10-Q 1 p15911_form10q.txt FORM 10-Q 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 June 29, 2002 or |_| 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 0-31162 O P T I C N E T, I N C. (Exact name of Registrant as specified in its charter) Delaware 94-3368561 ------------------------ ------------------------------------ (State of incorporation) (I.R.S. Employer Identification No.) One Post Street, Suite 2500 San Francisco, California 94104 ---------------------------------------- (Address of principal executive offices) (415) 956-4477 ------------------------------- (Registrant's telephone number) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock: $.0001 Par Value; 3,632,603 shares of Voting Common Stock and 2,591,857 shares of Nonvoting Common Stock outstanding as of June 29, 2002. Page 1 of 18 OPTICNET, INC. (a development stage company) INDEX PART 1. FINANCIAL INFORMATION PAGE ---- Item 1. Financial Statements Condensed Balance Sheets-- June 29, 2002 and September 29, 2001 3 Condensed Statements of Operations--Quarter and Nine Months ended June 29, 2002 and June 30, 2001 and the period from February 23, 2000 (inception) to June 29, 2002 4 Condensed Statements of Cash Flows-- Quarter and Nine Months ended June 29, 2002 and June 30, 2001 and the period from February 23, 2000 (inception) to June 29, 2002 5 Notes to Condensed Financial Statements-- June 29, 2002 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosure About Market Risk 15 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K 16 (a) Exhibits (b) Reports on Form 8-K SIGNATURES 18 Page 2 of 18 PART I. FINANCIAL INFORMATION Item 1. Financial Statements OPTICNET, INC. (a development stage company) CONDENSED BALANCE SHEETS June 29, September 29, 2002 2001 (Unaudited) (See note below) -------------------------------------------------------------------------------- ASSETS Cash and cash equivalents $ 21,655 $ 828,489 Trade receivables, net -- 99,720 Inventories 26,286 -- Other current assets 14,201 80,631 ----------- ----------- 62,142 1,008,840 Total current assets Property and equipment, net 11,879 17,984 Other assets 728 22,025 ----------- ----------- $ 74,749 $ 1,048,849 =========== =========== LIABILITIES AND STOCKHOLDERS' DEFICIT Accounts payable $ 138,507 $ 132,574 Accrued expenses and other liabilities 360,280 349,174 Note payable to related party 2,656,338 1,166,608 ----------- ----------- 3,155,125 1,648,356 Total current liabilities Other liabilities -- 14,670 Stockholders' deficit (3,080,376) (614,177) ----------- ----------- $ 74,749 $ 1,048,849 =========== =========== Note: The balance sheet at September 29, 2001 has been derived from the audited balance sheet at that date. See notes to condensed financial statements. Page 3 of 18 OPTICNET, INC. (a development stage company) CONDENSED STATEMENTS OF OPERATIONS (Unaudited)

See notes to condensed financial statements. Page 4 of 18 OPTICNET, INC. (a development stage company) CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)

See notes to condensed financial statements. Page 5 of 18 OPTICNET, INC. (a development stage company) NOTES TO CONDENSED FINANCIAL STATEMENTS (Unaudited) NOTE 1. BASIS OF PRESENTATION The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ending September 28, 2002. For further information, refer to the financial statements and footnotes thereto in the Company's registration statement on Form 10, as amended April 25, 2002. OpticNet, Inc. ("OpticNet" or the "Company") was incorporated on February 23, 2000 in the State of Delaware, as a majority owned subsidiary of BEI Technologies, Inc. ("BEI Technologies"). From its inception (February 23, 2000) through December 30 2000, OpticNet operated as a controlled subsidiary of BEI Technologies. BEI Technologies accumulated the costs associated with OpticNet's operation in the period from February 23, 2000 through December 30 2000 including all expenses directly attributable to OpticNet and an allocation of the costs of facilities, salaries and employee benefits based on relative headcount. These allocations were based on assumptions that management believes are reasonable under the circumstances. However, these allocations and estimates are not necessarily indicative of the costs that would have resulted if OpticNet had been operated on a stand-alone basis during this period. As of October 30, 2000, BEI Technologies distributed 3,578,387 shares in OpticNet to BEI Technologies' stockholders (the "Distribution"), substantially all of the Company's voting common stock held by BEI Technologies. In the Distribution, each holder of record of BEI Technologies common stock as of October 30, 2000 received one share of OpticNet voting common stock for every two shares of BEI Technologies common stock held, and cash in lieu of any fractional share of OpticNet common stock. After the Distribution, BEI Technologies continued to hold securities of the Company in the form of convertible preferred and voting common stock, representing an aggregate direct ownership interest of approximately 25% in the Company. During the fiscal quarter ended June 29, 2002, the Company continued negotiations with BEI Technologies regarding a further equity investment in the Company by BEI Technologies, contemplated to be in the form of nonvoting preferred stock, when, and if authorized by the Company for issuance to BEI Technologies. The principal focus of the Company's business is to develop, manufacture and market fiber optic components and subsystems for the telecommunications market. OpticNet's primary activities since inception have been devoted to developing its product offerings and related technologies, recruiting key management and technical personnel and raising capital to fund operations. OpticNet has not recognized significant revenues since inception. All revenue recognized to date relates to engineering agreements funded by unaffiliated customers. As a result, the accompanying financial statements are presented in accordance with Financial Accounting Statement ("FAS") No. 7, "Accounting and Reporting by Development Stage Enterprises." Page 6 of 18 OpticNet's operations are subject to significant risks and uncertainties, including competitive, financial, developmental, operational, growth and expansion, technological, regulatory and other risks associated with an emerging business. These financial statements have been prepared assuming that the Company will continue as a going concern. Since its inception, the Company has incurred recurring operating losses and negative cash flows from operations and has an accumulated deficit of $5.3 million at June 29, 2002. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. Management and the Company's board of directors decided in March 2002 to reduce the level of incremental spending for research and development and to reduce operations to a level that will solely support the current customer base. During the third quarter of fiscal 2002, the Company remained unsuccessful at attracting outside financing despite management's efforts, and continued operations on a reduced basis. The Company received approximately $1.2 million in cash from BEI Technologies during the third quarter, used for general operating expenses. The parties have been discussing the authorization by the Company of a nonvoting series of preferred stock for issuance to BEI Technologies representing this sum. The final terms of such an equity investment would be determined when, and if, such an equity investment is consummated. Use of Estimates The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. The estimates are based on historical experience and on various other assumptions that management believes to be reasonable under the circumstances. On an ongoing basis, the Company evaluates its estimates. Results may differ from these estimates due to actual outcomes being different from those on which the Company based its assumptions. Allowance for Doubtful Accounts The Company continuously monitors collections and payments from its customers and maintains allowances for doubtful accounts based upon historical experience and any specific customer collection issues that the Company has identified. While such credit losses have historically been within management's expectations, there can be no assurance that the Company will continue to experience the same relative level of credit losses that it has in the past. In addition, the Company's revenues and accounts receivable are concentrated in a relatively few number of customers. A significant change in the liquidity or financial position of any one of these customers or a further deterioration in the economic environment or telecommunications industry, in general, could have a material adverse impact on the collectability of the Company's accounts receivable and future operating results, including a reduction in future revenues and additional allowances for doubtful accounts. If, at the time revenue is recognized, the Company determines that collection of a receivable is not reasonably assured, the revenue is deferred and recognized at the time collection becomes reasonably assured, which is generally upon receipt of payment. Page 7 of 18 Revenue Recognition The Company has not recognized revenue from commercial product sales to date. All revenue recognized to date consisted of engineering work performed under engineering agreements with unaffiliated customers. Revenue for this engineering work is recognized based on customer acknowledgement of the achievement of milestones in the engineering agreement. Payments, if any, for prototype deliveries to customers by the Company are accounted for as an offset against research and development expense as described below. Research and Development Expense The Company's products are highly technical in nature and require a significant level of research and development effort. Research and development costs are charged to expense as incurred in accordance with FAS No. 2, "Accounting for Research and Development Costs." No prototype units were delivered during the quarter ended June 29, 2002. Prototype units were delivered during the quarter ended June 30, 2001, thus payments or receivables for prototype deliveries were offset against research and development expense in the statements of operations for the quarter ended June 30, 2001. NOTE 2. TRANSACTIONS WITH RELATED PARTIES On October 6, 2000, the Company and BEI Technologies entered into a Technology Transfer and Distribution Agreement (the "Distribution Agreement") whereby BEI Technologies contributed to the Company certain assets and intellectual property related to the fiber optic components technology developed by BEI Technologies and BEI Technologies' majority-owned subsidiary, SiTek, Inc. ("SiTek") in exchange for 3,616,000 shares of the Company's common stock. BEI Technologies later distributed 3,578,387 of these shares to its stockholders on November 21, 2000 in connection with the Company's separation from BEI Technologies. In connection with the Distribution Agreement, on October 6, 2000, the Company and SiTek entered into a License and Technical Assistance Agreement whereby Sitek agreed to license certain technology to the Company, assist the Company in certain research and development efforts following the Distribution and also fabricate and supply certain components utilized in the Company's products. Further, Sitek granted to the Company a perpetual, royalty free, worldwide, exclusive license to develop, make, use and sell products within the field of telecommunications data transmission utilizing technology now possessed or later developed by SiTek, and the Company has granted to SiTek a corresponding perpetual, royalty free, worldwide, exclusive license to develop, make, use and sell products outside of the Company's defined market utilizing technology now possessed or later developed by the Company. This agreement shall continue in effect for five years and automatically renew thereafter for consecutive one-year terms unless either party gives written notice of termination. On October 27, 2000, the Company and BEI Technologies entered into an InterCompany Services Agreement (the "Services Agreement") whereby BEI Technologies agreed to make available to the Company certain office and facility space, personnel support and supervision, financial and administrative services, record-keeping functions and other assistance, with BEI Technologies being reimbursed for the costs and expenses incurred in connection with the provision of these services to OpticNet. Charges for these services were allocated to the Company based upon usage, headcount and other methods that management believes to be reasonable. These allocations totaled $25,000 for the quarter ended June 29, 2002. In the current quarter, BEI Technologies agreed to suspend these and future quarters' service charges, due to the Company's inability to obtain significant strategic partners or third party financing. The Services Agreement further provided for a line of credit from BEI Technologies to the Company for up to $2.0 million with interest at prime plus 1.5%, expiring on September 28, 2002, unless extended by mutual agreement of the parties. In March 2002, BEI Technologies increased this line of credit by $1.0 million. As of Page 8 of 18 June 29, 2002, the Company had outstanding borrowings totaling approximately $2.7 million on this line of credit. During the fiscal quarter ended June 29, 2002, the Company was informed by BEI Technologies that no further advances would be made to the Company under this line of credit beyond the approximately $2.7 million funded as of March 30, 2002. To maintain sufficient liquidity in the future and to fund operations, the Company may need to enter into a new credit agreement in the future with a commercial lender. A new credit line, if available, could include less favorable terms than the existing line of credit agreement with BEI Technologies. On September 28, 2001 the Company entered into a general equipment sublease agreement with BEI Technologies as the lessor, which is subordinate to a master lease agreement entered into by BEI Technologies as the lessee. On September 28, 2001, December 20, 2001 and March 28, 2002, the Company executed equipment lease schedules under the general equipment sublease with BEI Technologies. The total value of the scheduled equipment under the sublease agreement was approximately $7.0 million, with an initial lease term of 36 months. Rental payments are due on a quarterly basis and the amount determined by the Company's level of usage of the equipment, the cost of the equipment and applicable interest. Payments due for the quarter ended June 29, 2002 are approximately $10,000. The Company originally entered into a lease agreement in October 2001 with BEI Technologies for a 15,571 square feet facility for administration, research and development and manufacturing activities in Hayward, California, expiring December 2005. As of March 30, 2002, the Company, in recognition of its inability to obtain significant strategic partners or third party financing, concluded it was necessary to reduce operating costs. The Company agreed with BEI Technologies that this reduction in operations would lower usage of the equipment and the subleased facilities described above. Accordingly, the annual lease payments to BEI Technologies have been prorated beginning March 31, 2002, based on the portion of the facilities the Company requires to support its current customers. In the fiscal quarter ended June 29, 2002, BEI Technologies advanced an additional $1.2 million to the Company. The parties have been discussing the authorization by the Company of a nonvoting series of preferred stock for issuance to BEI Technologies representing this investment. The final terms of such an equity investment remain under discussion by the parties and have yet to be determined. All of the arrangements outlined above were negotiated by related parties and may not represent transactions at arms length and the Company may not be able to obtain terms as favorable with third parties if and when the arrangements with BEI Technologies come to an end. NOTE 3. NOTE PAYABLE TO RELATED PARTY During fiscal 2001, the Company entered into a line of credit agreement with BEI Technologies, a minority investor. Borrowings outstanding on the line of credit were as follows: June 29, 2002 June 30, 2001 ------------- ------------- Unsecured revolving promissory note from BEI Technologies due 9/28/02, at a rate of prime plus 1.5%; 6.3% and 8.3% at June 29, 2002 and June 30, 2001, respectively $2,656,338 $655,744 ---------- -------- $2,656,338 $655,744 ========== ======== Page 9 of 18 No interest was paid during the quarter ended June 29, 2002 or in the quarter ended June 30, 2001. Accrued interest expense was approximately $111,000 and $11,000 at June 29, 2002 and June 30, 2001, respectively. NOTE 4. REDUCTION IN FORCE In April 2002, the Company underwent a reduction in force resulting in eight individuals departing employment with the Company, including engineering, manufacturing and marketing personnel. Severance pay for affected persons was per Company policy, including cash payment and the acceleration of the vesting of options for certain affected individuals. Total cash costs related to the reduction in force of approximately $86,000 were recorded in the fiscal quarter ending June 29, 2002. NOTE 5. SUBSEQUENT EVENTS During July 2002, a significant stockholder of the Company contributed a total of 420,572 shares of nonvoting common stock and a total of 546,484 shares of voting common stock to the capital of the Company. NOTE 6. CONTINGENCIES AND LITIGATION The Company has pending various legal actions arising in the normal course of business. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for the historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those expressed in, or implied by, such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section, and those discussed in the Company's Form 10, as amended April 25, 2002, in particular, within the "Risk Factors" section thereof. Critical Accounting Policy and the Use of Estimates Management's discussion and analysis of financial condition and results of operations is based upon the Company's financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company reviews the accounting policies used in reporting its financial results on a regular basis. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. The estimates are based on historical experience and on various other assumptions that management believes to be reasonable under the circumstances. On an ongoing basis, the Company evaluates its estimates. Results may differ from these estimates due to actual outcomes being different from those on which the Company based its assumptions. The Company believes the following critical accounting policy affects its more significant judgments and estimates used in the preparation of its financial statements. Allowance for Doubtful Accounts The Company continuously monitors collections and payments from its customers and maintains allowances for doubtful accounts based upon historical experience and any specific customer collection issues that the Company has identified. While such credit losses have historically been within management's expectations, Page 10 of 18 there can be no assurance that the Company will continue to experience the same relative level of credit losses that it has in the past. In addition, the Company's revenues and accounts receivable are concentrated in a relatively few number of customers. A significant change in the liquidity or financial position of any one of these customers or a further deterioration in the economic environment or telecommunications industry, in general, could have a material adverse impact on the collectability of the Company's accounts receivable and future operating results, including a reduction in future revenues and additional allowances for doubtful accounts. If, at the time revenue is recognized, the Company determines that collection of a receivable is not reasonably assured, the revenue is deferred and recognized at the time collection becomes reasonably assured, which is generally upon receipt of payment. Significant Accounting Policies Revenue Recognition The Company recognizes revenue using the guidance from SEC Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements." Under these guidelines, revenue recognition is deferred on transactions where (i) persuasive evidence of an arrangement does not exist, (ii) revenue recognition is contingent upon performance of one or more obligations of the Company, (iii) the price is not fixed or determinable or (iv) payment is not reasonably assured. To date, the Company has not recognized revenue related to non-prototype product offerings. All revenue recognized to date consisted of engineering work performed under engineering agreements with unaffiliated customers. Revenue for this engineering work is recognized based on customer acknowledgement of the achievement of milestones in the engineering agreement. Research and Development Expense The Company's products are highly technical in nature and require a significant level of research and development effort. Research and development costs are charged to expense as incurred in accordance with FAS No. 2, "Accounting for Research and Development Costs." Payments and receivables recorded from customers for the delivery under contracts of prototype units are offset against research and development expense in the statements of operations. Quarters ended June 29, 2002 and June 30, 2001 Revenues during the third quarter of fiscal 2002 and 2001 were $25,000 and $174,000, respectively, reflecting work performed under engineering agreements with unaffiliated customers. The decrease during the current quarter is due to the slow down of demand for new telecommunications equipment components compared to prior periods. In addition, during the third quarter of fiscal 2001 the Company recorded payments or receivables for deliveries of prototype products to five unaffiliated customers, accounted for as an offset against research and development expense. In the third quarter of fiscal 2002 and 2001, cost of revenues as a percentage of revenues was 50% and 37%, resulting in gross profit of approximately $13,000 and $109,000, respectively. The increase as a percentage of revenues is due to higher direct costs on engineering agreements in the period just ended. Cost of revenues includes employee compensation, materials and production overhead. Page 11 of 18 Selling, general and administrative expenses in the third quarter of fiscal 2002 increased approximately $140,000 from $292,000 in the same quarter of the prior fiscal year to $432,000. The increase was primarily due to increased facility rent and related costs of approximately $10,000, as well as increased travel expenses of approximately $9,000. The remaining increase was due to professional, consulting and legal fees, and other costs. In the third quarter of fiscal 2001, selling, general and administrative expenses included a payment of $25,000 made to BEI Technologies for accounting, human resources and other administrative services provided by BEI Technologies pursuant to the Services Agreement between the two companies. The cost of these services was established at $25,000 per fiscal quarter based upon square footage, headcount, usage and other methods management believes to be reasonable. In the period just ended, BEI Technologies agreed to suspend these charges due to the Company's inability to obtain significant strategic partners or third party financing. Research and development expenses in the third quarter of fiscal 2002 increased approximately $634,000 from $55,000 in the same quarter of the prior fiscal year to $689,000. The increase was primarily due to increased gross costs for direct employee compensation expense and related benefits of approximately $201,000, and increased gross costs for materials and supplies of approximately $85,000. In addition, during the third quarter of fiscal 2001 the Company recorded approximately $139,000 for deliveries of prototype products as an offset against research and development expense. The remaining increase was due to gross costs for professional fees, facility rent and operations, and other expenses. Interest expense in the third quarter of fiscal 2002 increased approximately $31,000 from $11,000 in the same quarter of the prior fiscal year to $42,000 due to the outstanding balance and additional borrowings during the period ended March 30, 2002, on the Company's line of credit agreement with BEI Technologies. Nine Months ended June 29, 2002 and June 30, 2001 Revenues during the first nine months of fiscal 2002 reflected work performed under engineering agreements with two unaffiliated customers and decreased approximately $386,000 to $113,000 from $499,000 during the same period in fiscal 2001. The decrease is due to the slow down of demand for new telecommunications equipment components compared to prior periods. In addition, during the first nine months of fiscal 2002, the Company recorded payments or receivables for deliveries of prototype products to two unaffiliated customers, accounted for as an offset against research and development expense. Cost of revenues as a percentage of revenues in the first nine months of fiscal 2002 decreased 2.0 percentage points to 50% from 52% in the comparable period of fiscal 2001. The decrease is due to slightly lower direct costs on engineering agreements in the current period. Selling, general and administrative expenses during the first nine months of fiscal 2002 increased approximately $701,000 from $499,000 in the comparable period of the prior fiscal year to $1,200,000. The increase was primarily due to increased professional, consulting and legal fees of approximately $359,000, as well as increased direct employee compensation expense and related benefits of approximately $139,000. The remaining increase was due to facility rent, travel and other costs. Selling, general and administrative expenses included payments made to BEI Technologies for various accounting, human resources and other administrative services provided by BEI Technologies pursuant to the Services Agreement between the two companies. These payments during the first nine months of both fiscal 2002 and 2001 were $50,000. The cost of these services was established at $25,000 per fiscal quarter at the time of entrance into the Services Agreement based upon square footage, headcount, usage and other methods management believes to be reasonable. In the current quarter, BEI Technologies agreed to suspend these charges due to the Company's inability to obtain significant strategic partners or third party financing. Page 12 of 18 Research and development expenses during the first nine months of fiscal 2002 increased approximately $2,068,000 from $341,000 in the comparable period of the prior fiscal year to $2,409,000. The increase was primarily due to increased gross costs for direct employee compensation expense and related benefits of approximately $806,000, as well as increased gross costs for facility rent and operations of approximately $583,000, and increased gross costs for materials and supplies of approximately $338,000. The remaining increase was due to gross costs for professional fees, travel and other costs. Interest expense during the first nine months of fiscal 2002 increased approximately $76,000 from $11,000 in the same period of the prior fiscal year to $87,000 due to the outstanding balance and additional borrowings during the period ended March 30, 2002, on the Company's line of credit agreement with BEI Technologies. Financing from Related Party Pursuant to the facilities sublease agreement, equipment sublease agreement and the Services Agreement described above, payments due to BEI Technologies were as follows:

Liquidity and Capital Resources During the first nine months of fiscal 2002, total cash used by operations was approximately $3,475,000. Cash provided by operations included the positive impact of non-cash charges from bad debt expense, and depreciation and amortization of $57,000 and $18,000, respectively. In addition, positive impacts to cash resources resulted from decreases in other current assets and trade receivables of $55,000 and $43,000, respectively, as well as increases in accrued expenses and other liabilities of $36,000, and other net impacts of $2,000. These cash inflows were offset by a net loss of $3,635,000, as well as increases in inventory of $26,000 and decreases in customer advances of $25,000. Cash used by investing activities during the first nine months of fiscal 2002 consisted of a purchase of $1,000 in capital equipment, offset by a decrease in other assets of $21,000. In addition, during the first nine months of fiscal 2002 the Company financed equipment with a value of approximately $6.3 million and an initial lease term of three years under the equipment sublease arrangement with BEI Technologies. The subleased equipment is in addition to the approximately $708,000 of equipment subleased as of fiscal 2001 year end. Rent expense related to this equipment totaled approximately $340,000 and $59,000 during the second and first quarters, respectively, of fiscal 2002. Beginning in the third quarter of fiscal 2002, the Company reduced operations due to its inability to obtain additional financing from unaffiliated investors to this date. Thus, due to reduced usage now expected on the subleased equipment, past rent expense on the subleases is not necessarily indicative of future results. Transactions with BEI Technologies, a minority investor and the Company's former parent company, are not Page 13 of 18 necessarily on an arms-length basis and the Company may receive more favorable terms under these arrangements than it would from an unrelated third party. Cash provided by financing activities consisted of net proceeds since inception of $2,656,000 from borrowings on the Company's note payable to BEI Technologies under its related party line of credit arrangement, of which $1,490,000 was provided during the first nine months of fiscal 2002. The borrowings were used to fund daily operations, capital investments and product development. In March 2002, BEI Technologies increased this line of credit by $1.0 million. Also during the first nine months of fiscal 2002, cash from financing activities included an investment of $1,157,000 by BEI Technologies, and option exercises for common stock of $1,000. The Company anticipates incurring substantial additional losses over at least the next several years. Since inception, the Company has incurred recurring operating losses and negative cash flows from operations. As of June 29, 2002, the Company had an accumulated deficit of $5.3 million. After extensive discussions with prospective outside investors throughout the Company's second fiscal quarter, during March 2002 the Company became aware that none of these discussions would result in a near term equity financing for the Company. As of March 30, 2002, the Company was advised by BEI Technologies that, in view of the Company's inability to obtain outside financing to date and other general indications of investor disaffection with businesses in the telecommunications market, further debt financing would not be provided by BEI Technologies. These conditions raise substantial doubt about the Company's ability to continue as a going concern. The Company has been in recent discussions with other prospective investors to obtain additional equity financing, however it can offer no assurances an investment by outside investors will be accomplished in the near future, if at all. During the fiscal quarter ended June 29, 2002, the Company continued negotiations with BEI Technologies regarding a further equity investment in the Company by BEI Technologies, contemplated to be in the form of nonvoting preferred stock, when, and if authorized by the Company for issuance to BEI Technologies. As of the end of the Company's March 30, 2002 fiscal quarter, management determined that the Company would not have sufficient financing for the remainder of its 2002 fiscal year without modifying the Company's business plan, implementing strict cost-cutting measures and unless additional financing was obtained. In March 2002, management and the Company's board of directors decided to reduce the level of spending by the Company for research and development and facility and equipment expenditures and to reduce operations to a level that will solely support the current customer base. The Company intends to continue to operate in such a scaled back manner until additional outside financing is available or other prospects are realized by the Company. In April 2002, the Company underwent a reduction in force resulting in eight individuals departing employment with the Company, including engineering, manufacturing and marketing personnel. Severance pay for affected persons was per Company policy, including cash payment and the acceleration of the vesting of options for certain affected individuals. Total cash costs related to the reduction in force of approximately $86,000 were recorded in the fiscal quarter ending June 29, 2002. In the fiscal quarter ended June 29, 2002, BEI Technologies advanced an additional $1.2 million to the Company. The parties have been discussing the authorization by the Company of a nonvoting series of preferred stock for issuance to BEI Technologies representing this investment. The final terms of such an equity investment remain under discussion by the parties. Recent Developments To further reduce costs for the Company in the near term, during July 2002, a total of 15 Company employees terminated their employment and accepted employment with a subsidiary of BEI Technologies, as previously had been agreed to by both companies. The Company's Chief Executive Officer and Chief Technical Officer have also become employees of this same subsidiary of BEI Technologies, but continue to serve as executive officers Page 14 of 18 of the Company. The services of certain key individuals, including the Company's Chief Executive Officer and Chief Technical Officer, are expected to continue to be available to the Company on an as needed basis, with reimbursement by the Company to their present employer for the time value of their services. Effects of Inflation Management believes that, for the periods presented, inflation has not had a material effect on the Company's operations. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company was incorporated in February 2000 and commenced independent operations in November 2000. The Company has not yet generated revenues from sales of its products but only from engineering work performed for three customers to date. The Company expects to incur net losses for the foreseeable future. The Company may never achieve profitability and may not succeed as a going concern and its independent auditor has included a statement to this effect in their most recently issued audit report. The Company believes that there have been no material changes in the reported market risks faced by the Company since those discussed in the Company's Form 10, as amended April 25, 2002, under the heading corresponding to that set forth above. The Company's exposure to market risk is limited to interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, as a portion of the Company's cash equivalents are in short-term debt securities issued by corporations. The Company's cash equivalents are placed with high-quality issuers and the Company attempts to limit the amount of credit exposure to any one issuer. Due to the nature of the Company's short-term investments, the Company believes that it is not subject to any material market risk exposure. The Company does not have any foreign currency or other derivative financial instruments. Page 15 of 18 OPTICNET, INC. (a development stage company) PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Listing of Exhibits

Page 16 of 18 10.8 Revolving Line of Credit Note executed by the registrant in favor of BEI Technologies, Inc. i 10.9 Form of Indemnity Agreement to be entered into by the registrant with each of its directors and executive officers ii 10.10 Consulting Agreement between Danforth Joslyn and the registrant ii 10.11 Consulting Agreement between Gary D. Wrench and BEI Technologies, Inc. iii 10.12 Amendment No. 1 to License and Technical Assistance Agreement between the registrant and SiTek, Inc. iii 99.1 Preliminary Information Statement of BEI Technologies, Inc. dated September 30, 2000 i 99.2 Final Information Statement of BEI Technologies, Inc. dated November 17, 2000 i 99.3 Certification pursuant to section 906 of the Corporate Fraud Accountability Act of 2002

(i) Incorporated by reference. Previously filed as an exhibit to the Registrant's Information Statement on Form 10 (file no. 0-31162) as filed on January 25, 2002. (ii) Incorporated by reference. Previously filed as an exhibit to Amendment No. 1 to the Registrant's Information Statement on Form 10 (file no. 0-31162) as filed on March 22, 2002. (iii) Incorporated by reference. Previously filed as an exhibit to Amendment No. 2 to the Registrant's Information Statement on Form 10 (file no. 0-31162) as filed on April 25, 2002. (b) Reports on Form 8-K No reports on Form 8-K were filed by the Company during the quarter ended June 29, 2002. Page 17 of 18 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 on August 8, 2002. OpticNet, Inc. By: /s/ Gary D. Wrench -------------------------- Gary D. Wrench Chief Financial Officer (Chief Accounting Officer) Page 18 of 18

OPTICNET INC 10-Q