, 2001...... $(118,010) 1 $(69) $44,949 $39,733
========= === ==== ======= =======
See accompanying notes to consolidated financial statements.
F-7
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
Year Ended January 31,
----------------------------------
2003 2002 2001
----------- --------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................... $ (26,210) $(43,136) $(41,905)
----------- --------- -----------
Adjustments to reconcile net loss to net cash used in operating activities:
Intangible assets valuation allowances (Note B).................... -- -- 435
Depreciation and amortization...................................... 4,063 2,794 4,386
Accounts receivable, option receivables and inventory reserves
(recoveries)................................................... (1,020) 9,309 6,347
Expenses paid through issuances of securities...................... 2,054 1,309 --
(Gain) loss on sale of marketable securities....................... (14,249) 1,204 (7,622)
Non-cash interest on debentures (Note F)........................... 6,894 994 --
Deferred and other stock compensation (Note B)..................... 433 812 1,908
Other non-cash..................................................... -- 794 --
Changes in assets and liabilities net of effects of business entity
divestitures:
(Increase) decrease in accounts receivable....................... 3,020 6,360 (15,597)
(Increase) decrease in inventories............................... 5,381 (8,247) (11,201)
(Increase) decrease in other current assets...................... 511 (438) 1,191
Increase (decrease) in accounts payable.......................... (440) (2,729) 4,951
Increase (decrease) in deferred revenue.......................... 3,637 -- --
Increase (decrease) in accrued expenses.......................... 1,681 (751) 5,303
Increase (decrease) in other current liabilities................. 55 (63) 122
----------- --------- ---------
NET CASH USED IN OPERATING ACTIVITIES................................ (14,190) (31,788) (51,682)
----------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment..................................... (3,333) (3,235) (14,413)
Cash received from sale of marketable securities and other investments
(Notes A and B) 17,178 144 13,393
Expenditures for investments........................................... (5,025) -- (7,111)
Purchase of other assets (Note B)...................................... 280 (895) --
Other receivables (Note M)............................................. -- -- 2,621
Cash of former subsidiary (Note A)..................................... -- -- (6,961)
----------- --------- ---------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES.................. 9,100 (3,986) (12,471)
----------- --------- ---------
F-8
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS -- (Continued)
(In Thousands)
Year Ended January 31,
--------------------------------------
2003 2002 2001
------------ ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term debt, net of repayments (Note D)............ (1,043) (172) (56)
Proceeds from long-term debt (Note E)................................ -- 26 2,412
Repayment of long-term debt (Note E)................................. (363) (39) (99)
Proceeds from debentures (Note F).................................... -- 29,749 --
Proceeds from convertible preferred stock issued by subsidiary
(Note J)........................................................... -- -- 46,638
Proceeds from common stock issued by subsidiary (Note I)............. -- -- 7,851
Proceeds from common stock (Note I).................................. -- 9,645 --
Proceeds from stock option and warrant exercises (Notes I, J and K).. -- 861 3,861
Other................................................................ -- (18) --
------------ ----------- -----------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES.................. (1,406) 40,052 60,607
------------ ----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........................ (6,496) 4,278 (3,546)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD......................... 14,243 9,965 13,511
------------ ----------- -----------
CASH AND CASH EQUIVALENTS - END OF PERIOD............................... $ 7,747 $ 14,243 $ 9,965
============ =========== ===========
See accompanying notes to consolidated financial statements.
F-9
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 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.
A. THE COMPANY AND BASIS OF PRESENTATION
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates that affect the reported amounts of assets,
liabilities, revenues and expenses, the disclosure of contingent assets and
liabilities. Actual results could materially differ from these estimates.
We have incurred significant losses and negative cash flows from
operations for the past two years. Sorrento Networks, Inc. ("SNI"), the
Company's principal operating subsidiary has primarily been the operating entity
responsible for these high losses and negative cash flows. The losses have been
generated as SNI continues to develop its technology, marketing and sales and
operations in its effort to become a major supplier of metro and regional
optical networks world-wide. In addition, we have incurred significant
restructuring costs of approximately $2.8 million in 2003 associated with
restructuring of our obligations under our Senior Convertible Debentures and
Series A Preferred Stock Holders obligations. While we feel these restructuring
costs are beneficial to our long-term survival in a depressed telecom market,
there is no certainty the restructuring will be approved by the shareholders or
will close with our Series A Holders and Senior Convertible Debenture Holders
even with Shareholder approval.
Even if our debenture repayment obligations are not accelerated, 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.
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 $22.3 million and we received net
proceeds of $15.4 million. In addition, NSI repaid advances due us of $5.9
million. 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 was accounted for as an "available for sale
security." Under this accounting, the 7.5 million shares of NSI held by us were
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 loss.
In October 2000, we sold 350,000 shares of our investment in NSI for $4.2
million. 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
former Chairman and CEO purchased 100,000 of these shares of NSI for $1.2
million 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% of the outstanding shares of
NSI 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 $13.6 million in cash. One December 9,
2002, we sold one-half of our holdings in DIGI for $3.10 per share. The
purchaser of the stock was
F-10
DIGI, itself. The proceeds from this sale, in the amount of $3.6 million, were
deposited on December 13, 2002. The remaining 1,162,341 DIGI 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. The closing price of DIGI common stock on January 31,
2003 was $3.35, and is reflected in the valuation of our marketable securities
as of that date.
Entrada Networks, Inc. -- On August 31, 2000, we completed a merger of
our then subsidiary 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 $3.3
million. 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, would have received 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, 2003 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 $5.1 million. 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. In April 2003 our Board of
Directors determined that our ENI should be made available for general corporate
purposes, and we are no longer reserving any for distribution to option and
warrant holders as of November 20, 2000.
The remaining 326,034 ENI shares owned by us were accounted for as of
July 31, 2003 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.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation -- The balance sheets and the consolidated
statement of operations for the years ended January 31, 2003 and 2002 and the
consolidated statement of operations for the year ended January 31, 2001 reflect
our accounts and all subsidiaries controlled by us after the elimination of
significant intercompany transactions and balances. The consolidated statement
of operations for the year ended January 31, 2001 includes the results of
Entrada through August 31, 2000 after which date we no longer controlled
Entrada. The consolidated group is referred to individually and collectively as
the "Company," "We," "Our," or "Us."
Use of Estimates --The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates that affect the reported amounts of
assets, liabilities, revenues and expenses, the disclosure of contingent assets
and liabilities. Actual results could materially differ from these estimates. In
the opinion of Management, all adjustments (which include normal recurring
adjustments and charges described in the notes to the financial statements)
necessary to present fairly the financial position, results of operations and
cash flows for the years ended January 31, 2003, 2002 and 2001 have been made.
Cash and Cash Equivalents -- All cash on hand and in banks, certificates
of deposit and other highly-liquid investments with original maturities of three
months or less, when purchased are considered to be cash equivalents.
F-11
Accounts and Notes Receivable -- In the normal course of business, we
extend unsecured credit to our customers related to the sales of various
products. Typically credit terms require payment within thirty days from the
date of shipment.
Allowance for Doubtful Accounts -- We provide an allowance for doubtful
accounts based on our continuing evaluation of our customers' credit risk. We
generally do not require collateral from our customers.
Inventory -- Inventory, comprised of raw materials, work in process,
finished goods and spare parts, are stated at the lower of cost (first-in,
first-out method) or market. We periodically evaluate our on-hand stock and make
appropriate disposition of any stock deemed excess or obsolete. Inventories at
January 31, 2003 and 2002 consist of:
2003 2002
---------- ----------
Raw material................................................................ $10,767 $14,593
Work in process............................................................. 2,804 879
Finished goods.............................................................. 6,326 9,806
-------- --------
19,897 25,278
Less: Valuation reserve..................................................... (5,963) (6,468)
-------- --------
$13,934 $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 and ENI 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
January 31, 2003, and 2002 marketable securities were as follows:
Cost Unrealized Gains Market Value
-------- ---------------- --------------
January 31, 2003:
DIGI.................................................. $ 1,009 $2,884 $3,893
Entrada............................................... 22 44 66
-------- ---------------- -------------
$ 1,031 $2,928 $3,959
======== ================ =============
January 31, 2002:
NETsilicon............................................ $ 3,938 $24,142 $28,080
Entrada............................................... 22 18 40
-------- ---------------- -------------
$ 3,960 $24,160 $28,120
======== ================ =============
Fair Value of Financial Instruments -- The fair value of financial
instruments is determined by reference to various market data and other
valuation techniques as appropriate. We believe that there are no material
differences between the recorded book values of our financial instruments and
their estimated fair value.
Property and Equipment -- Property and equipment are recorded at
historical cost. Depreciation and amortization are provided over the estimated
useful lives of the individual assets or the terms of the leases if shorter
using accelerated and straight-line methods. Property and equipment are reviewed
for impairment whenever events or circumstances indicate that the asset's
undiscounted expected cash flows are not sufficient to recover its carrying
amount. We measure impairment loss by comparing the fair market value,
calculated as the present value of expected future cash flows, to its net book
value. Impairment losses, if any, are recorded currently.
Capitalized leases - Capitalized leases are initially recorded at the
present value of the minimum payments at the inception of the contracts, with an
equivalent liability categorized as appropriate under current or non-current
liabilities. Such assets are depreciated on the same basis as described above.
Interest expense, which represents the
F-12
difference between the minimum payments and the present value of the minimum
payments at the inception of the lease, is allocated to accounting periods using
a constant rate of interest over the lease.
Software Development -- Software development costs where technological
feasibility has not been established, are expensed in the period in which they
occurred, otherwise, development costs that will become an integral part of our
products are deferred in accordance with Statement of Financial Accounting
Standards Nos. 2 and 86. The deferred costs are amortized using the
straight-line method over the remaining estimated economic life of the product
or the ratio that current revenues for the product bear to the total of current
and anticipated future revenues for that product. Amortization expense for the
years ended January 31, 2003, 2002 and 2001 was $0, $0, and $1,046,
respectively, over 3 to 5 years. Accumulated amortization was $398 as of January
31, 2003 and 2002, bringing the net book value to zero as of January 31, 2003
and 2002.
Purchased Technology -- Technology assets were acquired in connection
with the acquisition of Sciteq. These assets were analyzed during and after the
close of the acquisition. The discounted projected future cash flow from proven
technology and software are capitalized and amortized over their remaining
estimated economic life (7 years) using the straight-line method. Accumulated
amortization was $2,415 and $1,994 at January 31, 2003 and 2002, respectively.
We assess the recoverability of purchased technology primarily by
determining whether the amortization of the net book value of purchased
technology over its remaining life can be recovered through undiscounted future
operating cash flows of the acquired operation. The amount of the impairment, if
any, of the net book value of the excess cost over net assets acquired is
measured by determining the fair value of these assets primarily based on
projected discounted future operating cash flows from the purchased technologies
using a discount rate commensurate with our cost of capital.
Research and Development -- We expense research and development costs as
incurred in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 2, "Accounting for Research and Development Costs." Research and development
costs are costs associated with products or processes for which technological
feasibility has not been proven and future benefits are uncertain. In-process
research and development purchased by us includes the value of products and
processes in the development stage and have not reached technological
feasibility; this amount is expensed at the date of purchase.
Other investments -- Other investments, included in other assets, include
non-marketable securities held in other companies including a privately held
competitive local exchange carrier, and a broadband services carrier, UFO
Communications, Inc. ("UFO").
In November 2000, we sold all our shares in this local exchange carrier
for $9,937 and $320 in accumulated, unpaid dividends. Of the total $10,257 due
from the purchaser, approximately 7.7% or $787 was held in a segregated escrow
account for one year. The gain of $3,701 on the sale of the shares is included
in investment income in the accompanying income statement. Due to a dispute, a
$787 reserve against the remaining escrow balance was recorded during the fiscal
year ended January 31, 2002.
During the year ended January 31, 2001, we made sales of $5,746, to this
local exchange carrier under a long-term equipment financing agreement. The
purchase agreement with this customer provides for invoiced installation and
other deployment expenses not to exceed 10% of the equipment cost. The terms of
the financing agreement provide that the customer may convert any balances
outstanding longer than 90 days into a level 35-month term note at 11% per annum
interest. We financed $5,971, including deployment expenses of $210, during
fiscal 2001 for this customer, which was paid in full including accrued interest
during January 2001. We financed $3,328 of receivables, including deployment
expenses of $120, during fiscal 2000 for this customer and $3,000 of the then
unpaid note was exchanged for our equity interest in the customer. The remaining
balance of the note and accrued interest of $344 was paid in cash.
On November 12, 2002, as part of a strategic relationship, we purchased
$5 million of UFO Communications, Inc. Series B preferred stock. UFO provides
enterprise broadband optical communications services in major metropolitan
areas. UFO currently operates metropolitan optical networks in San Francisco and
Chicago. We have already supplied optical networking equipment for these
markets.
F-13
Revenue Recognition -- We generally recognize product revenue when the
products are shipped, all substantial contractual obligations, if any, have been
satisfied, and the collection of the resulting receivable is reasonably assured.
When title does not pass to the customer at time of shipment, revenue is not
recognized until all contractual requirements are met and title has transferred.
During this transition period, the amount of the sale and/or installation is
shown in deferred revenue.
Revenue from installation is recognized as the services are performed to
the extent of the direct costs incurred. To date, installation revenue has not
been material. Revenue from service obligations, if any, is deferred and
recognized over the life of the contract. Inventory or demonstration equipment
shipped to potential customers for field trials is not recorded as revenue. We
accrue for warranty costs, sales returns and other allowances at the time of
shipment. Although our products contain a software component, the software is
not sold separately and we are not contractually obligated to provide software
upgrades to our customers.
Warranty and Customer Support -- We typically warrant our products
against defects in materials and workmanship for a period of one to five years
from the date of sale and a provision for estimated future warranty and customer
support costs is recorded when revenue is recognized. To date, warranty and
customer support costs have not been material.
Income Taxes -- Income taxes are accounted for in accordance with
Statement of Financial Accounting Standards No. 109 "Accounting for Income
Taxes." The statement employs an asset and liability approach for financial
accounting and reporting of deferred income taxes generally allowing for
recognition of deferred tax assets in the current period for future benefit of
net operating loss and research credit carry forwards as well as items for which
expenses have been recognized for financial statement purposes but will be
deductible in future periods. A valuation allowance is recognized, if on the
weight of available evidence it is more likely than not that some portion or all
of the deferred tax assets will not be realized. (See Note L).
Advertising -- We expense advertising expenditures as incurred.
Loss Per Common Share -- We compute earnings per share based on the
provision of SFAS No. 128, "Earnings Per Share." Basic income and loss per
common share is computed by dividing net income or loss available to common
shareholders by the weighted average number of common shares outstanding during
each period presented. Diluted EPS is based on the weighted average number of
common shares outstanding as well as dilutive potential common shares, which in
our case consist of convertible securities outstanding, shares issuable under
stock benefit plans, and shares issuable pursuant to warrants. In computing
diluted EPS, net income or loss available to common shareholders is adjusted for
the after-tax amount of interest expense recognized in the period associated
with convertible debt. Potential common shares are not included in the diluted
loss per share computation for the years ended January 31, 2003, 2002 and 2001
as they would be anti-dilutive. All references in the financial statements of
common shares and per share data give effect to the 1-for-20 stock split
effective October 28, 2002. (See Note M).
Foreign Currency Translation -- Our foreign operations have been
translated into U.S. dollars in accordance with the principles prescribed in
SFAS No. 52, "Foreign Currency Translation." For the periods presented the
current rate method was used whereby all assets and liabilities are translated
at period end exchange rates, and the resultant translation adjustments would
have been included as a separate component of stockholders' equity had such
adjustments been material. Revenues and expenses are translated at the average
rates of exchange prevailing throughout the period, and the resultant gains and
losses are included in net earnings.
Stock-Based 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. The amount
of deferred stock compensation 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 fiscal years ended January 31, 2003 and 2002, we
amortized $250 and $625 of the total $2,604 initially recorded for deferred
stock compensation. (See Note J).
For non-employees, we compute the fair value of stock-based compensation
in accordance with Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for stock-Based Compensation," and Emerging
F-14
Issues Task 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 Networks subsidiary granted by it to its consultants; during the
fiscal years ended January 31, 2003 and 2002, we recorded $183 and $187 for
options granted to consultants. (See Note J).
The FASB 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 was 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 on our financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure," which amended SFAS No.
123, "Accounting for Stock-Based Compensation." The new standard proves
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. Additionally, the
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in the annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. This statement is effective for financial
statements for fiscal years ending after December 15, 2002. In compliance with
SFAS No. 148, Sorrento has elected to continue to follow the intrinsic value
method in accounting for its stock-based employee compensation arrangement as
defined by Accounting Principles Board Opinion ("APB") No. 25, Accounting for
Stock Issued to Employees, and has made the applicable disclosures in Note K to
the consolidated financial statements.
Computer Software for Internal Use -- Statement of Position ("SOP") 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," is effective for financial statements with fiscal years beginning
after December 15, 1998. The SOP provides guidance on accounting for the costs
of computer software developed or obtained for internal use. The SOP requires
that we continue to capitalize certain costs of software developed for internal
use once certain criteria are met. The adoption of SOP 98-1 had no effect on our
financial position or results of operations.
New Accounting Standards -- In January 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities", an
interpretation of Accounting Research Bulletin No. 51,"Consolidated Financial
Statements." This Interpretation addresses the consolidation by business
enterprises of variable interest entities as defined in the Interpretation. The
Interpretation applies immediately to variable interests in variable interest
entities created after January 31, 2003, and to variable interests in variable
interest entities obtained after January 31, 2003. We have no variable interest
entities and thus this Interpretation is not expected to have a material impact
on our financials statements.
In December 2002, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure." This pronouncement amends SFAS No. 123, "Accounting for Stock-Based
Compensation" to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, this statement also amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements. Certain of the disclosure modifications are
required for fiscal years ending after December 15, 2002 and are included in the
notes to these consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 applies to costs
associated with an exit activity (including restructuring) or with a disposal of
long-lived assets. Those activities can include eliminating or reducing product
lines, terminating employees and contracts, and relocating plant facilities or
personnel. Under SFAS No. 146, a company will record a liability for a cost
associated with an exit or disposal activity when that liability is incurred and
can be measured at
F-15
fair value. Under current rules, companies can record a liability for
restructuring costs when a commitment to a plan of action is made. SFAS No. 146
will require a company to disclose information about its exit and disposal
activities, the related costs, and changes in those costs in the notes to the
interim and annual financial statements that include the period in which an exit
activity is initiated and in any subsequent period until the activity is
completed. SFAS No. 146 is effective prospectively for exit or disposal
activities initiated after December 31, 2002, with earlier adoption encouraged.
Under SFAS No. 146, a company may not restate its previously issued financial
statements, and the new statement grandfathers the accounting for liabilities
that a company had previously recorded under Emerging Issues Task Force Issue
94-3. We do not believe the adoption of this statement will have a material
impact on our consolidated financial statements. We will apply this guidance
prospectively.
In April 2002, the Financial Accounting Standards Board issued SFAS No.
145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections". This statement eliminates the
current requirement that gains and losses on debt extinguishment must be
classified as extraordinary items in the income statement. Instead, such gains
and losses will be classified as extraordinary items only if they are deemed to
be unusual and infrequent, in accordance with the current GAAP criteria for
extraordinary classification. In addition, SFAS 145 eliminates an inconsistency
in lease accounting by requiring that modifications of capital leases that
result in reclassification as operating leases be accounted for consistent with
sale-leaseback accounting rules. The statement also contains other
nonsubstantive corrections to authoritative accounting literature. The changes
related to debt extinguishment will be effective for fiscal years beginning
after May 15, 2002, and the changes related to lease accounting will be
effective for transactions occurring after May 15, 2002. Adoption of this
standard will not have any immediate effect on our consolidated financial
statements. We will apply this guidance prospectively.
In August 2001, the Financial Accounting Standards Board issued SFAS No.
143, Accounting for Asset Retirement Obligations. This Statement is effective
for fiscal years beginning after June 15, 2002. SFAS No. 143 provides accounting
requirements for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. Under the
Statement, the asset retirement obligation is recorded at fair value in the
period in which it is incurred by increasing the carrying amount of the related
long-lived asset. The liability is accreted to its present value in each
subsequent period and the capitalized cost is depreciated over the useful life
of the related 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 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 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. We adopted both SFAS 141 and 142 on February 1, 2002, and
there was no impact to our financial statements.
C. PROPERTY AND EQUIPMENT
Property and equipment of the Company consisted of the following
components as of January 31, 2003 and 2002:
F-16
2003 2002
---------- ---------
Manufacturing, engineering and plant equipment and software............... $ 19,822 $ 15,354
Office furniture and fixtures............................................. 3,154 4,359
Land and building......................................................... 6,721 6,650
Leasehold and building improvements....................................... 1,294 1,294
--------- ---------
Total property and equipment........................................... 30,991 27,657
Less: Accumulated depreciation............................................ (13,888) (10,246)
--------- ---------
Net book value......................................................... $ 17,103 $ 17,411
========= =========
Depreciation expense for fiscal 2003, 2002 and 2001 was $3,642, $2,422,
and $3,404 and respectively.
D. SHORT TERM DEBT
Short term debt at January 31, 2003 and 2002 consisted of the following:
2003 2002
---------- ---------
Floating interest rate loan (2.5% over Coast's prime rate) secured by all $ - $ 1,043
the tangible assets of Meret:...........................................
========== =========
Meret had a line of credit of $2,000 from Coast Business Credit
("Coast"); the line of credit that was collateralized by substantially all the
assets of Meret including accounts receivable, inventory and property and
equipment. We guaranteed this line to the extent of $1,000. This line of credit
provided for interest at 2.5% over the bank's prime rate but not less than 8%
(8.75% at May 30, 2002) with a minimum monthly interest of $8. Advances were
limited to 80% of eligible accounts receivable and 40% of eligible inventory
limited to $740; this line also provides for a $500 letter of credit sub-line.
Subsequent to January 31, 2002, the Loan and Security Agreement was amended
reducing the line of credit to $1,000, adjusting the advance rate for eligible
inventory to 20%, limited to $370, eliminating minimum monthly interest with an
expiration date of July 1, 2002. The highest amount outstanding was $999 and
$1,259 during fiscal years 2003 and 2002 respectively. The average amount
outstanding was $300 and $1,419 during fiscal years 2003 and 2002, respectively.
The line of credit with Coast Business Credit was terminated in May 2002.
E. LONG TERM DEBT
Long term debt at January 31, 2003 and 2002 consisted of the following:
2003 2002
-------- ---------
Variable rate 30 year mortgage note payable (5.5% over LIBOR rate); interest $ 1,269 $ 1,283
rate at January 31, 2003 was 8.95%.........................................
Fixed rate 30 year mortgage note payable; interest rate at January 31, 2003
was 7.6%................................................................... 2,361 2,385
Obligations under finance leases (See Note G)................................. 237 561
-------- ---------
3,867 4,229
Less: Current portion......................................................... 223 362
-------- ---------
$3,644 $3,867
======== =========
On March 25, 1996, Meret completed the purchase of a 35,000 square foot
facility in San Diego, California for $1,779 in cash. On April 24, 1996, Meret
entered into a mortgage agreement with a lender in the amount of
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$1,331 amortized over 30 years with an adjustable interest rate of 5.5% over the
LIBOR rate, adjusted bi-annually. Monthly principal and interest payments are
$11. The interest rate at January 31, 2003 was 8.95%.
In October 2000, we completed our purchase of a 41,000 square foot
facility immediately adjacent to our existing San Diego, California facility.
The purchase price was $4,805 including the assumption of existing indebtedness
of $2,417. Monthly principal and interest payments are $18 and at the end of the
30 year term on January 1, 2010 the remaining balance of $2,109 is due. The loan
has a fixed interest rate of 7.6%.
Long term debt including capitalized leases at January 31, 2003 is
payable by year as follows:
2004................................................................................... $ 223
2005................................................................................... 109
2006................................................................................... 54
2007................................................................................... 58
2008................................................................................... 63
2009 and later......................................................................... 3,360
---------
$3,867
=========
F. DEBENTURES
Debentures - During August 2001, we completed a private placement of our
9.75% convertible debentures receiving net proceeds of $29.8 million. The
debentures, due August 2, 2004 have a face value of $32.2 million, which is
convertible into our common stock at $144.20 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. In addition, the purchasers
received four year warrants to acquire an additional 167,592 shares of our
common stock at $144.20 per share and the placement agent received five year
warrants to acquire 5,583 shares of our common stock, equity securities, options
or warrants at a price less than $144.20 per share or at a discount to the then
market price. The conversion price and warrant exercise 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 are amortized as additional interest expense over the period the debentures
are outstanding. Interest expense during the year ended January 31, 2003 of $9.6
million included the stated 9.75% interest of $2.3 million which was paid in
174,863 shares of common stock and $292 in cash, amortization of issuance costs
of $770, and amortization of the fair value of the warrants issued to the
purchasers and placement agent and the deemed beneficial conversion feature of
$6,134. The fiscal 2002 financial statements have been restated to reflect a
change in the beneficial conversion feature. The revision had the impact of
decreasing additional paid in capital and unamortized debenture discount by
approximately $7.7 million. At January 31, 2003 and 2002 debentures payable
consists of:
2003 2002
(Restated)
----------- -----------
Face Value...................................................................... $ 32,200 $ 32,200
Issuance costs.................................................................. (2,451) (2,451)
Value of warrants and deemed beneficial
Conversion feature....................................................... (19,525) (19,525)
----------- -----------
Debenture book value at issuance..................................... 10,224 10,224
Accumulated amortization of
Issuance costs........................................................... 881 92
Value of warrants and deemed beneficial conversion feature............... 7,016 911
----------- -----------
$ 18,121 $ 11,227
=========== ===========
F-18
We are in the process of a debt and equity restructuring plan that would
exchange current outstanding debentures and Series A Preferred stock for common
stock and an issuance of a smaller new debenture. See Note R for further
information.
G. LEASES, OTHER COMMITMENTS AND CONTINGENCIES
Leases
Rental expense under operating leases was $1.6 million, $1.3 million, and
$1.3 million for the years ended January 31, 2003, 2002 and 2001, respectively.
The table below sets forth minimum payments under capital and operating leases
with remaining terms in excess of one year, at January 31, 2003:
Capital Operating
Leases Leases
---------- -----------
2004.................................................................... 198 301
2005.................................................................... 55 158
2006.................................................................... -- 131
2007.................................................................... -- 42
2008 -- 18
---------- -----------
253 650
===========
Less: Amount representing interest...................................... (16)
-----------
Present value of minimum annual rentals................................. 237
===========
The net book value of equipment under capital leases was $657 and $1,071
at January 31, 2003 and 2002, respectively.
Other Commitments
We previously reimbursed Entrada on a prorata basis for space in its San
Diego facility utilized by Meret. During the twelve months ended January 31,
2003 and 2002, we paid $54 and $48 to Entrada under this month to month
agreement.
In March 2001, our Meret subsidiary entered into a $2.7 million supplier
agreement. The agreement requires a minimum monthly cash outlay of $50 extending
over a period of fifty-four months. The remaining balance at January 31, 2003 of
$1.5 million is expected to end in March 2005. The product being acquired is a
component used in a product for one of Meret's customers for which there is a
five year sales contract.
Contingent Liabilities
One of our component suppliers is contending that our efforts to
reschedule shipments of certain components constitutes an anticipatory breach of
the purchase order by which the components were ordered, and has informed us
that they believe they are entitled to damages in the approximate amount of
$900, despite the fact the goods in question have not as yet been shipped. We
do not believe that our supplier can support the amount of the alleged
cancellation fee, and we are trying to work out a business solution to the
dispute. Our supplier has threatened litigation if the dispute is not
satisfactorily resolved and while we believe that our defenses to both
liability and damages are strong, we can give no assurance that our position in
such litigation would prevail.
In the merger agreement between our predecessor corporation and Sync
Research, we agreed to indemnify and hold our former subsidiary, Entrada,
harmless against any liability arising after the merger in connection with the
termination of a certain pension plan previously maintained by Entrada. In the
third quarter, we were advised by a consultant retained by us and by the
successor corporation to the entity from whom we originally purchased the
company that became Entrada that the cost of termination of the pension plan in
question is in excess of $3 million.
F-19
While we do not believe that we are liable for this cost, it is possible that
the successor corporation, which has been funding the pension plan since 1996,
may seek a substantial contribution from us towards this liability.
H. 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 SNI 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, the 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. The Exchange Agreement
entered into in connection with our proposed capital restructuring provides that
this litigation will be dismissed with prejudice against the Company, its
subsidiaries, and its current officers and directors, and without prejudice
against all other defendants, at the closing of the Agreement. (See Note R).
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 per year for three years of consulting services and loans by us for the
exercise of previously granted options to acquire 58,925 options at prices
varying from $140.60 to $985.00 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 3,556 options, applying the $500 accelerated payment to the exercise.
In addition, he exercised 25,369 options for which we were contractually
obligated to loan the $5.0 million due on the exercise. Mr. Chadha provided us
with written notification dated in September 2001 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
25,369-option exercise was rescinded. Mr. Chadha returned the 25,369 shares to
us for cancellation and we cancelled the receivable due from him and restored
the original option agreements. In June 2002, we filed with the Superior Court
of California, County of Los Angeles a Complaint for Declaratory Relief
regarding the interpretation of the agreement. Also in June 2002, Mr. Chadha
filed a lawsuit against us in the Superior Court of California, County of Los
Angeles, seeking declaratory relief with respect to the interpretation of his
separation agreement and in addition, alleging breach of contract with respect
to his option exercise rights and fraud in connection with his rescission
agreement. In February 2003, both of these lawsuits were dismissed without
prejudice to facilitate settlement negotiations, but they can be refiled at any
time. In April 2003, an agreement in principle to settle these lawsuits was
reached, subject to the execution of a definitive agreement. There can be no
assurance that such a definitive settlement agreement will be executed. Should
the cases be refiled, and should Mr. Chadha prevail in Court, in addition to
any other relief that may be granted, we may be required to issue him 58,925
shares of our stock for no consideration, and/or pay him cash damages, which he
alleges to be in excess of $4 million.
F-20
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 arbitrator has issued a decision favorable to Dr.
Cheng, and having exhausted our legal remedies, we have paid Dr. Cheng $610 in
full satisfaction of the arbitration award.
In addition, claims in arbitration have been filed by two of our former
financial officers and employees who worked in our Santa Monica office, which
has now been closed, alleging that their resignations in May 2002 were for "good
reason" as defined in their employment agreements, all of which were to expire
on May 22, 2002. We are disputing these claims, and have filed counterclaims in
one of the arbitrations. The aggregate amount of these claims is in excess of
$490.
We have also filed a lawsuit against United Pan Europe Communications,
N.V., one of our customers and a related party to one of Sorrento's Series A
shareholders, in connection with a past due receivable in the amount of $1.6
million for equipment shipped in 2000. The defendant has filed for protection
under the federal bankruptcy laws, and pursuant to the Exchange Agreement
entered into in connection with our capital restructuring, we have executed a
definitive settlement agreement and a stipulation of dismissal with prejudice
resolving this lawsuit in return for a payment of $350 and the return of certain
of the equipment previously shipped. We have received the payment of $350 from
UPC and, in accordance with the terms of the exchange agreement, have paid that
same amount to certain Series A Preferred Stock holders. The equipment has
also been returned.
We have also been sued by a former officer of our Sorrento subsidiary
alleging breach of a consulting agreement we entered into with him in March
2002, following his resignation "for good reason" as defined in his employment
agreement. He is seeking acceleration of consulting fees due to him under his
consulting agreement in the amount of $229. We feel these claims are without
merit and are vigorously defending the claims. We have also filed counterclaims.
Currently, the matter is in the early stages of discovery.
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.
I. STOCKHOLDERS' EQUITY
Effective as of October 28, 2002 we implemented a one-for-twenty reverse
split of our outstanding shares of common stock. No fractional shares were
issued in connection with the reverse stock split. In lieu of fractional shares,
stockholders will receive a cash payment based on the market price, after
adjustment for the effect of the stock combination. The par value of the common
stock changed to $6.00 per share and the number of authorized shares decreased
from 150 million to 7.5 million shares of common stock. The reverse stock split
also affects options, warrants and other securities convertible into or
exchangeable for shares of the Company's common stock that were issued and
outstanding immediately prior to the effective time of the stock combination.
Preferred stock was not affected.
We are authorized to issue the following shares of stock:
7,500,000 shares of Common Stock ($6.00 par value)
2,000,000 shares of Preferred Stock ($.01 par value) of which the
following series have been designated:
3,000 shares of Preferred Stock, Series D
1,000,000 shares of Preferred Stock, Series F
F-21
We have outstanding the following shares of preferred stock:
Shares Par Liquidation
Outstanding Value Preference
----------- ----- ----------
Series D................................................. 1,353 $0.01 $ 1,353
----------- ----- -----------
1,353 $0.01 $ 1,353
=========== ===== ===========
During January 2001, we issued 86,464 shares of our common stock in
conversion of 1,500 shares of our Series D preferred stock. The remaining 1,353
shares of our non-voting, non-dividend bearing Series D preferred stock are
being held in escrow pending resolution of acquisition contingencies including
liabilities related to funding deficits related to a terminated defined benefit
pension plan of Entrada. Payments by the seller towards these liabilities will
have no effect on our financial results and payments, if any, by us will reduce
the face value of the preferred stock. Each share of Series D preferred stock is
convertible into common stock at the market value at the date of conversion and
we have the right to redeem the shares prior to conversion for 100% of their
conversion value.
J. OTHER CAPITAL STOCK TRANSACTIONS AND BUSINESS ACQUISITIONS
Stock Split - In October, 2002, approval was granted for a one-for-twenty
reverse stock split effective October 28, 2002. The effect of this stock split
was reflected in the financial statements retroactively as if the stock split
occurred at the beginning of the earliest period reported.
Private Placements - Immediately prior to its merger with Sync Research
our Entrada subsidiary completed a private placement of 2,431,818 of its common
shares receiving net proceeds of $7,851. We purchased 1,001,818 of these shares
for $3,306. (See Note A).
On March 22, 2001, we completed a private placement of 76,300
unregistered shares of our common stock receiving net proceeds of $9.6 million.
In addition, the purchasers received three-year warrants to acquire an
additional 19,075 shares of our common stock at $163.80 per share. For a period
of 18 months from the March 22, 2001 completion date in the event we were to
issue shares of common stock or equity securities convertible into our common
stock at a price less than $131.062 per share, the purchasers would be entitled
to receive additional shares of common stock.
During 2000, SNI completed a sale of 8,596,333 shares of its Series A
Convertible Preferred Stock receiving net proceeds of $46.6 million from a group
of investors. 1,467,891 shares were purchased by, and a finders fee of $2.0
million was paid through the issuance by Sorrento of an additional 357,799
shares of its Series A Convertible Preferred Stock to, entities in which one of
our outside directors at the time, who later in 2000 served for several months
as our Chairman and CEO, was a partner or member pursuant to a previously
contracted right of participation.
One of our current outside directors purchased 183,486 shares in this
placement. At the time of purchase, he was not one of our directors. This
individual is also a director of Liberty Media Corporation, which owns an
approximate 74% economic interest representing an approximate 94% voting
interest in United GlobalCom ("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 it has agreed to exchange for shares in UGC.
Each share of SNI's Series A Preferred Stock is convertible into one
share of SNI'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 SNI's
common stock upon an underwritten public offering by SNI with an aggregate
offering price of at least $50.0 million. As SNI did not complete a $50.0
million public offering by March 1, 2001, the holders of more than 50% of the
then outstanding Series A shares had the right to request in writing that SNI
redeem them at the adjusted liquidation preference. On receipt of such a
request, our Sorrento subsidiary has the obligation to redeem the shares in
cash, if funds are lawfully available for such a redemption, or to redeem such
pro rata portion as to which a lesser amount of lawfully available funds do
exist. In April 2001, our Sorrento subsidiary received written redemption
requests from holders of a majority of the Series A shares. The difference
between the net proceeds received on the sale of these shares
F-22
and their liquidation preference of $48.8 million was recorded as a deemed
dividend during the period from issuance to March 31, 2001. During the year
ended January 31, 2003 and 2002, we recorded a deemed dividend of $0 and $180
with respect to the SNI Series A shares.
As of January 31, 2003 and 2002, the Series A Preferred Stock has been
reclassified as a current liability since the holders have exercised their right
to request that SNI redeem the shares. The Series A liability can only be paid
through lawfully available funds that would normally be generated from SNI
profitable operations, which we do not currently have available or foresee the
availability of the near future.
We made sales of products to affiliates of two of the purchasers of
Sorrento's Series A Preferred Stock. During the years ended January 31, 2003 and
2002, we made sales of $29 and $2,076 to the subsidiaries of the purchaser of
33.8% of the shares of which $29 and $1,601 was outstanding at January 31, 2003
and 2002 under 180 days terms. During the fiscal years ended January 31, 2003
and 2002, we made sales of $568 and $2,553 to the subsidiaries of the purchaser
of 6.2% of the shares of which $324 and $2 was outstanding at January 31, 2003
and 2002 respectively.
Warrants - During the year ended January 31, 2001, we issued 13,009
shares of our common stock upon the cashless exercise by our lender of 16,668
warrants with exercise prices ranging from $10.02 to $15.94. (See Note D).
K. 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.
We account for these plans under the recognition and measurement
principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and
related Interpretations. No stock-based employee compensation cost is reflected
in net loss, as all options granted under these plans had an exercise price
equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net loss and loss per share if the
company had applied the fair value recognition provisions of FASB Statement No.
123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
The following table summarizes the activity in the plans:
Sorrento Networks Corporation (FIBR)
Weighted Average
Number of Shares Exercise Price
---------------- ----------------
Shares under option at January 31, 2000..................... 109,403 $236.60
Granted.................................................. 193,903 $748.40
Exercised................................................ (44,545) $200.20
Canceled................................................. (5,400) $246.20
----------------
Shares under option at January 31, 2001..................... 253,361 $618.60
Granted.................................................. 43,685 $150.40
Exercised................................................ (4,913) $163.40
Canceled................................................. (61,606) $519.60
----------------
Shares under option at January 31, 2002..................... 230,527 $566.00
Granted.................................................. 112,555 $ 25.31
Exercised................................................ -- --
Canceled................................................. (48,805) $406.62
----------------
Shares under option at January 31, 2003..................... 294,277 $387.53
F-23
Additional information relating to stock options outstanding and
exercisable at January 31, 2003 summarized by exercise price are as follows:
Outstanding Exercisable
---------------------------- -------------------------
Weighted Average
Exercise Price ---------------------------- Weighted Average
Per Share Shares Life (Years) Exercise Price Shares Exercise Price
-------------- ------- ------------ -------------- ------- ----------------
$ 4.20 -- $ 19.99...... 73,044 9.61 $ 15.67 43,794 $ 14.95
$ 20.00 -- $ 49.99...... 10,789 9.33 $ 31.70 4,203 $ 31.84
$ 50.00 -- $ 99.99...... 37,694 8.23 $ 57.03 20,837 $ 60.88
$100.00 -- $ 199.99...... 36,021 6.26 $ 142.31 33,879 $ 143.69
$200.00 -- $ 299.99...... 13,612 3.87 $ 243.94 13,612 $ 243.94
$300.00 -- $ 399.99...... 5,746 7.43 $ 355.47 5,746 $ 355.47
$400.00 -- $ 499.99...... 25,359 7.00 $ 447.27 21,194 $ 448.69
$500.00 -- $ 599.99...... 417 3.84 $ 569.20 417 $ 69.20
$600.00 -- $ 699.99...... 8 7.75 $ 623.60 8 $ 623.60
$700.00 -- $ 799.99...... 32,254 7.29 $ 717.91 32,254 $ 717.91
$800.00 -- $ 899.99...... -- -- -- -- --
$900.00 -- $1,382.40...... 59,333 7.34 $1,098.45 59,333 $1,098.45
------- -------
$ 4.20 -- $1,382.40...... 294,277 7.76 $ 387.53 235,277 $ 469.11
======= =======
At January 31, 2003, the Company has four stock-based employee
compensation plans.
Years Ended January 31,
-------------------------------
2003 2002 2001
--------- --------- ---------
Net loss:
As reported.............................................. $(26,210) $(43,136) $ (41,905)
Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects..................... (5,581) (3,842) (61,225)
-------------------------------
Pro forma ............................................... (31,791) (46,978) (103,130)
===============================
Loss per share:
Basic EPS as reported.................................... $ (33.29) $ (62.00) $ (74.20)
===============================
Pro forma basic EPS...................................... (40.37) (67.60) (177.40)
===============================
Diluted EPS as reported.................................. (33.29) (76.32) (74.20)
===============================
Pro forma diluted EPS.................................... (40.37) (91.80) (177.40)
===============================
The fair value of option grants is estimated on the date of grant
utilizing the Black-Scholes option-pricing model with the following weighted
average assumptions for grants during the year ended January 31, 2003: expected
life of option 3 years, expected volatility of 180%, risk free interest rate of
2.15% to 4.50% based upon the date of grant and a 0% dividend yield. The fair
value, at date of grant, using these assumptions range from $3.70 to $62.20 and
the weighted average was $22.19. The assumptions for the year ended January 31,
2002 were expected life of option 3 years, expected volatility of 140%, risk
free interest rate of 2.91% to 4.50% and a 0% dividend yield. The fair value, at
date of grant, using these assumptions range from $46.00 to $112.60 and the
weighted average was $83.60. The assumptions for the year ended January 31,
2001 were expected life of option 3 to 5 years, expected volatility of 85%, risk
free interest rate of 4.89 to 6.75% and a 0% dividend yield. The fair value, at
date of grant, using these assumptions range from $179.40 to $801.80 and the
weighted average was $443.40.
F-24
Sorrento Networks Inc.
In addition SNI adopted its 2000 Stock Option/Stock Issuance Plan in
February 2000 under which it has granted options to certain of its employees,
directors and consultants. All options are generally granted 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, either
through immediate purchase of the shares at fair value or as a bonus tied to
performance of services or the attainment of prescribed milestones. No
milestones were attained and, no stock has been issued under the stock issuance
program.
The option activity for this plan for the year ended January 31, 2003 is
summarized as follows:
Weighted Average
Number of Shares Exercise Price
----------------- ----------------
Shares under option at January 31, 2001................... 18,735,904 $5.34
Granted................................................ 1,193,064 $5.45
Exercised.............................................. (22,300) $2.60
Canceled............................................... (4,592,236) $5.52
-----------
Shares under option at January 31, 2002................... 15,314,432 $5.30
Granted................................................ --
Exercised.............................................. --
Canceled............................................... (12,018,429) $5.39
-----------
Shares under option at January 31, 2003................... 3,296,003 $4.93
Additional information relating to the stock options of SNI outstanding
and exercisable at January 31, 2003 summarized by exercise price are as follows:
Outstanding Exercisable
---------------------------- -------------------------
Weighted Average
Exercise Price ---------------------------- Weighted Average
Per Share Shares Life (Years) Exercise Price Shares Exercise Price
-------------- ------- ------------ -------------- ------- ----------------
$2.00.................... 485,211 7.05 $2.00 482,461 $2.00
$5.45.................... 2,810,792 7.26 $5.45 2,679,826 $5.45
--------- ---------
$2.00 - $5.45............ 3,296,003 7.22 $4.93 3,162,287 $4.93
========= =========
The holders of the options of our Sorrento subsidiary may elect to
convert all or a portion of their options into options to acquire our stock at a
ratio of 78 for one. During the year ended January 31, 2003, 2,340,585 shares
were exchanged for FIBR options and during January 31, 2002, no options were
converted.
Tender Offer
In May 2002 our Board of Directors approved an employees' stock option
exchange program. Under the program, employees holding options to purchase
Sorrento Networks Corp. common stock were given the opportunity to exchange
certain shares of their existing options, those with exercise prices above
$150.00 per share, for new options to purchase an equal number of shares of
Sorrento common stock. The new options were granted six months and one day after
the cancellation of the old options. The exercise price of the new options was
$109.00, the market price on the last reported trading price of Sorrento common
stock on their grant date. Options for 34,960 shares of Sorrento Networks Corp.
common stock were exchanged in the program. (Adjusted for 1-20 reverse split).
Options held by the company's executives and officers were not included in the
exchange program.
F-25
L. INCOME TAXES
Our provision for taxes on income for the years ended January 31, 2003,
2002 and 2001 consists of:
Year ended January 31, 2003:
Current......................................................... $ --
Deferred........................................................ --
--------
Total........................................................... $ --
========
Year ended January 31, 2002:
Current......................................................... $ --
Deferred........................................................ --
--------
Total........................................................... $ --
========
Year ended January 31, 2001:
Current......................................................... $ --
Deferred........................................................ --
--------
Total........................................................... $ --
========
Our domestic operations generate permanent and temporary differences for
depreciation, amortization, valuation allowances and tax attributes arising from
acquisitions. We have recorded a 100% valuation allowance against its deferred
tax assets, including net operating loss and research credit carry forwards, in
accordance with the provisions of Statement of Financial Accounting Standards
No. 109. Such allowance is recognized if, based on the weight of available
evidence, it is more likely than not that some portion or all of the deferred
tax assets will not be realized.
2003 2002
-------- --------
Deferred tax assets:
Valuation allowances.................................................... $ 2,875 $ 3,283
Research and development credits........................................ 63 63
Tax loss carry forwards................................................. 65,754 55,004
Purchase accounting..................................................... 2,057 2,057
Depreciable assets...................................................... 583 583
Other liabilities and reserves.......................................... 2,738 2,334
-------- --------
Gross deferred tax assets............................................. 74,070 63,324
Less: valuation allowance............................................... (74,070) (63,324)
-------- --------
Deferred tax asset.................................................... $ -- $ --
======== ========
At January 31, 2003, we had federal net operating losses which may be
available to reduce future taxable income. Among potential adjustments which may
reduce available loss carry forwards, the Internal Revenue Code of 1986, as
amended, (IRC), reduces the extent to which net operating loss carry forwards
may be utilized in the event there has been an "ownership change" of a company
as defined by applicable IRC provisions. We believe that the issuances of its
equity securities and transfers of ownership of outstanding equity securities
may have resulted in one or more such ownership changes and intends to analyze
the impact of such transfers on the continued availability, for tax purposes, of
the net operating losses incurred through January 31, 2003. Further ownership
changes, such as the pending restructuring agreement, in the future, as defined
by the IRC, may reduce the extent to which any net operating losses may be
utilized. These NOL carry forwards expire as follows:
F-26
2007................................................... $2,327
2008................................................... 1,209
2009................................................... 394
2010................................................... 3,588
2011................................................... 2,819
2012................................................... 4,707
2018................................................... 8,200
2019................................................... 3,963
2020................................................... 45,420
2021................................................... 36,780
2022................................................... 32,508
2023................................................... 22,472
--------
$164,387
========
The reconciliation between income tax expense and a theoretical United
States tax computed by applying a rate of 35% for the years ended January 31,
2003, 2002 and 2001, is as follows:
2003 2001 2001
-------- -------- --------
Income (loss) before income taxes.............................. $(22,610) $(43,136) $(41,905)
======== ======== ========
Theoretical tax (benefit) at 35%............................... (7,914) (15,098) (14,667)
Impact of purchase accounting.................................. -- -- 101
Impact of non-qualified stock options.......................... -- (434) (3,978)
Change in valuation allowance.................................. 10,750 16,862 18,499
Other individually immaterial items............................ (2,836) (1,330) 45
-------- -------- --------
$ -- $ -- $ --
======== ======== ========
M. EARNINGS PER SHARE CALCULATION
The following data show the amounts used in computing basic earnings per
share. The number of shares used in the calculations for the years ended January
31, 2003, 2002 and 2001 reflect a 1-for-20 reverse stock split effective October
28, 2002.
2003 2002 2001
-------- -------- --------
Net loss.................................................. $(26,210) $(43,136) $(41,905)
Less: deemed dividend..................................... -- (180) (1,982)
Less: preferred dividends paid............................ -- -- --
Less: accrued, unpaid preferred dividends................. -- -- (118)
-------- -------- --------
Net loss available to common shareholders used in basic
EPS.................................................... $(26,210) $(43,316) $(44,005)
======== ======== ========
Average number of common shares used in basic EPS......... 787,407 698,303 593,742
======== ======== ========
We incurred a net loss for the years ending January 31, 2003, 2002 and
2001. Accordingly, the effect of dilutive securities including convertible
debentures, convertible preferred stock, vested and nonvested 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.
F-27
2003 2002 2001
---------- -------- --------
Net loss available to common shareholders used in basic
EPS................................................... $ (26,210) $(43,316) $(44,005)
Interest on convertible debt (net of tax)................ (4,826) (18,405) --
---------- -------- --------
Net loss available to common shareholders after
Assumed conversions of dilutive securities............ $ (31,036) $(61,721) $(44,005)
========== ======== ========
Average number of common shares used in basic EPS........ 787,407 698,303 592,742
Effect of dilutive securities:
Convertible preferred stock........................... -- -- 1,102
Stock benefit plans................................... -- -- 81,413
Stock benefit plan of SNI............................. -- -- --
Warrants.............................................. -- -- 4,670
Convertible debentures................................ 223,301 110,437 --
---------- -------- --------
Average number of common shares and dilutive potential
common stock used in diluted EPS...................... 1,010,708 808,740 679,927
========== ======== ========
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.
N. OTHER RELATED PARTY TRANSACTIONS
Summarized below are all material related party transactions entered into
by us and our subsidiaries during the periods presented not otherwise disclosed
in these notes.
In February 2003 we entered into a consulting agreement with Mr. Robert
Hibbard, a member of the Board of Directors, to provide services to the company
at a consulting rate of $175 per hour plus a retainer of $20 thousand per month
for six months. Mr. Hibbard agrees to make himself available to the Company for
not less than 20 hours per week. The term of this agreement is for twelve
months, but may be terminated after six months by either party, with or without
cause, upon 5 days written notice. This agreement supersedes his August 2002
consulting agreement. Nearly all of Mr. Hibbard's consulting work for us has
involved matters being considered or reviewed by the board or by committees of
the board. His work has included structuring and implementing our 2003 Equity
Incentive Plan for employees, participation in settlement negotiations for
pending litigation, assistance in our capital restructuring and improving our
intellectual property policies and procedures, among other matters. In fiscal
year 2003 Mr. Hibbard was paid $92 thousand in consulting fees.
During fiscal 2002, we paid a total of $55 thousand to Phillip W. Arneson
as a Director of the Company. The amounts paid included $24 thousand for
consulting work performed for a special Committee of the Board, $21 thousand for
various other consulting services including outsourcing advice and
organizational matters, attendance fees of $6 thousand for Board and Committee
meetings and $5 thousand in reimbursable expenses. Consulting fees were paid at
a rate equal to normal fees for attendance at Board meetings.
During July 2000 we agreed to loan $300 thousand for three years at the
applicable federal rate provided for in Internal Revenue Code Section 1274 to
Mr. Jacobson in connection with accepting employment as our Senior Vice
President, Legal. This is a full recourse loan and Mr. Jacobson has pledged his
options to acquire our common stock and any options he may receive from any of
our subsidiaries as collateral. Mr. Jacobson has received $300 thousand in
advances under this loan agreement for which the interest rate is 6.6%. On July
3, 2002 a new note covering the $300 thousand was incorporated in Mr. Jacobson's
employment contract. The term remained the same as the July 2000 note, with all
unpaid, accrued interest and principal due and payable on August 30, 2003. In
December 2002, Mr. Jacobson paid $39 thousand on his loan that included payment
of all prior interest due and the remainder applied to his principal balance. As
of January 31, 2003 Mr. Jacobson's loan outstanding to the Company totaled $298
thousand.
F-28
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 thousand per year for three years of consulting services and loans by us
for the exercise of previously granted options to acquire 58,925 options at
prices varying from $140.60 to $985.00 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 3,556 options, applying the $500 thousand accelerated payment to the
exercise. In addition, he exercised 25,369 options for which we are
contractually obligated to loan the $5.0 million 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 25,369
option exercise was rescinded. Mr. Chadha returned the 25,369 shares to us for
cancellation and we cancelled the receivable due from him and restored the
original option agreements. The required non-cash expense as a result of the
rescission equal to the difference between the amount of the loan receivable and
the market value of the returned shares was recorded as a reserve of $2.7
million against the receivable during the year ended January 31, 2002 and is
included in other operating expenses in the accompanying income statement. This
rescission agreement did not resolve any underlying dispute as to the option
loan repayment obligations. An agreement in principle to resolve this dispute
has been reached, see details in Note H.
On September 30, 2001, our then Chairman and CEO executed a two year
consulting agreement with Leonard Hecht, A FORMER EMPLOYEE OF THE COMPANY,
whereby Mr. Hecht is to be paid a salary at $250 thousand per year plus benefits
and the vesting of all his options to acquire our common stock. We have since
stopped making payments under this agreement, and have been notified by Mr.
Hecht that he believes we have thereby breached this agreement.
In September 2000, our then Board of Directors approved a two year
consulting agreement with Rohit Phansalkar, A FORMER EMPLOYEE OF THE COMPANY,
whereby he is paid a salary of $250 thousand per year plus benefits and the
vesting of all his options to acquire our commons stock. This agreement was
amended in July 2001.
O. SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest expense for the years ended January 31, 2003, 2002 and 2001 was
$9,619, $3,311 and $918, respectively. During fiscal 2003, $292 was paid in cash
and the remaining $9,327 neither provided for nor used cash. For fiscal years
2002 and 2001, the interest expense neither provided nor used cash.
P. CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject us to concentrations of
credit risk consist primarily of temporary cash investments and trade
receivables. As regards the former, we place our temporary cash investments with
high credit financial institutions and limits. At times such amounts may exceed
the F.D.I.C. limits. We limit the amount of exposure with any one financial
institution and believe that no significant concentration of credit risk exists
with respect to cash investments. No accounts at a single bank accounted for
more than 10% of current assets.
Although we are directly affected by the economic well being of
significant customers listed in the following tables, we do not believe that
significant credit risk exists at January 31, 2003. We perform ongoing
evaluations of our customers and require letters of credit or other collateral
arrangements as appropriate. Accordingly, trade receivable credit losses have
not been significant.
The following data shows the customers accounting for more than 10% of
net receivables at January 31 2003 and 2002:
F-29
2003 2002
---- ----
Customer A..................................................... 29.6% 20.4%
Customer B..................................................... 18.7 --
Customer C..................................................... -- 19.8
Customer D..................................................... 15.9 13.9
Customer E..................................................... -- 24.7
Customer F..................................................... 31.2 3.9
The following data shows the customers accounting for more than 10% of
net sales during the years ended January 31, 2003, 2002 and 2001:
2003 2002 2001
---- ---- ----
Customer A..................................................... 23.0% 14.9% 8.2%
Customer B..................................................... 19.0 23.9 15.7
Customer C..................................................... 12.2 16.3 2.8
Customer D..................................................... 1.3 7.8 21.7
Customer E..................................................... 0.6 6.9 10.9
Customer F..................................................... -- 5.6 12.2
Q. SUBSEQUENT EVENTS
Litigation resolution
On March 4, 2003, SNI and UPC executed a Settlement Agreement resolving
the litigation between SNI and UPC, exchanging mutual releases, and dismissing
the litigation against UPC with prejudice, in exchange for the return of certain
equipment by UPC and the payment of $350 thousand. We have received the payment
of $350 from UPC and, in accordance with the terms of the Exchange Agreement,
have paid that same amount to certain Series A Preferred Stock holders to defray
legal costs incurred by them. The equipment has also been returned.
In April 2003, an agreement in principle was reached to settle our
dispute with Par Chadha and the other parties to our dispute with Mr. Chadha,
subject to the execution of a definitive agreement. There can be no assurance
that such a definitive agreement will be executed.
Nasdaq
On March 6, 2003 we presented before the Nasdaq Panel our reasons for
the request for an extension of time to complete our restructuring plans. On
April 4, 2003, the Panel issued a decision extending until May 16, 2003, our
time to demonstrate compliance with the minimum shareholder equity standard. As
our current plan is to close the capital restructuring, subject to shareholder
approval, on or about May 21, 2003, we are asking the Panel for a short
extension on the May 16 deadline. While there can be no assurance that the Panel
will grant this extension, our understanding is that Panels customarily grant
such short extensions under circumstances such as these.
If our stock is delisted from Nasdaq, the ability of holders of our
common stock to sell our stock could be adversely affected, our ability to
secure future funding might be severely impacted, and there could be a material
adverse effect on our financial condition.
R. RESTRUCTURING AGREEMENT IN PRINCIPLE
On March 6, 2003, we and our wholly-owned subsidiary Sorrento Networks,
Inc. entered into an Exchange Agreement with the holders of our 9.75% Senior
Convertible Debentures (the "Debentures") and the Series A Convertible Preferred
Stock (the "Preferred Stock") of Sorrento Networks, Inc. The Exchange Agreement
and associated documents contemplate an exchange (the "Exchange") of the
Debentures and the Preferred Stock at a closing into shares of common stock and
$12.5 million of our new 7.5% secured convertible debentures (the "New
F-30
Debentures"). Certain holders of the Preferred Stock would also receive
additional New Debentures of approximately $600,000 to pay certain legal fees.
The shares of common stock and the New Debentures to be issued in the
Exchange will represent, in the aggregate, approximately 87.5% of our common
stock on a diluted basis. This percentage takes into account the total number of
existing shares outstanding, the shares to be issued to the holders of the
Debentures and the Preferred Stock at the closing, the shares issuable upon
conversion of $12.5 million of New Debentures, and the shares issuable upon
conversion of warrants to be issued to existing shareholders. This percentage
does not take into account new employee stock options, shares issuable upon
conversion of approximately $600,000 in New Debentures to be issued to certain
holders of the Preferred Stock to pay certain legal fees, and certain other
issuances. The exact number of shares of common stock that will be issued to the
holders of the Debentures and the Preferred Stock upon consummation of the
Exchange will depend on the conversion price of the New Debentures, which will
not be known until shortly before closing. The New Debentures that will be
issued in the Exchange (not including the New Debentures to be issued in
satisfaction of legal fees) will be convertible into not less than 8.75%, or
more than 26.25%, of our shares of common stock, calculated on the same diluted
basis.
The Exchange Agreement contemplates that our existing shareholders will
retain 7.5% of our common stock on the same diluted basis, and will receive
non-transferable warrants to purchase approximately 5% of our common stock,
exercisable beginning one year after the closing at a 10% premium over an
average closing price of our stock prior to the closing of the Exchange. We will
establish a record date not more than ten business days prior to the closing to
determine the specific holders of our common stock who will be entitled to
receive the warrants. The warrants will be exercisable at any time prior to
August 2, 2007, provided that any such exercise of the warrants will be subject
to the effectiveness of a registration statement with respect to the common
shares to be issued upon exercise of the warrants. We may repurchase the
warrants for a nominal price, upon 30 days prior notice, at any time after the
volume-weighted average market price of our common stock for any ten consecutive
trading days equals or exceeds 150% of the exercise price.
The New Debentures will mature on August 2, 2007 and will be
convertible at any time at the option of the holder at a conversion price equal
to the reference price into shares of our common stock. However, the number of
shares issuable upon conversion of the New Debentures on a diluted basis as of
the closing cannot represent less than 8.75%, or more than 26.25%, of our shares
of common stock. Subject to certain limits, interest on the new debentures may
be paid, at our option, either in cash, additional new debentures or our common
stock.
The new debentures would include covenants restricting our ability to
incur senior or subordinated debt or preferred stock other than $5 million in
lease or equipment financing and a $5 million revolving credit facility (up to
$10 million with certain consents), as well as other standard covenants and
protective provisions. At any time prior to the maturity date, we may redeem for
cash on a pro rata basis some or all of the new debentures at par, plus accrued
interest.
At the closing of the restructuring transaction, the New Debentures
will be secured by substantially all of our assets and those of our subsidiaries
(with certain exceptions, including the real estate owned by Meret
Communications, Inc., and Sorrento Valley Real Estate Holdings, LLC). No later
than one year following the closing date, we must provide a second mortgage on
such real estate as security for the New Debentures. When we have done so and we
have merged our subsidiaries into us, most of the remaining collateral will be
released or subordinated at our request to permit us to obtain a secured loan
from a bank.
Until one year after the closing and subject to certain exceptions,
exchanging holders of debentures and Series A preferred stock who continue to
hold common stock received in the exchange and new debentures will be entitled
to certain weighted average anti-dilution protection for such continued holdings
with respect to certain additional issuances of our common stock. In addition,
if we are required to issue shares of common stock upon the exercise of any
right, option or warrant to purchase common stock that was issued prior to the
closing and was not listed on the option schedule to the exchange agreement,
then we will issue additional shares of common stock to the exchanging holders,
and will adjust the conversion price of the new debentures sufficient to offset
the dilutive impact of such issuances.
F-31
The Series A holders as a group may request, on or before the closing,
that we appoint one new director to our Board of Directors. The debenture
holders as a group may also request, on or before the closing, that we appoint
one new director to our Board of Directors. The new director(s) would continue
in office until the next regularly scheduled annual meeting of our shareholders
and shall be nominated for re-election at such meeting.
No later than the day before the closing date of the restructuring
transaction, we will merge with and into a to-be-formed Delaware corporation,
which will be formed solely for the purpose of effecting the change in our state
of incorporation from the State of New Jersey to the State of Delaware. Promptly
after the closing date of the restructuring transaction, and in no event later
than one year after the closing date, our subsidiaries, Sorrento Networks, Inc.,
Meret Communications, Inc., and Sorrento Valley Real Estate Holdings, LLC, will
be merged with and into us.
While we are working to complete the restructuring plan and consummate
the exchange, our ability to do so is not certain, and depends on many factors,
including but not limited to our ability to satisfy or obtain waivers with
regard to the conditions in the definitive agreement, obtain the requisite
consents from the debenture holders and Series A shareholders, pay the
substantial legal costs associated with the restructuring from existing capital
resources, and raise additional capital in a timely manner. If we are not able
to carry out the restructuring plan embodied in the letter of intent, we will
have to explore other alternatives on an expedited basis. There can be no
assurance, however, that we will be able to find an acceptable alternative.
If we are not successful in the restructuring we will be delisted from
Nasdaq, this delisting would constitute a triggering event that would allow our
debenture holders to request accelerated payment of their debentures at 125% of
the face value, this condition gives rise to substantial doubt about the
Company's ability to continue as a going concern. If such an event were to
occur, we would not have the financial resources to repay such a request, thus
resulting in a default under the debenture agreement.
S. SEGMENT INFORMATION
Information for the years ended January 31, 2003, 2002 and 2001 in the
table below is presented on the same basis utilized by the Company to manage its
business. The segments according to product lines are as follows; Sorrento
Networks, Meret Optical and other. Export sales and certain income and expense
items are reported in the geographic area where the final sale to customers is
made, rather than where the transaction originates. We have no material long
term assets outside the United States. The accounting policies of the segments
are the same as the policies described in the "Summary of Significant Accounting
Policies." Each segment operates independent of one another. The company
evaluates the performance of each segment and distributes resources to them
based on earnings before income taxes, excluding corporate charges ("Segment
income (loss) from operations"). Any corporate charges that are allocated to the
segments are allocated as a percentage of revenue. These charges, if any, are
recorded under "other income (expenses)" and are eliminated in the consolidation
process. "Other income (expenses) is not shown in the supplemental segment
information contained below.
Geographical Information
The table below present external revenues based on the locations of the
customer:
2003 2002 2001
------- ------- -------
Net sales:
United States.......................................................... $14,803 $28,341 $36,923
Asia................................................................... 865 1,340 247
Europe................................................................. 9,469 10,130 7,285
Other.................................................................. -- 1,016 186
-------- ------- -------
Total net sales...................................................... $25,137 $40,827 $44,641
======= ======= =======
Products and Service Revenue
The table below presents external revenues for groups of similar
products and services:
F-32
2003 2002 2001
------- ------- -------
Net sales:
Optical networking .................................................... $22,373 $36,034 $38,369
Switching and access................................................... 2,764 4,793 6,272
------- ------- -------
Total net sales...................................................... $25,137 $40,827 $44,641
======= ======= =======
Supplemental Segment Information:
Sorrento Meret
Networks Optical Other Consolidated
-------- ------- ------- -----------
As of January 31, 2003:
Revenues from external customers...................... $ 22,373 $ 2,764 $ -- $ 25,137
Cost of goods sold.................................... 19,257 2,560 -- 21,817
Gross profit....................................... 3,116 204 -- 3,320
Segment income/(loss) from operations................. (25,017) (1,329) (4,929) (31,329)
Depreciation and amortization expense................. 3,257 702 103 4,063
Valuation allowance additions (reductions):
Receivables and inventory.......................... (704) (316) -- (1,020)
Capital asset additions, net.......................... 3,201 62 70 3,333
Total assets.......................................... 31,497 5,375 18,933 55,805
Sorrento Meret
Networks Optical Other Consolidated
-------- ------- ------- -----------
As of January 31, 2002:
Revenues from external customers.................... $ 36,034 $4,793 $ -- $ 40,827
Cost of goods sold.................................. 28,384 3,123 -- 31,507
Gross profit..................................... 7,650 1,670 -- 9,320
Segment income/(loss) from operations............... (28,993) 246 (8,407) (37,154)
Depreciation and amortization expense............... 2,039 543 212 2,794
Valuation allowance additions:
Receivables and inventory........................ 5,328 269 987 5,597
Other............................................ 812 -- 1,788 2,600
Capital asset additions, net........................ 3,116 67 52 3,235
Total assets........................................ 36,089 7,282 46,968 90,339
Sorrento Meret Entrada
Networks Optical Networks Other Consolidated
--------- ------- -------- ------- ------------
As of January 31, 2001 except for Entrada
which is as of August 31, 2000:
Revenues from external customers.......... $ 26,477 $6,272 $11,892 $ -- $ 44,641
Cost of goods sold........................ 17,344 3,661 10,465 -- 31,470
Gross profit......................... 9,133 2,611 1,427 -- 13,171
F-33
Sorrento Meret Entrada
Networks Optical Networks Other Consolidated
--------- ------- -------- ------- ------------
Segment income/(loss) from continuing
operations........................... (36,147) 1,031 (7,859) (7,440) (50,415)
Depreciation and amortization expense... 2,593 515 1,024 254 4,386
Valuation allowance additions:
Receivables and inventory.......... 642 678 4,327 700 6,347
Other.............................. 1,979 -- 434 -- 2,413
Capital asset additions, net............ 8,320 157 444 5,492 14,413
Total assets........................... 36,524 9,088 n/a 67,511 113,123
T. VALUATION AND QUALIFYING ACCOUNTS
Changes in the inventory valuation reserve were as follows:
Balance at January 31, 2000............................................. $ 4,070
Additions charged to costs and expenses............................... 3,689
Amounts used during year.............................................. (55)
Balance of Entrada at August 31, 2000................................. (4,912)
Balance at January 31, 2001............................................. 2,792
Additions charged to costs and expenses............................... 4,038
Amounts used during year.............................................. (362)
Balance at January 31, 2002............................................. 6,468
Additions charged to costs and expenses............................... 4,152
Amounts used during year.............................................. (4,657)
Balance at January 31, 2003............................................. $ 5,963
=======
Changes in the accounts receivable valuation reserve were as follows:
Balance at January 31, 2000............................................. $ 1,203
Additions charged to costs and expenses............................... 1,958
Amounts used during year.............................................. (570)
Balance of Entrada at August 31, 2000................................. (1,589)
Balance at January 31, 2001............................................. 1,002
Additions charged to costs and expenses............................... 1,558
Amounts used during year.............................................. (821)
Balance at January 31, 2002............................................. 1,739
Additions charged to costs and expenses............................... 1,531
Amounts used during year.............................................. (2,046)
Balance at January 31, 2003............................................. $ 1,224
=======
U. UNAUDITED QUARTERLY FINANCIAL DATA (Unaudited)
Amounts in thousands, except per share amounts.
F-34
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
------- -------- -------- -------- --------
Year ended January 31, 2003:
Net sales......................................... $ 6,003 $ 5,199 $ 5,525 $ 8,410 $ 25,137
Gross profit (loss)............................... 1,488 (2,300) 962 3,170 3,320
Income (loss) from operations..................... 3,976 (15,806) (6,922) (7,458) (26,210)
Net income (loss)................................. 3,976 (15,806) (6,922) (7,458) (26,210)
Net income (loss) per share:
Basic........................................... 5.60 (21.40) (8.86) (8.42) (33.29)
Diluted......................................... (25.20) (45.20) (34.54) (32.64) (33.29)
Year ended January 31, 2002:
Net sales......................................... $14,497 $ 7,998 $ 10,066 $ 8,266 $ 40,827
Gross profit...................................... 4,929 1,296 1,321 1,774 9,320
Loss from operations.............................. (5,768) (10,961) (15,924) (10,483) (43,136)
Net loss.......................................... (5,768) (10,961) (15,924) (10,483) (43,136)
Net loss per share:
Basic........................................... (9.00) (15.40) (22.24) (14.80) (62.00)
Diluted......................................... (9.00) (15.40) (22.24) (14.80) (76.32)
F-35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
SORRENTO NETWORKS CORPORATION
By: /s/ Joe R. Armstrong Date: April 14, 2003
----------------------------
Joe R. Armstrong
Chief Financial Officer
Principal Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company and in
the capacities and on the dates indicated.
By: /s/ Phillip W. Arneson Date: April 14, 2003
-------------------------------------
Phillip W. Arneson
Chairman and Director
Chief Executive Officer
By: /s/ Donne F. Fisher Date: April 14, 2003
-------------------------------------
Donne F. Fisher
Director
By: /s/ Gary M. Parsons Date: April 14, 2003
-------------------------------------
Gary M. Parsons
Director
By: /s/ Robert L. Hibbard Date: April 14, 2003
-------------------------------------
Robert L. Hibbard
Director
By: /s/ Larry J. Matthews Date: April 14, 2003
-------------------------------------
Larry J. Matthews
Director
F-36
STATEMENT OF DIFFERENCES
The trademark symbol shall be expressed as..................................'TM'
The registered trademark symbol shall be expressed as........................'r'