##### **United States**

**Securitiesand Exchange Commission**

**Washington, D.C.  20549**

** **

**FORM 10-QSB**

 

**ý****                                ****QuarterlyReport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**For the Quarter Ended June 30,2005**

** **

**o****                                ****Transitionreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**Commission File Number 06425**

** **

**SENTOCORPORATION**

Exact Name of SmallBusiness Issuer asSpecified in its Charter

 

| **Utah**                                                        | ** ** | ** **                                                               | ** ** | **87-0284979**                        |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other Jurisdiction of  Incorporation or Organization) | ** ** |                                                                     |       | (I.R.S. Employer  Identification No.) |
|                                                            | ** ** | ** **                                                               |       |                                  |
|                                                            | ** ** | **420 East South Temple, Suite 400**                                |       |                                  |
|                                                            | ** ** | **Salt Lake City, Utah 84111**  (Address of Principal Executive Offices) |       |                                  |

 

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

 

Check whether the issuer (1) filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act during the past 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

 

Yes ý   No o

 

State the number of shares outstanding of each of the issuer’s classesof common equity, as of the latest practicable date:

 

| **Class**                             | ** ** | **Outstanding at  July 31, 2005** |
|---------------------------------------|------------|----------------------------------------|
| Common capital  stock  $.25 par value |       | 3,876,311                              |

 

Transitional SmallBusiness Disclosure Format (check one):

 

Yes o   No ý

 

 

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**SENTO CORPORATION**

Quarterly Report on Form 10-QSB

Quarter ended June 30, 2005

 

TABLE OF CONTENTS

 
| PART I.  |    FINANCIAL  INFORMATION                        |   |
|---------------|-----------------------------------------------------------------|--------|
|          |                                                            |   |
| Item 1.       | Financial  Statements                                           |   |
|          |                                                            |   |
|          | Condensed  Consolidated Balance Sheets                          |   |
|          |                                                            |   |
|          | Condensed Consolidated Statements of  Operations                |   |
|          |                                                            |   |
|          | Condensed Consolidated Statements of  Cash Flows                |   |
|          |                                                            |   |
|          | Supplemental Disclosures of Cash Flow  Information              |   |
|          |                                                            |   |
|          | Notes to Condensed  Consolidated Financial Statements           |   |
|          |                                                            |   |
| Item 2.       | Management’s  Discussion and Analysis or Plan of Operation |   |
|          |                                                            |   |
|          | Overview                                                        |   |
|          |                                                            |   |
|          | Critical Accounting Policies                                    |   |
|          |                                                            |   |
|          | Results of Operations                                           |   |
|          |                                                            |   |
|          | Liquidity and Capital Resources                                 |   |
|          |                                                            |   |
|          | Seasonality                                                     |   |
|          |                                                            |   |
|          | Risks Related to Existing  and Proposed Operations              |   |
|          |                                                            |   |
| Item 3.       | Controls  and Procedures                                        |   |
|          |                                                            |   |
| PART II. |    OTHER  INFORMATION                            |   |
|          |                                                            |   |
| Item 2.       | Recent  Sales of Unregistered Securities and Use of Proceeds    |   |
|          |                                                            |   |
| Item 6.       | Exhibits                                                        |   |
|          |                                                            |   |
| SIGNATURES    |                                                            |

 

i

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# **PART I.**     FINANCIAL INFORMATION

Item 1.             FinancialStatements

 

**SENTO CORPORATION**

**AND SUBSIDIARIES**

 

**CondensedConsolidated Balance Sheets**

** **
| ** **                                                                             | ** ** | **June 30,  2005** | ** ** | **March 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                                             | ** ** | **(Unaudited)**         | ** ** | ** **               | ** ** |
| **ASSETS**                                                                             |       |                    |       |                     |       |
| ** **                                                                             |       |                    |       |                     |       |
| Current assets:                                                                        |       |                    |       |                     |       |
| Cash and cash equivalents                                                              |       | $                       | 5,112,449  |                     | $          | 5,698,195 |   |
| Accounts receivable, net                                                               |       | 3,469,786               |       | 4,326,315                |       |
| Other current assets                                                                   |       | 731,913                 |       | 643,059                  |       |
| Total current assets                                                                   |       | 9,314,148               |       | 11,667,569               |       |
|                                                                                   |       |                    |       |                     |       |
| Property and equipment, net                                                            |       | 4,244,438               |       | 4,031,632                |       |
| Intangible assets, net                                                                 |       | 1,161,295               |       | 1,229,607                |       |
| Other assets                                                                           |       | 302,496                 |       | 296,775                  |       |
| Total Assets                                                                           |       | $                       | 15,022,377 |                     | $          | 16,225,583 |   |
|                                                                                   |       |                    |       |                     |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                          |       |                    |       |                     |       |
| ** **                                                                             |       |                    |       |                     |       |
| Current liabilities:                                                                   |       |                    |       |                     |       |
| Current portion of long-term debt and capital leases                                   |       | $                       | 1,188,470  |                     | $          | 745,699 |   |
| Accounts payable                                                                       |       | 1,958,820               |       | 2,110,013                |       |
| Accrued payroll and payroll taxes                                                      |       | 1,357,944               |       | 1,559,676                |       |
| Current portion of accrued restructuring expenses                                      |       | 172,347                 |       | 118,793                  |       |
| Accrued liabilities and other                                                          |       | 616,170                 |       | 635,834                  |       |
| Total current liabilities                                                              |       | 5,293,751               |       | 5,170,015                |       |
|                                                                                   |       |                    |       |                     |       |
| Long-term debt and capital leases, net of current portion                              |       | 1,282,080               |       | 959,259                  |       |
| Accrued restructuring expenses, net of current portion                                 |       | 171,447                 |       | —                   |       |
| Accrued contingent consideration from business acquisition                             |       | 907,898                 |       | 907,898                  |       |
| Total liabilities                                                                      |       | 7,655,176               |       | 7,037,172                |       |
|                                                                                   |       |                    |       |                     |       |
| Stockholders’ equity:                                                             |       |                    |       |                     |       |
| Common stock                                                                           |       | 969,078                 |       | 965,077                  |       |
| Additional paid-in capital                                                             |       | 20,634,431              |       | 20,662,508               |       |
| Treasury Stock                                                                         |       | (259,620                | )          | (203,681                 | )          |
| Accumulated other comprehensive income – foreign currency translation  adjustment |       | (33,460                 | )          | 42,670                   |       |
|                                                                                   |       |                    |       |                     |       |
| Accumulated deficit                                                                    |       | (13,943,228             | )          | (12,278,163              | )          |
| Total stockholders’ equity                                                        |       | 7,367,201               |       | 9,188,411                |       |
| Total Liabilities and Stockholders’ Equity                                        |       | $                       | 15,022,377 |                     | $          | 16,225,583 |   |

 

*Seeaccompanying notes.*

 

1

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**SENTO CORPORATION**

**AND SUBSIDIARIES**

 

**CondensedConsolidated Statements ofOperations**

**(Unaudited)**

 
| ** **                                                                                    | ** ** | **Three  Months Ended**     | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                    | ** ** | **June   30,****2005** | ** ** | **June 30,****2004** | ** ** |
|                                                                                          |       |                        |       |   |   |
| Revenue                                                                                       |       | $                           | 8,760,585  |   | $ | 6,566,748 |   |
|                                                                                          |       |                        |       |   |   |
| Cost of sales                                                                                 |       | 7,997,053                   |       | 5,775,952 |   |
|                                                                                          |       |                        |       |   |   |
| Gross profit                                                                                  |       | 763,532                     |       | 790,796 |   |
|                                                                                          |       |                        |       |   |   |
| Product development                                                                           |       | —                      |       | 119,013 |   |
| Selling, general and administrative expenses                                                  |       | 1,886,506                   |       | 826,481 |   |
| Amortization of intangible assets                                                             |       | 68,312                      |       | — |   |
| Restructuring charge                                                                          |       | 477,575                     |       | — |   |
| Non-cash charge for valuation of warrants                                                     |       | —                      |       | 111,592 |   |
| Stock-based compensation benefit                                                              |       | (54,572                     | )          | (150,749 | ) |
| Operating loss                                                                                |       | (1,614,289                  | )          | (115,541 | ) |
|                                                                                          |       |                        |       |   |   |
| Other expense, net                                                                            |       | (39,546                     | )          | (39,129 | ) |
|                                                                                          |       |                        |       |   |   |
| Net loss before income taxes                                                                  |       | (1,653,835                  | )          | (154,670 | ) |
| Income taxes                                                                                  |       | 11,230                      |       | — |   |
| Net loss                                                                                      |       | (1,665,065                  | )          | (154,670 | ) |
| Deemed dividend as a result of warrant modification                                           |       | —                      |       | (37,875 | ) |
| Net loss attributable to common stockholders                                                  |       | $                           | (1,665,065 | ) | $ | (192,545 | ) |
|                                                                                          |       |                        |       |   |   |
| Basic and diluted net loss per share                                                          |       | $                           | (0.44      | ) | $ | (0.05 | ) |
|                                                                                          |       |                        |       |   |   |
| Basic and diluted weighted average number of common and common  equivalent shares outstanding |       | 3,785,264                   |       | 3,627,686 |   |

 

*Seeaccompanying notes.*

 

2

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**SENTO CORPORATION**

**AND SUBSIDIARIES**

 

**CondensedConsolidated Statements of CashFlows**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Three Months Ended**  | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                                 | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
| Cash flows from operating activities:                                                      |       |                    |       |   |   |
| Net loss                                                                                   |       | $                       | (1,665,065 | ) | $ | (154,670 | ) |
| Adjustments to reconcile net loss to net cash provided by (used in)  operating activities: |       |                    |       |   |   |
| Depreciation and amortization                                                              |       | 510,125                 |       | 389,931 |   |
| Non-cash interest expense related to warrants issued with debt                             |       | 3,174                   |       | 4,257 |   |
| Stock-based compensation                                                                   |       | (54,572                 | )          | (150,749 | ) |
| Restructuring charge                                                                       |       | 477,575                 |       | — |   |
| Revaluation of non-employee warrants issued for services                                   |       | —                  |       | 111,592 |   |
|                                                                                       |       |                    |       |   |   |
| Changes in operating assets and liabilities:                                               |       |                    |       |   |   |
| Accounts receivable                                                                        |       | 856,529                 |       | 1,558,312 |   |
| Other assets                                                                               |       | (104,965                | )          | 46,687 |   |
| Accounts payable                                                                           |       | (151,193                | )          | (142,718 | ) |
| Accrued liabilities and other                                                              |       | (351,226                | )          | (361,414 | ) |
| Net cash provided by (used in) operating activities                                        |       | (479,618                | )          | 1,301,228 |   |
| Cash flows used in investing activities:                                                   |       |                    |       |   |   |
| Purchase of property and equipment                                                         |       | (766,973                | )          | (287,616 | ) |
|                                                                                       |       |                    |       |   |   |
| Cash flows from financing activities:                                                      |       |                    |       |   |   |
| Proceeds from issuance of long-term debt, capital leases and credit  line                  |       | 987,267                 |       | 316,140 |   |
| Principal payments of long-term debt, capital leases and credit line                       |       | (224,849                | )          | (246,971 | ) |
| Payment of accrued offering costs                                                          |       | —                  |       | (603,823 | ) |
| Proceeds from exercise of stock options, warrants and employee stock  purchases            |       | 30,496                  |       | 165,473 |   |
| Repurchase of common stock                                                                 |       | (55,939                 | )          | — |   |
| Net cash provided by (used in) financing activities                                        |       | 736,975                 |       | (369,181 | ) |
| Effect of foreign currency translations                                                    |       | (76,130                 | )          | — |   |
| Net increase (decrease) in cash and cash equivalents                                       |       | (585,746                | )          | 644,431 |   |
| Cash and cash equivalents at beginning of period                                           |       | 5,698,195               |       | 6,567,811 |   |
| Cash and cash equivalents at end of period                                                 |       | $                       | 5,112,449  |   | $ | 7,212,242 |   |

 

*See accompanying notes.*

 

3

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**SENTO CORPORATION**

**AND SUBSIDIARIES**

 

**SupplementalDisclosures of Cash Flow Information**

**(Unaudited)**

 
| ** **                                    | ** ** | **Three Months Ended**  | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|
| ** **                                    | ** ** | **June 30,  2005** | ** ** | **June 30,  2004** | ** ** |
|                                          |       |                    |       |   |   |
| Cash paid for:                                |       |                    |       |   |   |
| Interest                                      |       | $                       | 49,755     |   | $ | 36,006 |   |
| Income taxes                                  |       | 4,309                   |       | — |   |
|                                          |       |                    |       |   |   |
| Non-cash  investing and financing activities: |       |                    |       |   |   |
|                                          |       |                    |       |   |   |
| Equipment financed through long-term note     |       | $                       | —     |   | $ | 157,136 |   |

 

*See accompanying notes.*

 

4

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**SENTO CORPORATION**

**AND SUBSIDIARIES**

 

**Notes to Condensed ConsolidatedFinancial Statements**

**June 30, 2005**

**(Unaudited)**

 

A.                                   BASISOF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements ofSento Corporation (the “Company”) have been prepared in accordance with theinstructions to Form 10-QSB and do not include all of the information andfootnotes required by U.S. generally accepted accounting principles forcomplete financial statements.  In theopinion of management, all adjustments (consisting of normal recurring entries)considered necessary for a fair presentation have been included.

 

Operating results for the three month period ended June 30,2005 are not necessarily indicative of the results that may be expected for thefull fiscal year.  The unauditedcondensed consolidated financial statements should be read in conjunction withthe audited consolidated financial statements and footnotes thereto included inthe Company’s Annual Report on Form 10-KSB for the year ended March 31,2005.

 

The Company’s operations are carried out by its twowholly-owned subsidiaries, Sento Technical Services Corporation, a Utahcorporation, and Xtrasource Acquisition Inc., a Delaware corporation.  The Company’s operations are located in Utah,Wyoming, North Carolina, the Netherlands and France.  In addition, the Company has contractualrelations with a third-party provider in India.

 

The Company has adopted the footnote disclosureprovisions of Statement of Financial Accounting Standards No. 123, *Accounting for Stock Based-Compensation* (SFAS 123).  SFAS 123 encourages entities to adopt a fairvalue based method of accounting for stock options or similar equityinstruments.  However, it also allows anentity to continue measuring compensation cost for stock-based compensationusing the intrinsic-value method of accounting prescribed by AccountingPrinciples Board Opinion No. 25, *Accounting for StockIssued to Employees* (APB 25). The Company has elected to continue to apply the provisions of APB 25and provide pro forma footnote disclosures required by SFAS 123, which has beendetermined as if the Company had accounted for its employee stock options underthe fair value method.

 

The fair values of stockoption grants for the periods presented in the following financial statements weredeterminedusing the Black-Scholes option pricing model and the followingassumptions:expected stock price volatility of 66% to 90%, risk-freeinterestrates ranging from 2.7% to 4.5%, weighted average expected optionlivesof 5 years, and no dividend yield. The Black-Scholes optionvaluationmodel was developed for use in estimating the fair value of tradedoptionsthat have no vesting restrictions and that are fully transferable.Inaddition, option valuation models require the input of highly subjectiveassumptionsincluding expected stock price volatility. Because the Company’sstockoptions have characteristics significantly different from those oftradedoptions, and because changes in the subjective input assumptions canmateriallyaffect their fair value, in management’s opinion, the existingmodelsdo not necessarily provide a reliable measure of the fair value of stockoptions and restricted stock.

 

TheCompany applies APB 25 in accounting for options issued under the SentoCorporation 1999 Omnibus Stock Incentive Plan. Had the Company determined compensation cost based on the fair value atthe grant date for its stock options under SFAS 123, the Company’s loss wouldhave been changed to the pro forma amounts indicated below for the three-monthperiods ended June 30, 2005 and 2004:

 

 

Three-monthperiods ended June 30, 2005 and 2004:

 
| ** **                                    | ** ** | ** **  | ** ** | **2005**   | ** ** | **2004** | ** ** |
|-----------------------------------------------|------------|-------------|------------|------------|------------|----------|------------|
| Net loss  attributable to common stockholders |       | As reported |       | $          | (1,665,065 | )        | $          | (192,545 | ) |
|                                          |       | Pro forma   |       | (1,771,613 | )          | $        | (339,543   | ) |
| Basic and  diluted loss per share             |       | As reported |       | $          | (0.44      | )        | $          | (0.05 | ) |
|                                          |       | Pro forma   |       | $          | (0.47      | )        | $          | (0.09 | ) |

 

5

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The full impact of calculating compensation cost forstock options under SFAS 123 may not be representative of the effects onreported net loss for future periods.

 

B.                                     LONG-TERMDEBT AND CAPITAL LEASES

 

Effective March 31, 2005, the Company renewed itsline of credit with a bank that allows the Company to borrow up to****$3,000,000 or 80% of eligible accounts receivable.  The line of credit accrues interest at 1%over of the bank’s prime rate (6% as of June 30, 2005) and matures on March 31,2007.  As of June 30, 2005, theCompany had $500,000 outstanding against the line.

 

Effective March 31,2005, the Company also entered into a term debt agreement with a bank forequipment financing.  The loan allows fora minimum of $100,000 draws with a maximum of $1,000,000 through March 31,2006.  The Company is required to makeinterest only payments equal to 1.5% over the bank’s prime rate during thedraw-down period.  At the end of thedraw-down period, the Company will be required to pay monthly installments ofprincipal and interest over 36 months. During the three months ended June 30, 2005, the Company drew atotal of $487,267 on this facility which was all outstanding at June 30,2005.

 

C.                                     COMMONSTOCK

 

Three months endedJune 30, 2005

 

During the three months ended June 30, 2005, options to purchase250 shares of common stock were exercised and 15,757 shares of common stockwere purchased by employees under the Company’s Employee Stock Purchase Plan,resulting in $30,496 of net proceeds to the Company.

 

On April 23, 2003, theCompany’s Board of Directors approved an employee stock option exchange program(the “Exchange Program”), pursuant to which the Company granted options topurchase 313,592 shares of the Company’s common stock at an exercise price of$1.60 per share in exchange for the cancellation of options to purchase 377,342shares of the Company’s common stock at exercise prices in excess of $2.00 pershare.  The new options issued under theExchange Program are subject to variable plan accounting in accordance with FinancialAccounting Standards board Interpretation No. 44, *Accountingfor Certain Transactions Involving Stock Compensation*.  Under variable plan accounting, the Companyis required to recognize compensation expense (benefit) in its consolidatedstatements of operations for any change in the intrinsic value of theoptions.  The intrinsic value of therepriced options is based on the market price of the underlying shares ofcommon stock and is calculated as the difference between the fair market valueof the common stock and $1.60 (the market price at April 23, 2003, whichwas the effective date of the exchange). This compensation adjustment must be recorded on a quarterly basis untilthe new options issued under the Exchange Program are exercised, forfeited orexpire unexercised.  During the threemonths ended June 30, 2005, the Company recorded $54,572 of stock-basedcompensation benefit for these options since the value of the Company’s commonstock decreased between March 31, 2005 and June 30, 2005.

 

The impact of the newoptions issued under the Exchange Program on the Company’s consolidatedfinancial statements will depend on quarterly fluctuations in the price of theCompany’s common stock and the dates of exercises, forfeitures or cancellationsof the new options.  Moreover, becausethe precise amount of compensation expense will depend on the market price ofthe Company’s common stock at the end of each quarterly period, the Companywill not be able to forecast in advance the amount of compensation expense(benefit) related to these options that it will incur in any future period.  As of June 30, 2005, options to purchase117,889 shares of common stock remained outstanding under the Exchange Program.

 

On February 28, 2005, the Company’s Board ofDirectors approved a stock buy-back plan authorizing the Company to repurchaseup to 10% of its then outstanding common stock over a one-year period.  The purchase price, amount of shares perpurchase, and the specific purchase dates are subject to approval by theCompany’s Board of Directors and compliance with regulations of the Securitiesand Exchange Commission.  During thethree months ended June 30, 2005, the Company repurchased 16,938

 

6

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sharesof common stock at a cost of $55,939.  Asof June 30, 2005, a total of 76,737 shares had been repurchased under thestock buy-back plan and are accounted for as treasury stock in the accompanyingfinancial statements.

 

Three months endedJune 30, 2004

 

During the three months ended June 30, 2004, options to purchase93,179 shares of common stock were exercised and 14,820 shares of common stockwere purchased by Company employees under the Company’s Employee Stock PurchasePlan, resulting in $39,866 of net proceeds to the Company.

 

During the three months ended June 30, 2004, warrants to purchase204,250 shares of common stock were exercised under cashless provisions of theunderlying warrant agreements resulting in the Company issuing 167,853 sharesof common stock.

 

During the three monthsended June 30, 2004, the Company recorded $150,749 of stock-basedcompensation benefit from marking to market the options repriced under theExchange Program.

 

In January 2004, the Company entered into aconsulting agreement with terms that required the Company to issue theconsultant warrants to purchase 5,000 shares of common stock each month.   As of June 30, 2005 warrants topurchase 60,000 shares of common stock were outstanding under this agreement,of which warrants to purchase 15,000 shares were issued during the three monthsended June 30, 2004. The warrants vest 25% every three months from thedate of issuance, have a term of three and one-half years, and have an exerciseprice of $3.00 per share.  On October 31,2004, the Company terminated the consulting agreement.  Accordingly, subsequent to October 31,2004 no further warrants will be issued under the agreement.  The value of these warrants, as determinedusing the Black-Scholes valuation model, were recognized during the performanceperiod as opposed to the vesting schedule since the period of performancehas ended.

 

Effective May 21, 2004, the Company’s board ofdirectors modified certain warrants to extend the expiration date from May 31,2004 to August 31, 2004.  The valueof this warrant modification, as determined using the Black-Scholes valuationmodel, was $37,875 (which is the difference between the value of the originalwarrants immediately prior to the modification and the value of the extendedwarrants).  In connection with thismodification, the warrant holders did not provide any additional stated orunstated rights, privileges, or agreements to the Company. Accordingly, thistransaction has been reflected as a “deemed dividend as a result of warrantmodification” on the accompanying statement of operations and in determiningnet loss attributable to common stockholders. On August 31, 2004, the subject warrants expired unexercised.

 

D.                                    LOSSPER SHARE

 

Loss per share is computed in accordance with Statement of FinancialAccounting Standards No. 128, *Earnings Per Share*.  Basic loss per share is computed by dividingnet loss by the weighted average number of shares of common stock outstandingfor the period.  Diluted income or lossper share reflects the potential dilution that could occur from shares ofcommon stock issuable through stock options, warrants and other convertiblesecurities, if dilutive.  Options andwarrants to purchase 70,699 shares of common stock have not been included inthe calculation of diluted common stock outstanding for the three-month periodended June 30, 2005, because to do so would be anti-dilutive.  Options and warrants to purchase 18,552shares of common stock have not been included in the calculation of dilutedcommon stock outstanding for the three-month period ended June 30, 2004,because to do so would be anti-dilutive.

 

E.                                      FACILITIESCONSOLIDATION

 

In January 2005,Sento approved a plan to consolidate its Utah contact center facilities fromthree locations into one “super center” by July 2005.  During the three months ended June 30,2005, the Company completed this plan and ceased using the second of thecenters that was to be abandoned under the plan.  Costs incurred with closing this facility,including the impairment of leasehold improvements and the accrual of futurelease obligations have been recorded as a restructuring charge in the Company’scondensed consolidated statement of operations for the three months ended June 30,2005.  In addition,

 

7

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management determined that it was not economicallyfeasible to open its contact center in Green River, Wyoming which has been andis currently idle.  Therefore, the costof future lease payments for the Green River facility have also been includedin the restructuring charge in the accompanying condensed consolidatedstatement of operations for the three months ended June 30, 2005.  The following summarizes the costs recorded asa restructuring charge during the three months ended June 30, 2005:

 
| Discounted value  of future facilities lease obligations |   | $       | 329,831 |   |
|----------------------------------------------------------|--------|---------|---------|--------|
| Impairment of  leasehold improvements                    |   | 122,744 |    |
| Moving costs and  other                                  |   | 25,000  |    |
|                                                     |   | $       | 477,575 |   |

 

The following is a reconciliation of accrued restructuring expense forthe three months ended June 30, 2005:

 
| Accrued  restructuring expenses at March 31, 2005                  |   | $        | 118,793 |   |
|-------------------------------------------------------------------------|--------|----------|---------|--------|
| Accrual of  future facilities lease obligations, moving and other costs |   | 354,831  |    |
| Costs paid during  period                                               |   | (129,830 | )       |
| Accrued  restructuring expenses at June 30, 2005                   |   | 343,794  |    |
| Current portion  of accrued restructuring expenses                      |   | 172,347  |    |
| Long-term  portion of accrued restructuring expenses                    |   | $        | 171,447 |   |

 

F.                                  BUSINESSACQUISITION

 

In October 2004 the Company, through its wholly-owned subsidiary, Xtrasource Acquisition, Inc. (“Acquisition”), acquired substantially all of the assets of Xtrasource, Inc. (“Xtrasource”), a non-affiliated, privately-held Delaware corporation with approximately $10 million in annual sales.  Acquisition agreed to pay the former owners of Xtrasource a quarterly contingent earnout of 30% of earnings before interest, taxes, depreciation and amortization (“Earnout”) for the quarterly periods between the closing and September 30, 2009 (with a maximum aggregate cap of $6.5 million).  Earnout payments are subject to various reduction and offset rights including, but not limited to, reductions for debt payments (to secured and unsecured creditors) and working capital deficiencies.  The accrued contingent consideration represents the Company’s estimate of the Earnout liability.  This estimate is based on the Company’s forecasts of Xtrasource’s earnings through September 2009.  The actual amounts eventually paid for the Earnout could differ materially from management’s estimate.

 

The acquired assets consist of call center operationswith facilities in the United States, the Netherlands and France.  Assets acquired also include intangibleassets consisting primarily of the Xtrasource assigned customer contracts andrelated customer base.  These intangibleassets are being amortized over the expected useful life of five years.  As of June 30, 2005 and March 31,2005, the Company’s intangible assets consist entirely of the intangible assetsacquired through this transaction.  Thecarrying value of intangible assets at June 30, 2005 totaled $1,161,295,net of $204,906 of accumulated amortization. The carrying value of intangible assets at March 31, 2005 totaled$1,229,607, net of $136,594 of accumulated amortization.

 

G.                                     INCOMETAXES

 

Income tax expense for the three month period ended June 30,2005 consists of the provision for income taxes on the Company’s Europeanoperations.  Even though the Company hada consolidated net loss for the three months ended June 30, 2005, theCompany’s operations are located in different tax jurisdictions and may requirethe payment of income taxes in specific jurisdictions.

 

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H.                                    GEOGRAPHICINFORMATION

 

The following geographic area data includes net revenue and long-lived assets based on physical location as of and for the three months ended June 30, 2005 and 2004:

 
| ** **          | ** ** | **2005**  | ** ** | **2004** | ** ** |
|---------------------|------------|-----------|------------|----------|------------|
| Revenue:            |       |      |       |     |       |
| United States       |       | $         | 6,592,000  |     | $          | 6,567,000 |   |
| Europe              |       | 2,169,000 |       | —   |       |
| Consolidated  total |       | $         | 8,761,000  |     | $          | 6,567,000 |   |
|                |       |      |       |     |       |
| Long-lived  assets: |       |      |       |     |       |
| United States       |       | $         | 4,503,000  |     | $          | 5,558,000 |   |
| Europe              |       | 1,205,000 |       | —   |       |
| Consolidated  total |       | $         | 5,708,000  |     | $          | 5,558,000 |   |

 

I.                                         RECENTLYISSUED ACCOUNTING PRONOUNCEMENTS

 

In December 2004, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards No. 123R,*Share-Based Payment* (SFAS 123R), whichrequires the measurement of all share-based payments to employees, includinggrants of employee stock options, using a fair-value-based method and therecording of such expense in the consolidated statements of operations. TheCompany is required to adopt the accounting provisions of SFAS 123R forreporting periods beginning after December 15, 2006.  The Company’s pro forma disclosures currentlypermitted under SFAS 123 no longer will be an alternative to financialstatement recognition under SFAS 123R. Although the Company has not yet determined whether the adoption ofSFAS 123R will result in amounts that are similar to the current pro formadisclosures under SFAS 123, management is evaluating the requirementsunder SFAS 123R and expects the adoption could have a significant impacton Company’s consolidated statements of operations and net income/loss pershare.

 

Item 2.             Management’sDiscussion and Analysis or Plan of Operation.

 

**Forward-Looking Statements**

 

*Thestatements contained in this Quarterly Report on Form 10-QSB that are notpurely historical are “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. All forward-looking statements involve various risks anduncertainties.  Forward-lookingstatements contained in this Report include statements regarding our plans todevelop and deliver integrated information technology services, marketopportunities and acceptance, expectations, goals, revenues, financialperformance, strategies, mission and intentions for the future.  Such forward-looking statements are includedunder “Management’s Discussion and Analysis or Plan of Operation” and encompassSento’s beliefs, expectations, hopes or intentions regarding futureevents.  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 us as of such date, and we assume noobligation to update any forward-looking statement.  It is important to note that such statementsmay not prove to be accurate and that our actual results and future eventscould differ materially from those anticipated in such statements.  Among the factors that could cause actualresults to differ materially from our expectations are those described under “Management’sDiscussion and Analysis or Plan of Operations---Risks Related to Existing andProposed Operation.”  All subsequentwritten and oral forward-looking statements attributable to Sento or personsacting on our behalf are expressly qualified in their entirety by this section andother factors included elsewhere in this Report.*

 

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**Overview**

 

We area global provider of custom solutions that leverage “Right Channeling,” amethodology for ensuring that companies make informed choices for multi-channelcommunication that support their business goals and customer expectations.  We offer call and contact center solutionsfor customer acquisition, customer service, service intervention and technicalsupport.  We use modern customer contactcenters, coupled with our state-of-the-art proprietary software systems, toprovide domestic and international support services and technology solutions toour primary target markets consisting of either: (1) smaller to mid-sizedcompanies that are outsourcing customer and technical support for the firsttime or seeking to continue outsourcing with a new vendor or combination ofvendors; or (2) larger companies which may have already made the decisionto outsource and are interested in deploying our Right Channeling and otherunique offerings.  We conduct our principalbusiness operations through our wholly-owned subsidiaries, Sento TechnicalServices Corporation and Xtrasource Acquisition, Inc.

 

Effective October 1, 2004, through our wholly-owned subsidiary, Xtrasource Acquisition, Inc., we acquired substantially all of the assets of Xtrasource, Inc.****(“**Xtrasource**”)**,**a non-affiliated, privately-held Delaware corporation with approximately $10 million in annual sales.  We have agreed to pay the former owners of Xtrasource a quarterly contingent earnout of 30% of earnings before interest, taxes, depreciation and amortization from the Xtrasource operations (the **“Earnout”**) for the quarterly periods between the closing and September 30, 2009 (with a maximum cap of $6.5 million).  Earnout payments are subject to various reduction and offset rights including, but not limited to, reductions for debt payments (to secured and unsecured creditors) and working capital deficiencies.  We granted the former owners of Xtrasource a line of credit of no more than $200,000 to enable Xtrasource to pay costs and expenses associated with closing its Brazilian subsidiary, which we did not acquire (and we did not assume its liabilities), and for ordinary course expenses related to the transaction.  Amounts drawn on the line of credit will be deducted from Earnout payments.  Our consolidated operating results contain the operating results of the acquired business for the three months ended June 30, 2005.

 

On January 27, 2005, we announced our intentionsto consolidate our Utah call center operations from three centers into oneprimary super-center.  We completed thismove during June 2005.  We believe wewill be able to increase our efficiencies through this initiative and reducethe cost of providing our services over the long-term.  During the quarter ended June 30, 2005,we incurred moving costs of approximately $25,000 and a $123,000 write-down ofproperty and equipment that was not needed after the move.  In addition, we accrued rent expense for theremaining lease term on the vacated Utah centers (approximately $62,000) duringthe three months ended June 30, 2005. The above costs are identified as restructuring charges in our statementof operations for the three months ended June 30, 2005.  In addition, we reviewed the viability of thefuture utilization of our Green River, Wyoming facility that is currently notin use.  Based on our review, we determinedthat it would not be economically feasible to reopen this facility in thefuture and therefore have included the future costs associated with thisfacility ($268,000) in our restructuring accrual.  These restructuring charges discussed abovehad a negative impact on our operations during the quarter ended June 30,2005.

 

We believe that a significant issuecurrently facing our company relates to the variable pricing of a significantnumber of our outstanding employee stock options.  In April 2003, we repriced the majorityof our then outstanding employee stock options to the then-current market priceof $1.60 per share.  This re-pricing wasdone to give our employees incentive to grow revenues and improve profitability,with the objective of increasing shareholder value.  We believe this re-pricing contributed in alarge part to our improved operating results during the fiscal year ended March 31,2004.  Under U.S. generally acceptedaccounting principles (“**GAAP**”), weare required to “mark to market” these employee options, by adjusting thenon-cash compensation expense we record on these stock options on a quarterlybasis until they are exercised, forfeited or expire. This non-cash expense iscalculated by multiplying the number of currently exercisable options by theamount that the current market price of our common stock is above the exerciseprice of $1.60 per share, less any amounts previously recorded as expense forvested shares.  Thus, in a period of increasingstock prices we may record a significant amount of non-cash compensationexpense.  Conversely, if our stock pricefalls in a future period, we may subsequently reverse a portion of the expensepreviously recognized with respect to stock options that remainoutstanding.  These periodic adjustmentsof our non-cash compensation expense may result in significant volatility inthe results of our operations.  Duringthe three-month periods ended June 30, 2005 and 2004, we recognizednon-cash compensation benefits of $55,000 and $151,000, respectively, toreflect adjustments to the value of the options due to the decline in the marketprice of our common stock from March 31, 2005 and June 30, 2005.

 

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Becausethe actual amount of compensation expense we will recognize with respect tooutstanding stock options will depend on the market price of our common stockat the end of each quarterly period and the timing of exercise, forfeiture orexpiration of outstanding options, we are not able to forecast the amount ofnon-cash compensation expense related to these stock options that we may incurin any future period.

 

Pursuant to a consulting agreementwith a third party financial consulting firm, we agreed to issue the thirdparty, as partial consideration for consulting services, a warrant to purchase5,000 shares of our common stock each month during the term of theagreement.  Through October 31,2004, we issued warrants to purchase 60,000 shares of common stock.  The warrants permit the holder to acquireshares of common stock at an exercise price of $3.00 per share at any timeprior to the date that is three and one-half years after the date ofissuance.  Each warrant vests withrespect to 25% of the shares subject thereto on the first day of each calendarquarter following its issuance.  Thewarrants also include a net exercise provision and anti-dilution provisionspursuant to which the exercise price and number of shares issuable thereunderwill be adjusted proportionately in the event of a stock split, stock dividend,recapitalization or similar transaction. We also have granted the warrant holder piggyback registration rightswith respect to any registration (other than on Form S-4 or Form S-8)that permits the registration of secondary sales.  This agreement was terminated October 31,2004.  We have recognized expense basedon the fair value of the warrants over the period which the consulting serviceswere provided.

 

EffectiveMay 21, 2004, our Board of Directors modified certain warrants to extendthe expiration date from May 31, 2004 to August 31, 2004.  The value of this warrant modification, asdetermined using the Black-Scholes valuation model, was $37,875 (which is thedifference between the value of the original warrants immediately prior to themodification and the value of the extended warrants).  In connection with this modification, thewarrant holders did not provide to us any additional stated or unstated rights,privileges, or agreements. Accordingly, this transaction has been reflected asa “deemed dividend as a result of warrant modification” on our accompanyingconsolidated statement of operations and in determining net loss attributableto common shareholders.  On August 31,2004, the subject warrants expired unexercised.

 

**Critical Accounting Policies**

** **

Our significant accounting policiesare described in Note 2 to our Consolidated Financial Statements included inour Annual Report on Form 10-KSB for the year ended March 31, 2005.Those financial statements were prepared in accordance with U.S. generallyaccepted accounting principals.  Includedwithin these policies are our “critical accounting policies.”  Critical accounting policies are thosepolicies that are most important to the preparation of our consolidatedfinancial statements and require management’s subjective and complex judgmentsdue to the need to make estimates about the effect of matters that areinherently uncertain.  Our criticalaccounting policies relate to revenue recognition, credit risk and stock-basedcompensation.  The application of theseaccounting policies involves the exercise of judgment and the use ofassumptions as to future uncertainties, and as a result, actual results coulddiffer materially from these estimates. The development and selection of these critical accounting policies havebeen discussed, and are reviewed each year, with the Audit Committee of ourBoard of Directors.

 

*RevenueRecognition.*Revenue is recognized when persuasive evidence of an arrangement exists,delivery of services has occurred, the fee is fixed or determinable, andcollection of the resulting receivable is reasonably assured.  We generate revenue by delivering technicalassistance to users of our clients’ products through the use of live chat, Webcollaboration, email and telephone interactions.  We recognize revenues as services areprovided, according to the terms of the underlying agreement with our clientswhich specify how the client will be charged, generally based on a monthly, hourly,per minute or per-call rate.  We alsoprovide licenses to a limited number of our clients for the use of our customercontact software tools that we host.  Inthese arrangements, we charge our client a monthly fee based on the number ofusers.  Revenue under those arrangementsis recognized as the service is provided.

 

Revenues generated fromprofessional and consulting services are recognized as the service is provided,based on time and materials incurred at contractually agreed upon rates.

 

*Credit Risk.* We have established anallowance for doubtful accounts to reserve for uncollectible accountsreceivable.  Each quarter we review thereceivables on an account-by-account basis and determine the probability ofcollection.  Management judgment isexercised in determining the probability of collection. Factors we consider inmaking this judgment are the age of the receivable, the financial resources ofour clients, previous client history and

 

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recent client communications.  Our credit losses have generally been withinour expectations with the exception of a specific reserve we made in fiscal2005 of $475,000 for a financially distressed client.  However, there can be no assurance that ourfuture credit losses will be within our expectations.  In addition, our revenues and accountsreceivable 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 thecollectibility of our accounts receivable and our future operating results.

 

*Stock–BasedCompensation.*Statement of Financial Accounting Standards No. 123, *Accounting for Stock Based Compensation*(SFAS 123), encourages entities to adopt a fair-value-based method ofaccounting for stock options or similar equity instruments.  However, it also allows an entity to continuemeasuring compensation cost for stock based compensation using theintrinsic-value method of accounting prescribed by Accounting Principles BoardOpinion No. 25, *Accounting for StockIssued to Employees* (APB 25). We have elected to continue to apply the provisions of APB 25 andprovide pro forma disclosures required by SFAS 123 in the footnotes to theconsolidated financial statements.  Weuse the Black Scholes option-pricing model to determine the amount ofadditional pro forma expense related to these options as presented in ourdisclosures.  Had we adopted afair-value-based method of accounting for stock options, the pro forma expensefor these options in our disclosures would be recorded as expense in ourstatements of operations and could materially affect our operating results.

 

In April 2003, we repricedcertain of our outstanding employee stock options. We account for stock optionsthat were repriced in accordance with Financial Accounting Standards BoardInterpretation No. 44, *Accounting for CertainTransactions Involving Stock Compensation*, which requires that weadjust the compensation expense we record on these stock options based on themarket price of the Company’s underlying stock until the options are exercised,forfeited or expire.  This adjustment tocompensation expense is done quarterly and can fluctuate significantly due to thevolatility of the market price of our common stock.

 

While we currently have no sucharrangements, we also issue equity-based incentive compensation tonon-employees from time to time. Pursuant to Emerging Issues Task Force 96-18, *Accounting for Equity Instruments that are Issued to Other thanEmployees for Acquiring or in Conjunction with Selling Goods or Services*,we account for these arrangements based on the fair value of the equityinstrument issued.  The fair value ofthese instruments is measured each quarter as the related goods or services areprovided and the underlying securities vest. We use the Black Scholes pricing model to determine the value of theseinstruments.  The resulting quarterlychange in value of these instruments is either charged or credited to incomeand can also fluctuate significantly based on the change in value of theunderlying common stock.

 

**Results of Operations**

 

**Threemonths ended June 30, 2005 compared to three months ended June 30,2004**

 

*Revenues.*  Our revenues increased 33%, or $2,194,000,from $6,567,000 for the three months ended June 30, 2004 to $8,761,000 forthe three months ended June 30, 2005. The primary reason for the increase was $2,626,000 of revenue generatedfrom the operations we acquired from Xtrasource.  In addition, over $1,800,000 of revenuegenerated during the three months ended June 30, 2004 came from contractsthat expired during the prior year.  Wewere able to replace a majority of this revenue in the current fiscal yearthrough both volume growth from existing customers and revenue from newcustomers.

 

*Cost ofSales.*  Our cost ofsales increased $2,221,000, or 38%, from $5,776,000 for the three months ended June 30,2004 to $7,997,000 for the three months ended June 30, 2005.  A significant reason for this increase incost of sales was the increased business as discussed in the revenues section above.  In addition, we incurred costs related to “ramping-up”for projected volume increases from two of our largest customers.  The projects attributable to this projected volumeincrease were delayed until July 2005, resulting in additional costsduring the three months ended June 30, 2004 with no associated revenue.  Another reason for the increase in costs wasabnormally high rent expense due to the inclusion of rent expense from one ofthe facilities that was closed at the end of the quarter, as well as theinclusion of additional rent in our Orem facility needed for anticipated newbusiness.  Our gross profit as a percentageof sales decreased from 12% for the three months ended June 30, 2004 to 9%for the three months ended June 30, 2005 primary due to these “ramp-up”costs.

 

*Product Development*.  We spent $119,000 in product developmentduring the three months ended June 30, 2004.  This product development primarily related toenhancements of our Right-Channeling technology and the

 

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development of our businessintelligence system.  These projects werecompleted during fiscal 2005.  We did notincur product development costs during the three months ended June 30,2005.

 

*Selling,General and Administrative Expenses.*  Our selling, general and administrativeexpenses increased by 128%, or $1,061,000, from $826,000 for the three monthsended June 30, 2004 to $1,887,000 for the three months ended June 30,2005.  This increase was primarily causedby three factors.  The first of thesefactors was the acquisition of Xtrasource.** **The second factor was a plannedincrease in selling and marketing efforts that we believe will help us continueincreasing our revenue.  The third factorwas an increase in costs related to us becoming an international organization****which included professional services relating tointernational law, tax and accounting issues.

 

*Stock-Based Compensation.*  In April 2003, our Board of Directorsapproved an employee stock option exchange program.  Under this program, options to purchase377,342 shares of common stock with exercise prices above $2.00 per share were cancelledin exchange for options to purchase 313,592 shares of common stock at anexercise price equal to the then current market price of $1.60.  This exchange program was considered to be aneffective “repricing” of stock options, which requires us to adjust the amountof compensation expense we recognize each quarter until the stock options areexercised, forfeited or expire (see Note C to our unaudited condensedconsolidated financial statements).  Thecumulative amount of this charge is calculated by multiplying the exercisablenumber of options as of the applicablemeasurement date by the difference between the market price of the stockon such date and the exerciseprice of $1.60, less any amounts previously recognized.

 

Duringthe three months ended June 30, 2005 we recorded a non-cash stock-basedcompensation benefit of $55,000, a $96,000 decrease from $151,000****of non-cash stock-based compensationbenefit that we recorded during the three months ended June 30, 2004.  This decrease was primarily a result of smallerfluctuations in the market value of our common stock from March 31, 2005to June 30, 2005 than the fluctuations in the market value of our commonstock from March 31, 2004 to June 30, 2004.

 

Themarket value of our common stock has fluctuated from $1.60 at April 23,2003, the date of the exchange program approval, to a high of $17.89 during thefirst quarter of our 2005 fiscal year, and to $2.54 as of June 30, 2005.Due to the price volatility of our common stock and the inability to predictwhen and how many stock options will be exercised or cancelled, we cannotproject the impact of options under this exchange program on future quarters.

 

*Amortization of intangible assets.*  Effective October 1, 2004, we acquiredsubstantially all of the assets and operations of Xtrasource.  We allocated the purchase price over theassets acquired, including an allocation of $1,366,000 to intangible assetswhich primarily represent the acquired customer base and the related assignedcontracts.  We have determined that theexpected life of these intangible assets is five years and accordingly, werecorded an expense of $68,000 for the amortization of these intangibles duringthe three months ended June 30, 2005. There was no comparable expense during the three months ended June 30,2004.

 

*Restructuring charge*.  In January 2005 we approved a plan toconsolidate our three Utah contact centers into one “super-center”.  We believe that this consolidation willimprove our utilization of resources and thereby increase our productivity andprofitability.  We stopped using one ofthese facilities in March 2005 and one in June 2005.  In addition, we determined that it was noteconomically viable to reopen our center in Green River, Wyoming that has beenand is currently idle.  Therefore, werecorded $478,000 of restructuring charges relating to the Utah facility closedin June 2005 and the Green River, Wyoming facility.  The charges include accrued facilities andrelocation costs as well as an impairment of approximately $123,000 ofleasehold improvements that were located in the abandoned Utah facility.

 

*Non-CashCharge for Valuation of Warrants*.  This expense relates to recognized chargesfor the value of warrants issued to consultants.  We recognize these costs over the period theconsulting services are provided.  Thiscost was $112,000 for the three months ended June 30, 2004.  There were no warrants issued to or earned byconsultants during the three months ended June 30, 2005.

 

*Incometax expense.*  Incometax expense for the three month period ended June 30, 2005 consists of theprovision for income taxes for our European operations that were acquiredthrough the Xtrasource acquisition.  Eventhough we had a consolidated net loss for the three months ended June 30,2005, our operations are located in different tax jurisdictions and may requirethe payment of income taxes in specific jurisdictions.

 

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**Liquidity and Capital Resources**

 

Our working capital decreased $1,478,000, or 27%, from$5,498,000 at March 31, 2005 to $4,020,000 at June 30, 2005.  Our change in working capital was primarilythe result of a decrease in cash balances of $586,000 from $5,698,000 as of March 31,2005 to $5,112,000 as of June 30, 2005 and a decrease in receivable balancesof $856,000 from $4,326,000 to $3,470,000. The decrease in cash was mainly due to $480,000 of cash used inoperating activities and a $76,000 decrease for the effect of foreign currencytranslations.  The decrease inreceivables was due mainly to a seasonal slow-down during summer months forsome of our larger clients.

 

During the three months ended June 30, 2005, weused $480,000 of cash for operations. While we incurred a net loss from operations of $1,665,000, significantexpense items contributing to the loss such as $510,000 of depreciation andamortization and $478,000 of accrued restructuring charges did not require theuse of cash.   The timing of thecollection of receivables and the payment of accounts payable and accruedliabilities further helped to reduce the amount of cash used in operatingactivities.  We used $767,000 of cash forinvesting in property, and generated $737,000 of cash from financingactivities.

 

EffectiveMarch 31, 2005, we renewed our line of credit with a bank that allows usto borrow up to****$3,000,000 or 80% of eligibleaccounts receivable.  The line of creditaccrues interest at 1% over of the bank’s prime rate (6% as of June 30,2005) and matures on March 31, 2007. As of June 30, 2005, we had $500,000 outstanding against the line.

 

Effective March 31, 2005, we also entered intoa term debt agreement with a bank for equipment financing.  The loan allows for a minimum of $100,000draws with a maximum of $1,000,000 through March 31, 2006.  We are required to make interest onlypayments equal to 1.5% over the bank’s prime rate during the draw-downperiod.  At the end of the draw-downperiod, we will be required to pay monthly installments of principal andinterest over 36 months.  During thethree months ended June 30, 2005, we drew and had outstanding a total of$487,267 on this facility.

 

**Seasonality**

 

Our operating results have historically been affectedby the seasonal variances experienced by some of our significant clients.  Historically, our third and fourth quarters havebeen favorably affected by a significant increase in service requests weexperienced from our support of certain clients’ products.  Going forward, we anticipate that we willcontinue to have seasonal variances.

 

**Risks Related to Existing andProposed Operations**

 

Thereare a number of factors that may affect our operating results, including therisks and uncertainties identified in the following paragraphs.  In addition to other information set forth inthis Report, readers should review and carefully consider the followingfactors.

 

***We have a history of losses and may continue to experiencelosses****.*

 

Weexperienced net losses in four of our last six fiscal years and during our mostrecent quarter ended June 30, 2005 and we had an accumulated deficit of $(13,943,000)as of March 31, 2005.  Although ourcurrent goal is to reach operating profitability by the fourth quarter of thefiscal year ending March 31, 2006, we cannot provide any assurances thatwe will be able to do so and we may continue to incur net losses, particularlyif we lose clients, are unable to attract and retain new clients or do notproperly utilize our resources.  Wecannot ensure that we will be able to achieve or maintain consistent profitableoperations.

 

***Our revenues andquarterly results can be volatile, which makes evaluating our businessdifficult.***

 

Individualclient revenue transactions can constitute a substantial percentage of ourquarterly revenue, and some revenue transactions may generate a substantialportion of the operating profits for a quarter. Our revenues also are a function of the number of support requests wereceive, and the time we spend on such requests.  Thus, if we receive fewer support requeststhan anticipated or the time spent in resolving inquiries is greater thananticipated,

 

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our revenues mayfluctuate.  Further, delays in thereceipt of customer orders can cause significant fluctuations in revenues fromquarter to quarter.

 

Because our staffing and otheroperating expenses are based on anticipated revenue levels, and a highpercentage of our expenses are fixed, the volatility in our revenues can causesignificant variations in operating results from quarter to quarter and we maynot be able to achieve or sustain profitability on a quarterly basis.  In addition, we may expend significantresources pursuing potential sales that will not be consummated.  Furthermore, we may choose to reduce pricesor to increase spending in response to competition or to pursue new marketopportunities, which may adversely affect our operating results.

 

For the reasons identified above,we believe that period-to-period comparisons of our revenues and operatingresults may not be meaningful and should not be considered an indication offuture performance.

 

***Several key clients represent a significant portion of ourrevenues, and the loss of a key client could affect our revenues andprofitability.***

 

Twoclients accounted for approximately 46% of our revenues for the three months endedJune 30, 2005.  These two clientsaccounted for approximately 32% and 14%, respectively, of our revenues for thethree months ended June 30, 2005.  Akey client, who accounted for 28% of revenues in fiscal 2002, cancelled itscontract with us early in fiscal 2003. The loss of this client had a significant negative impact on our revenueand profitability in fiscal 2003 and for the first nine months of fiscal 2004,until we generated replacement business.

 

Someof our clients can generally cancel their contracts on short notice.  It can take a significant amount of time todevelop and obtain new clients and retrain employees to replace revenue from alost client.  Thus, the loss of any ofour key clients could have a significant effect on our revenues andprofitability.  In addition, our futurerevenue growth is dependent upon our ability to attract and retain new clients.

 

***We are subject to credit risks and may be unable to collectour accounts receivable balances.***

 

Weprovide unsecured credit terms to our clients. Based on credit evaluations and other information gathered by ourmanagement, we establish credit terms for each client; however, there can be noassurance that our future credit losses will be consistent with management’sexpectations.  A significant change inthe liquidity or financial condition of one or more key clients, or a largernumber of smaller clients, or further deterioration in the economicenvironment, in general, could have an adverse impact on the collectability ofour accounts receivable and our future operating results.

 

***Implementation of our growth plans will be dependent on ourability to market and sell our services to new and existing clients.***

 

Ourgrowth plans are dependent upon our ability to attract and retain new clientsand to generate additional business from existing clients.  Our efforts to market and sell our serviceswill be affected by fluctuations in technology and industry standards, changesin customer requirements and preferences, increased competition and generaleconomic conditions, among other factors. Many of these factors are beyond our control.  If we are incorrect in our assessment of thefeasibility of our growth plans, if we are not effective in our efforts tomarket and sell our services or if circumstances change in a way that we didnot foresee or anticipate, we may not grow as planned or our growth strategymay have an adverse effect on business operations and our profitability.

 

***Market volatility and fluctuations in our stock price andtrading volume may cause sudden decreases in the value of an investment in ourcommon stock.***

 

The market price of our commonstock has historically been, and we expect it to continue to be, volatile.  This price has ranged between $1.35 and$17.89 during the 27 months ended June 30, 2005.  The market for our common stock has, fromtime-to-time, experienced extreme price and volume fluctuations, which haveoften appeared to be unrelated to our operating performance.  Our stock price also has been affected by ourown public announcements regarding such things as quarterly earnings, changesin clients, obtaining financing and corporate partnerships.  Consequently, events both within and beyondour control may cause shares of our common stock to lose their value rapidly.

 

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***We repriced our employee stock options and may havesignificant volatility in our earnings if our stock price increases ordecreases.***

 

In April 2003,we repriced certain employee and director stock options in an effort to providean adequate incentive to assist in the retention and motivation of ouremployees and directors.  Currentaccounting rules require us to adjust the amount of compensation expensewe recognize in our financial statements for changes in the stock price untilthe stock options are exercised, forfeited or expire.  In fiscal 2004 we recognized expense of$1,562,108 related to our repriced stock options.  In fiscal 2005, we recognized a $346,337benefit due to our stock price being lower at the end of fiscal 2005 versusfiscal 2004.  We also recognized abenefit of $54,527 during the three months ended June 30, 2005 due to adrop in our stock price during that three month period.   If ourstock price is volatile, our future stock compensation charges may affect ourprofitability, either positively or negatively.

 

***Managing the utilization level of our resources is necessaryin order to achieve our desired profitability.***

 

Ourbusiness strategy requires us to fully utilize personnel and physicalfacilities in an effort to increase our profitability.  As we expand our operations, we may notalways be able to manage the level of personnel and facilities to reach ourdesired levels of utilization, which may affect our profitability.  Also, if we lose existing clients, we mayhave excess personnel and physical facilities that would have an adverse effecton our business operations and our profitability.

 

***If we do not keep up with the rapid technological changeexperienced by the customer contact service market, our products and servicesmay become obsolete and we may lose clients.***

 

Thecustomer contact service industry is characterized by rapid technologicalchange, alterations in customer requirements and preferences, and the emergenceof new industry standards and practices. Our operating results and financial condition will depend, in part, onour ability to develop solutions that keep pace with continuing changes ininformation technology, evolving industry standards, and changing clientrequirements.  There can be no assurancethat we will be successful in adequately addressing these developments on atimely basis or that, if these developments are addressed, we will besuccessful in the marketplace.  Inaddition, products or technologies developed by others could render ourservices non-competitive or obsolete. Our failure to address these developments could have a material negativeeffect on our business and financial condition.

 

***We are susceptible tobusiness and political risks from international operations that could result inreduced revenues or earnings.***

 

We operate businesses or havecontractual relationships in the Netherlands, France and India and are lookingto expand in other countries. Additionally, there is increasing demand for offshore customer careoutsourcing capacity from North American companies.  Expansion of our existing internationaloperations and entry into additional countries will require managementattention and financial resources.  Inaddition, there are certain risks inherent in conducting businessinternationally including: exposure to currency fluctuations, longer paymentcycles, greater difficulties in accounts receivable collection, difficulties incomplying with a variety of foreign laws, unexpected changes in legal orregulatory requirements, difficulties in staffing and managing foreignoperations, political instability and potentially adverse taxconsequences.  To the extent we do notmanage our international operations successfully, our business could be adverselyaffected and our revenues and/or earnings could be reduced.

 

***Volatile economic conditions have affected and will likelycontinue to affect our operations and financial results.***

 

Volatileeconomic conditions have adversely affected our operations and financialresults.  In certain sectors serviced byus in recent years, economic slowdowns have caused us to lose some clients andalso resulted in increased pricing pressures and lower call volumes from someexisting clients.  Slower economicconditions may limit our ability to attract new clients or retain existingclients.  The slower economy alsoresulted in excess capacity to service call volumes.  A substantial percentage of our expenses areattributable to labor costs associated with staffing Customer Contact SolutionsCenters, which we may not be able to significantly reduce on short notice inorder to compensate for unexpected shortfalls in call volumes.  We cannot forecast future fluctuations ineconomic conditions, and our operations and financial results may be materiallyand adversely affected by economic volatility.

 

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***If companies reduce their reliance on outsourced services,our revenues and financial condition may be adversely affected.***

 

Ourbusiness depends in large part on the trend within the IT industry to outsourcecertain services.  We cannot provide anyassurance that this trend will continue or that, if the trend continues, itwill continue at the same rate of growth. The failure of this trend to continue could have a material adverseeffect on our business, financial condition, and results of operations.

 

***Competitive pressures could harm our financial performance.***

 

Themarket for customer contact services is highly fragmented and very competitive.  In certain segments of the industry, however,the customer contact services industry has begun to experience a degree ofconsolidation, and the development of major customer contact center companieshas resulted in an additional level of competition from service providers thathave greater name recognition, larger installed customer bases, andsignificantly greater financial, technical, and marketing resources than wehave.  Large established enterprise softwarecompanies may leverage their existing relationships and capabilities to offercustomer service applications.  In otherinstances, many large companies provide their own in-house customer caresupport and customer training.  Also, anumber of existing companies have experienced rapid internal growth, andseveral of these companies have been active in acquiring smaller regionalcustomer contact services companies and are becoming major competitors with ameasurable share of this rapidly expanding market.  If our competitors provide more efficient orless expensive services, we may lose market share and revenues.

 

***We may be unable to attract, train and retain keymanagement, technical and marketing personnel.***

 

Oursuccess will depend, in large part, on our ability to attract, retain and trainhighly qualified technical, managerial and marketing personnel with theexpertise required to successfully conduct our operations.  We have entered into employment agreementswith certain of our key managerial personnel; however, those agreements aresubject to termination under various circumstances and we have not entered intoemployment agreements with any of our key technical personnel other than ourChief Technology Officer. If we lose any key personnel or are unable toattract, retain, train or motivate qualified personnel, our business operationsand financial condition may be materially and adversely affected.

 

***A failure of our computers, telecommunications equipment orsoftware systems could interrupt our ability to provide our services****.*

 

Ourbusiness depends to a large extent on computers, telecommunications equipmentand software systems (both equipment and systems maintained by us and equipmentand systems maintained by third parties). A natural disaster, human error, equipment malfunction or inadequacy ormultiple other events could result in a prolonged interruption in our abilityto provide support services to clients or their customers.  The temporary or permanent loss of computeror telephone equipment or systems, through casualty, operating malfunctions orotherwise, could have a material adverse effect on our operations, property orfinancial condition, and business interruption insurance may not be adequate tocompensate for all losses that may be incurred.

 

***We rely on a third-party software company for our chat andemail applications*.**

 

Wecontract with a third-party software company to provide chat and email toolsused with our CRM software, reporting and management services.  If this software company fails in itsbusiness efforts, we may lose our access to these software tools.  Our failure to obtain adequate replacementsoftware tools would cause us to experience service delays, interruptions orcancellations.

 

***Provisions of ourArticles of Incorporation, Bylaws and Shareholder Rights Plan could impair ordelay shareholders’ ability to replace or remove our management and coulddiscourage takeover transactions that shareholders might consider to be intheir best interests.***

 

Our Articles of Incorporation andBylaws, the Utah Revised Business Corporation Act, and the Utah Control SharesAcquisition Act each contain certain provisions that may have the effect ofinhibiting a non-negotiated merger or other business combination.  Our Articles of Incorporation grant to ourBoard of Directors the authority, without further action by our shareholders,to fix the rights and preferences of, and issue shares of

 

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preferred stock.  Ourrecently adopted Bylaws provide advance notice requirements that may limitthe opportunity for our shareholders to advance nominees for election to ourBoard of Directors or submit matters from the floor at our meetings of ourshareholders. In addition, our Board of Directors has adopted a ShareholderRights Plan which imposes constraints on transactions which could result in achange of control of Sento.  These provisions may deterhostile takeovers or delay or prevent changes in control of Sento or changes inour management, including transactions in which shareholders might otherwisereceive a premium for their shares over the then-current market prices.  In addition, these provisions may limit theability of our shareholders to approve transactions that they may deem to be intheir best interests.

 

***We have never declared adividend on our common stock and we do not anticipate paying dividends in theforeseeable future.***

 

No dividends have ever beendeclared or paid on our common stock.  Weintend to retain any future earnings for use in our business and do notanticipate paying any dividends on our common stock in the foreseeable future.

 

Item 3.             Controlsand Procedures

 

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”) of the effectiveness of our disclosure controls and procedures, as of June 30, 2005. Based on that evaluation, our management, including our CEO and CFO, concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported as specified in the SEC’s rules and forms.  Our management, including our CEO and CFO, also supervised and participated in an evaluation of any changes in internal controls as of the end of the period covered by this report and that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.  Based on that evaluation, our executive management, including our CEO and our CFO, concluded that there had been no changes to our internal controls that would have had a material affect over the financial reporting for the quarter ending June 30, 2005.

 

# **PART II.**                                                 OTHER INFORMATION

 

Item 2.             RecentSales of Unregistered Securities and Use of Proceeds

 

There were no sales ofunregistered securities during the three months ended June 30, 2005.  However, during the three months endedJune 30, 2005, we purchased the following shares of our common stock:

 

| **Period**                      | ** ** | **Total number  of shares  purchased** | ** ** | **Average  price paid  per share** | ** ** | **Total number  of  shares purchased  as part of publicly  announced plan** | ** ** | **Maximum  number  of shares that may  yet be purchased  under the plan** | ** ** |
|---------------------------------|------------|----------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| Month ended April 30, 2005 |       | 16,938                                 |       | $                                  | 3.30       |                                                                        | 76,737     |                                                                      | 309,293    |   |
| Total                           |       | 16,938                                 |       | $                                  | 3.30       |                                                                        | 76,737     |                                                                      | 309,293    |   |

 

Item 6.             Exhibits

 

Exhibits31.1 and 32.1 – Certifications of the Company’s Chief Executive Officer

Exhibits31.2 and 32.2 – Certifications of the Company’s Chief Financial Officer

 

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SIGNATURES

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,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/ ANTHONY J.  SANSONE |   |
|   |               | Anthony J.  Sansone |
|   |               | Senior Vice  President, Chief Financial Officer and Secretary |
|   |               | (Principal  financial and accounting officer) |
|        |                    |  |  |  |

 

Dated August 12,2005.

 

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