##### **United States**

**Securities andExchange Commission**

#### **Washington, D.C. 20549**

 

**FORM 10-QSB**

 
|   | **ý** | **Quarterly Report pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934**  |
|--------|------------|-----------------------------------------------------------------------------------------------|
|   |       |                                                                                          |
|   |       | **For the Quarter Ended December 31, 2003**                                                   |
|   |       |                                                                                          |
|   | **o**      | **Transition report pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934** |

 

#### **Commission File Number 06425**

** **

| **Utah**                                                        |   | **SENTO CORPORATION**                                            |   | **87-0284979**                        |
|-----------------------------------------------------------------|--------|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other Jurisdiction of  Incorporation or Organization) |   | Exact Name of Small Business Issuer as  Specified in its Charter |   | (I.R.S. Employer  Identification No.) |
|                                                            |   |                                                             |   |                                  |
|                                                            |   | **808 East Utah Valley Drive**                                   |   |                                  |
|                                                            |   | American Fork, Utah 84003                                        |   |                                  |
|                                                            |   | (Address of Principal Executive Offices)                         |   |                                  |

# ** **

Issuer’s telephone number, including areacode:  **(801)772-1100**

 

Checkwhether the issuer (1) filed all reports required to be filed by Section 13 or15(d) of the Exchange Act during the past 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

Yes  ý       No   o

 

Statethe number of shares outstanding of each of the issuer’s classes of commonequity, as of the latest practicable date:

 
| **Class**            |   | **Outstanding at  January 31, 2004** |
|----------------------|--------|--------------------------------------|
| Common capital stock |   | 2,448,321                            |
| $.25 par value       |   |                                 |

 

 

Transitional Small Business Disclosure Format (check one):

 

Yes  o       No   ý

 

----

 

**SENTOCORPORATION**

Quarterly Report on Form 10-QSB

Quarter ended December 31, 2003

 

TABLE OF CONTENTS

 

 
| PART  I                                                                         | -  FINANCIAL INFORMATION |   |
|---------------------------------------------------------------------------------|--------------------------|--------|
| Item  1.  Financial Statements                                             |                     |
|                                                                            |                     |
|                                                                            |                     |   | Condensed Consolidated Balance Sheets  December 31, 2003 and March 31, 2003 |   |
|                                                                            |                     |   |   |   |
|                                                                            |                     |   | Condensed Consolidated Statements of  Operations  Three and nine months ended December 31, 2003, and December 31, 2002 |   |
|                                                                            |                     |   |   |   |
|                                                                            |                     |   | Condensed Consolidated Statements of Cash  Flows  Nine months ended December 31, 2003 and December 31, 2002 |   |
|                                                                            |                     |   |   |   |
|                                                                            |                     |   | Notes to  Condensed Consolidated Financial Statements |   |
|                                                                            |                     |   |
| Item 2.   Management’s Discussion and Analysis or Plan of Operations. |                     |
|                                                                            |                     |   | Critical Accounting  Policies |   |
|                                                                            |                     |   |   |   |
|                                                                            |                     |   | Results of Operations |   |
|                                                                            |                     |   |   |   |
|                                                                            |                     |   | Liquidity and Capital Resources |   |
|                                                                            |                     |   |   |   |
|                                                                            |                     |   | Contractual Obligations |   |
|                                                                            |                     |   |   |   |
|                                                                            |                     |   | Risks Related to Existing and Proposed Operations |   |
|                                                                            |                     |   |   |   |
| Item 3. Controls and Procedures                                                 |                     |
|                                                                            |                     |
| PART II. OTHER  INFORMATION                                                     |                     |
|                                                                            |                     |
| Item 2. Changes in Securities                                                   |                     |
|                                                                            |                     |
| Item 4.   Submission of Matters to Vote of Security Holders                |                     |
|                                                                            |                     |
| Item 6.   Exhibits and Reports on Form 8-K                                 |                     |
|                                                                            |                     |
| SIGNATURES                                                                      |                     |

# ** **

i

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#  

# **PART I – FINANCIAL INFORMATION**

## Item 1.    FinancialStatements

 

#### **SENTO CORPORATION**

**ANDSUBSIDIARY**

 

### **CondensedConsolidated Balance Sheets**

 

**ASSETS**

 
|                                                       |   | **December  31, 2003** |      | **March 31, 2003** |   |
|------------------------------------------------------------|--------|------------------------|-----------|--------------------|--------|
|                                                       |   | **(Unaudited)**        |      |               |   |
| **ASSETS**                                                 |   |                   |      |               |   |
| Current  assets:                                           |   |                   |      |               |   |
| Cash                                                       |   | $                      | 1,402,371 |               | $      | 2,583,337 |   |
| Accounts  receivable, net                                  |   | 3,161,422              |      | 2,848,863          |   |
| Other current  assets                                      |   | 255,415                |      | 220,091            |   |
| Total current assets                                       |   | 4,819,208              |      | 5,652,291          |   |
|                                                       |   |                   |      |               |   |
| Property and  equipment, net                               |   | 3,932,518              |      | 4,130,921          |   |
| Other assets                                               |   | 439,358                |      | 321,521            |   |
| Total Assets                                               |   | $                      | 9,191,084 |               | $      | 10,104,733 |   |
|                                                       |   |                   |      |               |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**              |   |                   |      |               |   |
|                                                       |   |                   |      |               |   |
| Current  liabilities:                                      |   |                   |      |               |   |
| Current  portion of long-term debt and capital leases      |   | $                      | 1,630,374 |               | $      | 1,333,170 |   |
| Accounts  payable                                          |   | 1,608,372              |      | 1,728,768          |   |
| Accrued  liabilities                                       |   | 1,653,834              |      | 1,474,738          |   |
| Deferred  revenue and other current liabilities            |   | 38,393                 |      | 46,453             |   |
| Total current  liabilities                                 |   | 4,930,973              |      | 4,583,129          |   |
|                                                       |   |                   |      |               |   |
| Long-term debt  and capital leases, net of current portion |   | 404,683                |      | 888,825            |   |
| Convertible  debt                                          |   | 442,868                |      | 1,202,821          |   |
| Total  liabilities                                         |   | 5,778,524              |      | 6,674,775          |   |
|                                                       |   |                   |      |               |   |
| Stockholders’  equity:                                |   |                   |      |               |   |
| Common stock                                               |   | 602,293                |      | 524,953            |   |
| Additional  paid-in capital                                |   | 12,983,869             |      | 11,919,653         |   |
| Accumulated  deficit                                       |   | (10,173,602            | )         | (9,014,648         | )      |
| Total  stockholders’ equity                           |   | 3,412,560              |      | 3,429,958          |   |
| Total  Liabilities and Stockholders’ Equity           |   | $                      | 9,191,084 |               | $      | 10,104,733 |   |

 

*See accompanying notes.*

 

1

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**SENTOCORPORATION**

**ANDSUBSIDIARY**

 

### **Condensed Consolidated Statementsof Operations**

**(Unaudited)**

 
|                                                                                           |   | **Three Months Ended**   |      | **Nine Months Ended**    |   |
|------------------------------------------------------------------------------------------------|--------|--------------------------|-----------|--------------------------|--------|
|                                                                                           |   | **December 31,****2003** |      | **December 31,****2002** |   | **December 31,****2003** |   | **December 31,****2002** |   |
|                                                                                           |   |                     |      |                     |   |   |   |   |   |
| Revenue                                                                                        |   | $                        | 5,200,254 |                     | $      | 3,952,971 |   | $ | 13,439,919 |   | $ | 11,661,480 |   |
|                                                                                           |   |                     |      |                     |   |   |   |   |   |
| Cost of sales                                                                                  |   | 4,191,801                |      | 3,624,857                |   | 11,887,233 |   | 11,690,374 |   |
|                                                                                           |   |                     |      |                     |   |   |   |   |   |
| Gross profit  (loss)                                                                           |   | 1,008,453                |      | 328,114                  |   | 1,552,686 |   | (28,894 | ) |
|                                                                                           |   |                     |      |                     |   |   |   |   |   |
| Selling, general  and administrative expenses                                                  |   | 737,599                  |      | 588,572                  |   | 2,002,532 |   | 1,791,694 |   |
| Stock-based  compensation                                                                      |   | 275,189                  |      | —                   |   | 324,747 |   | — |   |
| Operating loss                                                                                 |   | (4,335                   | )         | (260,458                 | )      | (774,593 | ) | (1,820,588 | ) |
|                                                                                           |   |                     |      |                     |   |   |   |   |   |
| Non-cash  charge for valuation of warrants and conversion of debentures                        |   | (48,233                  | )         | (22,627                  | )      | (150,779 | ) | (72,013 | ) |
| Other expense,  net                                                                            |   | (88,891                  | )         | (89,866                  | )      | (233,582 | ) | (283,478 | ) |
| Net loss                                                                                       |   | $                        | (141,459  | )                        | $      | (372,951 | ) | $ | (1,158,954 | ) | $ | (2,176,079 | ) |
|                                                                                           |   |                     |      |                     |   |   |   |   |   |
| Basic and  diluted net loss per share                                                          |   | $                        | (0.06     | )                        | $      | (0.18 | ) | $ | (0.51 | ) | $ | (1.04 | ) |
|                                                                                           |   |                     |      |                     |   |   |   |   |   |
| Basic and  diluted weighted average number of common and common equivalent shares  outstanding |   | 2,372,232                |      | 2,099,960                |   | 2,258,541 |   | 2,099,260 |   |

 

*See accompanying notes.*

 

2

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**SENTOCORPORATION**

**ANDSUBSIDIARY**

 

### **Condensed Consolidated Statementsof Cash Flows**

**(Unaudited)**

 
|                                                                                |   | **Nine Months Ended**  |       |
|-------------------------------------------------------------------------------------|--------|------------------------|------------|
|                                                                                |   | **December 31,  2003** |       | **December 31,  2002** |   |
| Cash flows  from operating activities:                                              |   |                   |       |   |   |
| Net loss                                                                            |   | $                      | (1,158,954 | ) | $ | (2,176,079 | ) |
| Adjustments to  reconcile net loss to net cash provided by operating activities:    |   |                   |       |   |   |
| Depreciation  and amortization                                                      |   | 1,202,424              |       | 1,357,141 |   |
| Accretion of  debenture for warrant and revaluation of warrants issued for services |   | 150,779                |       | 72,013 |   |
| Stock-based  compensation                                                           |   | 324,747                |       | — |   |
| Gain on  disposal of assets                                                         |   | —                 |       | 3,824 |   |
| Write-down of  assets held for sale                                                 |   | —                 |       | 58,668 |   |
| Realized loss  on sale of short-term investments                                    |   | —                 |       | 11,618 |   |
| Changes in  operating assets and liabilities:                                       |   |                   |       |   |   |
| Accounts  receivable                                                                |   | (312,559               | )          | 1,732,329 |   |
| Other assets                                                                        |   | (190,585               | )          | (43,867 | ) |
| Accounts  payable                                                                   |   | (120,396               | )          | (284,778 | ) |
| Accrued  liabilities                                                                |   | 411,579                |       | 583,114 |   |
| Deferred  revenue and other current liabilities                                     |   | (8,060                 | )          | (205,790 | ) |
| Net cash  provided by operating activities                                          |   | 298,975                |       | 1,108,193 |   |
| Cash flows  from investing activities:                                              |   |                   |       |   |   |
| Proceeds from  sale of short-term investments                                       |   | —                 |       | 965,238 |   |
| Purchase of  short-term investments                                                 |   | —                 |       | (19,562 | ) |
| Proceeds from  sale of equipment                                                    |   | —                 |       | 37,834 |   |
| Purchase of  property and equipment                                                 |   | (904,185               | )          | (272,728 | ) |
| Net cash  provided by (used in) investing activities                                |   | (904,185               | )          | 710,782 |   |
| Cash flows  from financing activities:                                              |   |                   |       |   |   |
| Principal  payments on long-term debt and debentures                                |   | (1,555,794             | )          | (879,800 | ) |
| Net borrowings  under line of credit                                                |   | 300,669                |       | — |   |
| Issuance of  long-term debt and debentures                                          |   | 621,563                |       | — |   |
| Proceeds from  stock options exercised                                              |   | 31,371                 |       | — |   |
| Proceeds from  stock issued through employee stock purchase plan                    |   | 26,435                 |       | 21,898 |   |
| Net cash used  in financing activities                                              |   | (575,756               | )          | (857,902 | ) |
| Net increase  (decrease) in cash                                                    |   | (1,180,966             | )          | 961,073 |   |
| Cash at  beginning of period                                                        |   | 2,583,337              |       | 1,047,731 |   |
| Cash at end of  period                                                              |   | $                      | 1,402,371  |   | $ | 2,008,804 |   |
|                                                                                |   |                   |       |   |   |
| Supplemental disclosures of cash flow  information                                  |   |                   |       |   |   |
| Cash paid for:                                                                      |   |                   |       |   |   |
| Interest                                                                            |   | $                      | 181,164    |   | $ | 243,273 |   |
|                                                                                |   |                   |       |   |   |
| Non-cash  investing and financing activities:                                       |   |                   |       |   |   |
|                                                                                |   |                   |       |   |   |
| Value of warrants issued with long-term  debt and convertible debentures            |   | $                      | 179,841    |   | $ | — |   |
| Value of  warrants issued to placement agent                                        |   | 36,031                 |       | — |   |
| Conversion  of debentures (including accrued interest of $7,483)                    |   | 476,774                |       | — |   |
| Equipment purchased through capital lease                                           |   | 23,790                 |       | 431,288 |   |

* *

*See accompanying notes.*

 

3

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#### **SENTO CORPORATION**

**ANDSUBSIDIARY**

 

### **Notes**to Condensed Consolidated Financial Statements

**December31, 2003**

**(Unaudited)**

 

A.            BASIS OF PRESENTATION

 

Theaccompanying unaudited condensed consolidated financial statements are statedin accordance with the instructions to Form 10-QSB and do not include all ofthe information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, all adjustments (consisting of normalrecurring accruals) considered necessary for a fair presentation have beenincluded.

 

Operating results for the three and ninemonths ended December 31, 2003 are not necessarily indicative of the resultsthat may be expected for the full fiscal year. The unaudited condensed consolidated financial statements should be readin conjunction with the audited consolidated financial statements and footnotesthereto included in the Company’s Annual Report on Form 10-KSB for the yearended March 31, 2003.

 

The Company has adopted the footnotedisclosure provisions of Statement of Financial Accounting Standards No. 123, *Accountingfor Stock Based-Compensation* (SFAS 123).  SFAS 123 encourages entities to adopt a fair value based methodof accounting for stock options or similar equity instruments.  However, it also allows an entity tocontinue measuring compensation cost for stock-based compensation using theintrinsic-value method of accounting prescribed by Accounting Principles BoardOpinion No. 25, *Accounting for Stock Issued to Employees* (APB 25).  The Company has elected to continue to applythe provisions of APB 25 and provide pro forma footnote disclosures required bySFAS 123, which has been determined as if the Company had accounted for its employeestock options under the fair value method.

 

Thefair value of each option grant is estimated on the date of grant using theBlack Scholes option-pricing model with the following weighted-averageassumptions: expected dividend yield of zero percent, risk-free interest rateof 3.2 percent, expected life of 5 years, and expected stock-price volatilityof 68 percent.

 

TheCompany applies APB 25 in accounting for options issued under the Plan.  Had the Company determined compensation costbased on the fair value at the grant date for its stock options under SFAS 123,the Company’s net loss would have been changed to the pro forma amountsindicated below for the three and nine months ended December 31, 2003:

 
|                             |   |        |   | **Three Months** |     | **Nine Months** |   |
|----------------------------------|--------|-------------|--------|------------------|----------|-----------------|--------|
| Net loss                         |   | As reported |   | $                | (141,459 | )               | $      | (1,158,954 | ) |
|                             |   | Pro forma   |   | (195,064         | )        | (989,779        | )      |
| Basic and diluted loss per share |   | As reported |   | (0.06            | )        | (0.51           | )      |
|                             |   | Pro forma   |   | (0.08            | )        | (0.44           | )      |
|                                  |        |             |        |                  |          |                 |        |  |  |

 

The full impact of calculating compensationcost for stock options under SFAS 123 may not be representative of the effectson reported net loss for future years.

 

 

B.            CONVERTIBLEDEBT

 

On April 15, 2003, theCompany completed a refinancing of its convertible subordinateddebentures.  The refinancing includedthe issuance of new convertible subordinated debentures and a new $300,000, 8%term loan with a bank that was used to pay down a portion of the Company’sexisting debentures.  In total, theCompany issued 1,002 units at $1,000 each, consisting of one $990 debenture andwarrants to purchase 250 shares of the Company’s common stock at $2.25 pershare.  The debentures are convertibleat any time into shares of the Company’s common stock at $1.75 per share.  The debentures

 

4

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mature on April 15, 2006, and the exercise periodfor the warrants expire on the same date. Each existing debenture holder had the ability to exchange all or partof his/her old debentures for the new debentures.  New debentures totaling $991,980 were issued, including theexchange of $531,630 in existing debentures. The Company also issued warrants to a finder for 50,000 shares of commonstock that expire on April 15, 2006, 37,500 of which are exercisable at $1.60per share, and 12,500 of which are exercisable at $2.25 per share.

 

The above-mentionedwarrants were valued at $179,841 and $36,031, respectively, for the warrantsincluded in the debenture offering and the warrants issued to the finder.  The value of the warrants included in thedebenture offering was credited to additional paid in capital and charged as adiscount against the book value of convertible debt.  The value of the warrants issued to the finder was capitalized asdeferred financing costs with a corresponding credit to paid in capital.  The value of these warrants will beamortized over the life of the related debt.

 

C.            COMMONSTOCK

 

Ninemonths ended December 31, 2003

 

Duringthe nine months ended December 31, 2003, options to purchase 19,564 shares ofcommon stock were exercised and 18,231 shares of common stock were purchased byemployees under the Company’s Employee Stock Purchase Plan

 

Acredit to additional paid-in-capital of $215,872 was recorded for the valuationof the warrants discussed in note B.  Inaddition, debentures with a face value of $467,774, together with associatedaccrued interest of $7,483, were converted into 271,563 shares of the Company’scommon stock.

 

On April 23, 2003, theCompany’s Board of Directors approved an employee stock option exchange program(“Exchange Program”), pursuant to which the Company granted options to purchase313,592 shares of the Company’s common stock at an exercise price of $1.60 pershare in exchange for options to purchase 377,342 shares of the Company’scommon stock at exercise prices in excess of $2.00 per share.  The new options issued under the ExchangeProgram are subject to variable plan accounting in accordance with FASBInterpretation No. 44 “Accounting for Certain Transactions Involving StockCompensation” (“Interpretation 44”). Under variable plan accounting, the Company is required to recognizecompensation expense in its consolidated statements of operations for anyincrease in the market price of the Company’s common stock above $1.60 (themarket price at April 23, 2003, which was the effective date of the exchange).  This compensation must be recorded on aquarterly basis until the new options issued under the Exchange Program areexercised, forfeited or expire unexercised. During the nine months ended December 31, 2003, the Company recorded$324,747 of stock-based compensation for these options.

 

Of the options topurchase 377,342 shares of the Company’s common stock that were exchanged onApril 23, 2003, options to purchase 100,980 shares of common stock were notcancelled as the corresponding new options replacing these options were issuedunder parallel option agreements.  Theparallel option agreements allow the holders of options under the agreements toexercise either the new options issued on April 23, 2003 or the old, higher pricedoptions that were effectively being replaced. Under these agreements, a corresponding number of old options arecancelled upon the exercise of the parallel or new options.  If a holder of a parallel option elects toexercise an old option, a corresponding parallel option is cancelled.   Management believes that it is highlyunlikely that any of the old options effectively being replaced under theparallel option agreements will be exercised due to their unfavorable pricingas compared to the parallel options. Therefore, the old options associated with the parallel options have notbeen included in any pro forma calculations requiring disclosure under FASB 123in the accompanying condensed consolidated financial statements.

 

The impact of the newoptions issued under the Exchange Program on the Company’s consolidatedfinancial statements will depend on quarterly fluctuations in the Company’scommon stock price and the dates of exercises, forfeitures or cancellations ofthe new options by employees.  Moreover,because the precise amount of compensation expense will depend on the marketprice of the Company’s common stock at the end of each quarterly period, theCompany will not be able to forecast in advance the amount of compensationexpense related to these options that it will incur in any future period.

 

5

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Ninemonths ended December 31, 2002

 

Atotal of 6,778 shares of common stock were purchased by employees under theCompany’s Employee Stock Purchase Plan during the nine months ended December31, 2002.

 

D.            LOSSPER SHARE

 

Lossper share is computed in accordance with Financial Accounting Standards BoardStandard 128, “Earnings Per Share.” Basic loss per share is computed by dividing net loss by the weightedaverage number of shares of common stock outstanding for the period.  Diluted income or loss per share reflectsthe potential dilution that could occur from shares of common stock issuablethrough stock options, warrants and other convertible securities, ifdilutive.  Options and warrants topurchase 355,718 and 192,809 shares, respectively, of common stock have notbeen included in the calculation of diluted common stock outstanding for thethree and nine months ended December 31, 2003, because to do so would beanti-dilutive.  Options and warrants topurchase 113 and 5,894 shares, respectively, of common stock have not beenincluded in the calculation of diluted common stock outstanding for the threeand nine months ended December 31, 2002, because to do so would beanti-dilutive.  Shares issuable pursuantto convertible debentures (293,889 shares as of December 31, 2003, and 64,350shares as of December 31, 2002) have not been included in the calculations ofdiluted common stock outstanding for the three and nine months ended December31, 2003, and December 31, 2002, as to do so would be anti-dilutive.

 

Thefollowing tables set forth the computation of basic and diluted income (loss)per share for the three and nine months ended December 31, 2003 and December31, 2002:

 
|                                                                            |   | **Three Months Ended** |     |
|---------------------------------------------------------------------------------|--------|------------------------|----------|
|                                                                            |   | **December 31,  2003** |     | **December 31,  2002** |   |
|                                                                            |   |                   |     |   |   |
| Net loss                                                                        |   | $                      | (141,459 | ) | $ | (372,951 | ) |
| Denominator for basic  and diluted net loss per share - weighted average shares |   | 2,372,232              |     | 2,099,960 |   |
|                                                                            |   |                   |     |   |   |
| Basic and diluted net  loss per share                                           |   | $                      | (0.06    | ) | $ | (0.18 | ) |

 

 
|                                                                            |   | **Nine Months Ended**  |       |
|---------------------------------------------------------------------------------|--------|------------------------|------------|
|                                                                            |   | **December 31,  2003** |       | **December 31,  2002** |   |
|                                                                            |   |                   |       |   |   |
| Net loss                                                                        |   | $                      | (1,158,954 | ) | $ | (2,176,079 | ) |
| Denominator for basic  and diluted net loss per share - weighted average shares |   | 2,258,541              |       | 2,099,260 |   |
|                                                                            |   |                   |       |   |   |
| Basic and diluted net  loss per share                                           |   | $                      | (0.51      | ) | $ | (1.04 | ) |

 

 

F.             LINEOF CREDIT AND LONG-TERM DEBT

 

On April 15, 2003, the Company entered into anew loan agreement with a bank.  The newloan agreement includes a revolving credit line and two term loans (a thirdterm loan was added by amending the loan agreement in October 2003).  Under the credit line, the Company canborrow up to $2,500,000 or 75% of eligible accounts receivable after takinginto account reserves that are based primarily on outstanding balances of termloans outstanding with the bank.  Theline of credit accrues interest at 2% above the greater of 4.25% or the bank’sprime rate (4.0% as of December 31, 2003). As of December 31, 2003,

 

6

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theCompany had $605,000 of borrowings outstanding under the line of credit, whichis included in current portion of long-term debt in the accompanying condensedconsolidated financial statements.

 

The first term loan was extended to refinancethe Company’s existing equipment financing term debt with the bank.  The funding of this loan was limited to theremaining principal balance on existing term loans with the bank ($513,983 asof the date of funding, May 6, 2003). The loan calls for monthly principal and interest payments over 18months and accrues interest at 8%.  Thesecond term loan was extended to refinance a portion of the Company’s existingconvertible debt.  The second term loanis in the amount of $300,000 and calls for monthly principal and interestpayments over three years.  This loanaccrues interest at 8%. The third term loan, totaling $81,563 was used forfinancing equipment.  The third termloan calls for principal and interest payments over 30 months and accruesinterest at 10%.  The loan agreementcalls for the Company to maintain certain profitability and net worthcovenants.  As of December 31, 2003, theCompany was in compliance with all debt covenants.  Substantially all of the assetsof the Company serve as collateral for the above line of credit and loans.

 

The Company also issued a warrant to thebank, in connection with obtaining the above credit facilities, to purchase60,000 shares of Common Stock at $1.79 per share. The value ascribed to thewarrant of $42,470 has been reflected as a debt discount with an offsettingcredit to additional paid-in capital and is being amortized over the life ofthe related debt. The stock purchase warrant became exercisable on the date ofissuance (April 15, 2003) and expires April 15, 2008.

 

7

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## Item 2.  Management’sDiscussion and Analysis or Plan of Operations.

 

**General**

 

Sento Corporationprovides Web-enabled CRM (Customer Relationship Management) solutions for adiversified portfolio of organizations. These services include self-help, live chat via Text TalkSM,Web collaboration, email, and telephone. Utilizing a tested and proven technology set, Sento provides enhancedcustomer experience at a significant cost reduction compared to traditionalmodels.

 

During the quarter ended December 31, 2003, the Company announced thatit has obtained new contracts for significant additional business.  The Company has been and will continue to berequired to invest in additional equipment and hire additional personnel toservice these new contracts.  TheCompany believes it will be able to obtain the necessary equipment financing tosupport its additional business, but there is no assurance it will be able toobtain the financing.  If it does obtainsuch capital, some of its current liabilities will shift to the long-termliability category and will thus improve Sento’s working capital position.

 

There are significant training and other costs involved in hiring largenumbers of new employees needed to service the new contracts.  The Company hired over 450 new employeesduring the quarter ended December 31, 2003. A small percentage of these new hires have not performed as required andhave been or will be replaced to ensure that Sento’s clients receivesatisfactory service levels.  This hasresulted in additional training costs for replacements.  As the work for one of our seasonal clientsconcludes in April, the positions of approximately 170 temporary employees willbe terminated as planned.

 

The Company has also signed a lease for additional space in a new Utahlocation. The Lessor provided the Company, at no cost to the Company, twohundred (200) workstations owned by the Lessor in its new facilities.  This has allowed the Company to take advantageof currently low lease rates, thus reducing its rent expense, and to notrequire certain capital expenditures that would have otherwise been incurred toservice the new business.  In addition,the Company has generated additional cash flow by subleasing to a third party aportion of the space in its existing location in anticipation of the expirationof the existing lease in 2005.  At thattime the Company headquarters will be moved to a new location in order to takeadvantage of significantly improved lease terms.

 

The new business described above has caused the Utah facilities to beutilized at near capacity during the latter part of the quarter ended December31, 2003, and the Company expects that the Utah facilities will be utilizednear capacity for the quarter ending March 31, 2004.  The Company’s facility in Evanston, Wyoming, idled two years ago,has been reopened as of the date of this Report.  Due in large part to the Company’s increased ability to betterutilize these fixed costs, the Company’s gross margin percent increased from agross margin loss for the nine months ended December 31, 2002 to a gross marginpercent of 12% for the nine months ended December 31, 2003.

 

# **CriticalAccounting Policies**

 

Sento’s significantaccounting policies are described in Note 2 to Sento’s Consolidated FinancialStatements for the year ended March 31, 2003. Those financial statements wereprepared in accordance with accounting principles generally accepted in theUnited States and are included in Sento’s Form 10-KSB which has been filed withthe Securities and Exchange Commission. Included within these policies are the Company’s “critical accountingpolicies.”  Critical accounting policiesare those policies that are most important to the preparation of the Company’sconsolidated financial statements and require management’s subjective andcomplex judgments due to the need to make estimates about the effect of mattersthat are inherently uncertain.  TheCompany’s critical accounting policies relate to revenue recognition, creditrisk and stock-based compensation.  Theapplication of these accounting policies involves the exercise of judgment andthe use of assumptions as to future uncertainties and, as a result, actualresults could differ materially from these estimates.

 

The development and selection of these critical accounting policieshave been discussed with the Audit Committee. Such policies are reviewed periodically during each year by the AuditCommittee.

 

*Revenue Recognition.* Revenue is generallyrecognized when persuasive evidence of an arrangement exists, delivery ofservices has occurred, the fee is fixed or determinable, and collection of theresulting receivable is reasonably assured. This generally occurs when the Company provides customer support servicesto the end-user.  Certain of the Company’scustomer support services are delivered over a period of time.  Revenue associated with

 

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these services is deferred until the customer support is completed andSento has no remaining obligation to provide further support services.

 

*Credit Risk.*In the normal course of business, theCompany provides unsecured credit terms to its customers.  Accordingly, the Company performs ongoingcredit evaluations of its customers and maintains allowances for possiblelosses.  The Company’s credit losseshave generally been within management’s expectations.  However, there can be no assurance that the Company’s futurecredit losses will be within management’s expectations.  In addition, the Company’s revenues andaccounts receivable are concentrated in a relatively few number ofcustomers.  A significant change in theliquidity or financial position of any one of these customers or a furtherdeterioration in the economic environment, in general, could have an adverseimpact on the collectability of the Company’s accounts receivable and theCompany’s future operating results.

 

*Stock –Based Compensation.* Statement ofFinancial Accounting Standards No. 123, *Accounting for Stock Based Compensation*(SFAS 123) encourages entities to adopt a fair value based method of accountingfor stock options or similar equity instruments.  However, it also allows an entity to continue measuringcompensation cost for stock based compensation using the intrinsic-value methodof accounting prescribed by Accounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees* (APB 25).  The Company has elected to continue to apply the provisions ofAPB 25 and provide pro forma disclosures required by SFAS 123 in the footnotes tothe consolidated financial statements. Sento also issues equity-based incentive compensation to non-employeesfrom time to time.  Pursuant to EmergingIssues Task Force (EITF) 96-18, *Accounting for Equity Instruments that are Issued toOther than Employees for Acquiring or in Conjunction with Selling Goods orServices*, Sento accounts for these arrangements based on the fairvalue of the equity instrument issued. The fair value of such instruments is measured each quarter as therelated goods or services are provided. The resulting change in value of the instrument is either charged orcredited to income.

 

On April 23, 2003, the Company’s Board of Directorsapproved an employee stock option exchange program (“Exchange Program”),pursuant to which the Company granted options to purchase 313,592 shares of theCompany’s common stock at an exercise price of $1.60 per share in exchange foroptions to purchase 377,342 shares of the Company’s common stock at exerciseprices in excess of $2.00 per share. The new options issued under the Exchange Program are subject tovariable plan accounting in accordance with FASB Interpretation No. 44“Accounting for Certain Transactions Involving Stock Compensation”(“Interpretation 44”).  Under variableplan accounting, the Company is required to recognize compensation expense inits consolidated statements of operations for any increase in the market priceof the Company’s common stock above $1.60 (the market price at April 23, 2003,which was the effective date of the exchange). This compensation must be recorded on a quarterly basis until the newoptions issued under the Exchange Program are exercised, forfeited or expireunexercised.

 

Theimpact of the new options issued under the Exchange Program on the Company’sconsolidated financial statements will depend on quarterly fluctuations in theCompany’s common stock price and the dates of exercises, forfeitures orcancellations of the new options by employees. Moreover, because the precise amount of compensation expense will dependon the market price of the Company’s common stock at the end of each quarterlyperiod, the Company will not be able to forecast in advance the amount ofcompensation expense related to these options that it will incur in any futureperiod.

 

 

### **Results of Operations**

 

**Three Months EndedDecember 31, 2003, Compared to Three Months Ended December 31, 2002**

 

*Revenues.* Revenues increased $1,247,000 or 32%, from $3,953,000 for the threemonths ended December 31, 2002 to $5,200,000 for the three months endedDecember 31, 2003.  The increase inrevenue is due to additional revenue generated from new clients (the Companyannounced significant new contracts in October 2003), and an overall netincrease in volume from existing clients. In addition, the Company recognized approximately $300,000 of additionalrevenue during the quarter ended December 31, 2003 that had previously beendeferred, due to the uncertainty regarding the ultimate realization of thisrevenue.

 

*Cost of Sales.*  Cost of sales increased $567,000 or 16%,from $3,625,000 for the three months ended December 31, 2002, to $4,192,000 forthe three months ended December 31, 2003. Gross margin percent increased from 8% for the three months endedDecember 31, 2002 to 19% for the three months ended December 31, 2003.  This increase in gross margin is due tobetter utilization of overhead and fixed costs from increased sales volume,management’s cost reduction efforts, and the recognition of previously deferredrevenue as discussed in the above

 

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paragraph.  The most significant cost savings resultedfrom the consolidation of telephone and data services with the installation ofa new PBX switch.

 

*Selling, General and Administrative Expenses.*  Selling, general and administrative expensesincreased by $149,000, or 25% from $589,000 for the three months ended December31, 2002, to $738,000 for the three months ended December 31, 2003.  The increase in expenses is due mainly toincreased sales and marketing activity. As a percentage of revenue, selling, general and administrative expensesdecreased one percentage point to 14% of revenue for the three months endedDecember 31, 2003 from 15% of revenue for the three months ended December 31,2002.  Management anticipates thatselling, general and administrative expenses will increase in future periods asa result of increased selling efforts.

 

*Stock-based compensation.*  During the three months ended December 31,2003, the Company recorded a charge of $275,000 for variable-priced stockoptions issued in April 2003.  Theseoptions will be revalued on a quarterly basis with any change being recorded tostock-based compensation over the related vesting period.  There was no charge for stock-basedcompensation during the three months ended December 31, 2002, as there were novariable-priced stock options outstanding at that time.

 

*Non-cash charge for valuation of warrants andconversion of debentures*.  Non-cash charges for valuation of warrants and the conversion ofdebentures increased 109%, or $25,000, from $23,000 for the three months endedDecember 31, 2002, to $48,000 for the three months ended December 31,2003.  This increase is due mainly tothe conversion of debentures into common stock during the three months endedDecember 31, 2003, and an associated acceleration in debenture warrantaccretion due to the conversions.  Therewere no conversions of debentures during the three months ended December 31,2002.

 

 

**Nine Months EndedDecember 31, 2003, Compared to Nine Months Ended December 31, 2002**

 

*Revenues.* Revenues increased $1,779,000, or 15%, from $11,661,000 for the ninemonths ended December 31, 2002 to $13,440,000 for the nine months endedDecember 31, 2003.  The increase inrevenue is due to an overall net increase in volume from existing clients aswell as revenue generated from new clients.

 

*Cost of Sales.*  Cost of sales increased $197,000, or 2%,from $11,690,000 for the nine months ended December 31, 2002 to $11,887,000 forthe nine months ended December 31, 2003. Gross margin percent increased from a gross margin loss for the ninemonths ended December 31, 2002 to a gross margin percent of 12% for the ninemonths ended December 31, 2003.  Thisgross margin percent improvement is due to better utilization of overhead andfixed costs from increased sales volume and management’s cost reductionefforts.  The most significant costsavings resulted from the consolidation of telephone and data services with theinstallation of a new PBX switch and increased revenues as described in theimmediately preceding paragraph above.

 

*Selling, General and Administrative Expenses.*  Selling, general and administrative expensesincreased by $211,000, or 12%, from $1,792,000 for the nine months endedDecember 31, 2002 to $2,003,000 for the nine months ended December 31,2003.  The increase in expenses is duemainly to increased marketing activity. As a percentage of revenue, selling, general and administrative expensesremained constant at 15% of revenue for the nine months ended December 31, 2003and the nine months ended December 31, 2002. Management anticipates that selling, general and administrative expenseswill increase in future periods as a result of the increased number of sellingpersonnel and the associated efforts to improve sales.

 

*Stock-based compensation.*  During the nine months ended December 31,2003, the Company recorded a charge of $325,000 for variable-priced stockoptions issued in April 2003.  Theseoptions will be revalued on a quarterly basis with any change being recorded tostock-based compensation over the related vesting period.  There was no charge for stock-basedcompensation during the nine months ended December 31, 2002, as there were novariable-priced stock options outstanding at that time.

 

*Non-cash charge for valuation of warrants andconversion of debentures*.  Non-cash charges for valuation of warrants and the conversion ofdebentures increased 110%, or $79,000 from $72,000 for the nine months endedDecember 31, 2002, to $151,000 for the nine months ended December 31,2003.  This increase is due mainly tothe conversion of debentures into common stock during the nine months endedDecember 31, 2003, and an associated acceleration in debenture warrant accretiondue to the conversions.  There were noconversions of debentures during the nine months ended December 31, 2002.

 

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### **Liquidity andCapital Resources**

 

Cash decreased 46%, or $1,181,000 from $2,583,000 as of March 31, 2003to $1,402,000 as of December 31, 2003. Working capital also decreased $1,181,000 during the same period, from$1,069,000 as of March 31, 2003, to a negative $(112,000) as of December 31,2003. The primary reason for the decrease in cash and working capital was thepurchase of property and equipment needed to service new business and theprincipal payments of long-term debt and convertible debentures.  During the three months ended December 31,2003 the Company obtained extended payment terms in the amount of approximately$372,000 from two vendors to purchase additional equipment .  In addition, as of December 31, 2003, theCompany had approximately $880,000 available under its revolving line of creditwith its bank.  The Company believes itwill be able to obtain the necessary equipment financing to support itsadditional business, but there is no assurance it will be able to obtain thefinancing.  If it does obtain suchcapital, some of its current liabilities will shift to the long-term liabilitycategory and will thus improve Sento’s working capital position.

 

On April 15, 2003, theCompany completed a refinancing of its convertible subordinateddebentures.  The refinancing includedthe issuance of new convertible subordinated debentures and the pay down of aportion of the Company’s existing debentures using the proceeds of a new$300,000, 8% term loan with a bank that is more fully described below.  In total, the Company issued 1,002 units at$1,000 each, consisting of one $990 debenture and warrants to purchase 250shares of the Company’s common stock at $2.25 per share.  The debentures are convertible at any timeinto shares of the Company’s common stock at $1.75 per share.  The debentures mature on April 15, 2006, andthe exercise period for the warrants expire on the same date.  Each existing debenture holder had theability to exchange all or part of old debentures for the new debentures.  New debentures totaling $991,980 wereissued, including the exchange of $531,630 in existing debentures. During thenine months ended December 31, 2003, debentures with a face value of $476,774,together with associated accrued interest of $7,483, were converted into271,563 shares of the Company’s common stock.

 

OnApril 15, 2003, the Company entered into a new loan agreement with a bank,including a revolving credit line and two term loans (a third term loan wasadded by amending the loan agreement in October 2003).  Under the credit line, the Company canborrow up to $2,500,000, or 75% of eligible accounts receivable, after takinginto account reserves that are based primarily on outstanding balances of thefirst of outstanding term loans with the bank. The line of credit accrues interest at 2% above the greater of 4.25% orthe bank’s prime rate (4.0% as of December 31, 2003) and matures on April 15,2004.  As of December 31, 2003, theCompany had $605,000 of borrowings outstanding under the line of credit, whichis included in current portion of long-term debt in the accompanying condensedconsolidated financial statements.

 

The first term loan was extended to refinance the Company’s existingequipment financing term debt with the bank. The funding of this loan was limited to the remaining principal balanceon existing term loans with the bank ($513,983 as of the date of funding, May6, 2003).  The loan calls for monthlyprincipal and interest payments over 18 months and accrues interest at 8%.  The second term loan was extended torefinance a portion of the Company’s existing convertible debt.  The second term loan is in the amount of $300,000and calls for monthly principal and interest payments over three years.  This loan accrues interest at 8%. The thirdterm loan, totaling $81,563 was used for financing equipment.  The third term loan calls for principal andinterest payments over 30 months and accrues interest at 10%.  The loan agreement calls for the Company tomaintain certain profitability and net worth covenants.  Substantially all of the assets of theCompany serve as collateral for the above line of credit and loans.

 

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The Company has contractual obligations, including debt agreements andleases that will require the use of substantial amounts of cash.  The following table sets forth the Company’scontractual obligations as of December 31, 2003:

 

**Contractual Obligations**

 
|                                           |   | **Payments Due by  Period** |      |
|------------------------------------------------|--------|-----------------------------|-----------|
|                                           |   | **Under 1  Year**           |      | **1-3 Years** |   | **4-5 Years** |   | **After 5  Years** |   | **Total** |   |
| Line of Credit (1)                             |   | $                           | 605,000   |   | $ | — |   | $ | — |   | $ | — |   | $ | 605,000 |   |
| Long Term Debt (principal only) (2)            |   | 726,000                     |      | 185,000 |   | — |   | — |   | 911,000 |   |
| 8% Convertible Debentures (principal  only)(3) |   | —                      |      | 514,000 |   | — |   | — |   | 514,000 |   |
| Capital Leases                                 |   | 343,000                     |      | 268,000 |   | — |   | — |   | 611,000 |   |
| Operating Leases, net of subleases             |   | 859,000                     |      | 1,199,000 |   | 1,000,000 |   | — |   | 3,058,000 |   |
| Total Contractual Cash Obligations             |   | $                           | 2,533,000 |   | $ | 2,166,000 |   | $ | 1,000,000 |   | $ | — |   | $ | 5,699,000 |   |
|                                                |        |                             |           |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

(1)   The Company’s credit lineaccrues interest at 2% above the greater of 4.25% or the bank’s prime rate(4.0% at December 31, 2003).

(2)   The Company’s long-term debtcarries interest rates of 6% to 10%.

(3)   Assumes that the remainingdebentures, due in April 2006, will not be converted into shares of Sento’scommon stock even though $469,000 of the original $1,000,000 has been convertedinto shares of the Company’s common stock.

 

 

For the ninemonths ended December 31, 2003, net cash provided by operations was $299,000 ascompared to $1,108,000 for the nine months ended December 31, 2002. The mainreason for this decline in cash flow from operations was the increase in days salesoutstanding in accounts receivable. However, subsequent to the end of the quarter and as of the date of thisReport, substantially all past due amounts from clients have been collected.  During the nine months ended December 31,2003 the Company used $904,000 of cash for investing activities as compared tonet proceeds from investing activities of $711,000 during the nine months endedDecember 31, 2002.  During the ninemonths ended December 31, 2003, the Company used $576,000 for financingactivities as compared to using $858,000 for financing activities during thenine months ended December 31, 2002.

 

Historically the Company’s primary sources ofliquidity have been cash flow provided through private sales of equity anddebt, borrowings under a bank line of credit, and the sale of assets.  During the three years ended March 31, 2003,and the nine months ended December 31, 2003, liquidity and cash were alsoprovided by positive cash flow from operations.  In addition, the Company has financed some of the equipmentutilized in its business through long-term leasing and loan arrangements.  However, leasing and other finance companieshave become much more restrictive in providing financing, which coupled withthe Company’s financial performance during the most recent time period havemade it more difficult for the Company to obtain the needed capital forequipment financing and new hires. During the quarter ended December 31, 2003, the Company obtainedsignificant new contracts that require the Company to invest in equipment andhire additional personnel.  The recentbusiness growth of the Company has consumed and will continue to consumesubstantial amounts of cash, and the Company will be required to obtain additionalfinancing for its planned and committed growth and to sustain currentoperations.  The Company believes itwill be able to obtain equipment financing and fund and finance currentoperations.  However, in the event theCompany is not able to find additional sources of funding and enter into financingtransactions on reasonable terms, its ability to sustain current operationswill be limited, or it may be forced to reduce or suspend its operations.  There can be no assurance that the Companywill be able to obtain necessary capital funding on terms favorable to theCompany, if at all.

 

 

*The statements contained in this QuarterlyReport on Form 10-QSB that are not purely historical are “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, asamended.  All forward-looking statementsinvolve various risks and uncertainties. Forward-looking statements contained in this Report include statementsregarding the*

 

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*Company’s plans to develop and deliverintegrated information technology services, market opportunities andacceptance, expectations, goals, revenues, financial performance, strategies,mission and intentions for the future. Such forward-looking statements are included under “Management’sDiscussion and Analysis or Plan of Operations” and encompass Sento’s beliefs,expectations, hopes or intentions regarding future events.  Words such as “expects,” “believes,”“anticipates,” “should,” and “likely” also identify forward-looking statements.All forward-looking statements included in this Report are made as of the datehereof, based on information available to the Company as of such date, and theCompany assumes no obligation to update any forward-looking statement.  It is important to note that such statementsmay not prove to be accurate and that the Company’s actual results and futureevents could differ materially from those anticipated in such statements.  Among the factors that could cause actualresults to differ materially from the Company’s expectations are thosedescribed under “Management’s Discussion and Analysis or Plan ofOperations––Risks Related to Existing and Proposed Operations.”  All subsequent written and oral forward-lookingstatements attributable to the Company or persons acting on its behalf areexpressly qualified in their entirety by this section and other factorsincluded elsewhere in this Report.*

 

 

### **Risks Related toExisting and Proposed Operations**

 

In addition to other information in this Report, the following areimportant factors that should be considered carefully in evaluating the Companyand its business.

 

*Volatile Economic Conditions Have Affected and Will Likely**Continueto Affect Sento’s Operations and Financial Results*.  Volatile economic conditions have adverselyaffected the Company’s operations and financial results.  The slowing economy caused the Company tolose some clients and has also resulted in increased pricing pressures andlower call volumes from some existing clients, and may limit the Company’sability to attract new clients.  Thesefactors have contributed to a decline in the Company’s historical revenues andnet income and have resulted in the Company’s excess capacity to service callvolumes, although some of this excess capacity was used during the most recentfiscal quarter.  A substantialpercentage of the Company’s expenses is attributable to labor costs associatedwith staffing Customer Contact Solutions Centers, which the Company may not beable to reduce on short notice in order to compensate for unexpected shortfallsin call volumes.  The Company cannotforecast future fluctuations in economic conditions, and its operations andfinancial results may be materially and adversely affected by continuedeconomic volatility.

 

*Dependence on Key Clients.*  Two clients accounted for approximately 46%of the Company’s revenues for the nine months ended December 31, 2003.  These two clients accounted forapproximately 34% and 12%, respectively of revenues for fiscal 2003.  For the nine months ended December 31, 2002,five clients accounted for approximately 80% of the Company’s revenues.  These five clients accounted forapproximately 32%, 14%, 13%, 11% and 10%, respectively, of revenues for the ninemonths ended December 31, 2002.

 

Consistent with industry standards, theCompany’s contracts are generally cancelable by the client on short-termnotice.  The Company’s loss of asignificant amount of business with any of its key clients could have, and theloss of a substantial amount of business with any of its largest existingtechnical support clients would have, a material adverse effect on theCompany’s business, financial condition, and results of operations.  In addition, the Company’s future revenuegrowth is dependent upon its ability to attract and retain new clients.

 

*Liquidity and Capital Resources*.  At December 31, 2003, the Company hadnegative working capital of $(112,000). Future growth, particularly growth in excess of planned growth, willdepend on the Company’s ability to obtain financing. The historic growth rateof the Company’s Customer Contact Solutions operations (most of which was inthe United States) has consumed substantial amounts of cash.  During the quarter ended December 31, 2003,the Company obtained significant new contracts that require the Company toinvest in equipment and hire additional personnel.  The recent business growth of the Company has consumed and willcontinue to consume substantial amounts of cash, and the Company will berequired to obtain additional financing for its planned and committed growthand to sustain current operations.  TheCompany believes it will be able to obtain equipment financing and fund andfinance current operations.  However, inthe event the Company is not able to find additional sources of funding andenter into financing transactions on reasonable terms, its ability to sustaincurrent operations will be limited, or it may be forced to reduce or suspendits operations.  There can be noassurance that the Company will be able to obtain necessary capital funding onterms favorable to the Company, if at all.

 

*Credit Risk.*  In the normal course of business, theCompany provides unsecured credit terms to its customers.  Accordingly, the Company performs ongoingcredit evaluations of its customers and maintains allowances for possiblelosses.  The Company’s credit losseshave generally been within management’s

 

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expectations.  However, there can be no assurance that theCompany’s future credit losses will be within management’s expectations.  In addition, the Company’s revenues andaccounts receivable are concentrated in a relatively few number of customers.  A significant change in the liquidity orfinancial position of any one of these customers or a further deterioration inthe economic environment, in general, could have an adverse impact on thecollectability of the Company’s accounts receivable and the Company’s futureoperating results.

 

*Risks of Growth*Strategy. The Company’s businessstrategy is premised, in part, upon fully utilizing excess personnel andphysical facilities and subsequently upon expansion of its operations.Substantial risks accompany the Company’s growth plans. For example, theCompany’s growth plans are dependent upon its ability to attract and retain newclients and additional business from existing clients.  The Company’s failure to attract and retainnew clients and obtain additional business from existing clients, or the lossof existing clients, will not only prevent the implementation of its businessstrategy, but may cause the Company to return to the circumstance of excesspersonnel and physical facilities, which would have a negative impact on theCompany’s results of operations and financial condition (see Liquidity andCapital Resources).

 

The Company’s growth plans are also subject to fluctuations intechnology and industry standards, changes in customer requirements andpreferences and general economic conditions, among other factors.  Many of these factors are beyond theCompany’s control.  If the Company isincorrect in its assessment of the feasibility of its growth plans, or ifcircumstances change in a way that the Company did not foresee or anticipate,the Company may not be able to grow as planned or its growth strategy may havean adverse effect on its business operations and financial condition.

 

*Reliance on a Software Company for Chat and Email applications*.  The Company contracts with a software companyto provide chat and email tools used with the Company’s CRM software, reportingand management services.  If thissoftware company fails in its business efforts, the Company may be required toidentify and retain one or more alternate third-party providers of suchservices and could experience service delays, interruptions, cancellations orincreased costs.

 

*Changing Needs of the Customer ContactService Market*.  The customercontact service industry is characterized by rapid technological change, changesin customer requirements and preferences, and the emergence of new industrystandards and practices that could render the Company’s existing and proposedproducts, services, technology and systems obsolete.  To remain competitive, the Company must continually improve theperformance, features, and reliability of its products and services, includingits existing customer contact service applications, and develop new productsand services that address the increasingly sophisticated and varied needs of itsprospective clients.  If the Companycannot adapt or respond in a cost-effective and timely manner to changingindustry standards, market conditions, or client’s requirements, its businessand operating results would suffer and could negatively impact the Company’sfinancial condition.

 

The Company’s success may also depend in part on itsability to develop solutions that keep pace with continuing changes ininformation technology, evolving industry standards, and changing clientrequirements.  There can be no assurancethat the Company will be successful in adequately addressing these developmentson a timely basis or that, if these developments are addressed, the Companywill be successful in the marketplace. In addition, there can be no assurance that products or technologiesdeveloped by others will not render the Company’s services non-competitive orobsolete.  The Company’s failure toaddress these developments could have a material adverse effect on its businessand financial condition.

 

*Competition*. The market for customer contact services is highly fragmented and verycompetitive.  The customer contactservices industry, however, has begun to experience a degree of consolidation,and the existence of major customer contact center companies has resulted in anadditional level of competition from service providers that have greater namerecognition, larger installed customer bases, and significantly greaterfinancial, technical, and marketing resources than the Company.  Over the past several years, a number ofexisting companies have enjoyed increasing success and rapid internalgrowth.  Several of these companies havebeen active in acquiring smaller regional customer contact services companiesand are becoming major competitors with a measurable share of this rapidlyexpanding market.  Also, many majorcompanies provide their own in-house customer care support and customertraining.

 

The Company cannot provide any assurance that better andmore efficient services will not be provided by new or existing customercontact service providers in competition with the Company.  The services provided by such competitorsmay be more effective or less expensive than those provided by the Company.  There can be no assurance that the Companywill improve, refine or enhance the services it provides.

 

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*Competition in Customer Contact ServicesMarket*.  The customer contact services market isrelatively new and intensely competitive. There are no substantial barriers to entry, and established or newentities may enter this market in the near future.  Furthermore, established enterprise software companies, includingIBM, Hewlett-Packard Company, Microsoft Corporation, and similar companies, mayleverage their existing relationships and capabilities to offer customerservice applications.  The Company was arelatively early entrant in the customer self-services and chat markets.  Any delays in market acceptance of internetcustomer contact service applications in general, or the Company’s proposedproducts and services in particular, would likely harm the Company’scompetitive position.  Delays wouldallow the Company’s competitors additional time to improve their service orproduct offerings, and also provide time for new competitors to develope-business customer service applications and solicit prospective clients withinthe Company’s target markets.  Increasedcompetition could result in additional pricing pressures, reduced operatingmargins and loss of market share.

 

*Risk of Emergency Interruption ofCustomer Contact Solutions Center Operations*. The Company’s business depends to a large extent on computer andtelecommunications equipment and software systems (both equipment and systemsmaintained by the Company and equipment and systems maintained by thirdparties).  The Company cannot provideany assurance that natural disaster, human error, equipment malfunction orinadequacy, or other events would not result in a prolonged interruption in theCompany’s ability to provide support services to its clients.  The temporary or permanent loss of computeror telephone equipment or systems, through casualty, operating malfunction orotherwise, could have a material adverse effect on the Company.  Property and business interruption insurancemay not be adequate to compensate the Company for all losses that it may incur.

 

*Attracting,Training, and Retaining Quality Management and Employees*.  The Company’s success will depend, inlarge part, on its ability to attract, retain and train highly qualifiedtechnical, managerial and marketing personnel with the required expertise.  The Company has not entered into employmentagreements that require the services of any of its key managerial or technicalpersonnel to remain with the Company for any specified period of time.  There can be no assurance that the Companywill be able to attract and maintain the personnel necessary for thedevelopment and operation of its business or that it will be able to train itscurrent employees on new developments in technology.  Specifically, the loss of any key personnel or an inability toattract, retain, train or motivate qualified personnel could have a materialadverse effect on the Company’s business, financial condition and results ofoperations.

 

In addition, the Company’s total employee count hasfluctuated from approximately 585 as of March 31, 2000, to a high ofapproximately 953 as of December 31, 2000, and decreased to approximately 200as of June 30, 2003.  At January 31,2004, the Company’s total employee count was approximately 705.  The support required for one of theCompany’s largest clients is seasonal. There is, therefore, a necessity for very rapid increases in the numberof employees and subsequent decreases in the number of employees as therequirements for support change.  TheCompany cannot provide any assurance that its current management team cansuccessfully manage the Company’s rapidly evolving business, and any failure todo so could have a material adverse effect upon the Company’s operatingresults.

 

During the time period beginning July 2000 and continuing to date, theCompany has partnered and continues to partner with offshore entities thatsupply Customer Contact Center services on a contract basis to theCompany.  Currently there areapproximately 170 agents in these offshore contracted Customer Contact Centers.Managing the quality of services rendered to the Company’s clients is furthercomplicated by the remote location and language and cultural differences of agentssupplying these services, and there can be no assurance that the Company canadequately manage these remote agents. The lack of proper management of these offshore agents or the deliveryof low-quality services by such agents could have a material adverse effectupon the Company’s operating results.

 

*Dependence on Industry Trend to OutsourceServices*.  The Company’s business depends in large parton the trend within the IT industry to outsource certain services.  The Company cannot provide any assurancethat this trend will continue or that, if the trend continues, it will continueat the same rate of growth.  The failureof this trend to continue could have a material adverse effect on the Company’sbusiness, financial condition, and results of operations.

 

*Potential Significant Fluctuations inQuarterly Results*.  The value ofindividual transactions can constitute a substantial percentage of theCompany’s quarterly revenue, and particular transactions may generate asubstantial portion of the operating profits for a quarter.  Because the Company’s staffing and otheroperating expenses are based on anticipated revenue levels, and a highpercentage of its expenses are fixed, delays in the receipt of orders

 

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can cause significant variations inoperating results from quarter to quarter. In addition, the Company may expend significant resources pursuingpotential sales that will not be consummated. The Company also may choose to reduce prices or to increase spending inresponse to competition or to pursue new market opportunities, which mayadversely affect its operating results.

 

In particular, the Company’s quarterly revenues from itsCustomer Contact Solutions Center operations are potentially volatile.  Such revenues are principally a function ofthe number of support requests received by the Company, and the time spent onsuch requests.** **Consequently, the Company’s profitability may beadversely affected if the Company receives fewer support requests thananticipated or the time spent in resolving inquiries is greater thananticipated.

 

For the reasons identified above, managementbelieves that period-to-period comparisons of the Company’s results ofoperations may not be meaningful and that no one should rely upon them as anindication of future performance. Furthermore, the Company cannot provide any assurance that it will beable to achieve or sustain profitability on a quarterly basis.

 

*Volatility of Stock Price*. The trading price of the Company’s Common Stock has fluctuated widely inresponse to variations in quarterly operating results, announcements by theCompany or its competitors, industry trends, general economic conditions orother events or factors.  Suchfluctuations, as well as fluctuations in the trading volume of the CommonStock, may continue in the future. Regardless of the general outlook for the Company’s business, theannouncement of quarterly operating results below analyst and investor expectationscould have a material and adverse effect on the market price of the CommonStock.

 

*Anti-Takeover Considerations.* The Company’s Articles of Incorporation and Bylaws, the UtahRevised Business Corporation Act, and the Utah Control Shares Acquisition Acteach contain certain provisions that may have the effect of inhibiting anon-negotiated merger or other business combination.  The Company’s Articles of Incorporation grant to the Board ofDirectors the authority, without further action by the Company’s shareholders,to fix the rights and preferences of, and issue shares of preferred stock.  These provisions may deter hostile takeoversor delay or prevent changes in control of the Company or changes in theCompany’s management, including transactions in which shareholders mightotherwise receive a premium for their shares over the then-current marketprices.  In addition, these provisionsmay limit the ability of shareholders to approve transactions that they maydeem to be in their best interests.

 

*Common Stock Eligible for Future Sale.*  Sales of substantial amounts of the CommonStock or the perception that such sales could occur, could have a negativeimpact on the prevailing market prices for the Common Stock.  As of January 31, 2004, the Company had2,448,321 shares of Common Stock outstanding, substantially all of which wereeligible as of such date under applicable securities laws for immediate sale inthe public market without restriction, except for any shares purchased by any“affiliate” of the Company (as that term is defined under the rules andregulations of the Securities Act) which will be subject to the resalelimitations of Rule 144 under the Securities Act or any successor rule (“Rule144”).  As of January 31, 2004, thereremain up to 11,618 shares issuable upon conversion of debentures that may beeligible for immediate sale as described in Part II, Item 2. Changes inSecurities:  Recent Sales ofUnregistered Securities.

 

*Dividends.* Dividends are payable on the Common Stock when, as and if declared bythe Company’s Board of Directors.  Nodividend has been declared or paid on the Common Stock to date.  At present the Company intends to retain anyfuture earnings for use in its business and therefore does not anticipatepaying any dividends on the Common Stock in the foreseeable future.

 

 

## Item 3.   Controls andProcedures

 

As of December 31, 2003, an evaluation was performed under thesupervision and with the participation of the Company’s management, includingthe Chief Executive Officer and the Senior Vice President of Finance, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures (as defined in Exchange Act Rules 13a-14 and 15d-14).  Based upon the evaluation, the Company’smanagement, including the Chief Executive Officer and Senior Vice President ofFinance, concluded that, as of the date of that evaluation, the disclosurecontrols and procedures were effective in timely alerting them to materialinformation relating to the Company required to be included in the Company’speriodic SEC filings.  Subsequent to thedate of that evaluation, there have been no significant changes in the internalcontrols or in other factors that could significantly affect

 

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internalcontrols, nor were any corrective actions required with regard to significantdeficiencies and material weaknesses.

 

 

# **PART II.**                OTHER INFORMATION

 

 

### **Item 2.**    Changes in Securities

 

Recent Sales of Unregistered Securities 

 

As reported previously on Sento’s Form 10-KSB for the fiscal year endedMarch 31, 2003, on April 15, 2003, Sento issued an aggregate of$1 million of convertible debentures to 38 purchasers. Each debentureaccrues interest at the rate of 8% per year, is convertible into Sento’s CommonStock at $1.75 per share, expires in three years, and has attachedwarrants with an exercise price of $2.25 to purchase one share of Common Stockfor each $4 of debentures purchased. Those warrants expire on April 15,2006. Each purchaser was an accredited investor and was provided with a privateplacement memorandum detailing Sento’s business and financial information,including copies of Sento’s Annual Report on Form 10-KSB for the fiscalyear ended March 30, 2002 and Sento’s Quarterly Reports onForm 10-QSB for the periods ending June 29, 2002, September 28,2002, and December 31, 2002. Sento paid commissions of $46,960 to aplacement agent in connection with the sale of the convertible debentures andissued a warrant to purchase 50,000 shares to a finder. As of January 31, 2004,a total of 291,563 shares of Common Stock have been issued upon conversion ofsuch debentures (52,396 shares of which were issued during the quarter endedDecember 31, 2003).  In addition, 18,928shares of Common Stock were issued pursuant to the exercise of warrants topurchase 35,000 shares of Common Stock under cashless exercise provisions ofthe warrant agreements associated with the above mentioned convertibledebentures.

 

The securities purchased in the above transactions were restrictedsecurities taken for investment. Certificates for all debentures (and sharesissued upon conversion of debentures) issued in such transactions bore arestrictive legend conspicuously on their face and stop-transfer instructionswere noted respecting such certificates on our transfer records, except incircumstances in which Sento received a written opinion from legal counsel tothe holders of such securities to the effect that due to the tacking of holdingperiods of previously held debentures (given in exchange for the recentlyissued debentures) such common share certificates issued on debentureconversion did not need to bear a restrictive legend. Each of the foregoingtransactions was effected in reliance on the exemption from registrationprovided in Section 4(2) of the Securities Act of 1933 andRule 506 of Regulation D adopted thereunder as transactions notinvolving any public offering.

 

### **Item 4.**    Submission of Matters to Vote of Security Holders

 

On October 22, 2003, the Company held its Annual Meeting of Shareholders(the “Annual Meeting”).  At the AnnualMeeting, two matters were submitted to the Company’s shareholders forconsideration and approval.  Thosematters, together with the voting results for each matter, are described in thefollowing paragraphs.

 
| 1.     |   | Six directors of the Company were elected to serve until the 2004  Annual Meeting of Shareholders of the Company.  The directors elected, together with votes received are: Gary  B. Filler 2,124,461 votes; Patrick F. O’Neal 2,124,461 votes; Kieth E.  Sorenson 2,008,280 votes; Kim A. Cooper 2,100,653 votes; Eric Olafson  2,100,653 votes; and Phillip J. Windley 2,100,653 votes. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.     |   | The Company’s shareholders approved a proposal to ratify the  appointment of Ernst & Young LLP as independent auditors of the Company  for the fiscal year ending March 31, 2004.   With respect to this proposal, there were 2,124,057 shares cast in  favor of the proposal, 248 shares cast against the proposal, and 1,859 votes  abstained.                                      |

 

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## Item 6.    Exhibits and Reports on Form 8-K

 
| a)     |   | Exhibits attached to the 10-QSB are as follows:                                                                                                                                                                                                                                                                                                   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                              |
|   |   | Exhibits 31.1 and 32.1 – Certifications of the Company’s Chief  Executive Officer                                                                                                                                                                                                                                                       |
|   |   | Exhibits 31.2 and 32.2 – Certifications of the Company’s Chief Financial  Officer                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                              |
| b)     |   | Reports on Form  8-K:                                                                                                                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                              |
|   |   | Current report  filed January 22, 2004 for the purpose of disclosing to shareholders and the  financial markets a press release dated January 20, 2004 and furnished as an  exhibit to the Form 8-K.  This press release  discussed the Company’s unaudited financial results for the quarter and nine  months ended December 31, 2003. |

 

 

### **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 theundersigned thereunto duly authorized.

 
|                    |   |   |   |   | SENTO CORPORATION |
|-------------------------|--------|--------|--------|--------|-------------------|
|                    |   |   |   |   | (Registrant)      |   |
|                    |   |   |   |   |              |
|                    |   |   |   |   | By:               | /s/ PATRICK F. O’ NEAL |   |
|                    |   |   |   |   |              | Patrick F. O’ Neal |
|                    |   |   |   |   |              | President and Chief Executive Officer |
|                    |   |   |   |   |              | (Principal executive officer) |
|                    |   |   |   |   |              |   |
|                    |   |   |   |   | By:               | /s/ STANLEY J. CUTLER |   |
|                    |   |   |   |   |              | Stanley J. Cutler |
|                    |   |   |   |   |              | Senior Vice President of Finance and Secretary |
|                    |   |   |   |   |              | (Principal financial and accounting officer) |
|                    |   |   |   |   |              |   |
| Dated February 9, 2004. |   |   |   |   |              |   |
|                         |        |        |        |        |                   |  |  |  |

 

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