<Page> UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 -------------------- FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended July 31, 2001 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________ to __________ ----------------- Commission file number: 000-26952 ENTRADA NETWORKS, INC. (Exact name of registrant as specified in its charter) Delaware 33-0676350 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 10070 Mesa Rim Road, San Diego, California 92121 (Address of principal executive office) (Zip Code) (858) 623-3265 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ (Indicate the number of shares of each of the registrant's classes of common stock, as of the latest practicable date.) Title Date Outstanding ----- ---- ----------- Common Stock, $.001 Par Value August 30, 2001 10,992,634 Entrada Networks, Inc. Consolidated Balance Sheets (in thousands, except per share data) July 31, January 31, 2001 2001 ---------- ----------- (unaudited) ASSETS Current assets: Cash $ 1,522 $ 9,953 Restricted cash 300 300 Accounts receivable, net of allowance for doubtful accounts of $396 and $400, respectively 1,440 4,373 Inventories, net of reserves of $2,755 and $3,340, respectively 3,794 4,636 Prepaid expenses and other current assets 362 298 ------- -------- Total current assets 7,418 19,560 Property and equipment, net 2,284 2,452 ------- -------- Total assets $ 9,702 $ 22,012 ======= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Short-term debt $ 1,700 $ 3,568 Current maturities of long-term debt 189 394 Accounts payable 917 1,725 Net liabilities of discontinued operations 1,299 3,892 Other current and accrued liabilities 1,621 2,166 ------- -------- Total current liabilities 5,726 11,745 Long-term debt and capital lease obligations 37 131 ------- -------- Total liabilities 5,763 11,876 Stockholders' equity Common stock, $0.001 par value; 50,000 shares authorized, 10,993 and 4,244 shares issued and outstanding at July 31, 2001 and January 31, 2001 11 11 Additional paid-in capital 51,765 51,722 Accumulated deficit (47,837) (41,597) ------- -------- Total stockholders' equity 3,939 10,136 ------- -------- Total liabilities and stockholders' equity $ 9,702 $ 22,012 ======= ======== See accompanying notes to consolidated financial statements. 2 Entrada Networks, Inc. Consolidated Statements of Operations (unaudited, in thousands, except per share data) Three months ended Six months ended July 31, July 31, ------------------------ -------------------------- 2001 2000 2001 2000 ---------- ----------- ------------ ------------ Net sales $ 2,164 $ 6,041 $ 3,485 $ 9,751 Cost of sales 1,568 3,696 2,822 9,093 ------- ------- ------- ------- Gross profit 596 2,345 663 658 Operating expenses: Selling and marketing 1,157 1,318 2,348 2,352 Engineering, research and development 2,017 1,108 4,355 2,758 General and administrative 822 541 1,701 1,052 Other 292 - 559 2,088 ------- ------- ------- ------- Total operating expenses 4,288 2,967 8,963 8,250 Income (loss) from operations (3,692) (622) (8,300) (7,592) Interest expense, net (42) (129) (114) (225) ------- ------- ------- ------- Income (loss) from continuing operations before income taxes (3,734) (751) (8,414) (7,817) Provision for income taxes - - - - ------- ------- ------- ------- Net income (loss) from continuing operations (3,734) (751) (8,414) (7,817) Net income from discontinued operations 909 - 2,174 - Loss on disposal of discontinued operations - - - - ------- ------- ------- ------- Net income (loss) $(2,825) $ (751) $(6,240) $(7,817) ======= ======= ======= ======= Net income (loss) per common share: Income (loss) from continuing operations: Basic $ (0.34) $ (0.18) $ (0.77) $ (1.84) ======= ======= ======= ======= Diluted $ (0.34) $ (0.18) $ (0.77) $ (1.84) ======= ======= ======= ======= Net income from discontinued operations: Basic $ 0.08 $ - $ 0.20 $ - ======= ======= ======= ======= Diluted $ 0.08 $ - $ 0.20 $ - ======= ======= ======= ======= Net income (loss): Basic $ (0.26) $ (0.18) $ (0.57) $ (1.84) ======= ======= ======= ======= Diluted $ (0.26) $ (0.18) $ (0.57) $ (1.84) ======= ======= ======= ======= Weighted average shares outstanding: Basic 10,993 4,244 10,993 4,244 ======= ======= ======= ======= Diluted 10,993 4,244 10,993 4,244 ======= ======= ======= ======= See accompanying notes to consolidated financial statements. 3 Entrada Networks, Inc. Consolidated Statements of Cash Flows (unaudited, in thousands) Six months ended July 31, --------------------------- 2001 2000 ------------- ------------ Cash flows from operating activities: Net loss from continuing operations $ (8,414) $ (7,817) Adjustments to reconcile net loss from continuing operations to net cash used in operating activities: Intangible asset valuation allowance - - Depreciation and amortization 579 1,316 Accounts receivable and inventory reserves 45 4,318 Changes in assets and liabilities: Accounts receivable 2,887 (1,203) Due from affiliates - 596 Inventories 843 (790) Other current assets (65) 335 Accounts payable (808) (1,946) Accrued expenses (545) (96) Other current liabilities - - -------- -------- Net cash used in continuing operating activities (5,478) (5,287) Net cash used in discontinued operations (418) - -------- -------- Net cash provided by (used in) operating activities (5,896) (5,287) Cash flows from investing activities: Purchase of property and equipment (411) (184) -------- -------- Net cash used in investing activities (411) (184) Cash flows from financing activities: Bank overdraft - - Proceeds from issuance of short-term debt, net of repayments (1,868) 1,099 Repayment of capital lease obligations (299) (51) Advances from former parent company, net of repayments - 4,317 Warrants issued in conjunction with credit facility 43 - -------- -------- Net cash provided by (used in) financing activities (2,124) 5,365 -------- -------- Net increase in cash and cash equivalents (8,431) (106) Cash and cash equivalents at beginning of year 9,953 112 -------- -------- Cash and cash equivalents at end of period $ 1,522 $ 6 ======== ======== See accompanying notes to consolidated financial statements. 4 <Page> ENTRADA NETWORKS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (In thousands, except per share amounts) - ----------------------------------------------------------------------------- We design, manufacture and market products that provide access to and enhance the performance of data and telecommunication networks, and are currently developing storage area networks ("SANs") transport technology which will enable inter-networking of isolated islands of SANs over wide area networks, metro area networks and local area networks via internet protocol and light. Our products are deployed by telecommunications network operators, application service providers, internet service providers, and the operators of corporate local area and wide area networks for the purpose of providing access transport within their networks. Our corporate headquarters and engineering facilities are located in San Diego, California. We perform assembly, system integration, quality control, final testing and configuration at our facility in Annapolis Junction, Maryland. In addition, we have various sales offices located in the United States. We pursue a strategy of outsourcing some of our products and components to third party contract manufacturers to enable us to react quickly to market demand and avoid significant capital investment required to establish and maintain full manufacturing facilities. Operations of our frame relay segment based in Irvine, California, are being discontinued. We market and sell our products and services directly to end users as well as through a broad array of channels including system integrators, worldwide distributors, value added resellers, original equipment manufacturers ("OEMs"), telecommunication service providers and governmental agencies. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation Entrada Networks, Inc., the "Company," "We," "Our" or "Us," has prepared, without audit, the accompanying financial data as of July 31, 2001, and for the three and six months ended July 31, 2001 and 2000 in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The January 31, 2001 balance sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. However, we believe that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in our Annual Report on Form 10-K filed on May 4, 2001. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses, the disclosure of contingent assets and liabilities and the loss on disposal of discontinued operations. Actual results could differ from these estimates. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows as of July 31, 2001 and for the three and six months ended July 31, 2001, have been made. The results of operations for the three and six months ended July 31, 2001 are not necessarily indicative of the operating results for the full year. Discontinued Operations The accompanying financial statements reflect the operations and financial position of the frame relay business segment as a discontinued business segment for all periods reported in conformity with generally accepted accounting principles. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board finalized FASB Statements No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method of accounting and prohibits the use of the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. SFAS 141 also requires that the Company recognize acquired 5 ENTRADA NETWORKS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (In thousands, except per share amounts) - -------------------------------------------------------------------------------- intangible assets apart from goodwill if the acquired intangible assets meet certain criteria. SFAS 141 applies to all business combinations initiated after July 1, 2001 and for purchase business combinations completed on or after July 1, 2001. It also requires, upon adoption of SFAS 142, that the Company reclassify the carrying amounts of intangible assets and goodwill based on the criteria in SFAS 141. The Company does not believe the adoption of SFAS 141 will have a material effect, if any, on our financial position of results of operations. SFAS 142 requires, among other things, that companies no longer amortize goodwill, but instead test goodwill for impairment at least annually. In addition, SFAS 142 requires that the Company identify reporting units for the purposes of assessing potential future impairments of goodwill, reassess the useful lives of other existing recognized intangible assets, and cease amortization of intangible assets with an indefinite useful life. An intangible asset with an indefinite useful life should be tested for impairment in accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years beginning after December 15, 2001 to all goodwill and other intangible assets recognized at that date, regardless of when those assets were initially recognized. SFAS 142 requires the Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is also required to reassess the useful lives of other intangible assets within the first interim quarter after adoption of SFAS 142. The Company does not believe the adoption of SFAS 142 will have a material effect, if any, on our financial position of results of operations. Statement of Financial Accounting Standards ("SFAS") No. 133 as amended by SFAS 137 and 138, "Accounting for Derivative Instruments and Hedging Activities," is effective for financial statements with fiscal quarters of all fiscal years beginning after June 15, 2000. The Accounting Standards Executive Committee issued Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," and SOP 98-5, "Reporting on the Costs of Start-up Activities," effective in the current or future periods. The adoption or future adoption of these standards has had or will have no material effects 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. In December, 1999 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. Staff Accounting Bulletin No. 101B delayed the date of required adoption to October 1, 2000. Management believes that adoption of this policy had no material effect on our financial position or results of operations. 6 ENTRADA NETWORKS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (In thousands, except per share amounts) - -------------------------------------------------------------------------------- BALANCE SHEET DETAIL Inventories at July 31, 2001 and January 31, 2001 consist of: July 31, 2001 January 31, 2001 ------------- ---------------- Raw material $ 4,248 $ 5,659 Work in process 1,096 672 Finished goods 1,205 1,645 ------- ------- 6,549 7,976 Less: Valuation reserve (2,755) (3,340) ------- ------- $ 3,794 $ 4,636 ======= ======= STOCKHOLDERS' EQUITY We are authorized to issue the following shares of stock: 50,000,000 shares of Common Stock ($0.001 par value) 2,000,000 shares of Preferred Stock ($0.001 par value) None of our preferred stock was outstanding during the six months ended July 31, 2001. All shares of our preferred stock, Series A, were automatically converted into 700,000 shares of our common stock in connection with our merger on August 31, 2000. EARNINGS PER SHARE CALCULATION The following data show the amounts used in computing basic earnings per share for the three and six month periods ended July 31, 2001 and 2000. Three Months Ended July 31, Six Months Ended July 31, 2001 2000 2001 2000 -------- ------- -------- ------- Net income (loss) available to common stockholders used in basic EPS $ (2,825) $ (751) $ (6,240) $ (7,817) ========== ========= =========== ========= Average number of common shares used in basic EPS 10,992,634 4,244,155 10,992,634 4,244,155 ========== ========= ========== ========= We incurred a net loss from continuing operations for the three and six month periods ended July 31, 2001 and 2000. Accordingly, the effect of dilutive securities including vested and non-vested stock options 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. 7 ENTRADA NETWORKS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (In thousands, except per share amounts) - -------------------------------------------------------------------------------- Three Months Ended July 31, Six Months Ended July 31, 2001 2000 2001 2000 -------- ------- -------- ------- Net loss available to common stockholders used in basic EPS $ (2,825) $ (751) $ (6,240) $(7,817) ========= ======= ======== ======= Average number of common shares used in basic EPS 10,992,634 4,244,155 10,992,634 4,244,155 Effect of dilutive securities: Stock benefit plans 1,121 - 25,529 - ---------- --------- ----------- --------- Average number of common shares and dilutive potential common stock used in diluted EPS 10,993,755 4,244,155 11,018,163 4,244,155 ========== ========= ========== ========= The shares issuable upon exercise of options represent 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 with exercise prices in excess of the average market price for the period are excluded because their effect would be antidilutive. There were no options to purchase common shares or convertible preferred stock outstanding during the six months ended July 31, 2000. Options to purchase common shares that were outstanding but were not included in the computation of diluted earnings per shares because their exercise price was greater than the average market price of the common shares for the period each option was outstanding were 3,702,547 and 3,308,374 for the three and six months ended July 31, 2001, respectively. COMMITMENTS On February 20, 2001, our credit arrangement with Coast Business Credit was fully replaced with a credit facility with Silicon Valley Bank. The Silicon Valley Bank credit facility has a maximum limit of $5.0 million, subject to a limitation equal to 75% of our eligible receivables plus the lesser of $1.0 million or 40% of the liquidation value of our eligible inventory. Borrowings under the credit line bear interest at the bank's prime rate plus 1.75%. In connection with the line of credit, we issued Silicon Valley Bank five-year warrants to purchase 75,757 shares of our common stock at $3.30 per share. We have accrued $43 of deferred interest in connection with these warrants. The deferred interest is being amortized as interest expense over the twelve month term of the credit arrangement. The credit arrangement is subject to covenants regarding our tangible net worth, and is collateralized by accounts receivable, inventory and equipment. CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject us to concentration of credit risk consist primarily of temporary cash investments and trade receivables. As regards the former, we place our temporary cash investments with high credit financial institutions. At times such amounts may exceed F.D.I.C. limits. One of our short-term investment accounts at a single institution accounted for approximately 3% of current assets at July 31, 2001. Although we are directly affected by the economic well being of significant customers listed in the following tables, management does not believe that significant credit risk exists at July 31, 2001. We perform ongoing evaluations of our customers and require letters of credit or other collateral arrangements as appropriate. 8 ENTRADA NETWORKS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (In thousands, except per share amounts) - -------------------------------------------------------------------------------- Three customers each account for 67.7%, 23.6%, and 10.1% of net receivables at July 31, 2001, which is within terms. At January 31, 2001, three customers each accounted for 37.0%, 12.6%, and 12.1% of net receivables. Customers accounting for more than 10% of net sales during the quarters ended July 31, 2001 and 2000: July 31, 2001 July 31, 2000 ------------- ------------- Customer W 49.7% 50.0% Customer X 13.3 - Customer Y 11.7 Customer Z - 13.3 SEGMENT INFORMATION We operate one business segment for the design and manufacture of computer networking products. The operations of the business segment formerly known as Sync Research, Inc., are being discontinued and the segment's results of operations are shown as "Loss from discontinued operations" in the accompanying Consolidated Statements of Operations. Export sales are not a material component of total sales. GOING CONCERN The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern that contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The carrying amounts of assets and liabilities presented in the financial statements do not purport to represent realizable or settlement values. However, the Company has determined that its available cash resources will be insufficient to meet its anticipated working capital requirements for the next twelve months. These factors, along with the fact that the Company has suffered recurring operating losses, raise doubt about the Company's ability to continue as a going concern. The Company is continuing its efforts to secure working capital for operations. However, there can be no assurance that the Company will be able to secure additional capital, or that if such capital is available, whether the terms or conditions would be acceptable to the Company. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated unaudited financial statements and related notes thereto. The results of operations in the consolidated unaudited financial statements reflect the operating results of Entrada Networks for all periods presented. The periods presented include the operating results of the former Sync Research, Inc., beginning on September 1, 2000, as discontinued operations. Further reference should be made to our Form 10-K, filed May 4, 2001, containing our audited financial statements for the years ended January 31, 2000 and 2001. Results of Operations/Comparison of the Three Months Ended July 31, 2001 and 2000 Net sales. Net sales were $2.2 million for the three months ended July 31, 2001, compared with $6.0 million for the three months ended July 31, 2000. The decrease in net sales in the three months ended July 31, 2001 resulted primarily from decreased sales to OEMs of fast Ethernet local area networking LAN adapter products due to the general economic slowdown being experienced by our major OEM customers. Gross profit. Cost of sales consists principally of the cost of components and subcontract assembly from outside manufacturers, in addition to in-house system integration, quality control, final testing and configuration. Gross profit decreased to $0.6 million for the quarter ended July 31, 2001, compared with $2.3 million for the comparable quarter last year. Our gross margin declined to 27.5% for the three months ended July 31, 2001, from 38.8% for the three months ended July 31, 2000. The decline in gross margins resulted primarily from the reduced revenues for the second quarter fiscal 2002. Selling and marketing. Selling and marketing expenses consist primarily of employee compensation and related costs, commissions to sales representatives, tradeshow expenses, facilities costs, and travel expenses. Selling and marketing expenses decreased to $1.2 million, or 53.5% of net sales for the quarter ended July 31, 2001, from $1.3 million and 21.8% of net sales for the quarter ended July 31, 2000. The decrease in selling and marketing costs reflects the expense reduction measures undertaken in the six months ended July 31, 2001. Engineering, research and development. Engineering, research and development expenses consist primarily of compensation related costs for engineering personnel, facilities costs, and materials used in the design, development and support of our technologies. Engineering, research and development expenses were $2.0 million, or 93.2% of net sales, for the quarter ended July 31, 2001, compared with $1.1 million, or 18.3% of net sales, for the quarter ended July 31, 2000. The increase in research and development expenses was primarily due to increased new product development costs. General and administrative. General and administrative expenses consist primarily of employee compensation and related costs, legal and accounting fees and public company costs. General and administrative expenses increased to $0.8 million, or 38.0% of net sales, for the quarter ended July 31, 2001 from $0.5 million, or 9.0% of net sales, for the quarter ended July 31, 2000. As a result of the merger and establishment of the Company as a publicly traded entity headquartered in San Diego, the Company has added a layer of senior management and will incur additional costs associated with operating as a public company, including the costs of proxies, mailing, annual reports and stockholders' meetings. These costs are incremental to the Company's general and administrative costs and will continue indefinitely. Other operating expenses. Other operating expenses for the three months ended July 31, 2001, were $0.3 million, consisting of severance costs associated with a reduction in staff associated primarily with our legacy products. Income taxes. There was no provision for income taxes for the three-month periods ended July 31, 2001 and 2000. We have carry forwards of domestic federal net operating losses, which may be available, in part, to reduce future taxable income in the United States. However, the Internal Revenue Code limits the application of net operating loss carry forwards in the event of ownership changes of greater than 50%. We have had a change of ownership that will limit the amount of any net operating loss carry forward we may use in a particular year. 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. Discontinued operations. Net income from discontinued operations was $0.9 million for the second quarter ended July 31, 2001. Net sales from discontinued operations were $1.9 million for the second quarter ended July 31, 2001. 10 This represents the operating results of the former Sync Research, Inc. frame relay business based in Irvine, California. On September 29, 2000, after completion of the merger on August 31, 2000, the Company entered into a plan to discontinue the operations of the frame relay business segment. Results of Operations/Comparison of the Six Months Ended July 31, 2001 and 2000 Net sales. Net sales were $3.5 million for the six months ended July 31, 2001, compared with $9.8 million for the six months ended July 31, 2000. The decrease in net sales in the six months ended July 31, 2001 resulted primarily from decreased sales to OEMs of fast Ethernet local area networking LAN adapter products due to the general economic slowdown being experienced by our major OEM customers. Gross profit. Cost of sales consists principally of the cost of components and subcontract assembly from outside manufacturers, in addition to in-house system integration, quality control, final testing and configuration. Gross profit was $0.7 million for each of the six month periods ended July 31, 2001 and 2000. Our gross margin was 19.0% for the six months ended July 31, 2001, compared with 6.7% for the six months ended July 31, 2000. The lower gross margin for the six months ended July 31, 2000 was primarily due to a $2.7 million inventory valuation adjustment. Our gross margin, excluding the valuation adjustment, declined to 19.0% for the six months ended July 31, 2001, from 34.3% for the six months ended July 31, 2000. The decline in gross margins resulted primarily from the reduced revenues for the first six months of fiscal 2002. Selling and marketing. Selling and marketing expenses consist primarily of employee compensation and related costs, commissions to sales representatives, tradeshow expenses, advertising, facilities costs, and travel expenses. Selling and marketing expenses decreased to $2.3 million, or 67.4% of net sales for the six months ended July 31, 2001, from $2.4 million and 24.1% of net sales for the six months ended July 31, 2000. The decrease in selling and marketing costs reflects the expense reduction measures undertaken in the six months ended July 31, 2001, partially offset by increases in marketing costs. 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. Engineering, research and development expenses were $4.4 million, or 125.0% of net sales, for the six months ended July 31, 2001, compared with $2.8 million, or 28.3% of net sales, for the six months ended July 31, 2000. The increase in research and development expenses was primarily due to increased new product development costs. General and administrative. General and administrative expenses consist primarily of employee compensation and related costs, legal and accounting fees and public company costs. General and administrative expenses increased to $1.7 million, or 48.8% of net sales, for the six months ended July 31, 2001 from $1.1 million, or 10.8% of net sales, for the six months ended July 31, 2000. As a result of the merger and establishment of the Company as a publicly traded entity headquartered in San Diego, the Company has added a layer of senior management and will incur additional costs associated with operating as a public company, including the costs of proxies, mailing, annual reports and stockholders' meetings. These costs are incremental to the Company's general and administrative costs and will continue indefinitely. Other operating expenses. Other operating expenses for the six months ended July 31, 2001, were $0.6 million, consisting of severance costs associated with a reduction in staff associated primarily with our legacy products. Other operating expenses for the six months ended July 31, 2000, were $2.1 million, consisting primarily of a $1.4 million valuation reserve recorded against distributor receivables and $0.5 million of costs associated with the closure of our Massachusetts facility. Income taxes. There was no provision for income taxes for the six-month periods ended July 31, 2001 and 2000. We have carry forwards of domestic federal net operating losses, which may be available, in part, to reduce future taxable income in the United States. However, the Internal Revenue Code limits the application of net operating loss carry forwards in the event of ownership changes of greater than 50%. We have had a change of ownership that will limit the amount of any net operating loss carry forward we may use in a particular year. 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. 11 Discontinued operations. Net income from discontinued operations was $2.2 million for the six months ended July 31, 2001. Net sales from discontinued operations were $3.3 million for the six months ended July 31, 2001. This represents the operating results of the former Sync Research, Inc. frame relay business based in Irvine, California. On September 29, 2000, after completion of the merger on August 31, 2000, the Company entered into a plan to discontinue the operations of the frame relay business segment. Liquidity and Capital Resources The amounts included in our statement of cash flows for the first six months of fiscal 2002 are not comparable to our first six months of fiscal 2001 amounts due to the inclusion of the former Sync Research, Inc., for first six months fiscal 2002. Readers should refer to Sync's quarterly report on Form 10-Q for information concerning Sync. We financed our operations before the merger through a combination of debt and non-interest bearing advances from our former parent. At July 31, 2001, our working capital was $1.7 million and cash and cash equivalents were $1.8 million, including $0.3 million of restricted cash. Cash flow used in operations was $5.9 million during the six months ended July 31, 2001 compared with $5.3 million for the six months ended July 31, 2000. The increase in cash flows used in operations reflects a substantial increase in our net loss from operations after adjustment for non-cash expenses including depreciation, amortization, reserves and valuation allowances, in addition to $0.4 million of cash used in discontinued operations. During the six months ended July 31, 2001, operating cash flow reflected decreases in net accounts receivable and net inventories, partially offset by decreases in accounts payable and accrued expenses and increases in other current assets. During the same six months last year, our cash flow used in operations reflected increases in accounts receivable and inventory along with a decrease in accounts payable. Our investing activities consist primarily of purchases of property, plant and equipment. We purchased $0.4 million and $0.2 million in equipment during the six months ended July 31, 2001 and 2000, respectively. Our financing activities during the six months ended July 31, 2001 used cash flows of $2.1 million, primarily in connection with a $1.9 million decrease in short-term debt. During the six months ended July 31, 2000, financing activities provided cash flows of $5.4 million, which included $4.3 million of non-interest bearing advances from our former parent, net of repayments. We have a line of credit totaling $5.0 million. Outstanding borrowings against this line of credit were $1.7 million at July 31, 2001. Our credit line is collateralized by accounts receivable, inventory and equipment. We anticipate that our available cash resources will be insufficient to meet our presently anticipated working capital requirements to continue the development of the SAN product line for the next 12 months. The Company is currently pursuing possible strategic alternatives including external equity financing arrangements that, if successful, would enable the continuation of the development of SAN products. 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. Item 3. Quantitative and Qualitative Disclosures About Market Risk We periodically need 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. 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. 12 All of our sales and expenses are currently denominated in U.S. dollars and to date our business has not been affected by currency fluctuations. In the future, however, we could 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. 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. Part II. Other Information Item 5. Other Information Nasdaq Listing Qualifications We have been informed by The Nasdaq National Market that we are not in compliance with Marketplace Rule 4450(a)(5) because our common stock failed to maintain a minimum bid price of $1.00 over 30 consecutive trading days. We have been granted until October 22, 2001 to regain compliance with the Rule. Compliance will be determined by the Nasdaq Staff, but generally requires that the bid price of our common stock be at least $1.00 for a minimum of 10 consecutive trading days. If the Staff determines that we are not in compliance by October 22, 2001, we have the right to appeal the Staff's decision to a Nasdaq Listing Qualifications Panel. Failure to regain compliance would result in the delisting of our securities from the Nasdaq National Market. Delisting of our securities could have a material adverse effect on the price of our common stock and upon the ability of our stockholders to buy or sell our common stock. Certain Cautionary Statements Certain statements in this Quarterly Report on Form 10-Q, including, but not limited to, Part I, Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations," contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, that are not historical facts but rather reflect current expectations concerning future results and events. The words "believes," "expects," "intends," "plans," "anticipates," "likely," "will" and similar expressions identify such forward-looking statements. These forward-looking statements are subject to risks, uncertainties and other factors, some of which are beyond the Company's control that could cause actual results to differ materially from those forecast or anticipated in such forward-looking statements. These factors include, but are not limited to, the technical and commercial success of the Company's current and future products, the performance and ultimate disposition of our discontinued business segment based in Irvine, California, the integration of operations as a result of the merger, reliance on vendors and product lines, competition, performance of new products, performance of affiliates and their future operating results, the Company's ability to establish successful strategic alliances, quarterly and seasonal fluctuations, dependence on senior management and possible volatility of stock price. These factors are discussed generally in greater detail under the caption "Risk Factors" in our Annual Report on Form 10-K, filed May 4, 2001. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None. (b) Reports on Form 8-K On July 16, 2001, the Company filed a report on Form 8-K describing the effect of a general economic slowdown on it financial results and operations, and the cost-cutting measures implemented by the Company in response. 13 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ENTRADA NETWORKS, INC. By: /s/ Gilbert G. Goldbeck -------------------------------------- Gilbert G. Goldbeck Vice President, Finance and Operations Chief Financial Officer Principal Accounting Officer Date: August 31, 2001 14