10-Q 1 p16610_10q.txt QUARTERLY REPORT 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 December 28, 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; 3,093,202 shares of Voting Common Stock and 2,998,902 shares of Nonvoting Common Stock outstanding as of December 28, 2002. Page 1 of 23 OPTICNET, INC. (a development stage company) INDEX PART 1. FINANCIAL INFORMATION PAGE --------------------- ---- Item 1. Financial Statements Condensed Balance Sheets--December 28, 2002 and September 28, 2002 3 Condensed Statements of Operations--Quarters ended December 28, 2002 and December 29, 2001 and the period from February 23, 2000 (inception) to December 28, 2002 4 Condensed Statements of Cash Flows-- Quarters ended December 28, 2002 and December 29, 2001 and the period from February 23, 2000 (inception) to December 28, 2002 5 Notes to Condensed Financial Statements-- December 28, 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 14 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 23 PART I. FINANCIAL INFORMATION Item 1. Financial Statements OPTICNET, INC. (a development stage company) CONDENSED BALANCE SHEETS December 28, September 28, 2002 2002 (Unaudited) (See note below) ----------- -------------- ASSETS Cash and cash equivalents $ 57,945 $ 4,881 Prepaid expenses 9,114 3,263 Other current assets 324 324 ----------- ----------- Total current assets 67,383 8,468 Other assets 728 728 ----------- ----------- $ 68,111 $ 9,196 =========== =========== LIABILITIES AND STOCKHOLDERS' DEFICIT Accounts payable $ -- $ 13,713 Accrued expenses and other liabilities 12,707 40,394 Other related party liability 244,577 214,078 Note payable to related party 2,656,338 2,656,338 Customer funded research and development liability 70,500 -- ----------- ----------- Total current liabilities 2,984,122 2,924,523 Stockholders' deficit (2,916,011) (2,915,327) ----------- ----------- $ 68,111 $ 9,196 =========== =========== Note: The balance sheet at September 28, 2002 has been derived from the audited balance sheet at that date. See notes to condensed financial statements. Page 3 of 23 OPTICNET, INC. (a development stage company) CONDENSED STATEMENTS OF OPERATIONS (Unaudited)

See notes to condensed financial statements. Page 4 of 23 OPTICNET, INC. (a development stage company) CONDENSED STATEMENTS OF CASH FLOWS (Unaudited)

See notes to condensed financial statements. Page 5 of 23 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 fiscal year ending September 27, 2003. For further information, refer to the financial statements and footnotes thereto in the Company's annual report on Form 10-K, as amended January 24, 2003. OpticNet, Inc. ("OpticNet" or the "Company") was incorporated on February 23, 2000 in the State of Delaware. From its inception (February 23, 2000) through December 31, 2000, OpticNet operated as a controlled subsidiary of BEI Technologies, Inc. ("BEI Technologies"). BEI Technologies accumulated the costs associated with OpticNet's operations in the period from February 23, 2000 through December 31, 2000 including all expenses directly attributable to OpticNet and an allocation of the costs of shared facilities, salaries and employee benefits attributable to OpticNet 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 to BEI Technologies' stockholders ("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 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 common stock, representing an aggregate ownership interest of approximately 25% in the Company up until the issuance of the Company's Series B nonconvertible preferred stock to BEI Technologies during the first quarter of fiscal 2003. 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 attempting to raise capital to fund operations. OpticNet has not recognized significant revenues since inception. All revenue recognized to date consisted of engineering work performed under engineering agreements with unaffiliated customers and not from the sale of fiber optic components and subsystems. As a result, the accompanying financial statements are presented in accordance with Financial Accounting Standards ("FAS") No. 7, "Accounting and Reporting by Development Stage Enterprises." 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 had recurring operating losses and negative cash flows from operations and has an accumulated deficit of $6.0 million at December 28, 2002. These conditions raise substantial doubt about the Page 6 of 23 Company's ability to continue as a going concern. During fiscal 2002 and the first quarter of fiscal 2003, the Company continued to be unsuccessful in attracting outside financing despite management's efforts and continued operations on a reduced basis. 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 would solely support the current customer base. Management's plan to enable the Company to continue as a going concern calls for the Company's operations to be frozen at a minimal level, sufficient to support current product delivery commitments. The Company reduced its fixed cost base to an absolute minimum and no longer maintains any employees of its own other than officers of the Company, each of whom provide services to the Company on a part time basis. The majority of OpticNet's operating costs are paid by BEI Technologies, who shares the Hayward facility and from whom engineering and other services are rented on an as-required basis. The cash outlay for the Company's portion of these costs are recorded as additional investment in the Company by BEI Technologies. Future operating expenses are expected to be funded by product and prototype revenue under existing contracts. In addition, new prototype or product contracts will not be initiated if these contracts cannot generate positive cash flows within the next 12 months. Management believes that additional funding of less than $1.0 million will enable the Company to continue on a reduced basis as a going concern through September 30, 2003 and that such funding will be available from BEI Technologies, if required. However, management cannot be certain such additional funding will be on desirable, or acceptable, terms to the Company. Management continues to seek additional equity financing from existing sources on an opportunistic and as-available basis. Management plans to defer substantially all research and development activity in the absence of additional equity financing. These 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. During the third and fourth quarters of fiscal 2002, BEI Technologies provided the Company with approximately $1.8 million in financing, which was advanced with the understanding that such amount would be converted into a form of nonvoting equity in the Company. Effective September 28, 2002, the Company and BEI Technologies determined the Company would authorize and issue to BEI Technologies a series of nonvoting preferred stock. In November 2002, the Company issued a total of 18,146,420 shares of the Company's newly authorized nonvoting Series B Preferred Stock to BEI Technologies, in consideration of the approximately $1.8 million advanced. The Company received approximatley $190,000 in equity funding from BEI Technologies during the first quarter of fiscal 2003, used for general operating expenses. The parties have been discussing the authorization by the Company of additional equity securities 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 the Company's financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Long-Lived Assets The Company recognizes impairment losses in accordance with FAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of." Long-lived assets, including property and equipment and other assets, are reviewed and impairment recognized when indicators of impairment are present and undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of the assets. Indicators of impairment were present during the periods presented. Total net realizable fair value of all long-lived assets at December 28, 2002 was $728. Page 7 of 23 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. In the fiscal quarter ended June 29, 2002, BEI Technologies agreed to suspend charges for the third and fourth quarters of fiscal 2002 and future quarters' service charges, due to the Company's inability to obtain significant strategic partners or third party financing and reduced services to a minimal level. 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. During fiscal 2002, BEI Technologies increased this line of credit by $1.0 million. As of September 28, 2002 and December 28, 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. During October 2002, BEI Technologies extended the maturity date of the line of credit to December 31, 2002. The parties intend to extend the maturity date of the line of credit. The final terms of such an extension would be determined when, and if, such an extension is consummated. To maintain sufficient liquidity in the future and to fund operations, the Company will need to obtain additional financing, which may be on unfavorable terms in light of the Company's credit position. 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. Payment due for the quarter ended December 28, 2002 was approximately $46,000. The Company originally entered into a sublease 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 Page 8 of 23 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 six months ended September 28, 2002, BEI Technologies advanced an additional $1.8 million to the Company. Effective September 28, 2002, the Company and BEI Technologies had determined the Company would authorize and issue to BEI Technologies a series of nonvoting preferred stock. In November 2002, the Company issued a total of 18,146,420 shares of the Company's newly authorized nonvoting Series B Preferred Stock to BEI Technologies, in consideration of the approximately $1.8 million advanced noted above. The Company received approximately $190,000 in equity funding from BEI Technologies during the first quarter of fiscal 2003, used for general operating expenses. The parties have been discussing the authorization by the Company of additional equity securities 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. 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. Under the terms of the agreement, BEI Technologies has made available to the Company from time to time until December 31, 2002, an amount not to exceed at any time the aggregate principle amount of $3.0 million, as amended. The Company's obligation to repay the loans outstanding is due in full on December 31, 2002, unless extended by mutual agreement of the parties. The parties intend to extend the maturity date of the line of credit. The final terms of such an extension would be determined when, and if, such an extension is consummated. 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 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. Borrowings outstanding on the line of credit were as follows: December 28, December 29, 2002 2001 ---------- ---------- Unsecured revolving promissory note from BEI Technologies due 12/31/02, at a rate of prime plus 1.5%; 6.25% and 5.75% at December 28, 2002 and December 29, 2001, respectively $2,656,338 $1,729,004 ---------- ---------- $2,656,338 $1,729,004 ========== ========== No interest was paid during the quarter ended December 28, 2002 or in the quarter ended December 29, 2001. Accrued interest expense was approximately $189,000 and $19,000 at December 28, 2002 and December 29, 2001, respectively. The interest payable of approximately $189,000 at December 28, 2002 was recorded as an other related party liability. 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 was recorded in the fiscal quarter ending June 29, 2002 within research and development expenses. Page 9 of 23 To further reduce costs for the Company in the near term, during July 2002, all of the Company's remaining 15 employees were released from their employment with the Company and accepted employment with a subsidiary of BEI Technologies, as agreed to by both companies, but still perform services for OpticNet. The Company's newly appointed President and Chief Technical Officer have also become employees of this same subsidiary of BEI Technologies, but continue to serve as executive officers of the Company. The services of certain key individuals, including the Company's newly appointed President 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. NOTE 5. CONTINGENCIES AND LITIGATION The Company has pending various legal actions arising in the normal course of business. Management believes that none of these legal actions, individually or in the aggregate, will have a material impact on the Company's business, financial condition or operating results. The Company is a codefendant in a dispute with a former employee, which at December 28, 2002, cannot be reasonably estimated to the future financial impact. The Company believes this claim has no merit and is defending the allegation. 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-K, as amended January 24, 2003, in particular, within the "Risk Factors" section thereof. See "Critical accounting policies and the use of estimates" for a description of the Company's critical accounting policies. Quarters ended December 28, 2002 and December 29, 2001 Revenues during the first quarter of fiscal 2002 were $87,500, reflecting work performed under engineering agreements with unaffiliated customers. There were no revenues during the first quarter of fiscal 2003. The decrease is primarily due to the continued slow down of demand for new telecommunications equipment components compared to prior periods. In addition, during the first quarters of fiscal 2002 and 2003, the Company made prototype deliveries to one customer. In the first quarter of fiscal 2002, cost of revenues as a percentage of revenues was 50%, resulting in gross profit of approximately $44,000. Cost of revenues includes salaries, materials and production overhead. Selling, general and administrative expenses in the first quarter of fiscal 2003 decreased approximately $229,000 from $288,000 in the same quarter of the prior fiscal year to $59,000. During fiscal 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 subleased facilities. Accordingly, the annual lease payments to BEI Technologies are now prorated based on the portion of the facilities the Company requires to support its current customers. In the first quarter of fiscal 2002, 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. Commencing with the second fiscal quarter of 2002, these charges have been waived in light of the Company's financial position. Page 10 of 23 Research and development expenses in the first quarter of fiscal 2003 decreased approximately $401,000 from $464,000 in the same quarter of the prior fiscal year to $63,000. The decrease was primarily due to the Company's decision to significantly reduce operations to support its current customers. During the first quarter of fiscal 2002 the Company recorded approximately $900 for deliveries of prototype products as an offset against research and development expense. Interest expense in the first quarter of fiscal 2003 increased approximately $21,000 from $19,000 in the same quarter of the prior fiscal year to $40,000 due to the increased outstanding balance on the Company's line of credit agreement with BEI Technologies. Financing from Related Party Since inception, all operating capital of the Company has been provided by BEI Technologies as debt or equity financing. The Company has been unable to gain outside financing from independent parties to date, in light of the severe downturn in the optical networking industry. In October 2000, BEI Technologies agreed to provide OpticNet with a line of credit originally established for up to $2.0 million. During fiscal 2002, the line of credit was amended to allow for borrowings up to $3.0 million. During the fiscal quarter ended June 29, 2002, BEI Technologies suspended the availability of advances to the Company under the line of credit, under which amounts outstanding at such time totaled approximately $2.7 million in principal amount. 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 dissatisfaction with businesses in the telecommunications market, further debt financing would not be provided by BEI Technologies. During October 2002, BEI Technologies extended the maturity date of the line of credit to December 31, 2002. The parties intend to extend the maturity date of the line of credit. The final terms of such an extension would be determined when, and if, such an extension is consummated. In the six months ending September 28, 2002, BEI Technologies provided an additional $1.8 million, approximately, of financing to the Company, which was advanced with the intent to convert such cash advances into additional equity. Effective September 28, 2002, the Company and BEI Technologies had determined the Company would authorize and issue to BEI Technologies a series of nonvoting preferred stock. In November 2002, the Company issued a total of 18,146,420 shares of nonvoting and nonconvertible Series B Preferred Stock to BEI Technologies, in consideration of the $1.8 million advanced during the third and fourth quarters In the quarter ended December 28, 2002, BEI Technologies provided additional funding of approximately $190,000 to the Company for general operating expenses. The parties have been discussing the authorization by the Company of additional equity securities 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. Pursuant to the facilities sublease agreement, equipment sublease agreement and the Services Agreement described above, payments due to BEI Technologies were as follows: Page 11 of 23

Liquidity and Capital Resources During the first quarter of fiscal 2003, total cash used by operations was approximately $103,000. Cash provided by operations included the positive impact of non-cash charges from depreciation and amortization of $5,000. In addition, positive impacts to cash resources resulted from increases in customer funded research and development liabilty and accrued expenses and other liabilities of approximately $71,000 and $3,000, respectively. These cash inflows were offset by an increase in prepaid expenses of approximately $6,000, a decrease in accounts payable of approximately $14,000 and a net loss of $161,758. Cash provided by financing activities consisted of net proceeds since inception of approximately $2,656,000 from borrowings on the Company's note payable to BEI Technologies under its related party line of credit arrangement. 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 and in October 2002, the maturity date was extended to December 31, 2002. Also during the first quarter of fiscal 2003, cash from financing activities included an investment of approximately $190,000 by BEI Technologies. If the Company continues as a going concern, 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 December 28, 2002, the Company had an accumulated deficit of $6.0 million. After extensive discussions with prospective outside investors throughout fiscal 2002, during March 2002 the Company became aware that none of these discussions would result in 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. In the first quarter of fiscal 2003, the Company issued nonvoting preferred stock to BEI Technologies in consideration of amounts received in the third and fourth quarters of fiscal 2002. 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 obtaining additional financing was obtained. Therefore, management and the Company's board of directors reduced 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 terminating 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 was recorded in the fiscal quarter ending June 29, 2002. No costs related to the reduction in force was recorded in the first quarter of fiscal 2003. Page 12 of 23 To further reduce costs for the Company in the near term, during July 2002, all of the Company's remaining 15 employees were released from their employment with the Company and accepted employment with a subsidiary of BEI Technologies, as agreed to by both companies. The Company's newly appointed President and Chief Technical Officer have also become employees of this same subsidiary of BEI Technologies, but continue to serve as executive officers of the Company. The services of certain key individuals, including the Company's newly appointed President 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. Critical Accounting Policies 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 policies affect 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 from time to time 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. Litigation The Company reserves for legal claims when payments associated with the claims become probable and can be reasonably estimated. Due to the difficulty in estimating costs of resolving legal claims, actual costs may be substantially higher than the amounts reserved. Environmental Matters The Company reserves for known environmental claims, of which there are none in the quarter ended December 28, 2002, when payments associated with the claims become probable and the costs can be reasonably estimated. The Company's environmental reserves, for all periods presented, are recorded at the expected payment amount. The actual cost of resolving environmental issues may be higher than that reserved primarily due to difficulty in Page 13 of 23 estimating such costs and potential changes in the status of government regulations. 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 of approximately $187,000, $900 and $398,000 were offset against research and development expense in the statements of operations for the quarters ended December 29, 2001, December 28, 2002, and from inception through the quarters ended December 28, 2002, respectively. Eight prototype units were delivered during the quarter ended December 28, 2002. Property, Plant and Equipment and Related Depreciation The Company records property, plant and equipment at cost, which is depreciated using the straight-line method for structures and accelerated or straight-line methods for equipment over their estimated useful lives. Leasehold improvements and assets acquired under capital leases are amortized over the shorter of the lease term or their estimated useful lives. Management reviews the estimated useful lives of property, plant and equipment to verify that the assets are being depreciated in accordance with their usage and all assets no longer in service are fully depreciated. Accrued Expenses and Other Liabilities The Company records liabilities for services or products received in the period in which the benefit was recognized. Due to the difficulty in estimating costs of these services or products received, actual costs may be substantially higher than the amounts recorded. 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-K, as amended January 24, 2003, under the heading corresponding to that set forth above. The Company's exposure to market risk is limited to interest income sensitivity, which is Page 14 of 23 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 23 OPTICNET, INC. (a development stage company) PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Listing of Exhibits

(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. (iv) Incorporated by reference. Previously filed as an exhibit to Form 10-K (file no. 0-31162) as filed on January 10, 2003. (b) Reports on Form 8-K No reports on Form 8-K were filed by the Company during fiscal quarter ended December 28, 2002 Page 17 of 23 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 February 10, 2003. OpticNet, Inc. By: /s/ Gary D. Wrench --------------------- Gary D. Wrench Chief Financial Officer Page 18 of 23 CERTIFICATION OF PRESIDENT I, Gerald D. Brasuell, certify that: 1. I have reviewed this quarterly report on Form 10-Q of OpticNet, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors and material weakness in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated February 10, 2003 ------------------- /s/ Gerald D. Brasuell ------------------------- Gerald D. Brasuell President Page 19 of 23 CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Gary D. Wrench, certify that: 1. I have reviewed this quarterly report on Form 10-Q of OpticNet, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors and material weakness in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated February 10, 2003 ------------------- /s/ Gary D. Wrench ------------------------- Gary D. Wrench Chief Financial Officer Page 20 of 23 INDEX TO EXHIBITS Exhibit Number Description ------ ----------- 99.3 President Certification Pursuant to 18 U.S.C as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.4 CFO Certification Pursuant to 18 U.S.C as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Page 21 of 23

OPTICNET INC 10-Q