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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(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, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File number: 0-15810
SORRENTO NETWORKS CORPORATION
(Exact name of Registrant as specified in charter)
New Jersey 22-2367234
(State or other jurisdiction of incorporation or (IRS Employer Identification Number)
organization)
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 $0.30 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.
The Registrant's revenues for its most recent fiscal year were $44,641,000.
The aggregate market value of voting stock based upon the bid and ask price held
by non-affiliates of the Registrant on April 20, 2001 was $113,737,000.
Number of shares outstanding of the Registrant's only class of common stock as
of April 20, 2001 (the latest practicable date): 14,148,007.
DOCUMENTS INCORPORATED BY REFERENCE:
None.
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 end-to-end, intelligent optical networking
solutions for metro and regional applications world-wide. Our solutions enable
communication service providers to increase bandwidth utilization, reduce
network costs and complexity and provide a scaleable and efficient networking
platform to address the rapidly growing demand for bandwidth. Our systems allow
communication service providers to relieve the growing traffic bottlenecks in
the metropolitan and regional networks by supporting a wide variety of
protocols, mixed speeds of traffic and changing traffic patterns directly over
optical networks. Our optical multiplexing platform can be used in both
metropolitan and regional network applications. Our comprehensive suite of
optical networking interfaces and optical access multiplexers allow us to also
address the optical access market. We are currently developing all-optical
wavelength routing switches that will further increase the functionality of our
end-to-end all-optical networking solution. Our optical network element
management platforms permit management of end to end optical networks. We
currently have an installed base with over 20 communications service providers
and system integrators worldwide, including AT&T Broadband Network Solutions,
Deutsche Telekom, Belgacom, United Pan-Europe Communications, Cox Communications
and INRANGE Technologies. According to Ryan, Hankin & Kent, a telecommunications
industry research group, we garnered 5.3% of the North American metropolitan
DWDM system market in calendar 2000 by selling our GigaMux'r' optical transport
systems and EPC'TM' access multiplexers.
On January 17, 2001, we changed our name to Sorrento Networks Corporation
from Osicom Technologies, Inc., in recognition of the growth and momentum
created by our flagship optical networking subsidiary, Sorrento Networks, Inc.
Understanding Our Market
Definitions of technical terms used throughout this documents can be found at
the end of this Item 1.
Rapid Growth in Bandwidth Demand
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. According to
Ryan, Hankin & Kent, Internet traffic is projected to increase from 350,000
terabytes, or trillions of bytes, per month at the end of 1999 to over
15,000,000 terabytes per month during 2003.
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 order to upgrade network
infrastructure to effectively meet the growth in demand for bandwidth,
telecommunications service providers continue to build fiber optic,
multi-wavelength networks as an alternative to legacy networks. While
multi-wavelength optical networks for long-haul applications were the first to
be deployed, optical solutions specifically designed to address the challenges
faced by metropolitan markets only recently started to get deployed. In
addition, recent developments in technology are permitting metropolitan optical
networking vendors to address regional applications which prior to 2000 were
only addressable by long haul networking products.
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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), IXCs and PTTs are
seeing new entrants in the service provider market seeking to capitalize on the
growing demand for bandwidth. While a number of Competitive Local Exchange
Carriers (CLECs) are building new data-centric networks to address the present
bandwidth bottlenecks in the metropolitan markets, other entrants such as
utilities and cable television companies (MSOs) are upgrading their current
networks and 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 service provider market is driving increased capital
expenditures on network infrastructure 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 the SONET/SDH hierarchy
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 the metropolitan areas and between the
network edge and long-haul networks. Metropolitan core networks
typically transport voice and data traffic between central offices
across several nodes with distances reaching up to 150 kilometers.
Regional networks typically transport voice and data traffic between
cities across distances of 100 to 600 kilometers.
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
While optical technologies are being deployed in the long-haul network to
relieve capacity constraints, these solutions are not specifically designed to
address the issues inherent in metropolitan and regional optical networks.
Metropolitan optical networks are characterized by varying traffic patterns and
protocols, 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. According to Ryan, Hankin and Kent, in 2000,
carriers in the North American metropolitan market increased their spending on
DWDM equipment by 263%, to $606 million from $167 million in 1999. Also in 2000,
North American metropolitan DWDM system spending accounted for 7.8% of total
DWDM spending, up from 5% in 1999. Ryan, Hankin and Kent projects that these
carriers will continue to spend strongly on North American metropolitan DWDM
equipment over the next four years. They also expect that the compound annual
growth rate in North American DWDM spending over the next four years (2001-2004)
will be 39.2%, with spending in 2004 totaling $2.3 billion. In 2004, Ryan,
Hankin and Kent expects that North American metropolitan DWDM spending will
account for 8.7% of total DWDM spending.
The North American and European metropolitan DWDM market is expected to
grow from $218 million in 1999 to over $5.7 billion in 2004, a compound annual
growth rate of 92%, as international communication service providers expand the
buildout of their metropolitan networks according to Ryan, Hankin and Kent.
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Regional optical network opportunity
In addition to the metropolitan market, recent engineering enhancements have
permitted the use of metropolitan optical (DWDM) networking platforms to
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
expected until next year.
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 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 overlaying new layers of similar equipment in response to
changes or increases in bandwidth demand.
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.
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 for 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 in that 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 service,
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 Solution
We are a leading supplier of end-to-end, intelligent optical networking
solutions for metro and regional applications world-wide. Our solutions feature
products designed to significantly improve the performance of existing bandwidth
intensive 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 switching of traffic. Our current products,
including our GigaMux'r' DWDM transport system, our EPC'TM' access
multiplexer, and our developmental products, TeraManager'TM' network management
software and TeraMatrix'TM' all-optical wavelength routing switch, are
specifically designed to meet the
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unique requirements of the metropolitan and regional markets. Our end-to-end
metropolitan optical networking solution offers numerous benefits, including:
Scalable Architecture. We have created a delayered or flat 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 to multiple channels providing up to 640Gbps of transmission
capacity without interrupting existing traffic.
Protocol and Signal Transparency. Our suite of solutions transports a
mix of protocols and signals, including SONET, ATM, IP, Gigabit Ethernet,
Fibre Channel and ESCON in their native formats over numerous wavelengths
in the same fiber. This "transparency" brings in 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 are varied. The transparency of our solution eliminates
the unnecessary opto-electro-optical conversions that would otherwise be
required in the transport and switching of traffic thus reducing latency
and network complexity.
Efficient and Cost Effective Bandwidth Utilization. Our EPC'TM',
optical access sub-rate multiplexer aggregates traffic, of varied rates
utilizing a wavelength per direction of transmission, from businesses and
network points of presence for transport throughout optical network. This
sub-rate aggregation allows better utilization of wavelengths. and lowers
capital expenditures of service providers by reducing investments in excess
network capacity. 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
opto-electro-optical conversion.
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.
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.
Sorrento Strategy
Our objective is to be the leading supplier of end-to-end, intelligent
optical networking solutions for metro and regional applications world-wide. The
key elements of our strategy are to:
Enhance and complete our end-to-end metropolitan optical networking solution
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 are currently
developing our all-optical wavelength switching router, the TeraMatrix'TM',
which will enable service providers to dynamically reassign bandwidth in
response to changing network traffic patterns. The combination of our GigaMux'r'
optical transport products, EPC'TM' optical access products and TeraMatrix'TM'
switching products creates an all-optical networking solution. Our
TeraMatrix'TM' switching product will provide more efficient use of bandwidth,
require less network equipment and allow for greater scalability. We are
currently completing the first phase of development on our intelligent network
management software platform, TeraManager'TM', which provides fault,
configuration, performance and security management. The TeraManager'TM' is based
on our proprietary universal management protocol that provides a unified
environment for service providers to manage metropolitan optical networks.
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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 optical networking systems and 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, 2001, we had
a skilled team of 92 engineers that continually focus on developing products for
the metropolitan 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 market.
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 network infrastructure. We intend to
continue to develop and provide solutions that will enable our customers to
leverage their existing 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 in sales and
marketing resources to maintain our high level of customer service and remain
responsive to our customers' changing needs.
Further develop our strategic alliances
We are actively pursuing strategic relationships to expand our sales
opportunities and technological capabilities. To date, we have entered into
strategic alliances with AT&T Broadband, INRANGE, WESCO, and United Pan-Europe
Communications. We believe strategic relationships will allow us to anticipate
market needs, develop products that work optimally with the products of our
customers and enhance market acceptance of our products.
Expand our sales, service and support organizations worldwide
We intend to continue to expand our sales capability in global markets. 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' - 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 O-E-O conversions. 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, certified. As of January 31, 2001, we have shipped our GigaMux'r'
product to over 20 customers 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.
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o Protocol transparency: the system can aggregate and transport
SONET/SDH (OC-3 through OC-192), IP, ESCON, ATM, 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. A 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 networks. The traffic is aggregated and effectively
shares a wavelength per direction of transmission and can be ported
directly into our GigaMux'r' optical transport product. EPC'TM' is designed
to lower the cost and increase the efficiency of bandwidth delivery within
optical networks.
Our EPC'TM' product includes the following key features:
o Asynchronous time division multiplex technology
o Provisionable bit rates and protocol transparency
o Eight low speed traffic streams share one wavelength
TeraMatrix'TM' - Switching
Our TeraMatrix'TM', a MEMS-based, all-optical wavelength routing switch
enables dynamic, real-time wavelength provisioning. TeraMatrix'TM' is
designed to utilize advanced optical technology to create an all-optical
switching product requiring significantly less space in the service
provider's central office than do competing solutions. TeraMatrix'TM' is
designed to be scalable and protocol and signal transparent. The design
uses built-in amplifiers, gain equalization, and optical performance
monitoring to guarantee signal integrity, combat attenuation, and allow for
span lengths of up to 80 kilometers without additional signal regeneration.
TeraMatrix'TM' will support multiple topologies (hub, ring and mesh)
and can function independently of, or in conjunction with present SONET
constrained metropolitan optical networks. TeraMatrix'TM' offers protection
at the optical layer using a suite of intelligent IP-based multiprotocol
lambda switching. These protocols provide network topology and resource
recovery, link state and inventory updates, wavelength assignment and
routing for automatic optical channel set-up. Our TeraMatrix'TM' product is
designed to enable all-optical network services to be provided end-to-end
and dynamically reconfigure and reallocate these connections in order to
meet changing traffic demands.
Our TeraMatrix'TM' product is currently in lab trials at our corporate
headquarters in San Diego, California. We expect to be shipping our
TeraMatrix'TM' product in the fourth quarter of fiscal 2002 or in the first
quarter of fiscal 2003. The initial release of TeraMatrix'TM' will include
the following features:
o 8 x 8 fiber ports with integrated wavelength demux/muxes
o 40 wavelengths per C and L band supporting up to 640 x 640
wavelengths
o Built-in performance monitoring and amplification
o Optical dynamic add/drop functionality
o Optical protection/restoration
TeraManager'TM' - Element Management System
TeraManager'TM' is our TL1-based intelligent element management software
platform that will provide fault, configuration, performance and security
management for all the Sorrento networks products and for networks built
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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 is currently in beta trial, and we expect to
begin commercial shipments of our TeraManager'TM' product in the second quarter
of fiscal 2002. The initial release of our TeraManager'TM' product will include
the following features:
o Fault, configuration and performance management
o Carrier class management platform
o Interface with operation support systems
Meret Optical Communications
Our other optical networking subsidiary, Meret Communications, Inc., doing
business as Meret Optical Communications, produces feature-rich products for
complex and high-performance network needs. Meret has a variety of broadband
communication products addressing the video, voice, data transmission and
distance extension market.
Customers
Our target customer base includes service providers such as competitive
local exchange carriers, local and foreign telephone companies, utilities
(telecom arm of), cable television service providers (telecom arm of), system
integrators and distributors.
Our customers generally fit the following customer profiles:
o Service Providers - these customers provide communication services and
include telecommunication carriers, cable, utility companies and
Internet Service Providers.
o System Integrators - companies that specialize in providing turn-key
networking solutions for enterprise networks and applications such as
storage area networks.
o Enterprise - enterprise customers are generally large organizations
with complex networking needs, usually spanning multiple locations and
difficult types of network requirements. Enterprise customers include
corporations, government agencies, utilities, and educational
institutions.
o Small and Medium Business - 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 2001 the majority of our sales were to relatively few
customers, and we expect this customer concentration to continue in the
foreseeable future. For fiscal 2001, we shipped our optical networking
products to a total of 19 customers worldwide. Two customers, INRANGE
Technologies Corporation and its subsidiaries as well as El Paso
Networks (formerly Pontio Communications) represented more than 10% of our net
sales for fiscal 2001 and five customers accounted for, in the aggregate, 44.4%
of our net sales during fiscal 2001.
Key Relationships
We have entered into long-term agreements with some of our customers and
strategic allies, including:
AT&T Broadband Network Solutions
In February 2000, we entered into a strategic alliance agreement with AT&T
Broadband. Under the terms of this agreement, we and AT&T Broadband Network
Solutions 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 expires in February 2002 and will be automatically renewed for
additional one-year
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terms. 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. We started shipping our products to AT&T Broadband in the
second quarter of this year.
INRANGE Technologies
In March 2000, we entered into a strategic alliance agreement with INRANGE.
Under the terms of the agreement, INRANGE will act as an exclusive worldwide
distributor of our optical networking products for storage networks of
enterprise customers. INRANGE has agreed to offer our wave division multiplexing
(WDM) and dense wave division multiplexing, or DWDM products, including
GigaMux'r', as part of family of virtual storage networking products. In
addition, INRANGE must purchase minimum amounts of our products in order to
retain exclusive worldwide rights for offering our products in the enterprise
storage networking market. These products will facilitate the creation of
virtual storage networks by reducing the costs of sending information over long
distances. The initial term of this agreement expires in March 2005 and will be
automatically renewed for additional two-year terms. INRANGE has agreed to
purchase targeted minimum amounts of products from us. We have a right to
terminate this agreement with sixty days prior written notice to INRANGE in the
event INRANGE fails to purchase the applicable targeted minimum amounts of
products. In addition, General Signals Holding Company, the parent company of
INRANGE, purchased 550,459 of our Sorrento subsidiary's series A convertible
preferred shares in March 2000. We started shipping our products to INRANGE in
the second quarter of fiscal year 2001.
United Pan-Europe Communications
In March 2000, we entered into a strategic alliance agreement and an
equipment purchase agreement with United Pan-Europe Communications, N.V., or
UPC. Under the terms of these agreements, United Pan-Europe Communications has
agreed to make us their preferred supplier for optical networking products in
networks deployed throughout Europe, subject to the results of product
evaluation. These agreements also contemplate our working together with United
Pan-Europe Communications on joint sales and marketing initiatives. The initial
terms of these agreements expire in March 2003 and will be automatically renewed
for additional one-year periods unless either we or United Pan-Europe
Communications provide notice at least 90 days prior to the expiration of the
then-current term of the intent to terminate the agreements. In addition,
UnitedGlobalCom, Inc., parent to United Pan-Europe Communications, purchased
3,027,523 of our Sorrento subsidiary's series A convertible preferred shares in
March 2000, through an affiliated entity. We started shipping our products to
UPC in the second quarter of fiscal year 2001.
A last mile wireless service provider
In June 2000, we entered into a development, purchase and strategic
partnership agreement with a last mile wireless service provider. Under the
terms of this agreement, the customer has agreed to make commercially reasonable
efforts to purchase target quantities of our products but is not contractually
committed to purchase these target quantities. The initial term of this
agreement is 48 months from the date of the first commercial shipment of our
products to the customer. At the end of the initial term, the agreement will
automatically renew for four successive one year terms. Either we or the
customer may terminate the agreement for any reason upon 180 days prior written
notice as to the initial term or 90 days prior written notice as to any renewal
term. In addition, either we or this customer may terminate the agreement at any
time subject to customary termination provisions. We expect to start shipping
our products to this customer in fiscal year 2002.
Sales and Marketing
Our sales effort is currently focused on North America, Europe and Asia. As
of January 31, 2001 our sales and marketing organization included 68 employees,
including account managers, sales engineers and support 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 offices in The Netherlands, 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 well as
expanding our customer base. Our customer acquisition strategy has focused on
targeting customers who are
9
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 the 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 relations 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 teams provide a critical component of our
customer satisfaction initiative. This team provides support to our customers
that allows 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 web based support and 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 provides a total service solution. Our hardware products are warranted
against defects for a period of 36 months, including technical support and parts
repair/replacement.
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 markets was a result of our strength in
research and development. As of January 31, 2001, 92 employees were engaged in
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 and
delivering innovative products and address the needs of the regional and
metropolitan market.
Our engineering, research and development expenses were $23.9 million,
$11.7 million, and $9.8 million for the years ended January 31, 2001,
January 31, 2000 and January 31, 1999, respectively. We will continue to make
substantial investments in research and development.
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 and Fremont, California locations. Our San Diego
facility is ISO-9002 certified. 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 do not have long-term contracts with any
of our contract manufacturers or suppliers, and none of them are 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 20 patents and additionally have numerous
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 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 days from the date of shipment, however, for some
customers we extend 180 day payment terms.
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 receive financial instruments such as letters of credit for
payments for international customers. At January 31, 2001, accounts receivable
due from AT&T Broadband, Cox Communications, INRANGE, Deutsche Telekom, and UPC
accounted for 12.0%, 20.6%, 15.6%, 14.1% and 20.5% of net receivables,
respectively. At January 31, 2000 accounts receivable due from Ingram Micro, a
customer of Entrada Networks, accounted for 14.7%, of net receivables.
Backlog
At January 31, 2001, our backlog was approximately $5.4 million as compared
with backlog of approximately $3.2 million at January 31, 2000 exclusive of $3.6
million backlog of Entrada Networks. 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 are never 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, if any, penalty.
11
Competition
The market for optical networking equipment is extremely competitive and
subject to rapid technological change. We expect competition to intensify in the
future. Our primary competitors include vendors of optical networking and
infrastructure equipment such as Nortel Networks, CIENA Corporation, ONI
Systems, Cisco Systems, Lucent Technologies, and Sycamore Networks , as well as
private companies that have been or will be focusing on our target markets. 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; and
o service, support and financing.
We believe we complete favorably with our competitors with respect to most
of these factors.
The competitors for Meret products include Pesa, Artel, RGB Spectrum, Utah
Scientific, and many other companies.
Increased competition may result from 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, 2001, we had 266 employees of which 92 were in research
and development, 68 in sales and marketing, 60 in manufacturing and 46 in
general and administrative functions. Of the 92 employees in research and
development 33 have masters degrees and 25 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 of the Private Securities Litigation Reform Act of
1995. Although we believe that our expectations reflected in
12
these forward-looking statements are based on reasonable assumptions, such
statements involve risk and uncertainties and no assurance can be given that
actual results will be consistent with these forward-looking statements.
Important factors that could cause actual results to differ materially from
those forward-looking statements include without limitation: our ability to
successfully develop, sell and market our optical networking and other products;
our expectations concerning factors affecting the markets for our products, such
as demand for increased bandwidth; the scope and duration of the economic
slowdown currently being experienced by many of our existing and prospective
customers; our ability to compete successfully with companies who are much
larger than we are and who have much greater financial resources at their
disposal; our ability, or failure, to complete strategic alliances and strategic
opportunities such as sales or spin-offs of subsidiaries or business units on
terms favorable to us for reasons either within or outside our control; our
ability successfully to finance our current and future needs for working
capital; 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:
We have a history of losses and expect to incur future losses.
We have incurred operating losses during the years ended January 31, 2001,
2000 and 1999 of $50.4 million, $10.0 million and $10.0 million, respectively,
and as of January 31, 2001, we had an accumulated deficit of $118.0 million. We
expect to continue to incur loses in the future. If we do not become profitable,
the value of our stock will decrease. We have large fixed expenses, and we plan
to incur significant and increasing sales and marketing, research and
development, manufacturing, and general and administrative expenses. 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 while maintaining reasonable expense levels.
We will need additional funds to support operations. If we are unable to obtain
them, we would have to reduce or cease operations, or attempt to sell some or
all of our operations or to merge with another entity.
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 require the commitment of substantial funds.
Our existing working capital will not 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 or our Sorrento subsidiary. It is our current intention to
obtain these additional funds through placements by our Sorrento subsidiary of
its securities, however, there is no assurance that it will be able to do so.
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.
13
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.
We have the authority to issue up to 150 million shares of our common stock
and 2 million shares of our preferred stock without shareholder approval. We may
also issue options and warrants 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 stockholders. While we intend to pursue placements of
the shares of our Sorrento subsidiary, we may be unable to do so and therefore
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 stockholders and may adversely affect the voting and other
rights of holders of common stock.
The redemption rights of the Series A preferred stock of our Sorrento
subsidiary, Sorrento Networks, Inc. or "SNI", may impact our ability to use
otherwise available funds for business purposes.
The holders of the Series A preferred stock have the right to ask SNI to
redeem their shares if holders of more than 50% make such a request in writing.
If such a request is made, our subsidiary has the obligation to redeem the
Series A preferred stock within 30 days for approximately $49 million in cash.
If funds are lawfully available for such redemption, or for such pro rata
portion as to which a lesser amount of lawfully available funds would exist. If
such request is made and SNI is found to have lawfully available funds to redeem
all or a portion of such shares, it may have a material adverse affect on our
business.
Provisions of our charter documents and New Jersey law may have anti-takeover
effects that could prevent a change in control, which could negatively affect
the market price for our stock.
Provisions of New Jersey law and our amended and restated certificate of
incorporation and bylaws could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders.
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,
ONI Systems, Sycamore 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 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 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 new, and we cannot be
certain that a feasible market for our products will develop or be sustainable.
If this market does not develop, or develops more slowly than we expect, 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
14
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.
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, United
Pan-Europe Communications, INRANGE, WESCO and a last mile wireless service
provider. 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. Except for INRANGE, which is exclusive in the
field of storage networks of enterprise customers, 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.
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.
During the year ended January 31, 2001, five customers accounted for 44.4% of
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 of 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 time
frames, 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 an adverse effect on our
business, financial condition and results of operations in periods in which the
inventory is reduced.
15
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 including 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.
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' and EPC'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' and EPC'TM' products in large numbers, our
revenue may not grow and our business, financial condition and results of
operations will be seriously harmed. Since 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. No communications service
provider has fully deployed our products in large network environments, and they
may choose not to do so. Even if service providers do deploy our product fully,
it may not operate as expected, which could delay or prevent its adoption.
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 develop new or enhanced
products. The development of new or enhanced products is a complex and uncertain
process that requires the accurate anticipation of technological and market
trends. Our next generation of transport and network management products, as
well as our TeraMatrix'TM' line of wavelength switching products, are 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
16
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
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 optical networking products can only be fully tested after deployment
in networks. 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 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.
17
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 rapid 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, new
product introductions by our competitors or other factors. 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.
Our future success depends upon the continued services of our key
management, sales and marketing, and engineering personnel, many of who 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. In addition, we will need to hire additional
personnel for most areas of our business, including our sales and marketing and
engineering operations. 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 others' intellectual property. 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
18
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 of the intellectual property 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.
If necessary licenses of third-party technology are not available to us or are
very expensive, our products could become obsolete.
We 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.
We are subject to various risks associated with international sales and
operations.
We expect that international sales will continue to increase as a
percentage of our net sales for the foreseeable future. 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 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.
Growth of our business has placed, and will continue to place, 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.
Definitions
As used in this Annual Report on Form 10-K, the following terms have the
meanings indicated:
"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 to 622 Mbps as
compared to maximum 100 Mbps for Fast Ethernet.
"Backbone" means a spine or main segment of a network. Individual metro and
interoffice rings are attached as ribs to the backbone.
19
"Bandwidth" means the capacity to move information down a communications
channel. Bandwidth is measured by the difference between the highest and lowest
frequencies that can be transmitted by that channel and is commonly measured in
bits per second (bps). For example, Ethernet has a 10 to Mbps bandwidth and
OC192 has a 10 gigabits per second
"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 decision on each packet received from any of the networks
to which it is connected.
"Broadband" means a set of technologies that provide several paths for
transmitting text, graphics, voice or video data so that different types of data
can be transmitted simultaneously and, depending on the technology deployed, at
different speeds and protocols.
"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.
"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 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 coax,
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.
"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. There are a number of
competing HDTV standards, which is one reason that the new technology has not
been widely implemented.
"Hub" means a central connection device to which many network tributaries are
connected.
"ILEC" means Incumbant 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.
"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.
20
"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).
"OC-1, OC-3, OC-12, OC-48, OC-192" means 51.85Mbps, 155 Mbps, 622 Mbps, 2.5 Gbps
and 10Gbps transmission speeds for signals over fiber optic cables.
"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 are
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.
"PTT" means Postal, Telephone and Telegraph which is a generic telephone company
apply to companies 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. 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.
"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.
21
"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 each of which 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.
We occupy an additional 14,000 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
San Diego, California 3,000 Office/R&D/Manufacturing n/a - month to
month
We have one sales office located in the United States, three sales offices
located in Europe (The Netherlands, Belgium and Germany) and two sales office
located in Asia (China and Singapore) totaling approximately 10,000 square feet.
All such offices are leased for varying terms.
We believe that suitable additional space will be available to us, when
needed, on commercially reasonable terms. See Note E to the Consolidated
Financial Statements contained in Part II herein for terms and amounts of
mortgages on the facility we own.
Item 3. Legal Proceedings
On November 6, 2000, the court granted final approval to the settlement of the
consolidated shareholder class actions pending in Federal district court in Los
Angeles against us and certain present and former officers, and dismissed the
actions against all defendants with prejudice. The settlement, which was entered
into without any admission of liability by any of the defendants, provided for
an aggregate cash payment to class members of $3.75 million, plus accrued
interest from September 1, 2000, if any, less approved attorneys' fees and
related expenses. The settlement was funded by our insurance carrier, and did
not have a material adverse effect on our financial position or results of
operations.
The settled lawsuit, entitled "In re Osicom Technologies, Inc. Securities
Litigation, Master File No. CV-99-4321-R", was filed on August 20, 1999 against
the Company and our then Chief Executive Officer, our then President and our
former Chief Financial Officer, in the United States District Court for the
Central District of California. The
22
consolidated complaint generally alleged that, during the period July 1, 1998 to
April 20, 1999, the defendants made false and misleading public statements
related to a contract entered into by our former Far East business unit with a
Japanese customer. The consolidated complaint asserted that the defendants'
conduct violated Sections 10(b) and 20(a) of the Securities Exchange Act of
1934, and SEC Rule 10b-5 promulgated thereunder, as well as state common law.
The consolidated complaint did not specify an amount of damages.
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
Our Annual Meeting of Stockholders was held on January 17, 2001. During the
Annual Meeting, the stockholders elected our nominees to the Company's Board of
Directors to serve for the term of one year or until their successors have been
elected and qualified with each nominee receiving no less than 11,477,758 of the
total 11,751,620 votes cast for the election of directors.
In addition, the stockholders approved the following proposals:
Votes Broker
Votes For Against Abstentions Non-Votes
--------- ------- ----------- ---------
Name change to Sorrento
Networks Corporation 11,668,945 68,124 13,917 n/a
Ratification of the appointment of
BDO Seidman, LLP as auditors 11,111,316 629,573 10,731 n/a
Increase in authorized shares 10,738,426 1,000,006 13,188 n/a
Approve the 2000 Stock Incentive Plan 3,780,220 1,527,456 27,352 6,416,592
Approve the Employee Stock Purchase Plan 4,435,778 876,986 22,264 6,416,592
23
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.
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, 1999 to January 31,
2001, based upon information obtained from Nasdaq and taking into account the
1-for-3 reverse split on July 24, 1998. Quotations represent inter-dealer
prices; they do not include retail markups, markdowns, or commissions; and, they
may not represent actual transactions.
Fiscal 1999-2000 High Low
---------------- ---- ---
Quarter from February 1, 1999 to April 30, 1999 $28.50 $5.00
Quarter from May 1, 1999 to July 31, 1999 $15.38 $7.50
Quarter from August 1, 1999 to October 31, 1999 $12.88 $7.13
Quarter from November 1, 1999 to January 31, 2000 $59.00 $7.75
Fiscal 2000-2001
----------------
Quarter from February 1, 2000 to April 30, 2000 $144.88 $29.19
Quarter from May 1, 2000 to July 31, 2000 $86.00 $32.44
Quarter from August 1, 2000 to October 31, 2000 $74.50 $14.88
Quarter from November 1, 2000 to January 31, 2001 $40.88 $10.38
On April 20, 2001, the average of the high and low bid quotation for our common
stock was $8.63 per share. There is no assurance that a market in our common
stock will continue.
As of April 20, 2001 (the latest practicable date) there were 762 shareholders
of record, including brokerage firms and nominees, of our common stock.
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.
24
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, 2001 and 2000, 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, 1998 and 1997,
and the consolidated balance sheet data set forth below at January 31, 1999,
1998 and 1997 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,
-----------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Statement of Operations Data:
Net sales $ 44,641 $ 68,372 $ 58,362 $ 65,811 $ 65,219
Net income (loss) from
continuing operations $(41,905) $ 2,410 $(11,069) $(16,377) $ (18,705)
Net income (loss) per share from
continuing operations:
Basic $( 3.71) $ 0.17 $( 1.69) $( 3.32) $( 7.06)
Diluted $( 3.71) $ 0.15 $( 1.69) $( 3.32) $( 7.06)
Balance Sheet Data:
Cash and cash equivalents $ 9,965 $ 13,511 $ 3,480 $ 1,422 $ 2,881
Working capital 71,993 189,486 11,399 8,986 9,709
Total assets 113,123 223,265 66,796 69,589 61,521
Total debt (including short-term debt) 24,770 20,727 27,938 26,872 28,651
Stockholders' equity 39,733 202,538 38,858 42,717 32,870
25
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".
Entrada Networks
On August 31, 2000 we completed a merger of our Entrada subsidiary with Sync
Research, Inc., a Nasdaq listed company. After the merger, our purchase of Sync
shares prior to the merger and our purchase of shares for cash from Entrada we
owned 48.9% of the merged entity which changed its name to Entrada Networks.
Pursuant to our plans adopted prior to the merger, we distributed one-fourth
shares of an Entrada share for each of our outstanding shares and reserved a
similar number for each unexercised option and warrant to acquire our common
stock outstanding on the record date. After the distribution and reserve for
options and warrants we own approximately 10.3% of Entrada and account for this
remaining interest as an "available for sale security" which is marked to
market at the end of each period. The amounts included in our fiscal 2001 year
are not comparable to our fiscal 2000 year due to the inclusion of Entrada for
less than a full year. Additional information regarding the Entrada is available
from its various filings with the Securities and Exchange Commission which are
available online at www.freeedgar.com and www.sec.gov or from the Securities and
Exchange ommission.
NETsilicon or NSI
The results of NSI were included in our consolidated results only through
September 15, 1999. Additional information regarding NSI is available
from its various filings with the Securities and Exchange Commission which are
available online at www.freeedgar.com and www.sec.gov or from the Securities and
Exchange Commission. See "Results of Operations, Comparison of the years ended
January 31, 2000 and January 31, 1999."
Results of Operations: Comparison of the Years Ended January 31, 2001 and
January 31, 2000
Net sales. Our consolidated net sales from continuing operations decreased to
$44.6 million, or by 34.8%, for fiscal 2001 from $68.4 million for fiscal 2000.
Net sales for our Sorrento Networks segment increased by $14.0 million for
fiscal 2001 from fiscal 2000. Net sales for Meret Optical segment decreased by
approximately $682,000 in fiscal 2001 from the same comparable period last year.
The remaining change was related to NSI and Entrada.
Gross profit. Cost of sales consists principally of the costs of components,
subcontract assembly from outside manufacturers, and in-house system
integration, quality control, final testing and configuration costs. Gross
profit decreased to $13.2 million, or by 58.5%, for fiscal 2001 from $31.8
million for fiscal 2000. Gross profit for our Sorrento Networks segment
increased to $9.1 million or 28.2% in fiscal 2001 and, our Meret Optical segment
decreased by $242,000. The remaining change was related to NSI and Entrada.
Gross margin decreased to 29.5% for fiscal 2001 from 46.5% for fiscal 2000.
The decrease in our gross margin during fiscal 2001, resulted from a change in
the customer mix for our Sorrento subsidiary. During fiscal 2000, high margin
products were being shipped to a single customer. During fiscal 2001, products
were being shipped to multiple customers at a lower margin than last year.
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 intend to increase expenditures for
sales and marketing including the recruitment of additional sales and marketing
personnel, the expansion of our domestic and international distribution channels
and the establishment of strategic relationships. In addition, we expect sales
commissions to increase as we increase our sales volume. Our consolidated
selling and marketing expenses increased to $17.2 million, or 38.5% of net
sales, for fiscal 2001 from $16.9 million, or 24.7% of net sales for fiscal
2000.
26
Engineering, research and development. Engineering, research and development
expenses consist primarily of compensation related costs for engineering
personnel, facilities costs, and materials used in the design, development and
support of our technologies. All research and development costs are expensed as
incurred. We expect research and development costs to increase substantially as
we continue to develop our technologies and future products. Our consolidated
engineering, research and development expenses increased to $23.9 million, or
53.6% of net sales, for fiscal 2001 from $11.7 million, or 17.1% of net sales,
for fiscal 2000.
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. Increases in general and
administrative expenses are planned as we strengthen our infrastructure to
provide sufficient administrative support for the growth of our businesses.
Consolidated general and administrative expenses increased to $18.1 million, or
40.6% of net sales, for fiscal 2001 from $12.8 million, or 18.7% of net sales,
for fiscal 2000.
Other operating expenses. Other operating expenses for both fiscal
2001 and 2000 include approximately $400,000 of amortization of
purchased technology related to acquisitions included in Meret. 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.
Other income (charges). Other net income (charges) from continuing operations
decreased to $8.5 million income for fiscal 2001 from $12.4 million income for
fiscal 2000. During fiscal 2001, we had recognized gains of $3.7 million on the
sales of shares from our investment with one of Sorrento's customers. We also
recognized $1.4 million and $330,000 in interest income and dividend income
respectively. In addition, we had a recognized gain of $3.9 million related to
the sale of a portion of our investment in NETsilicon. These gains were offset
by interest expense incurred on borrowings from our lines of credit, short term
borrowing facilities and long term debt. During the fiscal year ended January
31, 2000, we recognized a gain of $14.0 million related to the sale of a portion
of our investment in NETsilicon in connection with its initial public offering
completed on September 15, 1999.
Income taxes. There was no provision for income taxes for fiscal years 2001 and
2000. We have carry forwards of domestic federal net operating losses, which may
be available, in part, to reduce future taxable income in the United States.
However, due to potential adjustments to the net operating loss carry forwards
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 $26.5 million, or 112.0%, for fiscal 2001 from
$12.5 million for fiscal 2000. The increase in net sales was primarily due to an
increase in the deployments of our systems by new and existing customers. In
fiscal 2001, seven customers accounted for 91.1% of our net sales compared with
three customers accounting for 88.4% in fiscal 2000.
Gross profit. Gross profit increased to $9.1 million, or 28.2%, for fiscal 2001
from $7.1 million for fiscal 2000. Gross margin decreased to 34.3% of net sales
for fiscal 2001 from 56.8% for fiscal 2000. The gross margin percentage decrease
resulted from the shipment of higher margin products to a single customer in
fiscal 2000 and lower margin product shipments to multiple customers with long
term purchase commitments or strategic alliance agreements in fiscal 2001.
Selling and marketing. Sales and marketing expenses increased to $14.0 million,
or 52.8% of net sales, for fiscal 2001 from $5.6 million, or 44.8% of net sales
for fiscal 2000. The increase in sales and marketing expenses resulted from
personnel additions to the sales and marketing staff, increased travel expenses,
trade show participation, and advertising expenses. This increase is also
attributable to expenses related to the opening of five foreign sales offices
located in China, Singapore, Germany, Belgium and the United Kingdom. The number
of sales and marketing personnel increased to 65 at January 31, 2001 from 30 at
January 31, 2000.
27
Engineering, research and development. Engineering, research and development
expenses increased to $20.4 million, or 77.0% of net sales, for fiscal 2001 from
$3.4 million, or 27.2% of net sales, for fiscal 2000. The increase in
engineering, research and development expenses was the result of increased
expenditures associated with the continuing development of our existing products
as well as future technologies, increases in engineering personnel and,
increases in employee relocation and recruiting expenses. The number of
engineering personnel increased to 91 at January 31, 2001 from 23 at January 31,
2000.
General and administrative. General and administrative expenses increased to
$9.0 million, or 34.0% of net sales, for fiscal 2001 from $3.8 million, or 30.4%
of net sales, for fiscal 2000. The increase in general and administrative
expenses reflects the hiring of additional executive and administrative
personnel and higher operating expenses necessary to strengthen our
infrastructure to support our continuing growth. The number of general and
administrative personnel increased to 32 at January 31, 2001 from 16 at January
31, 2000.
Deferred and other stock compensation. Deferred and other stock compensation for
the year ended January 31, 2001 includes $1.7 million of amortization of
deferred stock compensation and $184,000 of expense resulting from the value of
stock options granted to consultants. In connection with the grants of stock
options with exercise prices determined to be below the fair value of 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
During the periods prior to January 31, 2000, Meret was an integral portion of
the "Optical Networking" business unit which also included Sorrento. As of
January 31, 2000, we separated Meret from the Optical Networking business
segment. For periods prior to January 31, 2000, amounts reported for the Meret
segment of our business may not be indicative of the results of operations that
would have resulted had Meret been operated as a stand-alone entity.
Net sales. Net sales decreased slightly to $6.3 million, or 10.0%, for fiscal
2001 from $7.0 million for fiscal 2000. The decrease in net sales was primarily
due to changes in product demand in the legacy product family.
Gross profit. Gross profit decreased slightly to $2.6 million, or 10.4%, for
fiscal 2001 from $2.9 million for fiscal 2000. Gross margin as a percentage of
net sales increased slightly to 41.6% for fiscal 2001 compared to 41.0% for the
same comparable period last year. The increase in the gross margin percentage
from the prior year resulted from changes in the mix of products shipped.
Selling and marketing. Sales and marketing expenses decreased to $437,000, or
6.9% of net sales, for fiscal 2001 from $1.4 million, or 20.0% of net sales, for
the same comparable period last year. Overall selling and marketing expenses
decreased as revenue decreased.
Engineering, research and development. Meret incurred engineering expenses
during fiscal 2001 of $177,000. No engineering expenses were incurred during
the fiscal year ended January 31, 2000. After Meret's separation from the
Optical Networking segment, we increased engineering expenditures to update
older products and we will continue to increase engineering spending in the
future to support existing as well as new products.
General and administrative. General and administrative expenses decreased to
$595,000, or 9.4% of net sales during fiscal 2001 from $640,000, or 9.1% of net
sales for the same comparable period last year. After Meret's separation from
the Optical Networking segment, the need for general and administrative
operations were minimal.
Results of Operations: Comparison of the Years Ended January 31, 2000 and
January 31, 1999
In connection with the initial public offering by NETsilicon, Inc., our
remaining 55.4% interest became non-voting shares. Accordingly, our financial
statements for fiscal 2000 include the results of operations of NETsilicon only
through September 14, 1999 at which time our remaining interest is accounted for
as an "available
28
for sale" security which is marked-to-market at the end of each period. The
amounts included in our fiscal 2000 year are not comparable to our fiscal 1999
year due to the inclusion of NETsilicon for less than a full year. Readers
should refer to NETsilicon's annual report on Form 10-K for information
concerning NETsilicon.
Net sales. Our consolidated net sales from continuing operations increased to
$68.4 million, or by 17.1%, for fiscal 2000 from $58.4 million for fiscal 1999.
Net sales for our Sorrento Networks segment increased by $10.3 million for
fiscal 2000 from fiscal 1999. Net sales for our Meret Optical segment decreased
by $5.0 million during fiscal 2000 from the same comparable period last year.
The remaining change was related to Entrada and NSI.
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
profit increased to $31.8 million, or by 22.8%, for fiscal 2000 from $25.9
million for fiscal 1999. Gross profit for our Sorrento Networks segment
increased by $6.0 million and our Meret Optical segment gross profit decreased
by $2.1 million for fiscal 2000 from the same comparable period last year.
The remaining change was related to Entrada and NSI. Gross margin increased
to 46.5% for fiscal 2000 from 44.4% for fiscal 1999.
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 intend to increase expenditures for
sales and marketing including the recruitment of additional sales and marketing
personnel, the expansion of our domestic and international distribution channels
and the establishment of strategic relationships. In addition, we expect sales
commissions to increase as we increase our sales volume. Our consolidated
selling and marketing expenses increased to $16.9 million, or 24.7% of net
sales, for fiscal 2000 from $15.5 million, or 26.5% of net sales for fiscal
1999.
Engineering, research and development. Engineering, research and development
expenses consist primarily of compensation related costs for engineering
personnel, facilities costs, and materials used in the design, development and
support of our technologies. All research and development costs are expensed as
incurred. We expect research and development costs to increase substantially as
we continue to develop our technologies and future products. Our consolidated
engineering, research and development expenses increased to $11.7 million, or
17.1% of net sales, for fiscal 2000 from $9.8 million, or 16.8% of net sales,
for fiscal 1999.
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. Increases in general and
administrative expenses are planned as we strengthen our infrastructure to
provide sufficient administrative support for the growth of our businesses.
Consolidated general and administrative expenses increased to $12.8 million, or
18.7% of net sales, for fiscal 2000 from $10.3 million, or 17.6% of net sales,
for fiscal 1999.
Other operating expenses. Other operating expenses consist of amortization of
purchased technology related to acquisitions included in our Meret Optical
segment and remained unchanged at approximately $400,000 for fiscal 2000 and
1999.
Other income (charges). Other net income (charges) from continuing operations
increased to $12.4 million income for fiscal 2000 from $(1.0) million expense
for fiscal 1999. The increase included a recognized gain of $14.0 million
related to the sale of a portion of our investment in NETsilicon in connection
with its initial public offering completed on September 15, 1999. The gain was
offset by increases in interest expense incurred on increased borrowings on our
lines of credit, short term borrowing facilities and long term debt.
Income taxes. There was no provision for income taxes for fiscal years 2000 and
1999. 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.
29
Discontinued operations. The loss from our discontinued Far East business unit's
operating activities increased to $12.4 million for fiscal 2000 from $2.3
million for fiscal 1999. The increased loss is the result, in part, of a 47.4%
decline in net sales and a $6.3 million reduction in the remaining book value of
excess cost over net assets acquired.
Our Far East business unit, consisting of Uni Precision Industrial Limited
has been accounted for as a discontinued operation pursuant to our
formal adoption on May 15, 1999 to sell this division. As of January 31, 2000,
we sold Uni to a group led by its Hong Kong-based management for $2.5 million in
cash in repayment of our advances to Uni and a $3.0 million non-voting
redeemable preferred security. This security has not been considered in the
estimated proceeds from disposal due to the uncertainty of future collection.
Net assets disposed and amounts due from the purchaser, at their expected
realizable values, are included in other assets in the accompanying balance
sheets. During the year ended January 31, 2001 we received payments of $819,000.
Due to the continuing economic downturn in Asia and the decline in the value of
marketable securities held as collateral from the purchasers, we recorded a
$700,000 reserve against the remaining balance due of $1.7 million.
Sorrento Networks
Net sales. Net sales totaled $12.5 million for the year ended January 31, 2000,
a 468.2% increase from $2.2 million for the year ended January 31, 1999. The
increase in net sales was due to an increase in the deployments of our systems
by new and existing customers. For the year ended January 31, 2000, three
customers accounted for 88.4% of net sales. Sales to international customers
accounted for 27.6% of net sales for the year ended January 31, 2000 compared to
29.7% for the same comparable period last year.
Gross profit. Gross profit increased to $7.1 million, or 56.8%, of net sales for
the year ended January 31, 2000 from $1.1 million or, 50.0% of net sales for the
same comparable period last year. The increase in the gross profit percentage
reflects the absorption of production overhead costs resulting from higher net
sales during the year ended January 31, 2000, as well as lower gross profits on
sales to a single customer during the year ended January 31, 1999.
Selling and marketing. Sales and marketing expenses increased to $5.6 million,
or 44.8% of net sales, for the year ended January 31, 2000 from $1.8 million, or
81.8% of net sales for the same comparable period last year. The increase in
sales and marketing expenses was the result of hiring additional sales and
marketing personnel and, increased promotional activities and travel expenses
incurred to support our continued growth. We increased our sales and marketing
personnel to 30 at January 31, 2000 from 21 at January 31, 1999.
Engineering, research and development. Engineering, research and development
expenses increased to $3.4 million, or 27.2% of net sales, for the year ended
January 31, 2000 from $2.0 million, or 90.9% of net sales, for the same
comparable period last year. The increase in engineering, research and
development expenses was primarily the result of hiring additional research and
development personnel to support the continued development and enhancements to
our existing products as well as development of new products and technologies.
We increased our engineering personnel to 23 at January 31, 2000 from 18 at
January 31, 1999.
General and administrative. General and administrative expenses increased to
$3.8 million, or 30.4% of net sales, for year ended January 31, 2000 from $2.3
million, or 104.5% of net sales, for the same comparable period last year. The
increase in general and administrative expenses reflects the hiring of
additional general and administrative personnel and higher expenses necessary to
support and scale our operations.
Meret Optical Communications
Net sales. Net sales for our Optical Networking segment decreased to $7.0
million, or 41.7%, for fiscal 2000 from $12.0 million for fiscal 1999. The
decrease in net sales was primarily due to changes in demand for the legacy
product family.
Gross profit. Gross profit decreased to $2.9 million, or 40.8%, for fiscal 2000
from $4.9 million for fiscal 1999. Gross margin remained unchanged as a
percentage to net sales approximating 41.0% for fiscal 2000 and fiscal 1999.
30
Selling and marketing. Sales and marketing expenses decreased to $1.4 million,
or 20.0% of net sales, for fiscal 2000 from $1.6 million, or 13.3% of net sales
for the same comparable period last year. The decrease in sales and marketing
expenses was the result of lower sales volume, decreases in commission expenses,
trade show participation and advertising.
Engineering, research and development. No engineering expenses were incurred
during both fiscal 2000 and 1999. During fiscal 2000 and 1999, Meret was in
the process of separating from the Optical Networking segment. Engineering
expenditures are expected to be incurred in the future to update older
products as well as new ones.
General and administrative. General and administrative expenses of $640,000 were
incurred for fiscal 2000. These expenses were incurred to build the
administrative infrastructure necessary to support the expected future
growth. During fiscal 2000 and 1999, Meret was involved in the process of
separating from the Optical Networking segment and incurred no general and
administrative expenses during fiscal 1999.
Liquidity and Capital Resources
We finance our operations through a combination of debt and equity financing. At
January 31, 2001, our working capital was $72.0 million including $50.3 million
of investments in marketable securities and $9.9 million in cash and cash
equivalents.
The amounts included in our statement of cash flows for fiscal 2001 is not
comparable to our fiscal 2000 amounts due to the inclusion of Entrada and
NETsilicon for less than a full year. Readers should refer to Entrada's
NETsilicon's annual reports on Form 10-K for information concerning Entrada and
NETsilicon.
Our operations used cash flows of $51.7 million during fiscal 2001. During
fiscal 2000 we incurred a cash flow deficit of $2.7 million from continuing
activities and discontinued operations provided cash of $953,000. The increase
in cash flows used by operations reflects a substantial decrease in our net loss
as well as increases in accounts receivable and inventories, partially offset by
a decrease in other current assets and increases in accounts payable and accrued
liabilities.
To support our anticipated growth, we expect our selling and marketing, research
and development and general and administrative expenses will increase in future
periods. There can be no assurance that our available cash will be sufficient to
fund such additional expenses.
Our standard payment terms range from net 30 to net 90 days. Receivables from
international customers have frequently taken longer to collect. For some of the
customers of our optical networking products payment is required within 180 days
from the date of shipment
We provided long-term equipment financing to an optical networking customer
during fiscal 2000 and 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 this financing provide that the customer may
convert any balances outstanding longer than 90 days into a level payment
35-month term note at 11% per annum interest. We financed $3.3 million of
receivables, including deployment expenses, during fiscal 2000 for this
customer. During the fourth quarter of fiscal 2000 we exchanged $3.0 million of
the then unpaid balance shares of the customer's 8% convertible preferred stock,
an approximately 6% interest on a fully diluted basis. The remaining balance of
the note and accrued interest of $344,000 was paid in cash. During fiscal 2000
we made sales of $5.5 million and reimbursed deployment expenses of $120,000 to
this customer.
In November 2000, we sold all our shares for $9 million and $320,000 in
accumulated, unpaid dividends. Of the total $10.3 million due from the
purchaser, approximately 7.7% or $787 is held in a segregated escrow account
for one year. The gain of $3.7 million on the sale of the shares is included
in investment income in the accompanying income statement.
During fiscal 2001 and 2000 we made sales of $5.7 million and $5.5 million
respectively, to this customer under a long-term equipment financing
agreement. The purchase agreement with this customer provides for invoiced
31
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 $5.9 million, including deployment expenses
of $210,000 during fiscal 2001 for this customer which was paid in full
including accrued interest during January 2001. We financed $3.3 million of
receivables, including deployment expenses of $120,000 during fiscal 2000 for
this customer and $3 million of the then unpaid note was exchanged for our
equity interest in the customer. The remaining balance of the note and accrued
interest of $344,000 was paid in cash.
Our investing activities during fiscal 2001 used cash flows of $12.5 million
including $7.0 million in cash balances at Entrada on August 31, 2000 when it
ceased to be a subsidiary. 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 in NSI and $819,000 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 The investing activities of continuing operations during
fiscal 2000 provided cash flows of $4.3 million. We received gross proceeds of
$15.4 million from the sale of shares in NETsilicon in September 1999 which was
offset by NETsilicon's cash at the time of sale. Our other investing activities
during fiscal 2000 included $2.1 million for the purchases of capital equipment,
$886,000 for software development, $3.6 million for investments in other assets
and advances to our discontinued operations net of repayments received from
NETsilicon of $3.4 million.
We expect our investments in property and equipment will increase to support the
anticipated growth of our operations and infrastructure.
Our financing activities during fiscal 2001 provided cash
flows of $60.6 million which consisted primarily of $46.6 million in net
proceeds from a private placement by Sorrento 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. The financing activities of continuing operations during fiscal 2000
provided cash flows of $14.3 million which consisted primarily of $6.9 million
in net proceeds from a private placement of our common stock, and $8.2 million
in proceeds from option and warrant exercises offset by preferred stock
dividends paid in cash and treasury stock purchases.
We have a line of credit which totals $8.0 million. Outstanding borrowings
against these lines of credit were $1.3 million at January 31, 2001. Our various
credit line is collateralized by accounts receivable, inventory and equipment.
During fiscal 2000 we completed one sale of our common stock receiving net
proceeds of $6.9 million and issued 1,048,440 shares of our common stock in
conversions of preferred stock issued in prior years. At January 31, 2000 the
liquidation preference of the outstanding preferred stock is $6.5 million and
none of the shares are currently convertible. (See Notes I and J to the
Consolidated Financial Statements contained in Part II herein.)
During fiscal 1999 we completed several private placements of our common and
convertible preferred stock receiving net proceeds of $9.4 million, and issued
1,911,717 shares of our common stock in these placements and in conversions of
these and other previously issued securities. (See Note I and J to the
Consolidated Financial Statements contained in Part II herein.)
During March 2000, our Sorrento subsidiary completed a private placement of
8,596,333 shares of its Series A Convertible Preferred Stock to a group of
investors receiving net proceeds of approximately $46.6 million. Each share of
our Sorrento subsidiary's Series A Preferred Stock is convertible into one share
of its common stock at the option of the holder, may vote on an "as converted"
basis except for election of directors, and has a liquidation preference of
$5.45 per share. The shares are automatically converted into Sorrento's common
stock upon an underwritten public offering by Sorrento with an aggregate
offering price of at least $50 million. Since Sorrento did not complete
a $50 million public offering by March 1, 2001, the holders of more than 50% of
the then outstanding Series A shares may request to be redeemed at the shares
then adjusted liquidation preference. If such a request is made in writing, our
Sorrento subsidiary has the obligation to redeem the shares in cash, if funds
are lawfully
32
available to such a redemption, or for such pro rata portion as to which a
lesser amount of lawfully available funds would exist.
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 $5,122. In addition we have granted
options to purchase 410,000 of our Entrada shares for $3.19 per share (the
merger price) to several of our then officers and consultants.
During March 2001 we completed a private placement of 1,525,995 shares of our
common stock receiving net proceeds of $9.6 million. In addition the purchasers
received three year warrants to acquire an additional 381,499 shares of our
common stock at $8.19 per share. In the event we issue shares of our common
stock or equity securities convertible into our common stock at a price less
than $6.5531 per share the purchasers are entitled to receive additional shares
of common stock.
We anticipate that our available cash resources, and marketable securities
available for sale together with the proceeds of Sorrento's private placement,
will be sufficient to meet our presently anticipated capital requirements for
the next year. Nonetheless, our future capital requirements may vary materially
from those now planned including the need for additional working capital to
accommodate 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.
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
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities," is effective for financial
statements with fiscal quarters of all fiscal years beginning after June 15,
2000. The Accounting Standards Executive Committee issued Statement of Position
("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use," and SOP 98-5, "Reporting on the Costs of
33
Start-up Activities," effective in the current or future periods. The adoption
or future adoption of these standards has had or will have no material effects,
if any, on our financial position or results of operations.
The Financial Accounting Standards Board issued Interpretation ("FIN") No.
44, "Accounting for Certain Transactions involving Stock Compensation," an
Interpretation of APB Opinion No. 25. FIN 44 clarifies the application of
Opinion No. 25 for (a) the definition of an employee for purposes of applying
Opinion No. 25, (b) the criteria for determining whether a plan qualifies as a
non-compensatory plan, (c) the accounting consequences of various modifications
to the terms of a previously fixed stock option award, and (d) the accounting
for an exchange of stock compensation awards in a business combination. FIN 44
is effective July 2, 2000, but certain conclusions cover specific events that
occur after either December 15, 1998, or January 12, 2000. The adoption of this
standard had no material effect, if any, on our financial position or results of
operations.
The Securities and Exchange Commission issued Staff Accounting Bulletin
No. 101, Revenue Recognition ("SAB 101") which broadly addresses how companies
report revenues in their financial statements effective the fourth fiscal
quarter of years beginning after December 31, 1999. The adoption of this policy
had no effect on our financial position or results of operations.
.
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. Additionally, the interest rates charged by
our present lenders adjust on the basis of the lenders' prime rate.
Almost all of our sales have been denominated in U.S. dollars. A portion of
our expenses are denominated in currencies other than the U.S. dollar and in the
future a larger portion of our sales could also be denominated in non-U.S.
currencies. As a result, currency fluctuations between the U.S. dollar and the
currencies in which we do business could cause foreign currency translation
gains or losses that we would recognize in the period incurred. We cannot
predict the effect of exchange rate fluctuations on our future operating results
because of the number of currencies involved, the variability of currency
exposure and the potential volatility of currency exchange rates. We attempt to
minimize our currency exposure risk through working capital management and do
not hedge our exposure to translation gains and losses related to foreign
currency net asset exposures.
We do not hold or issue derivative, derivative commodity instruments or
other financial instruments for trading purposes. Investments held for other
than trading purposes do not impose a material market risk.
We believe that the relatively moderate rate of inflation in the United
States over the past few years and the relatively stable interest rates incurred
on short-term financing have not had a significant impact on our sales,
operating results or prices of raw materials. There can be no assurance,
however, that inflation or an upward trend in short-term interest rates will not
have a material adverse effect on our operating results in the future should we
require debt financing in the future.
Item 8. Financial Statements and Supplementary Data.
The information required by Item 8 is set forth in Item 13 of this Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
34
PART III
Item 10. Directors and Executive Officers of the Company
On April 30, 2001, the Company's directors and executive officers were:
Name Age Position
---- --- --------
Xin Cheng, Ph.D. 45 Chief Executive Officer, Chairman, Director (ii)
James M. Dixon 53 Chief Operating Officer, President, Director
Phillip W. Arneson 64 Director (i)
Tingye Li, Ph.D 69 Director (ii)
Gary M. Parsons 51 Director (i)
Joe R. Armstrong 52 Chief Financial Officer
Leonard N. Hecht 64 Executive Vice President
John A. Mason 43 Sr. Vice President, Business Development and
President, Sorrento Europe
Christopher E. Sue 38 Vice President, Finance
Richard R. Jacobson 58 Senior Vice President, Legal, and Secretary
(i) member of the Audit Committee
(ii) member of the Compensation Committee
The Company's By-Laws provide that the members of the Board of Directors be
elected annually by the Shareholders of the Company for one-year terms. Each
director who is not an employee of the Company or its 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.
Xin Cheng, Ph.D., has been our Chairman and Chief Executive Officer since
September 2000. He has been our President and a director since September 1995,
and was Secretary from June 1993 to February 1997. Dr. Cheng has served as the
Chief Executive Officer and Chairman of our Sorrento Subsidiary since January
2000. In 1995, Dr. Cheng founded the optical networking division of the Company.
From 1988 to 1990, Dr. Cheng served as Senior Staff Scientist and from 1990 to
1993 as a director of Advanced Technology for Amoco Technology Company, a
photonics technology development company and a subsidiary of Amoco Oil
Corporation. While at Amoco, Dr. Cheng led their development of the WDM-based
fiber optic high-resolution computer graphics link, a high-dynamic range
microwave fiber optic system, a fiber optic HDTV transmission system, multiple
fiber optic serial digital video transmission systems as well as other
technologies. Dr. Cheng holds a Ph.D. and M.S. in Electrical Engineering from
the University of California, Irvine, and a B.S. degree in Physics from Nanjing
University, China.
James M. Dixon became a director, our President and Chief Operating Officer in
November 2000. From its inception in 1999 to the present, Mr. Dixon has served
as the Chairman of Aeris.Net South America. From 1997 to 1998, Mr. Dixon served
as President of International Wireless Communications, Inc. Latin America. Mr.
Dixon served in various executive management positions with Nextel
Communications, Inc. from 1991 to 1996, including Executive Vice President of
Nextel from 1994 to 1996, President of Digital Mobile Networks from 1992 to
1996, and Senior Vice President of Nextel from 1992 to 1994. From 1986 to 1991
Mr. Dixon held various senior management positions with McCaw Cellular
Communications, Inc. including Chairman of Bay Area Cellular Telephone Company.
Mr. Dixon served as President and Chief Operating Officer of Bay Area Cellular
Telephone Company (Cellular One) from 1984 to 1986. Mr. Dixon holds an M.B.A.
from Pepperdine University.
Phillip W. Arneson has served as one of our directors since October 2000. Since
1996, Mr. Arneson has held the position of Executive Vice President for Frandsen
Corporation, a privately held company consisting of over twenty banks and five
manufacturing companies. Additionally, he serves as President of two its
operating companies. From 1994 to 1995, Mr. Arneson was Managing Partner for
Morningside Technology, a management consulting firm. From 1982 to 1986, he
served as Executive Vice President of Allied Signal's Electronic Sector and as
Chief
35
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.
Tingye Li, Ph.D., 69, has served as one of our directors since October 2000 and
as a director of our Sorrento Subsidiary since February 2000. Dr. Li has been a
consultant in the field of lightwave communications since December 1998. From
1957 to 1998, Dr. Li served in a number of senior research positions at AT&T
Bell Labs, ultimately serving as head of the Lightwave Networks Research
Department of AT&T Labs-Research. Dr. Li also serves as a director of
LightCross, Inc., a supplier of passive components for wavelength-division-
multiplexed lightwave transmission systems and networks, and Micron Optics,
Inc., a supplier of components and subsystems for optical networks. He is a
fellow of the Optical Society of America and the Institute of Electrical and
Electronic Engineers, and a member of the National Academy of Engineering.
In 1995, he served as the President of the Optical Society of America.
Dr. Li holds a Ph.D. from Northwestern University.
Gary M. Parsons, 50, has served on our Board of Directors since October 2000.
Since 1996, Mr. Parsons has held the position of Chairman of the Board for
Motient Corporation, a wireless data firm, and XM Satellite Radio Holdings, Inc.
From 1990 to 1996, Mr. Parsons held a number of executive positions at MCI
Communications, Inc., including Executive Vice President, Chief Executive
Officer of MCImetro, Inc., and President of MCI's Southern Division. From 1984
to 1990, Mr. Parson 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.
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 us, 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. Joe holds both bachelors and masters degrees in business from
Utah State University.
Leonard N. Hecht has served as our Executive Vice President since August 2000,
and as one of our directors from June 1996 to January 2001, and a director of
our Sorrento Subsidiary from February 2000 to August 2000. Mr. Hecht did not
stand for re-election at the annual meeting in January 2001. Since 1994, he has
been President of Chrysalis Capital Group, an investment banking company
specializing in mergers, acquisitions and financing that he founded. From 1987
to 1993, Mr. Hecht was Managing Director of the Investment Banking Group and
head of the Technology Assessment Group of Houlihan Lokey Howard & Zukin, a
financial advisory firm. From 1984 to 1987, Mr. Hecht was the Vice Chairman of
the Board and Chief Executive Officer of Quantech Electronics Corp., a
diversified publicly held electronics company. Prior to joining Quantech, Mr.
Hecht was a founding principal of Xerox Development Corporation, a wholly owned
subsidiary of the Xerox Corporation. Xerox Development Corporation was active in
strategic planning, mergers and acquisition, divestitures, licensing, joint
ventures and venture investing for the Xerox Corporation.
John A. Mason has served as our Senior Vice President, Business Development and
President of Sorrento Europe since September 2000 where he is responsible for
our European sales and marketing activities, as well as the structuring and
negotiation of contracts between us and our key customers and oversight of the
roll-out of our solution into those customers' optical networks. Mr. Mason
joined us in 1996 and became our Director of Business and Strategic Planning in
1997 where he has been responsible for our strategic planning efforts, as well
as its corporate partnering, merger and acquisition activity. Mr. Mason worked
in the television and allied industries, including positions with subsidiaries
of Telecommunications Incorporated and Fox, Inc., in the Mergers and
Acquisitions Department of Smith Barney and in the strategic
consulting/technology practice at Booz, Allen and Hamilton, Inc. Mr. Mason holds
an M.B.A. from the Harvard University Graduate School of Business Administration
and an A.B. in economics from Stanford University.
Christopher E. Sue has been our Vice President, Finance since September 1997.
From January 1996 to September 1997, he served as our Chief Financial Officer.
Mr. Sue served as our Secretary from February 1997 to September
36
1997 and from November 1998 to March 2000. In December 1995 Mr. Sue became Chief
Financial Officer of our Meret subsidiary. From 1993 to 1995, he was Accounting
Manager at Haskel International, Inc., and from 1990 to 1993 he was Assistant
Controller at Sun Computers, Inc. From 1986 to 1990, Mr. Sue was employed by
KPMG Peat Marwick in both its audit and management consulting practices. Mr. Sue
is a certified public accountant.
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 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 Clause 32 Vice President, Strategic Sales
Demetri Elias, Ph.D. 57 Vice President, Marketing
Susan Hamlin 38 Vice President, Sales (North America)
Beth Kriegel 39 Vice President, Finance
Jin-Yi Pan, Ph.D. 41 Vice President, Systems Architecture
Marc Thurman 51 Vice President, Operations
Similar to all rapidly growing companies, we are constantly seeking to augment
our existing management staff at all levels. Our Board members, officers and
employees continue to be extremely helpful in identifying and attracting
potential candidates to us. In addition, we utilize the services of outside
recruitment agencies to expand and expedite the process.
Darin Clause has served as our 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.
Demetri Elias, Ph.D. has served as our Vice President, Marketing since October
2000 and joined us in April 2000 as Director, Product Line Management. Prior to
joining us, 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 Hamlin has served as our Vice President, Sales (North America) since
September 2000 and joined us in November 1999 as Regional Vice President of
Sales. Ms. Hamlin is also responsible for our 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 programs at Harvard University and
the Wharton School of Business.
37
Beth Kriegel has served as our Sorrento subsidiary's Vice President, Finance
since October 2000 and joined us in August 2000. From June 1999 to August 2000,
she served as Senior Director, Finance, and from February 1997 to June 1998 she
served as Director of Investor Relations for Advanced Tissue Sciences, a
biotechnology company based in San Diego, California. From June 1998 to May
1999, Ms. Kriegel served as Director, Financial Reporting for Stratagene, a
biotechnology company. From February 1993 to February 1997 she served in various
capacities for Cytel Corporation, most recently as Manager, Planning and
Financial Analysis from May 1992 to February 1993. Ms. Kriegel was employed with
the accounting firms of Pannell Kerr Forster from 1988 to 1991,
PricewaterhouseCoopers LLP from 1985 to 1988 and KPMG Peat Marwick from 1983 to
1985. Ms. Kriegel is a certified public accountant.
Jin-Yi Pan, Ph.D., has served as our Vice President, System Architecture since
February 2000. From 1996 to 1999, Dr. Pan was a senior research engineer at
Nokia Research Center, the corporate research arm of Nokia Corporation
responsible for developing networking system architectures, equipment and
software. From 1993 to 1996, Dr. Pan served as a researcher at Bell
Communications Research, or Bellcore, the research center created to service the
regional bell operating companies in the areas of software, networking standards
and architecture. At Bellcore, he participated in the development of network
system architecture and protection scheme for MONET, the government funded
national optical networking consortium. Dr. Pan holds a Ph.D. in Electrical
Engineering from the City University of New York and a B.S. in Optics from
Zhejiang University, China.
Marc Thurman has served as our 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.
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, Thurman had manufacturing responsibilities including internal
production, contract manufacturing (EMS) and third party manufacturing (TPM),
supporting revenues of $2 billion. Thurman holds a BSEE degree from Oregon State
University as well as an MBA degree from University of Portland.
38
Item 11. Executive Compensation
The following tables set forth the annual compensation for both individuals who
served as the Company's Chief Executive Officer ("CEO") for the fiscal year
ended January 31, 2001, 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
$100,000.
Summary Compensation Table
Annual Compensation Long-Term Compensation
-------------------------------- -----------------------------------
Other Restricted Securities Long-Term All
Annual Stock Underlying Incentive Other
Salary Bonus Compensation Award(s) Options Plan Compensation
Name and Principal Position Year ($) ($) ($) ($) (#) Payouts ($)(A)
- --------------------------- ---- ------- ------- ------------ -------- ---------- --------- ------------
Xin Cheng, Chairman, 2001 239,217 - - - 175,000 - -
Chief Executive Officer 2000 180,000 8,365 - - 100,000 - -
1999 125,031 51,066 - - 196,183 - -
James M. Dixon, Director, 2001 54,464 100,000 - - 740,000 - -
President, COO
Leonard N. Hecht, 2001 104,808 - - - 435,000 - -
Executive VP
Christopher E. Sue, VP 2001 155,880 - - - 110,000 - -
Finance 2000 134,904 27,947 - - 15,000 - -
1999 103,077 - - - 66,665 - -
John A. Mason, Sr. VP 2001 151,878 - - - 42,500 - -
Business Development
President, Sorrento Europe
Richard L. Jacobson, Sr. VP 2001 140,850 - - - 154,000 - 42,746
Legal and Secretary
Par Chadha, 2001 80,128 - - - 600,000 - 750,000
former CEO 2000 230,000 - - - 70,000 - -
1999 147,500 - - - 349,164 - -
Rohit Phansalkar, 2001 177,020 - - - 450,000 - 91,177
former CEO
(A) Other compensation for Mssrs. Jacobson and Phansalkar represents
relocation related expenses reimbursed by us. Mr. Chadha's other
compensation represents payments pursuant a consulting agreement entered
into in connection with his resignation as Chairman and CEO. Of this
amount, $500,000 was applied to an option exercise.
Long-Term Incentive Plans
The Company has no long-term incentive plans other than our various
stock option plans.
39
Option Grants in Last Fiscal Year
Individual Grants
------------------------------------------------------------
Number of Percent of Market Potential Realizable Value at
Securities Total Options Exercise Price on Assumed Annual Rates of Stock Price
Underlying Granted to or Base Date Appreciation for Option Term (A)
Options Employees in Price Granted Expiration -----------------------------------
Name Granted (#) Fiscal Year ($/Share) ($/Share) Date 0% ($) 5% ($) 10% ($)
---- ----------- ----------- --------- --------- --------- ------- -------- ----------
Xin Cheng 175,000 4.51 49.25 49.25 5-01-2010 - 5,420,286 13,736,068
James M. Dixon 700,000 18.05 26.64 26.64 10-19-2010 - 11,727,627 29,720,109
40,000 1.03 22.00 18.75 1-17-2011 - 341,671 1,065,307
Leonard N. Hecht 75,000 1.93 35.50 35.50 5-22-2010 - 1,674,432 4,243,339
350,000 9.03 59.88 59.88 8-22-2010 - 13,179,273 33,398,865
10,000 0.26 18.75 18.75 1-17-2011 - 117,918 298,827
Christopher E. Sue 50,000 1.29 21.80 21.80 4-17-2010 - 1,548,653 3,924,591
50,000 1.29 25.00 25.00 1-17-2011 - 786,118 1,992,178
10,000 0.26 18.75 18.75 1-17-2011 - 117,918 298,827
John A. Mason 37,500 0.97 21.80 21.80 4-17-2010 - 514,121 1,302,884
5,000 0.13 18.75 18.75 1-17-2011 - 58,959 149,413
Richard L. Jacobson 150,000 3.87 69.13 69.13 7-12-2010 - 6,520,851 16,525,117
4,000 0.10 18.75 18.75 1-17-2011 - 47,167 119,531
Par Chadha 600,000 15.47 49.25 49.25 4-26-2010 - 18,583,836 47,095,090
Rohit Phansalkar 450,000 11.60 35.50 35.50 6-9-2010 - 10,046,592 25,460,036
(A) In accordance with Securities and Exchange Commission rules, these
columns show gains that might exist for the respective options, assuming
that the market price of the Company's common stock appreciates from the
date of the grant over the term of the option at rates of 5% and 10%,
respectively.
Aggregated Option Exercises in Fiscal Year 2001 and January 31, 2001 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
------- ------- ------- ------------ --------------- ------------ -------------
Xin Cheng - - 478,001 - 5,368,307 -
James M. Dixon - - 70,000 670,000 - 170,000
Leonard N. Hecht - - 548,336 10,000 1,615,299 75,000
Christopher E. Sue - - 171,999 60,000 1,439,034 137,500
John A. Mason - - 100,001 5,000 1,222,120 37,500
Richard L. Jacobson - - 150,000 4,000 - 30,000
Par Chadha 578,500 756,909 600,000 - - -
Rohit Phansalkar - - 485,000 - - -
(A) Options are "in-the-money" if, on January 31, 2001, the market price of
the Common Stock ($26.25) 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, 2001, and the aggregate exercise price of such
options.
40
Employment Agreements
In September 2000, we assumed our Sorrento subsidiary's obligations
under its two year employment agreement with Dr. Cheng. The agreement, ending
March 2002, provides for a salary of $250,000 per year, vesting of all his
options to acquire our common stock granted prior to February 1, 2000, and a
bonus equal to two year's base salary payable at the end of the contract. This
agreement may be terminated for cause. However, should Dr. Cheng be terminated
without cause he will receive a continuation of his salary and benefits for two
years and he is required to provide consulting services to us during that
period.
We entered into a two year employment contract with Mr. Hecht ending
August 2002 which provides for a salary of $250,000 per year and vesting of all
his options to acquire our common stock granted prior to February 1, 2000. This
contract may be terminated for cause. However, should Mr. Hecht be terminated
without cause or resign in certain circumstances he will receive a continuation
of his salary and benefits for two years, vesting of all his options to acquire
our common stock, and he is required to provide consulting services to us during
the two years following his termination.
We entered into a two year employment contract with Mr. Mason ending
May 2002 which provides for a 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 may be terminated for cause. However, should Mr. Mason be terminated
without cause or resign in certain circumstances he will receive a continuation
of his salary and benefits for two years, vesting of all his options to acquire
our common stock, and he is required to provide consulting services to us during
the two years following his termination.
We have entered into 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 may be terminated for cause. However, should Mr. Sue be terminated
without cause or resign in certain circumstances he will receive a continuation
of his salary and benefits for two years, vesting of all his options to acquire
our common stock and he is required to provide consulting services to us during
that period.
We entered into a two year employment contract with Mr. Jacobson ending
in July 2002 which provides for a salary of $250,000 per year. This contract may
be terminated for cause. However, should Mr. Jacobson be terminated without
cause or resign in certain circumstances he will receive a continuation of his
salary and benefits for two years, vesting of all his options to acquire our
common stock, and he is required to provide consulting services to us during two
years following his termination.
Compliance with Section 16(a) of the Exchange Act
The Securities Exchange Act of 1934 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. To
our knowledge, all filing requirements by our officers and directors were
complied with during the year ended January 31, 2001, except for late reporting
of initial option grants by Mssrs. Armstrong, Arneson, Dixon, Jacobson, and
Parsons and Dr. Li at the time each joined our Board of Directors or became one
of our officers.
41
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information as of April 20,
2001, regarding the ownership of the Common Stock by (i) each Director of the
Company; (ii) each of the executive officers named in the Summary Compensation
Table, above; (iii) each person known to the Company to beneficially own 5% or
more of Common Stock; and (iv) all Directors and executive officers of the
Company 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.
Common Stock
Number of Percentage of
Name of Beneficial Owner (A) Shares Outstanding (K)
Xin Cheng, Ph.D. 525,735 (B) 3.6%
James M. Dixon 70,000 (C) *
Philip W. Arneson 8,750 (D) *
Tingye Li, Ph.D. 8,750 (E) *
Gary M. Parsons 8,750 (F) *
Joe R. Armstrong - *
Leonard N. Hecht 576,667 (G) 3.9%
John A. Mason 100,001 (H) *
Christopher E. Sue 172,568 (I) 1.2%
Richard R. Jacobson 150,000 (J) 1.0%
Par Chadha 1,482,368 (K) 10.0%
15332 Antioch Street
Pacific Palisades, CA 90272
Rohit Phansalkar 494,768 (L) 3.4%
First Hand Capital Management, Inc. 676,950 (M) 4.8%
125 South Market, Suite 1200
San Jose, CA 95113
All Directors and Executive Officers as a group 1,621,221 10.3%
* 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 the Company. Except as noted the addresses for each
beneficial owner is 9990 Mesa Rim Road, San Diego, CA 92121.
(B) Includes exercisable options held by Dr. Cheng to acquire 426,515 shares
of common stock and exercisable options to acquire 51,486 shares of
common stock held as custodian or trustee for minor children, as to
which beneficial ownership is disclaimed. Dr. Cheng holds options to
acquire 12,632 of our NETsilicon shares at $7.00 per share. On March 7,
2000, Dr. Cheng was granted options to acquire 5,000,000 shares of our
Sorrento subsidiary's common stock at $5.45 as the Chairman, CEO and
founder of Sorrento.
(C) Includes exercisable options held by Mr. Dixon to acquire 70,000 shares
of common stock.
(D) Includes options to acquire 8,750 shares of common stock held by Mr.
Arneson that are exercisable within 60 days.
42
(E) Includes options to acquire 8,750 shares of common stock held by Dr. Li
that are exercisable within 60 days. On March 7, 2000, Dr. Li was
granted an option to acquire 100,000 shares of our Sorrento subsidiary's
common stock at $5.45 per share under its option plan which provided for
automatic grants to directors.
(F) Includes options to acquire 8,750 shares of common stock held by Mr.
Parsons that are exercisable within 60 days.
(G) Includes shares and options held in the name of Chrysalis Capital Group
and exercisable options to acquire 548,336 shares of common stock. Mr.
Hecht owns, directly and indirectly, 100% of the outstanding capital
stock of Chrysalis Capital Group. Mr. Hecht holds options to acquire
25,000 of our NETsilicon shares at $7.00 per share and 90,000 of our
Entrada shares at $3.19 per share. On March 1, 2000, Mr. Hecht was
granted an option to acquire 100,000 shares of our Sorrento subsidiary's
common stock at $5.45 per share under its option plan which provided for
automatic grants to directors.
(H) Includes exercisable options held by Mr. Mason to acquire 100,001 shares
of our common stock. On October 1, 2000, Mr. Mason was granted an option
to acquire 400,000 shares of our Sorrento subsidiary's common stock at
$5.45 per share.
(I) Includes exercisable options held by Mr. Sue to acquire 171,999 shares
of common stock. Mr. Sue holds options to acquire 4,421 of our
NETsilicon shares at $7.00 per share and 35,000 of our Entrada shares at
$3.19 per share. Mr. Sue holds unexercisable options to acquire 50,000
shares of common stock at $49.25 granted under the 2000 Stock Incentive
Plan.
(J) Includes exercisable options held by Mr. Jacobson to acquire 150,000
shares of our common stock.
(K) Includes shares and options held in the name of R II Partners, Inc.
including exercisable options to acquire 600,000 shares of common stock.
Mr. Chadha, our former Chairman and CEO, owns, directly and indirectly,
100% of the outstanding capital stock of R II Partners, Inc. Mr. Chadha
holds options to acquire 12,632 of our NETsilicon shares at $7.00 per
share and 200,000 of our Entrada shares at $3.19 per share. Does not
include 471,937 shares of common stock held by his wife, their two
children and RT Investments, Inc., in which shares Mr. Chadha disclaims
beneficial ownership. Mr. Chadha has neither investment nor voting power
with respect to such shares.
(L) Includes exercisable options held by Mr. Phansalkar to acquire 485,000
shares of common stock. Mr. Phansalkar holds options to acquire 50,000
of our Entrada shares at $3.19 per share. In addition, on March 7, 2000
he was granted options to acquire 100,000 shares of our Sorrento
subsidiary's common stock at $5.45 under its option plan for services as
an advisory director to it. Mr. Phansalkar was also granted options to
acquire 200,000 shares of our shares of common stock in the Sorrento
subsidiary at $5.45 by the Board of Directors of Osicom on August 10,
2000 for services rendered. Mr. Phansalkar was a manager, member or
partner of entities which hold 1,825,690 shares of the Series A
Preferred stock of Sorrento including Andersen Weinroth & Co., LP,
("AW"), Andersen Weinroth Capital Corporation ("AW") and Sorrento
Holdings, LLC. Mr. Phansalkar was a manager and is a beneficial owner of
FIBR Holdings, LLC which holds 142,692 shares of common stock. Mr.
Phansalkar's beneficial ownership of these shares is not determinable at
the date of this Proxy Statement due to a dispute with AW.
(M) Represents holdings reported by Firsthand Capital Management, Inc., as
of December 31, 2000, reported on Form 13-F, "Quarterly Reports Filed by
Institutional Managers".
(N) For each beneficial owner, the "Percentage of Outstanding" equals each
owner's actual holdings of shares plus shares represented by unexercised
options and warrants held, divided by the total of our outstanding
shares at April 20, 2000 plus the unexercised options and warrants
detailed above for 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.
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
43
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%.
During October, 2000 Mr. Chadha, our former CEO and Chairman, and Mrs.
Sharon Chadha, also a former officer, exercised options to acquire 507,388
shares of our common stock through their transferees, RII Partners, Inc. and RT
Investments, Inc. Mr. Chadha owns 100% of the outstanding capital of RII
Partners, Inc. and Mrs. Chadha owns 100% of the outstanding capital of RT
Investments, Inc. Pursuant to Mr. Chadha's separation agreement we loaned the
exercise price of $5,034,279 at the applicable federal rate of 6.30% for two
years. The loan is fully collateralized by the 507,388 shares of our common
stock.
During fiscal 2001, we entered into employment agreements with Dr.
Cheng, Mr. Hecht, Mr. Phansalkar, Mr. Sue, and Mr. Jacobson which provide for
loans to the employees to exercise stock options to acquire our common stock and
the stock of our subsidiaries including any required tax withholdings due upon
exercise. The loans are for a period not to exceed two years at the applicable
federal rate, are full recourse and require the pledge of shares issued upon
exercise. As of April 30, 2001 no such loans are outstanding.
During fiscal 2000 we paid $40,000 to Renn Zaphiropoulos, a then
director, for management consulting services.
During fiscal 1998, we made 8% demand loans totaling $165,000 to
Chrysalis Capital Group which were repaid with interest in April 1999. The loans
were collateralized by 20,408 shares of our common stock. During fiscal 2000 and
1999, we paid $190,070 and $25,000, respectively, in fees to Chrysalis Capital
Group for services rendered in connection with various amended loan and security
agreements. Leonard Hecht was a director when such transactions occurred and
owns, directly and indirectly, 100% of the outstanding capital stock of
Chrysalis Capital Group.
During fiscal 2000 FIBR Holdings, LLC purchased 679,483 unregistered
shares of our common stock for $7,500,000. In connection with this placement
Humbert B. Powell, III, then a director, received a finder's fee of $300,000.
Andersen Weinroth Capital Corp. ("AW") received a placement fee of $300,000 in
connection with this placement and Rohit Phansalkar, who subsequently became one
of our directors, and later became our Chairman and Chief Executive Officer, was
a partner of AW at that time. FIBR Holdings, LLC had the right to nominate one
member of the Board of Directors to serve until the annual shareholders' meeting
in 2001 and had the right to participate in any stock offering by our Sorrento
Subsidiary, to the extent of $7,500,000 subject to certain limitations. Mr.
Phansalkar was nominated by AW and joined our Board of Directors on January 6,
2000.
On March 3, 2000, our Sorrento subsidiary completed a sale 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. Of these shares,
1,467,891 shares were purchased for $8,000,000 pursuant to the previously
contracted right of participation by entities in which Mr. Phansalkar was
partner or member. In addition, AW received a placement fee of $1,950,000 paid
through the issuance by Sorrento of 357,799 shares of its Series A Convertible
Preferred Stock. Mr. Phansalkar disclaims beneficial ownership of these shares
except to the extent of his beneficial ownership of each entity. In addition,
Renn Zaphiropoulos, a former director, purchased 45,872 of these shares for
$250,000.
44
PART IV
Item 14. 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, 2001 and 2000
Consolidated Statements of Operations for the Years Ended
January 31, 2001, 2000 and 1999
Consolidated Statements Comprehensive Income for the Years
Ended January 31, 2001, 2000 and 1999
Consolidated Statement of Stockholders' Equity for the Years
Ended January 31, 2001, 2000 and 1999
Consolidated Statements of Cash Flows for the Years Ended
January 31, 2001, 2000 and 1999
Notes to Consolidated Financial Statements
2. Exhibits:
2. Stock Purchase Agreement dated as of June 1, 1996
between Osicom and BWA (A)
3.1 Restated Certificate of Incorporation dated June 14,
1988 (B)
3.2 Amended and Restated By-Laws of Registrant (C)
3.3 Series A Preferred Stock Certificate of Designation
(D)
3.4 Series B Preferred Stock Certificate of Designation
(A)
3.5 Series C Preferred Stock Certificate of Designation
(A)
3.6 Series D Preferred Stock Certificate of Designation
(E)
3.7 Series E Preferred Stock Certificate of Designation -
(F)
3.8 Series B Preferred Stock Certificate of Designation -
(F)
3.9 Certificate of Amendment to the Certificate of
Incorporation dated January 16, 1998 - (G)
3.10 Certificate of Amendment to the By-Laws dated January
30, 1998 - (G)
3.11 Corrected Certificate of Incorporation of Sorrento
Networks, Inc. - filed herewith
4.1 1988 Stock Option Plan - (H)
4.2 Amended and Restated 1997 Incentive and Non-Qualified
Stock Option Plan -(G)
4.3 1997 Directors Stock Option Plan - (I)
4.4 2000 Stock Incentive Plan - (J)
4.5 2000 Employee Stock Purchase Plan - (J)
4.6 2000 Stock Option/Stock Issuance Plan of Sorrento
Networks, Inc. - filed herewith
10.1 Line of Credit Agreement with Coast Business Credit
dated May 28, 1995 and Modification dated January 31,
1996 (K)
10.2 Acquisition Agreement of Rockwell Network Systems,
Inc. dated January 31, 1996 (L)
10.3 Acquisition Agreement of Digital Products, Inc. dated
as of July 1, 1996 (M)
45
10.4 Acquisition Agreement of Cray Communications, Inc.
dated as of July 1, 1996 (N)
10.5 Agreement dated June 12, 2000 with Par Chadha - (O)
10.6 Agreement dated March 3, 2000 with Xin Cheng - (O)
10.7 Agreement dated May 22, 2000 with Rohit Phansalkar -
(O)
10.8 Agreement dated May 22, 2000 with Christopher E. Sue
- (O)
10.9 Agreement dated August 22, 2000 with Leonard N. Hecht
- filed herewith
10.10 Agreement dated May 22, 2000 with John A. Mason -
filed herewith
10.10 Agreement dated July 12, 2000 with Richard L.
Jacobson - filed herewith
21 Subsidiaries of the Registrant - filed herewith
23.1 Consent of BDO Seidman LLP - filed herewith
23.2 Consent of Arthur Andersen & Co., L.L.P. - filed
herewith
----------------
The foregoing are incorporated by reference from the
Registrant's filings as indicated:
A Form S-4 dated September 6, 1996
B Form 10-QSB for the quarter ended July 31, 1996
C Form 10-K for the year ended January 31, 1988
D Form 10-K for the year ended January 31, 1993
E Form S-3 dated February 25, 1997
F Form 10-KSB for the year ended January 31, 1997
G Proxy Statement dated December 1, 1999
H Proxy Statement dated May 13, 1988
I Proxy Statement dated November 21, 1997
J Proxy Statement dated December 11, 2000
K Form 10-KSB for year ended January 31, 1996
L Form 8-K dated February 2, 1996
M Form 8-K dated September 12, 1996
N Form 8-K dated September 23, 1996
O Form 10-Q for the quarter ended October 31, 2000
--------------------
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
November 14, 2000 Record date for distribution of Entrada
Networks, Inc. shares
March 23, 2001 Private Placement of Common Stock
46
OSICOM TECHNOLOGIES, INC.
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----------
Independent Certified Public Accountants' Reports F-2 to F-3
Consolidated Balance Sheets as of January 31, 2001 and 2000 F-4
Consolidated Statements of Operations and Comprehensive Income for the years ended
January 31, 2001, 2000 and 1999 F-5
Consolidated Statements of Shareholders' Equity for the years ended
January 31, 2001, 2000 and 1999 F-6 to F-8
Consolidated Statements of Cash Flows for the years ended
January 31, 2001, 2000 and 1999 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
We have audited the accompanying consolidated balance sheets of Sorrento
Networks Corporation (a New Jersey corporation) and subsidiaries (the "Company")
as of January 31, 2001 and 2000 and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the years ended
January 31, 2001, 2000 and 1999. 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 did
not audit the financial statements of a foreign subsidiary which statements
reflect net assets of $1,632,000 as of January 31, 2000 and total revenues of
$20,819,000 and $39,039,000 for the years ended January 31, 2000 and 1999,
respectively. These amounts are included in the net investment in and results of
discontinued operations in the accompanying financial statements. Those
statements were audited by other auditors whose reports have been furnished to
us, and our opinion, insofar as it relates to the amounts included for such
subsidiary, is based solely on the reports of the other auditors.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those 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, and reports of the
other auditors, provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company and
subsidiaries as of January 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the years ended January 31, 2001,
2000 and 1999 in conformity with generally accepted accounting principles, in
the United States of America.
/s/ BDO Seidman LLP
BDO Seidman LLP
Los Angeles, California
March 2, 2001, except for Note P which is as of March 23, 2001
F-2
ARTHUR ANDERSEN
Arthur Andersen & Co.
21st Floor Edinburgh Tower
The Landmark
15 Queen's Road Central
Hong Kong
REPORT OF INDEPENDENT PUBLIC ACCOUNTS
To: Uni Precision Industrial Limited and Subsidiaries
We have audited the accompanying balance sheets of Uni Precision Industrial
Limited and Subsidiaries (the "Group), incorporated in Hong Kong, as of January
31, 1999 and 2000 and the related statements of income, cash flows, and changes
in shareholders' equity for the years ended January 31, 1998, 1999 and 2000,
expressed in Hong Kong dollars. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards
in the United States of America. Those 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 that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Group as of January 31,
1999 and 2000, and the results of its operations and cash flows for the years
ended January 31, 1998, 1999 and 2000 in conformity with generally accepted
accounting principles in the United States of America.
/s/ Arthur Andersen & Co.
Hong Kong,
March 3, 2000
F-3
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In Thousands)
================================================================================================================
January 31, 2001 January 31, 2000
- ----------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 9,965 $ 13,511
Accounts receivable, net (Notes D, I and R) 16,000 11,639
Inventory, net (Notes B, D and R) 14,601 13,004
Prepaid expenses and other current assets (Note M) 813 1,503
Investment in marketable securities (Note B) 50,258 168,750
- -------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 91,637 208,407
- -------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT, NET (Notes C, D and E) 16,600 5,520
- -------------------------------------------------------------------------------------------------------------
OTHER ASSETS
Purchased technology, net (Note B) 1,023 1,395
Capitalized software, net (Note B) - 1,773
Other assets (Notes A, B and M) 2,556 3,337
Investment in former subsidiary (Note A) 1,307 2,833
- -------------------------------------------------------------------------------------------------------------
TOTAL OTHER ASSETS 4,886 9,338
- -------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 113,123 $223,265
=============================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term debt (Note D) $ 1,342 $ 5,407
Current maturities of long term debt (Note E) 422 721
Accounts payable 8,382 6,417
Accrued liabilities 9,131 5,882
Other current liabilities 367 494
- -------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 19,644 18,921
- -------------------------------------------------------------------------------------------------------------
Long-term debt and capital lease obligations (Note E) 3,819 1,806
Dividends payable (Note A) 1,307 -
- -------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 24,770 20,727
- -------------------------------------------------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes F and G)
MINORITY INTEREST
Preferred stock, 8,954 shares issued and outstanding; liquidation
preference $48,800 (Note I) 48,620 -
STOCKHOLDERS' EQUITY (Note H)
Preferred stock, $.01 par value; liquidation preference $1,353 1 1
Common stock, $.30 par value; 150,000 shares authorized; 12,608 shares
issued 12,599 shares outstanding at January 31, 2001;
11,483 shares issued and 11,474 shares outstanding 3,782 3,445
at January 31, 2000
Additional paid-in capital 114,994 102,418
Note receivable from option exercise (Note M) (5,034) -
Deferred stock compensation (880) -
Accumulated deficit (118,010) (67,771)
Unrealized gain on maketable securities 44,949 164,514
Treasury stock, at cost; 9 shares at January 31, 2001 and
January 31, 2000, respectively (69) (69)
- -------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 39,733 202,538
- -------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 113,123 $223,265
=============================================================================================================
See accompanying notes to consolidated financial statements.
F-4
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, except per share amounts)
=====================================================================================================================
Twelve Months Ended
January 31
----------------------------------------------------
2001 2000 1999
- ---------------------------------------------------------------------------------------------------------------------
NET SALES (Notes B and I) $ 44,641 $ 68,372 $ 58,362
COST OF SALES 31,470 36,590 32,477
- ---------------------------------------------------------------------------------------------------------------------
GROSS PROFIT 13,171 31,782 25,885
- ---------------------------------------------------------------------------------------------------------------------
OPERATING EXPENSES
Selling and marketing 17,200 16,914 15,480
Engineering, research and development 23,928 11,695 9,778
General and administrative 18,110 12,753 10,315
Deferred compensation 1,908 - -
Other operating expenses 2,440 371 372
- ---------------------------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 63,586 41,733 35,945
- ---------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM OPERATIONS (50,415) (9,951) (10,060)
- ---------------------------------------------------------------------------------------------------------------------
OTHER INCOME (CHARGES)
Investment income 5,507 236 242
Interest expense (918) (1,864) (1,325)
Other income (charges) - 19 74
Gain on sale of marketable securities (Note A) 3,921 13,970 -
- ---------------------------------------------------------------------------------------------------------------------
TOTAL OTHER INCOME (CHARGES) 8,510 12,361 (1,009)
- ---------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAX (41,905) 2,410 (11,069)
PROVISION FOR INCOME TAXES (Note R) - - -
- ---------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) FROM CONTINUING OPERATIONS (41,905) 2,410 (11,069)
LOSS FROM DISCONTINUED OPERATIONS
(NET OF INCOME TAX PROVISION OF $-0-, $246, AND $-0-) - (12,419) (2,319)
ESTIMATED LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS
(NET OF INCOME TAX PROVISION OF $-0-, $-0-, AND $-0-) - (11,644) -
NET INCOME (LOSS) $ (41,905) $ (21,653) $ (13,388)
=====================================================================================================================
INCOME (LOSS) PER COMMON SHARE (Note L)
BASIC
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (RESTATED, IN THOUSANDS) 11,855 9,631 7,673
NET INCOME (LOSS) PER COMMON SHARE:
Continuing operations (3.71) 0.17 (1.69)
Discontinued operations n/a (2.50) (0.30)
- ---------------------------------------------------------------------------------------------------------------------
BASIC NET INCOME (LOSS) PER COMMON SHARE $ (3.71) $ (2.33) $ (1.99)
=====================================================================================================================
DILUTED
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (RESTATED, IN THOUSANDS) 11,855 10,605 7,673
NET INCOME (LOSS) PER COMMON SHARE:
Continuing operations (3.71) 0.15 (1.69)
Discontinued operations n/a (2.27) (0.30)
- ---------------------------------------------------------------------------------------------------------------------
DILUTED NET INCOME (LOSS) PER COMMON SHARE $ (3.71) $ (2.12) $ (1.99)
=====================================================================================================================
COMPREHENSIVE INCOME AND ITS COMPONENTS CONSIST OF
THE FOLLOWING:
Net income (loss) $ (41,905) $ (21,653) $ (13,388)
Unrealized gains (losses) from marketable securities:
Unrealized holding gains (losses) arising during the
period (123,486) 164,514 -
Reclassification adjustment for gains included in
net income 3,921 - -
- ---------------------------------------------------------------------------------------------------------------------
NET COMPREHENSIVE INCOME (LOSS) $ (161,470) $ 142,861 $ (13,388)
=====================================================================================================================
See accompanying notes to consolidated financial statements.
F-5
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
For the Year Ended January 31, 2001
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In Thousands)
=============================================================================================================================
COMMON PREFERRED ADDITIONAL NOTES
STOCK STOCK PAID IN RECEIVABLE
Shares Amount Shares Amount CAPITAL OPTIONS
- ----------------------------------------------------------------------------------------------------------------------
Balance at
January 31, 2000 11,483 $ 3,445 5 $ 1 $ 102,418 $ -
Preferred stock conversions
(Note H) 167 50 (3) - (50)
Stock option and
warrant exercises
(Notes I, J and M) 919 276 8,619 (5,034)
Unrealized losses on
available for sale
securities (Note B)
Deferred stock compensation
of subsidiary (Note B) 2,788
Amortization of deferred stock
compensation (Note B)
Distribution of shares of
subsidiary (Note A)
Deemed dividend
(Note I)
Dividends paid (Note H) 39 11 1,219
Net loss
- ----------------------------------------------------------------------------------------------------------------------
BALANCE AT
JANUARY 31, 2001 12,608 $ 3,782 2 $ 1 $ 114,994 $ (5,034)
======================================================================================================================
=======================================================================================================================
DEFERRED TREASURY ACCUMULATED TOTAL
STOCK ACCUMULATED STOCK UNREALIZED STOCKHOLDERS'
COMPENSATION DEFICIT Shares Amount GAIN EQUITY
- -----------------------------------------------------------------------------------------------------------------------
Balance at
January 31, 2000 $ - $ (67,771) 9 $ (69) $ 164,514 $ 202,538
Preferred stock conversions
(Note H) -
Stock option and
warrant exercises
(Notes I, J and M) 3,861
Unrealized losses on
available for sale
securities (Note B) (119,565) (119,565)
Deferred stock compensation
of subsidiary (Note B) (2,788) 0
Amortization of deferred stock
compensation (Note B) 1,908 1,908
Distribution of shares of
subsidiary (Note A) (5,122) (5,122)
Deemed dividend
(Note I) (1,982) (1,982)
Dividends paid (Note H) (1,230) -
Net loss (41,905) (41,905)
- -----------------------------------------------------------------------------------------------------------------------
BALANCE AT
JANUARY 31, 2001 $ (880) $(118,010) 9 $ (69) $ 44,949 $ 39,733
=======================================================================================================================
See accompanying notes to consolidated financial statements.
F-6
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
For the Year Ended January 31, 2000
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In Thousands)
========================================================================================================================
COMMON PREFERRED ADDITIONAL TREASURY
STOCK STOCK PAID IN ACCUMULATED STOCK
Shares Amount Shares Amount CAPITAL DEFICIT Shares Amount
- ------------------------------------------------------------------------------------------------------------------------
Balance at
January 31, 1999 8,924 $ 2,677 12 $ 1 $ 85,183 $(48,479) 80 $(524)
Common stock placements,
net (Note I) 679 204 6,658
Preferred stock conversions
(Note H) 1,048 314 (7) - (314)
Stock option and
warrant exercises
(Note I and J) 820 246 8,298 (16) 119
Expenses paid with stock
issuances (Note I) 3 1 58 (75) 489
Costs attributed to
stock issuances (81)
Treasury stock purchases 20 (153)
Unrealized gains on
available for sale
securities (Note B)
Pre-acquisition deficit
and additional paid in
capital reltaed to former
subsidiary (Note A) 2,433 3,028
Deemed dividend
(Note H) 103 (103)
Dividends paid (Note H) 9 3 80 (564)
Net loss (21,653)
- ------------------------------------------------------------------------------------------------------------------------
BALANCE AT
JANUARY 31, 2000 11,483 $ 3,445 5 $ 1 $102,418 $(67,771) 9 $ (69)
========================================================================================================================
===========================================================================
ACCUMULATED TOTAL
UNREALIZED STOCKHOLDERS'
GAIN EQUITY
- ---------------------------------------------------------------------------
Balance at
January 31, 1999 $ - $ 38,858
Common stock placements,
(Note I) - 6,862
Preferred stock conversions
net (Note H) - -
Stock option and
warrant exercises
(Note I and J) 8,663
Expenses paid with stock
issuances (Note I) - 548
Costs attributed to
stock issuances - (81)
Treasury stock purchases - (153)
Unrealized gains on
available for sale
securities (Note B) 164,514 164,514
Pre-acquisition deficit
and additional paid in
capital reltaed to former
subsidiary (Note A) 5,461
Deemed dividend
(Note H) - -
Dividends paid (Note H) - (481)
Net loss - (21,653)
- ---------------------------------------------------------------------------
BALANCE AT
JANUARY 31, 2000 $ 164,514 $ 202,538
===========================================================================
See accompanying notes to consolidated financial statements.
F-7
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
For the Year Ended January 31, 1999
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In Thousands)
==============================================================================================================
COMMON PREFERRED ADDITIONAL
STOCK STOCK PAID IN ACCUMULATED
Shares Amount Shares Amount CAPITAL DEFICIT
- --------------------------------------------------------------------------------------------------------------
Balance at
January 31, 1998 6,896 $2,069 6 $ 1 $ 74,003 $ (33,331)
Common stock placements,
net (Note I) 636 191 1,798
Preferred stock placements,
net (Note H) 8 1 7,419
Preferred stock conversions
(Note H) 1,133 340 (2) (1) (339)
Debenture conversions
(Note I) 143 43 367
Stock option exercises (Note J) 20 6 142
Stock issued in connection
with acquisitions
(Note I) 50 15 (15)
Expenses paid with stock
issuances (Note I) 46 13 399
Costs attributed to
stock issuances (86)
Cashless option exercises (265)
Treasury stock purchases
Deemed dividend
(Note H) 1,760 (1,760)
Net loss (13,388)
- --------------------------------------------------------------------------------------------------------------
BALANCE AT
JANUARY 31, 1999 8,924 $2,677 12 $ 1 $ 85,183 $ (48,479)
==============================================================================================================
======================================================================================
TREASURY TOTAL
STOCK STOCKHOLDERS'
Shares Amount EQUITY
- --------------------------------------------------------------------------------------
Balance at
January 31, 1998 3 $ (22) $ 42,720
Common stock placements,
net (Note I) 1,989
Preferred stock placements,
net (Note H) 7,420
Preferred stock conversions
(Note H) -
Debenture conversions
(Note I) 410
Stock option exercises (Note J) 148
Stock issued in connection
with acquisitions
(Note I) -
Expenses paid with stock
issuances (Note I) (8) 67 479
Costs attributed to
stock issuances (86)
Cashless option exercises (265)
Treasury stock purchases 85 (569) (569)
Deemed dividend
(Note H) -
Net loss (13,388)
- --------------------------------------------------------------------------------------
BALANCE AT
JANUARY 31, 1999 80 $ (524) $ 38,858
======================================================================================
See accompanying notes to consolidated financial statements.
F-8
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
======================================================================================================================
Year Ended January 31,
--------------------------------------
2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) from continuing operations $ (41,905) $ 2,410 $ (11,069)
- ----------------------------------------------------------------------------------------------------------------------
Adjustments to reconcile net loss to net cash used in
operating activities:
Intangible assets valuation allowances (Note B) 435 1,742 -
Depreciation and amortization 4,386 4,624 3,274
Accounts receivable and inventory reserves 6,347 2,674 2,364
Expenses paid through issuances of securities - 548 479
Gain on sale of marketable securitites (7,622) (13,970) -
Deferred and other stock compensation (Note B) 1,908 - -
Changes in assets and liabilities net of effects of business entity
divestitures:
Increase in accounts receivable (15,597) (839) (5,592)
Increase in inventories (11,201) (3,963) (869)
(Increase) decrease in other current assets 1,191 (1,196) 300
Increase in accounts payable 4,951 1,942 199
Increase in accrued expenses 5,303 3,729 18
Increase (decrease) in other current liabilities 122 (437) 129
- ----------------------------------------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES (51,682) (2,736) (10,767)
- ----------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY DISCONTINUED OPERATIONS - 953 7,398
- ----------------------------------------------------------------------------------------------------------------------
NET CASH USED IN OPERATING ACTIVITIES (51,682) (1,783) (3,369)
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of property and equipment (14,413) (2,133) (1,614)
Software development costs (Note B) - (886) (2,048)
Cash received from sale of marketable securities and other investments
(Notes A and B) 13,393 13,717 -
Expenditures for investments (7,111) - -
Purchase of other assets (Note B) - (3,597) (656)
Other receivables (Notes M and N) 2,621 557 1,443
Cash of former subsidiary (Note A) (6,961) - -
Advances to affiliates, net of repayments (Note A) - (3,371) 97
Investing acitivities of discontinued operations - (5,519) (952)
- ----------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (12,471) (1,232) (3,730)
- ----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term debt, net of repayments (Note D) (56) (690) 873
Proceeds from long-term debt (Note E) 2,412 988 362
Repayment of long-term debt (Note E) (99) (266) (89)
Proceeds from convertible preferred stock issued by subsidiary (Note I) 46,638 - -
Proceeds from convertible preferred stock (Note H) - - 7,420
Proceeds from common stock issued by subsidiary (Note I) 7,851 - -
Proceeds from common stock (Note I) - 6,862 1,989
Proceeds from stock option and warrant exercises (Notes H, I and J) 3,861 8,165 148
Dividends paid - (481) -
Treasury stock purchases - (153) (569)
Other - (81) (86)
Financing activities of discontinued operations - (1,298) (891)
- ----------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 60,607 13,046 9,157
- ----------------------------------------------------------------------------------------------------------------------
INCREASE(DECREASE) IN CASH AND CASH EQUIVALENTS (3,546) 10,031 2,058
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 13,511 3,480 1,422
- ----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 9,965 $ 13,511 $ 3,480
======================================================================================================================
See accompanying notes to consolidated financial statements.
F-9
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
Sorrento Networks Corporation (formerly Osicom Technologies, Inc.) (the
"Company," "We," "Our," or "Us") through its subsidiaries designs, manufactures
and markets integrated networking and bandwidth aggregation products for
enhancing the performance of data and telecommunications networks. Our products
are deployed in telephone companies, Internet Service Providers, governmental
bodies and the corporate/campus networks that make up the "enterprise" segment
of the networking marketplace. We have facilities in San Diego, California,
Santa Monica, California and Fremont, California. In addition, we have various
sales offices located in the United States and Europe. Our former subsidiary,
Entrada Networks is located in San Diego, California. Our former subsidiary,
NETsilicon, Inc., is located in Waltham, Massachusetts. 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.
The accompanying consolidated financial statements are the
responsibility of the management of the Company.
A. THE COMPANY, BASIS OF PRESENTATION AND DISCONTINUED OPERATIONS
The Company, incorporated in New Jersey on July 7, 1981 as Osicom
Technologies, Inc., operates as a holding company for its various subsidiaries
and their divisions, more fully described below. The companies and assets
acquired have been integrated in accordance with product lines: Sorrento
Networks (regional and metropolitan optical networking products), Meret Optical
(distance extension networking equipment), Entrada Networks (storage area
networks as well as remote access and internetworking equipment), and
NETsilicon, Inc. (formerly Embedded Networking Solution products). For reference
purposes acquired businesses have been identified by legal entity, which is not
indicative of our operational integration.
Sorrento Networks - This segment consists of Sorrento Networks, Inc.
("Sorrento"). Sorrento develops and markets end-to-end intelligent optical
networking solutions for regional and metropolitan applications.
Meret Optical - This segment consists of Meret Communications, Inc.
("Meret" doing business as Meret Optical Communications), and Sciteq
Communications, Inc. ("Sciteq"). Meret designs, manufactures, and markets
distance extension networking equipment. Sciteq designs and markets products
based on radio frequency synthesis technologies.
Entrada Networks - This segment consisted of Osicom Technologies, a
Delaware corporation (formerly known as Cray Communications, Inc., "Cray"),
Rockwell Network Systems ("RNS", a division of Cray), and Distributed Systems
International, Inc. ("DSI"). Entrada Networks develops, manufactures and markets
an extensive range of communications products and systems for storage area
networks, remote access and internetworking markets. On August 31, 2000, we
completed a merger of Entrada with Sync Research, Inc. ("Sync"), a Nasdaq listed
company in which we received 4,244,155 shares of the merged entity which changed
its name to Entrada Networks, Inc. and changed its symbol to ESAN. We purchased
93,900 shares of Sync in the open market during June and July, 2000 for $388 and
on August 31, 2000 purchased an additional 1,001,818 shares directly from
Entrada for $3,306. After these transactions and Entrada's issuance of
additional shares to outside investors in connection with the merger we owned
48.9% of Entrada Networks. Accordingly , the accompanying financial statements
reflect the results of operations of Entrada through August 31, 2000.
Pursuant to a plan adopted by our Board of Directors prior to the
merger we distributed 3,107,155 of our Entrada shares on December 1, 2000 to our
shareholders of record as of November 20, 2000. The distribution was made at the
rate of one-fourth (0.25) of an Entrada share for each of our outstanding
shares. At exercise, options
F-10
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
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 $5,122. In addition we have granted options to purchase 410,000
of our Entrada shares for $3.19 per share (the merger price) to several of our
then officers and consultants.
The remaining 1,132,253 Entrada shares owned by us are accounted for as
an "available for sale security". Under this accounting, these shares are
marked-to-market at the end of each reporting period. The difference between our
basis and the fair market value, as reported on Nasdaq, is a separate element of
stockholders' equity and is included in the computation of comprehensive income.
More information concerning Entrada is available in its public filings with the
Securities and Exchange Commission.
NETsilicon - This segment consists of NETsilicon, Inc. ("NSI"). On
September 15, 1999 NSI completed an initial public offering in which 6,037,500
shares of its common stock were sold (3,537,500 shares by NSI and 2,500,000
shares by us). NSI received net proceeds of $22,249 and we received net proceeds
of $15,382. In addition, NSI repaid advances due us of $5,884. In connection
with the initial public offering by NSI our remaining 55.4% interest became
non-voting shares. Accordingly, the accompanying financial statements reflect
the results of operations of NSI through September 14, 1999 at which time our
remaining interest is accounted for as an "available for sale security." Under
this accounting, the 7.5 million shares of NSI held by us are marked-to-market
at the end of each reporting period with the difference between our basis and
the fair market value, as reported on Nasdaq, reported as a separate element of
stockholders' equity and is included in the computation of comprehensive income.
In October 2000, we sold 350,000 shares of our investment in NSI for
$4,219. The purchasers had the right to receive additional NSI shares from us if
the three day average high for the NSI common stock, as quoted on Nasdaq, at
December 31, 2000 is 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 $1,164 and
received an additional 45,546 shares pursuant to the price protection provision.
As a result of this transaction, our remaining interest is approximately 7.0
million shares of NSI, or 50.6% as of January 31, 2001, and continues to be
accounted for as a marked-to-market security. More information concerning NSI is
available in its public filings with the Securities and Exchange Commission.
Discontinued Operations - Our Far East business unit, consisting of Uni
Precision Industrial Limited ("Uni"), has been accounted for as a discontinued
operation pursuant to our formal adoption on May 15, 1999 of a plan to sell this
division. As of January 31, 2000, we sold Uni to a group led by its Hong
Kong-based management for $2,500 in cash in repayment of our advances to Uni and
a $3,000 non-voting redeemable preferred security. This security has not been
considered in the estimated proceeds from disposal due to the uncertainty of
future collection. Net assets disposed and amounts due from the purchasers, at
their expected realizable values, are included in other assets in the
accompanying balance sheets. During the year ended January 31, 2001 we received
payments of $819. Due to the continuing economic downturn in Asia and the
decline in the value of marketable securities held as collateral from the
purchasers, we recorded a $700 reserve against the remaining balance due of
$1,688.
F-11
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
During the year ended January 31, 2000, we recorded a reduction to the
estimated realizable value of the net assets of this discontinued operation of
$11,644 which has been separately presented as the estimated loss on the
disposal of discontinued operations in the accompanying income statement. Net
assets of discontinued operations at January 31, 2000 consist of:
2000
----
Cash $ 398
Accounts receivable, net 2,862
Inventory, net 2,135
Other current assets 367
Property, plant and equipment, net 7,962
Excess cost over net assets acquired -
Other non-current assets 342
-------
Total assets 14,066
-------
Accounts payable and other current liabilities 4,444
Short-term debt 791
Long-term debt, current portion 448
Long-term debt, non-current portion 918
Deferred income taxes -
Intercompany payable 5,833
-------
Total liabilities 12,434
Net assets to be disposed of 1,632
Less: valuation adjustment (1,632)
-------
-
Recoverable receivable 2,833
-------
Due from disposal of discontinued operations $ 2,833
=======
Operating results of this discontinued operation for the years ended
January 31, 2000 and 1999 are shown separately in the accompanying income
statement. The operating results of this discontinued operation for the years
ended January 31, 2000 and 1999 consist of:
2000 1999
-------- ------- ----
Net sales $ 20,819 $39,039
Gross profit 5,022 9,156
Income (loss) from operations (11,948) (1,876)
Net income (loss) (12,419) (2,319)
Cash flows of this discontinued operation for the years ended January
31, 2000 and 1999 are shown separately in the accompanying statement of cash
flows. The cash flows provided by (used in) this discontinued operation for the
years ended January 31, 2000 and 1999 consist of:
2000 1999
-------- --------
Operating activities $ 953 $7,398
Investing activities (5,519) (952)
Financing activities (1,298) (891)
F-12
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - The balance sheets and the consolidated
statement of operations for the years ended January 31, 2001 and 2000 and the
consolidated statement of operations for the year ended January 31, 1999 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 statement of operations for the year ended January 31,
2000 includes the results of NSI through September 15, 1999 after which date we
no longer controlled NSI. (See Note A). The consolidated group is referred to
individually and collectively as the "Company," "We," "Our," or "Us".
Use of Estimates - The financial statements are prepared in conformity
with generally accepted accounting principles which requires management to make
estimates that affect the reported amounts of assets, liabilities, revenues and
expenses, the disclosure of contingent assets and liabilities and the values of
purchased assets and assumed liabilities in acquisitions. Actual results could
differ from these estimates.
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.
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. For some of the customers of our optical networking products
payment is required within 180 days from the date of shipment and at January 31,
2001 $3,281 of net receivables are due within 180 days. We evaluate and monitor
the creditworthiness of each customer on a case-by-case basis.
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. Inventories at January 31, 2001 and 2000 consist
of:
2001 2000
------- ------
Raw material $10,201 $ 9,024
Work in process 4,310 3,677
Spare parts - 141
Finished goods 2,882 4,232
------- -------
17,393 17,074
Less: Valuation reserve (2,792) (4,070)
------- -------
$14,601 $13,004
======= =======
Marketable Securities - Marketable securities, which consist of equity
securities that have a readily determinable fair value and do not have sale
restrictions lasting beyond one year from the balance sheet date, are classified
into categories based on our intent. Investments not classified as held to
maturity, those for which we have the intent and ability to hold, are classified
as available for sale. Our investments in NETsilicon and Entrada are classified
as available for sale and are carried at fair value, based upon quoted market
prices, with net unrealized gains reported as a separate component of
stockholders' equity until realized. Unrealized losses are charged against
income when a decline in fair value is determined to be other than temporary. At
January 31, 2001, and 2000 marketable securities were as follows:
F-13
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
Cost Unrealized Gains Market Value
---- ---------------- ------------
January 31, 2001:
NETsilicon $3,938 $42,303 $46,241
Entrada 1,371 2,646 4,017
------ ------- -------
$5,309 $44,949 $50,258
====== ======= =======
January 31, 2000:
NETsilicon $4,236 $164,514 $168,750
------ -------- --------
$4,236 $164,514 $168,750
====== ======== ========
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. Useful lives for property and
equipment range from 3 to 15 years. Depreciation of land improvements and
buildings is computed using the straight-line method over 39 years.
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 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.
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.
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, 2001, 2000 and 1999 was $1,046, $1,841 and $865,
respectively, over 3 to 5 years. Accumulated amortization was $398 and $1,125 as
of January 31, 2001 and 2000, respectively.
The recoverability of capitalized software costs are reviewed on an
ongoing basis primarily based upon projections of discounted future operating
cash flows from each software product line. The excess amount, if any, of the
remaining net book value over the calculated amount is fully reserved. During
the quarters ended April 30, 2000 and January 31, 2000 we recorded reductions to
the net book value of our capitalized software development costs of $435 and
$1,742, respectively, recorded as engineering expense, to reflect the decline in
the net realizable value of these assets as a result of changing market
conditions.
F-14
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
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 $1,623 and $1,251 at January 31, 2001 and 2000, 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. During the fourth quarter of fiscal
2000 we exchanged $3,000 of trade receivables due us from this customer for
333,334 shares of its convertible preferred stock, a 5.9% equity interest on a
fully diluted basis. These shares were entitled to a cumulative preferred
dividend of $240 per year, were entitled to nominate one member to the
customer's board of directors, vote as part of single class for one member of
its board of directors and were convertible into 333,334 shares of its common
stock. During March and September 2000 we purchased an additional 269,608 shares
of this customer's convertible preferred stock for $3,235, bringing our equity
interest on a fully diluted basis to 9.7%. These shares were entitled to a
cumulative preferred dividend of $259 per year and are convertible into 269,608
shares of its common stock.
In November 2000, we sold all our shares for $9,937 and $320 in
accumulated, unpaid dividends. Of the total $10,257 due from the purchaser,
approximately 7.7% or $787 is 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.
During the years ended January 31, 2001 and 2000 we made sales of $
5,746 and $5,496 respectively, to this customer 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 $344,000 was paid in cash.
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.
Revenue from installation is recognized as the services are performed to the
extent of the direct
F-15
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
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.
The Securities and Exchange Commission issued Staff Accounting Bulletin
No. 101, Revenue Recognition ("SAB 101") which broadly addresses how companies
report revenues in their financial statements effective the fourth fiscal
quarter of years beginning after December 31, 1999. The adoption of this policy
had no effect on our financial position or results of operations.
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 carryforwards 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 K).
Advertising - We expense advertising expenditures as incurred.
Advertising expenses consist of allowances given to customers as well as direct
expenditures.
Income and Loss Per Common 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, 2001 and 1999 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-3 stock split effective July
24, 1998. (See Note L).
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
F-16
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
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 year ended January 31, 2001 we amortized $1,724 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 No.
123, "Accounting for stock-Based Compensation," and Emerging Issues Tax Force
(EITF) 96-18, "Accounting for Equity Instruments that are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services." All
such amounts relate to options to acquire common stock of our Sorrento Networks
subsidiary granted by it to its consultants; during the fiscal year ended
January 31, 2001 we recorded $184 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, if any, on our financial position or results of operations.
Derivative Instruments - SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS 137 and 138, is
effective for financial statements with fiscal quarters of all fiscal years
beginning after June 15, 2000. The statement establishes standards for
accounting for derivatives and hedging instruments of which we currently have
none. We do not expect the adoption of SFAS No. 133 to have a material effect,
if any, on our financial position or results of operations.
Computer Software for Internal Use - The Accounting Standards Executive
Committee issued Statement of Position ("SOP") 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use," 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.
Start-up Costs - Statement of Opinion 98-5, "Reporting on the Costs of
Start-up Activities," is effective for financial statements for fiscal years
beginning after December 31, 1998. The SOP provides guidance and examples of the
types of expenses associated with one-time (start-up) activities which under
this SOP must be expensed as incurred. The adoption of SOP 98-5 had no effect on
our financial position or results of operations.
F-17
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
C. PROPERTY AND EQUIPMENT
Property and equipment of the Company consisted of the following
components as of January 31, 2001 and 2000:
2001 2000
---- ----
Manufacturing, engineering and plant equipment and software $13,884 $ 20,397
Office furniture and fixtures 2,717 1,936
Land and building 6,650 1,779
Leasehold and building improvements 1,186 919
------- --------
Total property and equipment 24,437 25,031
Less: Accumulated depreciation (7,837) (19,511)
------- --------
Net book value $16,600 $ 5,520
======= ========
Depreciation expense for fiscal 2001, 2000 and 1999 was $3,404, $2,413
and $2,038, respectively.
D. SHORT TERM DEBT
Short term debt at January 31, 2001 and 2000 consisted of the
following:
2001 2000
---- ----
Floating interest rate loan (2.5% over Coast's prime rate)
secured by all the tangible assets of Meret; weighted
average interest rate for the year ended January 31, 2001
was 18.3% $1,342 $3,143
Floating interest rate loan (2.5% over Coast's prime rate)
secured by all the tangible assets of Entrada; weighted average
interest rate for the period ended August 31, 2000 was 13.6% - 2,264
------ ------
$1,342 $5,407
====== ======
Meret has a line of credit of $8,000 from Coast Business Credit
("Coast"); the line of credit is collateralized by substantially all the assets
of Meret including accounts receivable, inventory and property and equipment. We
have guaranteed this line to the extent of $1,000. This line of credit provides
for interest at 2.5% over the bank's prime rate but not less than 8% (12.0% at
January 31, 2001) with a minimum monthly interest of $20. In addition, we issued
to Coast warrants to purchase shares of our common stock at the then market
prices at funding: 3,334 shares of our common stock at $10.02 per share and
13,334 shares of our common stock at $15.94 which were exercised during June
2000. (See Note I). Advances are limited to 80% of eligible accounts receivable
and 40% of eligible inventory limited to $2,000; this line also provides for a
$500 letter of credit sub-line. The agreement automatically renews for
successive one year terms on a continuous basis at February 1st of each year
unless terminated by written notice of either party or by default. Additionally,
the agreement provides for term loans more fully described in Note E. The
highest amount outstanding was $3,001 and $4,838 during fiscal years 2001 and
2000, respectively. The average amount outstanding was $1,419 and $3,274 during
fiscal years 2001 and 2000, respectively.
Entrada had a line of credit of $7,000 from Coast; the line of credit
is collateralized by substantially all the assets of Entrada and guaranteed by
us. Advances are limited to 80% of eligible receivables and 30% of eligible
inventory. The loan bears interest at 2.5% over the bank's prime rate but not
less than 8%; the interest rate on the line of credit was 12.0% at August 31,
2000. The agreement automatically renewed for successive one-year terms on a
continuous basis at February 1st of each year unless terminated by written
notice of either party or by default. The highest and average amounts
outstanding were $4,011 and $3,061 during the period ended August 31, 2000.
F-18
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
The highest and average amounts outstanding were $5,283 and $4,156 during the
year ended January 31, 2000. On March 1, 2001, Entrada replaced the outstanding
debt with Coast with a line of credit from another lender and we were released
from our guarantee.
NSI, prior to its IPO, had a line of credit of $5,000 from Coast; the
line of credit was collateralized by substantially all the assets of NSI.
Advances were limited to 80% of eligible receivables and 45% of eligible
inventory. The loan bears interest at 2.5% over the bank's prime rate but not
less than 8%; the interest rate on the line of credit was 10.75% at September
15, 1999. The agreement expires February 1, 2001. NSI reduced its borrowings
under this line of credit to $1,000 with a portion of the proceeds of its
initial public offering. The highest and average amounts outstanding were $4,021
and $3,314 during the period ended September 15, 1999.
We had a revolving demand loan agreement with Banca di Roma which
provided for interest at 1% above the bank's base lending rate, which was 8.75%,
at April 30, 1999 when the loan was paid in full. The line of credit was
collateralized by accounts receivable and personally guaranteed by one of our
directors. The highest amount and average amount outstanding were $38 and $9
during the year ended January 31, 2000.
We had a $2,500 short term loan from a group of private investors with
interest at 1.25% per month and a loan fee of $250 which was due August 31, 1999
and September 30, 1999. Principal of $1,400 and the loan fee was repaid during
August and September, 1999. The remaining balance of $1,100 was converted into
125,000 shares of common stock on September 30, 1999 through the exercise of a
warrant.
The Company is in compliance with its debt covenants at January 31,
2001.
E. LONG TERM DEBT
Long term debt at January 31, 2001 and 2000 consisted of the following:
2001 2000
---- ----
Variable rate 30 year mortgage note payable (5.5% over
LIBOR rate); interest rate at January 31, 2001 was 12.3% $1,296 $1,303
Fixed rate 30 year mortgage note payable;
interest rate at January 31, 2001 was 7.6% 2,410 -
Floating interest rate term loans (2.5% over Coast's prime
rate) secured by machinery and equipment of Meret;
interest rate for year ended January 31, 2001 was 11.5% - 225
Floating interest rate term loans (2.5% over Coast's prime
rate) secured by machinery and equipment of Cray;
interest rate for year ended August 31, 2000 was 11.0% - 345
Obligations under finance leases (See Note F) 535 654
------ ------
4,241 2,527
Less: Current portion 422 721
------ ------
$3,819 $1,806
====== ======
On March 25, 1996, Meret purchased land and building 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 $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 $14. The interest rate at January
31, 2001 was 12.3%. Net book value of the property securing this mortgage was
$1,623 and $1,653 at January 31, 2001 and 2000, respectively.
F-19
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
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%. Net book value of the property securing this
mortgage was $5,411 at January 31, 2001.
Long term debt including capitalized leases at January 31, 2001 is
payable by year as follows:
2002 $ 422
2003 143
2004 79
2005 43
2006 47
2007 and later 3,507
------
$4,241
======
F. LEASES AND OTHER COMMITMENTS
Rental expense under operating leases was $1,277, $1,533 and $1,733 for
the years ended January 31, 2001, 2000 and 1999, respectively. The table below
sets forth minimum payments under capital and operating leases with remaining
terms in excess of one year, at January 31, 2001:
Capital Operating
Leases Leases
------ ------
2002 $422 $1,149
2003 117 1,182
2004 42 1,227
2005 - 1,211
2006 - 270
---- ------
$581 $5,039
=======
Less: Amount representing interest (46)
----
Present value of minimum annual rentals $535
====
The net book value of equipment under capital leases was $714 and $734
at January 31, 2001 and 2000, respectively.
We currently reimburse Entrada on a prorata basis for space in its San
Diego facility utilized by Meret. During the five months ended January 31, 2001
we paid $15 to Entrada under this month to month agreement.
We have an employment agreement with Xin Cheng, our Chairman and Chief
Executive Officer, ending March 2002, which provides for a salary of $250 per
year and a bonus equal to two year's base salary payable at the end of the
contract. The agreement may be terminated for cause, however, should Dr. Cheng
be terminated without cause he will receive a continuation of his salary and
benefits for two years and he is required to provide consulting services to us
during that period.
We entered into a two year employment contract with Rohit Phansalkar,
our immediate past Chairman and Chief Executive Officer ending May 2002, which
provides for a salary of $250 per year. He resigned as our CEO in September
2000, in order that the CEO of our Sorrento subsidiary, Dr. Xin Cheng, became
our CEO and
F-20
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
Chairman of the Board. His contract requires us to continue his salary and
benefits for two years, during which he is available to provide consulting
services to us.
Four of our officers, an employee and consultant have two year
employment agreements ending in May, July and August 2002, which provide for
salaries totaling $1,096 per year. These contracts may be terminated for cause.
However, should any of these individuals be terminated without cause or resign
in certain circumstances they will receive a continuation of their salary and
benefits for two years, and they are required to provide consulting services to
us during that period. In addition, these agreements provide for loans to
exercise previously granted stock options to acquire our common stock and the
stock of our subsidiaries including any required tax withholdings due upon
exercise. The loans are for a period not to exceed two years at the then
applicable federal rate, are full recourse and require the pledge of shares
issued upon exercise. No amounts have been loaned to these persons to date.
Under the terms of a purchase agreement as of May 31, 1995, we were
obligated to pay the seller additional cash consideration equal to a percentage
of net revenues in excess of $5,000 within a post-closing year derived from the
sales of the acquired product line, for each of the five years subsequent to the
acquisition date or through May 31, 2000. No liabilities related to this
additional consideration were incurred as the target net revenues were not met.
G. LITIGATION
On November 6, 2000, the court granted final approval to the settlement
of the consolidated shareholder class actions pending in Federal district court
in Los Angeles against us and certain present and former officers, and dismissed
the actions against all defendants with prejudice. The settlement, which was
entered into without any admission of liability by any of the defendants,
provided for an aggregate cash payment to class members of $3,750, plus accrued
interest from September 1, 2000, if any, less approved attorneys' fees and
related expenses. The settlement was funded by our insurance carrier, and did
not have a material adverse effect on our financial position or results of
operations.
From time to time, we are involved in various other legal proceedings
and claims incidental to the conduct of our business. Although it is impossible
to predict the outcome of any outstanding legal proceedings, we believe that
such legal proceedings and claims, individually and in the aggregate, are not
likely to have a material effect on our financial position or results of
operations or cash flows.
H. STOCKHOLDERS' EQUITY
The Company is authorized to issue the following shares of stock:
150,000,000 shares of Common Stock ($.30 par value)
2,000,000 shares of Preferred Stock ($.01 par value) of which
the following series have been designated:
2,500 shares of Preferred Stock, Series A 1,000 shares of
Preferred Stock, Series B 10,000 shares of Preferred
Stock, Series C 3,000 shares of Preferred Stock, Series D
1,000,000 shares of Preferred Stock, Series E
F-21
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
The Company has outstanding the following shares of preferred stock:
Shares Par Liquidation
Outstanding Value Preference
----------- ----- ----------
Series D $1,353 $1 $1,353
------ -- ------
$1,353 $1 $1,353
====== == ======
The Series A preferred stock was issued in August, 1992 in exchange for
$2,500 of trade debt. The Series A preferred stock accrued cumulative dividends
at 6% and was convertible into common stock (i) at the option of the holder at
the market price of our common stock provided the market price equals or exceeds
$202.50, and (ii) at our option at 110% of the market price our common stock.
These shares of preferred stock were redeemable at our option at $1,000 per
share. During October 2000 we elected to convert all the outstanding Series A
shares and during November 2000 we issued 80,276 shares of our common stock in
conversion of the preferred shares and 39,509 shares of our common stock in
payment of the accrued, unpaid dividends of $1,230.
We issued 274,888 shares of our common stock in complete conversion of
our Series B preferred stock, which was issued in January 1997, during the year
ended January 31, 1999.
In May 1998, we issued 8,000 shares of our Series C preferred stock
with a $1 liquidation value receiving net proceeds of $7,420. These Series C
preferred shares, as revised, did not bear dividends and were not entitled to
vote. Each share of Series C preferred stock was convertible into common shares
beginning 90 days from issuance. The conversion price was the lesser of (i) 86%
of the average of the three lowest closing bid prices for our common stock
during the 22 trading days immediately prior to conversion, and (ii) $5.81 (the
average closing bid price for our common stock for the 22 trading days
immediately prior to November 10, 1998). We had the right to redeem any
outstanding Series C preferred shares at 116.28% of face value if the average
closing bid price for our common stock was less than $10.50 during any
consecutive ten trading days. We issued 857,766 shares of our common stock in
conversions of 1,945 shares of the Series C preferred stock during the year
ended January 31, 1999.
We recorded a deemed dividend of $1,459 during the quarters ended July
31 and October 31, 1998 with respect to our Series C preferred stock. This
amount represents the difference between the liquidation value of the Series C
preferred stock and the estimated market value of the common shares issuable
upon conversion as of the issue date of the Series C preferred shares assuming
that all such shares were convertible beginning 90 days from issuance. We also
paid dividends in cash of $481 during the year ended January 31, 2000 with
respect to the Series C preferred stock.
In November, 1998, we assigned to an unrelated third party the right to
redeem 2,000 shares of the Series C preferred stock. The assignee redeemed the
shares for $2,500. In consideration for the assignee's acceptance of new terms
with respect to conversion and other features of the Series C preferred stock,
we issued an additional 500 shares of Series C preferred stock to the assignee
and three year warrants exercisable at $10.66 to acquire 70,000 shares of common
stock. The modified Series C stock is convertible at the lesser of (i) 86% of
the average closing bid price for the common stock for the five days prior to
conversion, and (ii) $8.528. After registration of the underlying common stock
the Series C preferred stock is convertible at multiple intervals over 150 days.
The remaining 355 shares of Series C preferred stock held by the redeemed
shareholder were modified to provide for a fixed conversion price of $5.81 and
received a three year warrant exercisable at $10.66 to acquire 20,000 shares of
common stock. The Series C shares were converted during August 1999 and the
warrant was exercised during January, 2000 for which we received net proceeds of
$213.
F-22
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
All of these revised Series C preferred shares were converted prior to
January 31, 2000; an aggregate of 1,906,206 shares of our common stock have been
issued in conversions of these Series C preferred shares of which 1,048,440
shares were issued during the year ended January 31, 2000.
We recorded a deemed dividend of $301 during the quarter ended January
31, 1999 with respect to the assigned redemption and modification of terms of
the Series C preferred stock and an additional $103 was recorded during the
quarters ended April 30 and July 31, 1999. The total amount of $404 represents
the estimated value of the warrants issued, the estimated market value of the
common shares issuable upon conversion of the 500 shares of Series C issued to
the assignee in excess of the face value, and the excess of the redemption
payment received by the original holder and the original face value plus the
previously recognized deemed dividend. We also paid a dividend of $83 through
the issuance of 9,402 shares of our common stock.
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 then market value and we have the right to
redeem the shares prior to conversion for 100% of their conversion value.
I. OTHER CAPITAL STOCK TRANSACTIONS AND BUSINESS ACQUISITIONS
Stock Split - In July, 1998, approval was granted for a one for three
reverse stock split effective July 24, 1998. The effect 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 3, 2000, our Sorrento subsidiary completed a sale of 8,596,333
shares of its Series A Convertible Preferred Stock receiving net proceeds of
$46,638 from a group of investors. 1,467,891 shares were purchased by entities
in which our immediate past Chairman and CEO, who was an outside director at
that time, was a partner or member pursuant to a previously contracted right of
participation. In addition, Sorrento paid a finders fee of $1,950 through the
issuance by Sorrento of an additional 357,799 shares of its Series A Convertible
Preferred Stock to an entity in which our immediate past Chairman and CEO, who
was an outside director at that time, was a partner. Subsequent to the purchase
of 2,697,248 of these shares an officer and director of the purchaser joined the
Board of Directors of Sorrento. One of our then outside directors purchased
45,872 shares and a then director of Sorrento purchased 91,744 in this
placement.
Each share of Sorrento's Series A Preferred Stock is convertible into
one share of Sorrento's common stock at the option of the holder, may vote on an
"as converted" basis except for election of directors, and has a liquidation
preference of $5.45 per share. The shares are automatically converted into
Sorrento's common stock upon an underwritten public offering by Sorrento with an
aggregate offering price of at least $50,000. Since Sorrento did not
complete a $50,000 public offering by March 1, 2001, the holders of more than
50% of the then outstanding Series A shares may request to be redeemed at the
shares then adjusted liquidation preference. If such a request is made in
writing, our Sorrento subsidiary has the obligation to redeem the shares in
cash, if funds are lawfully available to
F-23
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
such a redemption, or for such pro rata portion as to which a lesser amount of
lawfully available funds would exist. The net proceeds from the issuance of
these shares has been classified as a minority interest in the accompanying
financial statements. The difference between the net proceeds received on the
sale of these shares and their liquidation preference of $48,800 will be
recorded as a deemed dividend during the period from issuance to March 31, 2001.
During the year ended January 31, 2001 we recorded a deemed dividend of $1,982
with respect to the Sorrento Series A shares.
Subsequent to the sale by our Sorrento subsidiary of these shares we
made sales to subsidiaries of two of the purchasers. We made sales of $3,364,
including deferred revenue, to the subsidiaries of the purchaser of 33.8% of the
shares of which $3,281 was outstanding at January 31, 2001 under 180 days terms.
We made sales of $4,781 to the subsidiaries of the purchaser of 6.2% of the
shares of which $2,496 was outstanding at January 31, 2001.
In December, 1999 we issued 679,483 unregistered shares of common stock
receiving net proceeds of $6,862. In connection with this placement one of our
then outside directors received a finder's fee of $300. In addition, we paid a
$300 finders fee to an entity in which our immediate past Chairman and CEO, who
was not a director at the time, was an officer. The holder had the right to
request us to register their shares upon the earlier of December 1, 2000 or the
disposition of substantially all of our NSI shares. The holder had the right to
nominate one member of the Board of Directors to serve until the next annual
shareholders' meeting and had the right to participate in any stock offering by
Sorrento to the extent of $7,500 subject to certain limitations. Our immediate
past Chairman and CEO was the purchaser's appointee to our Board of Directors.
In April 1998, we issued 203,998 unregistered shares of common stock
receiving net proceeds of $1,989. The holders had the right to request
additional shares to be issued by the Company to the extent that 86% of the ten
day average trading price of the originally issued shares is below $9.80 per
share at the time of the request; such request may be made only once with
respect to each original share which had been continuously held by the original
holder from the original issue date. The Company issued 431,950 common shares
during the year ended January 31, 1999 pursuant to such requests and no original
shares remain for which additional shares may be requested.
Debentures payable - We issued 143,115 shares of our common stock in
conversions of these securities and accrued interest thereon during the year
ended January 31, 1999. We had the right to call the debentures prior to
conversion at 90% of face value and had the right to assign this call option.
The debentures bore interest at 8% beginning specified periods after date of
issue payable in our common shares. The debentures were convertible at the
average closing price as reported by Nasdaq for the five preceding business days
not to exceed $18.00 per share.
FED Acquisition - We were required to issue 49,569 shares of our common
stock during the year ended January 31, 1999 in satisfaction of the price
protection guarantee we made in connection with common stock issued in
satisfaction of the additional purchase payment made to the former owners of
FED.
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).
During the year ended January 31, 2000, 125,000 of the 265,340 warrants
held by a former strategic partner were exercised by an assignee. The remaining
warrants expired unexercised.
We issued independently exercisable warrants to purchase 85,000 shares
at prices ranging from $8.80 to $10.66 which expire at various dates through
August 26, 2002 in connection with various stock placements. 15,000 of these
warrants were exercised during the year ended January 31, 2001 and we received
net proceeds of $132. The remaining warrants expire during November 2001.
F-24
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
We issued independently exercisable warrants to purchase 179,684 shares
of our common stock at prices ranging from $24.00 to $54.00 to independent
placements agents in connection with various stock and debt placements all of
which expired unexercised during the years ended January 31, 1999 and 1998.
In addition, we have outstanding warrants to purchase 33,334 shares at
$12.00 which expire December 31, 2002 may be redeemed by us for $1,000.
J. 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. The following table summarizes the activity in
the plans:
Weighted Average
Number of Shares Exercise Price
---------------- -----------------
Shares under option at January 31, 1998 1,206,771 $18.57
Granted 1,466,684 $9.27
Exercised (29,053) $15.76
Canceled (220,227) $17.13
---------
Shares under option at January 31, 1999 2,424,175 $11.83
Granted 998,213 $13.36
Exercised (717,373) $12.47
Canceled (516,960) $16.71
---------
Shares under option at January 31, 2000 2,188,055 $11.17
Granted 3,878,068 $37.42
Exercised (890,898) $10.01
Canceled (107,990) $12.31
---------
Shares under option at January 31, 2001 5,067,235 $30.93
=========
Additional information relating to stock options outstanding and
exercisable at January 31, 2001 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
--------- ------ ------------ -------------- ------ ---------------
$3.00 - $9.99 789,306 7.92 $7.14 717,682 $7.06
$10.00 - $19.99 642,787 8.69 $15.97 241,886 $13.21
$20.00 - $29.99 1,485,538 9.52 $24.82 334,426 $23.44
$30.00 - $39.99 649,354 8.10 $35.87 640,453 $35.88
$40.00 - $69.13 1,500,250 9.22 $53.77 1,210,000 $54.79
--------- ---------
$3.00 - $69.13 5,067,235 8.89 $30.93 3,144,447 $33.51
========= =========
As of April 30, 1998 employees were allowed to elect to re-price their
most recent grant only to an exercise price of $15.9375, the then market price,
upon the condition that such re-priced options will not be exercisable unless
the closing price as reported by Nasdaq for the Company's common stock is $30.00
per share or greater. Employees holding 199,698 options with exercise prices
varying from $19.32 to $45.00 elected to have their options re-priced.
F-25
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
All stock options issued to employees have an exercise price not less
than the fair market value of the Company's common stock on the date of grant,
and in accordance with the accounting for such options utilizing the intrinsic
value method there is no related compensation expense recorded in the Company's
financial statements. Had compensation cost for stock-based compensation been
determined based on the fair value at the grant dates in accordance with the
method delineated in Statement of Accounting Standards No. 123, the Company's
net loss and loss per share for the years ended January 31, 2001, 2000 and 1999,
would have been increased to the pro forma amounts presented below:
2001 2000 1999
-------- -------- --------
Net loss:
As reported $ (41,905) $(21,653) $ (13,388)
Pro forma (103,130) (25,146) (14,500)
Loss per share:
Basic EPS as reported $ (3.71) $ (2.33) $ (1.99)
Pro forma basic EPS (8.87) (2.70) (2.14)
Diluted EPS as reported (3.71) (2.12) (1.99)
Pro forma diluted EPS (8.87) (2.45) (2.14)
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, 2001: expected
life of option 3 to 5 years, expected volatility of 85%, risk free interest rate
of 4.89% to 6.75% based upon the date of grant and a 0% dividend yield. The fair
value, at date of grant, using these assumptions range from $8.97 to $40.09 and
the weighted average was $22.17. The assumptions for the year ended January 31,
2000 were expected life of option 3 to 4 years, expected volatility of 85%, risk
free interest rate of 5.56% and a 0% dividend yield. The fair value, at date of
grant, using these assumptions range from $2.73 to $22.15 and the weighted
average was $7.68. The assumptions for the year ended January 31, 1999 were
expected life of option 3 years, expected volatility of 45%, risk free interest
rate of 4.25% and a 0% dividend yield. The fair value, at date of grant, using
these assumptions range from $0.01 to $4.24 and the weighted average was $2.22.
In addition our Sorrento subsidiary 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 stock
has been issued under the stock issuance program and option activity for the
plan for the year ended January 31, 2001 is summarized as follows:
Weighted Average
Number of Shares Exercise Price
---------------- ---------------
Shares under option at January 31, 2000 - -
Granted 22,071,074 $5.37
Exercised - -
Canceled (3,335,170) $5.52
----------
Shares under option at January 31, 2001 18,735,904 $5.34
==========
F-26
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
Additional information relating to the stock options of our Sorrento
subsidiary outstanding and exercisable at January 31, 2001 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
--------- ------ ------------ -------------- ------ --------------
$2.00 755,000 9.05 $2.00 223,123 $2.00
$5.45 17,614,404 8.89 $5.45 7,364,996 $5.45
$6.85 366,500 9.52 $6.85 130,220 $6.85
---------- ---------
$2.00 - $6.85 18,735,904 8.91 $5.34 7,718,339 $5.37
========== =========
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 3.9 for one. During the year ended January 31, 2001 no options were
converted.
K. INCOME TAXES
The Company's provision for taxes on income for the years ended January
31, 2001, 2000 and 1999 consists of:
U.S. Non-U.S.
---- --------
Continuing Discontinued
Operations Operations Total
---------- ---------- -----
Year ended January 31, 2001:
Current $ - $ - $ -
Deferred - - -
------- ------ ------
Total $ - $ - $ -
======= ====== ======
Year ended January 31, 2000:
Current $ - $ - $ -
Deferred - (246) (246)
------- ------ ------
Total $ - $ (246) $ (246)
======= ====== ======
Year ended January 31, 1999:
Current $ - $ - $ -
Deferred - - -
------- ------ ------
Total $ - $ - $ -
======= ====== ======
The Company's domestic operations generate permanent and temporary
differences for depreciation, amortization, valuation allowances and tax
attributes arising from acquisitions. The Company has recorded a 100% valuation
allowance against its deferred tax assets, including net operating loss and
research credit carryforwards, 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.
F-27
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
2001 2000
--------- ---------
Deferred tax assets:
Valuation allowances $ 1,798 $ 2,109
Research and development credits 100 106
Tax loss carryforwards 40,189 28,286
Purchase accounting 2,057 2,047
Depreciable assets 583 -
Other liabilities and reserves 1,735 717
------- ------
Gross deferred tax assets 46,462 33,265
Less: valuation allowance (46,462) (32,556)
Deferred tax asset - 709
Deferred tax liabilities:
Software development costs - 709
Deferred tax liabilities - 709
Net deferred tax liability $ - $ -
======= ========
At January 31, 2001, the Company has federal net operating losses which
may be available to reduce future taxable income. Among potential adjustments
which may reduce available loss carryforwards, the Internal Revenue Code of
1986, as amended, (IRC), reduces the extent to which net operating loss
carryforwards may be utilized in the event there has been an "ownership change"
of a company as defined by applicable IRC provisions. The Company believes 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 Company's net operating losses incurred through January
31, 2001. Further ownership changes in the future, as defined by the IRC, may
reduce the extent to which any net operating losses may be utilized. These NOL
carryforwards expire as follows:
2007 $ 5,140
2008 3,097
2009 2,794
2010 1,052
2011 386
2012 4,678
2018 14,257
2019 11,243
2020 32,394
2021 39,786
$114,827
========
F-28
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
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,
2001, 2000 and 1999, is as follows:
2001 2000 1999
-------- ------- --------
Income (loss) from continuing operations
before U.S. and non-U.S. income taxes:
United States $ (41,905) $ 2,410 $ (11,069)
Foreign - - -
--------- ------- ---------
Loss before income taxes $ (41,905) $ 2,410 $ (11,069)
========= ======= =========
Theoretical tax (benefit) at 35% $ (14,667) $ 844 $ (3,874)
Impact of purchase accounting 101 (8,197) 51
Impact of non-qualified stock options (3,978) (4,905) (47)
Change in valuation allowance 18,499 12,258 3,870
Other individually immaterial items 45 - -
--------- ------- ---------
$ - $ - $ -
========= ======= ==========
F-29
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
L. 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, 2001, 2000 and 1999 reflect a 1-for-3 stock split effective July 24,
1998.
2001 2000 1999
--------- --------- ----------
Net loss $(41,905) $(21,653) $(13,388)
Less: deemed dividend (1,982) (103) (1,760)
Less: preferred dividends paid - (564) -
Less: accrued, unpaid preferred dividends (118) (150) (150)
----------- --------- ---------
Net loss available to common shareholders
used in basic EPS $(44,005) $(22,470) $(15,298)
=========== ========= =========
Average number of common shares used in basic EPS 11,854,848 9,630,713 7,673,431
=========== ========= =========
For the year ended January 31, 2000 our convertible preferred stock was
antidilutive. Accordingly, the weighted average number of dilutive potential
common stock of 463,401 and the dividends paid on these preferred shares of $564
are excluded from the calculation of diluted EPS. We incurred a net loss from
continuing operations for the years ending January 31, 2001 and 1999.
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.
2001 2000 1999
----------- ----------- ----------
Net loss available to common shareholders used
in basic EPS $(44,005) $(22,470) $(15,298)
Preferred stock dividends - - -
Interest on convertible debt (net of tax) - - 31
----------- ----------- ----------
Net loss available to common shareholders after
Assumed conversions of dilutive securities $(44,005) $(22,470) $(15,267)
=========== =========== ==========
Average number of common shares used in basic EPS 11,854,848 9,630,713 7,673,431
Effect of dilutive securities:
Shares issuable pursuant to contracts that may be
settled in stock - - 43,010
Convertible preferred stock 22,046 - 809,409
Convertible debentures - - 59,330
Stock benefit plans 1,628,255 861,077 192,682
Warrant exercises 93,384 112,741 30,428
----------- ----------- ----------
Average number of common shares and dilutive
potential common stock used in diluted EPS 13,958,533 10,604,531 8,808,290
=========== =========== ==========
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.
F-30
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
M. 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.
During the year ended January 31, 2001 we made a 6.6% three year loan
in the amount of $300 to an officer in connection with his accepting employment
as our Senior Vice President, Legal. This is a full recourse loan and the
officer has pledged all his options to acquire our common stock and any options
he may receive from any of our subsidiaries as collateral. Interest of $6 was
paid on this loan during the year ended January 31, 2001.
During June 2000, we entered into various agreements with our former
CEO and Chairman which, among other matters, provide for payments of $250 per
year for three years of consulting services and loans to exercise previously
granted options to acquire our common stock. 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, he
exercised 71,112 options, applying the $500 accelerated payment to the exercise.
In addition, he exercised 507,388 options for which we are contractually
obligated to loan the $5,034 due on the exercise at the then applicable federal
rate of 6.3% for two years and we hold the shares as collateral for the loan.
During the year ended January 31, 2000 we paid $40 to a then outside
director for management consulting services rendered to us and our subsidiaries.
During the years ended January 31, 2000 and 1999 we paid $190 and $25,
respectively, in fees for assistance in obtaining the amended loan and security
agreements to an entity controlled by a then outside director. During the year
ended January 31, 1998 we made 8% demand loans in the amount of $165 to an
entity controlled by a then outside director which was fully repaid, including
interest thereon, during April 1999. The loan was collateralized by 20,408
shares of the Company's common stock.
N. SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest expense and taxes paid approximated the related expenses for
the years ended January 31, 2001, 2000 and 1999.
Common shares issued upon a cashless warrant exercise applied to an
outstanding short term note during the year ended January 31, 2000 neither
provided nor used cash. Accordingly, the $1,100 value assigned to such stock has
been excluded from the statement of cash flows.
Cashless option exercises applied to other receivables including
interest thereon valued at $265 during the year ended January 31, 1999 neither
provided nor used cash. Accordingly, the values assigned to such stock have been
excluded from the statements of cash flows.
Common shares issued on conversion of convertible debentures during the
year ended January 31, 1999 neither provided nor used cash. Accordingly, the
$410 value assigned to such stock for the year ended January 31, 1999, have been
excluded from the statement of cash flows.
F-31
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
Pursuant to a separate loan agreement with a strategic partner we
advanced it $2,000 at 3% over prime rate due upon demand of which $1,443 was
repaid during the year ended January 31, 1999 and the remaining amount was
repaid during the year ended January 31, 2000.
O. 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, 2001. 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 2001 and 2000:
2001 2000
---- ----
Customer A 15.6% -
Customer B 2.4 22.2%
Customer C 20.5 -
Customer D 20.6 -
Customer E 14.1 -
Customer F 12.0 -
Customer G - 14.7
The following data shows the customers accounting for more than 10% of
net sales during the years ended January 31, 2001, 2000 and 1999:
2001 2000 1999
-------- -------- --------
Customer A 10.7% - -
Customer B 12.9 8.0 1.7
Customer C 7.3 - -
Customer D 9.3 - -
Customer E 4.2 - -
Customer F 4.9 - -
Customer G 0.2 7.9 8.1
P. SUBSEQUENT EVENTS
During March 2001 we completed a private placement of 1,525,995 shares
of our common stock receiving net proceeds of $9,600. In addition the purchasers
received three year warrants to acquire an additional 381,499 shares of our
common stock at $8.19 per share. In the event we issue shares of our common
stock or equity securities convertible
F-32
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
into our common stock at a price less than $6.5531 per share the purchasers are
entitled to receive additional shares of common stock.
Q. SEGMENT INFORMATION
Information for the years ended January 31, 2001, 2000 and 1999 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, Optical Networking, Entrada Networks and NETsilicon. 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.
2001 2000 1999
-------- -------- -------
Net sales:
United States $36,923 $53,158 $47,465
Asia 247 12,982 5,735
Europe 7,285 1,656 4,455
Other 186 576 707
-------- -------- -------
Total net sales $44,641 $68,372 $58,362
======== ======== =======
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
Intersegment revenues - - - - -
------ ----- ------ -------- -------
Total revenues 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
Operating 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 5,467 14,388
Total assets 36,524 9,088 n/a 67,511 113,123
F-33
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
Sorrento Meret Entrada
Networks Optical Networks NETsilicon Other Consolidated
-------- ------- -------- ---------- ------ ------------
As of January 31, 2000 except
for NETsilicon which is as of
September 14, 1999:
Revenues from external customers $12,511 $6,953 $28,771 $20,137 $ - $ 68,372
Intersegment revenues - - - - - -
Total revenues 12,511 6,953 28,771 20,137 - $ 68,372
------ ----- ------ ------- ------- --------
Cost of goods sold 5,415 4,100 17,498 9,577 - 36,590
Gross profit 7,096 2,853 11,273 10,560 - 31,782
Operating income/(loss) from
continuing operations (5,754) 415 (3,124) 2,540 (4,028) (9,951)
Depreciation and amortization
expense 825 1,021 2,118 660 - 4,624
Valuation allowance additions:
Receivables and inventory 373 657 911 733 - 2,674
Other - - 1,742 - - 1,742
Capital asset additions, net 1,839 (576) 140 721 9 2,133
Total assets 7,973 7,925 16,135 n/a 191,232 223,265
Sorrento Meret Entrada
Networks Optical Networks NETsilicon Other Consolidated
-------- ------- -------- ---------- ----- ------------
As of January 31, 1999:
Revenues from external customers $ 2,172 $12,014 $30,717 $13,373 $ 86 $58,362
Intersegment revenues - - - - - -
-------- ------- -------- -------- ------ ---------
Total revenues 2,172 12,014 30,717 13,373 86 58,362
-------- ------- -------- -------- ------ ---------
Cost of goods sold 1,067 7,083 17,057 7,270 - 32,477
Gross profit 1,105 4,931 13,660 6,103 86 25,885
Operating income/(loss) from
continuing operations (5,009) 3,471 (4,201) (1,581) (2,740) (10,060)
Depreciation and amortization
expense 384 332 2,035 522 1 3,274
Valuation allowance additions:
Receivables and inventory 189 658 1,073 444 - 2,364
Other - - - - - -
Capital asset additions, net 1,599 (802) 817 - - 1,614
Total assets 4,106 9,518 12,179 5,430 35,563 66,796
F-34
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
R. VALUATION AND QUALIFYING ACCOUNTS
Changes in the inventory valuation reserve were as follows:
Balance at February 1, 1998 $ 4,393
Additions charged to costs and expenses 1,624
Amounts used during year (2,528)
-------
Balance at January 31, 1999 3,489
Additions charged to costs and expenses 1,600
Amounts used during year (589)
Balance of NSI at September 15, 1999 (430)
-------
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
=======
Changes in the accounts receivable valuation reserve were as follows:
Balance at February 1, 1998 $ 704
Additions charged to costs and expenses 740
Amounts used during year (308)
-------
Balance at January 31, 1999 1,136
Additions charged to costs and expenses 1,074
Amounts used during year (279)
Balance of NSI at September 15, 1999 (728)
-------
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
=======
F-35
SORRENTO NETWORKS CORPORATION
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In Thousands, except share and per share amounts)
- ------------------------------------------------------------------------------
S. UNAUDITED QUARTERLY FINANCIAL DATA (Unaudited)
Amounts in thousands, except per share amounts.
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
------- ------- ------- ------- ----
Year ended January 31, 2001:
Net sales $ 10,048 $ 11,376 $ 10,849 $ 12,368 $ 44,641
Gross profit 1,855 3,842 3,509 3,965 13,171
Income (loss) from
continuing operations (12,837) (13,524) (6,903) (8,641) (41,905)
Provision for income taxes - - - - -
Loss from discontinued operations - - - - -
Net income (loss) (12,837) (13,524) (6,903) (8,641) (41,905)
Net income (loss) per share:
Basic (1.15) (1.21) (0.63) (0.74) (3.71)
Diluted (1.15) (1.21) (0.63) (0.74) (3.71)
Year ended January 31, 2000:
Net sales $ 19,129 $ 17,206 $ 18,948 $ 13,089 $ 68,372
Gross profit 8,878 8,120 9,328 5,456 31,782
Income (loss) from
continuing operations (1,043) (2,493) 14,246 (8,300) 2,410
Provision for income taxes - - (3,406) 3,406 -
Loss from discontinued operations (1,229) (120) (9,307) (13,407) (24,063)
Net income (loss) (2,272) (2,613) 1,533 (18,301) (21,653)
Net income (loss) per share:
Basic (0.29) (0.30) 0.13 (1.66) (2.33)
Diluted (0.29) (0.30) 0.14 (1.66) (2.12)
Year ended January 31, 1999:
Net sales $ 14,788 $ 15,101 $ 14,094 $ 14,379 $ 58,362
Gross profit 7,232 6,741 5,916 5,996 25,885
Loss from continuing operations (2,336) (3,323) (2,791) (2,619) (11,069)
Provision for income taxes - - - - -
Loss from discontinued operations (342) (1,142) (797) (38) (2,319)
Net income (loss) (2,678) (4,465) (3,588) (2,657) (13,388)
Net income (loss) per share:
Basic (0.39) (0.80) (0.50) (0.34) (1.99)
Diluted (0.39) (0.80) (0.50) (0.34) (1.99)
F-36
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: May 1, 2001
-----------------------------------------------
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/ Xin Cheng Date: May 1, 2001
-----------------------------------------------
Xin Cheng, Ph.D.
Chairman and Director
Chief Executive Officer
By: /s/ James Dixon Date: May 1, 2001
-----------------------------------------------
James Dixon
Director
Chief Operating Officer, President
By: /s/ Phil Arneson Date: May 1, 2001
-----------------------------------------------
Phil Arneson
Director
By: Date: May 1, 2001
-----------------------------------------------
Tingye Li, Ph.D.
Director
By: /s/ Gary M. Parsons Date: May 1, 2001
-----------------------------------------------
Gary M. Parsons
Director
40
STATEMENT OF DIFFERENCES
The division sign shall be expressed as.............................[div]
The trademark symbol shall be expressed as.......................... 'TM'
The registered trademark symbol shall be expressed as............... 'r'