**United StatesSecurities and Exchange 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 September 30, 2004** |
|                                         |       |                                                                                          |
| **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 area code:  **(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:

 

|                 |   | Outstanding at   |
|----------------------|--------|------------------|
| Class                |   | October 31, 2004 |
| Common capital stock |   | 3,791,270        |
| $.25 par value       |   |             |
|                 |   |             |

 

Transitional Small BusinessDisclosure Format (check one):

 

Yes o  No ý

 

 

----

 

**SENTO CORPORATION**Quarterly Report on Form 10-QSBQuarter ended September 30, 2004

 

 

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                                     |   |
|                                                                                 |   |
| Notes to Condensed Consolidated Financial  Statements                                |   |
|                                                                                 |   |
| Item 2.  Management’s Discussion  and Analysis or Plan of Operations. |   |
|                                                                                 |   |
| 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.  Unregistered Sales of  Equity Securities and Use of Proceeds      |   |
|                                                                                 |   |
| Item  6.  Exhibits                                                         |   |
|                                                                                 |   |
| SIGNATURES                                                                           |   |

 

i

----

 

PART I —FINANCIAL INFORMATION

Item 1.    Financial Statements

 

**SENTO CORPORATION**

**AND SUBSIDIARY**

** **

**Condensed Consolidated Balance Sheets**

 
| ** **                                                 | ** ** | **September 30, 2004** | ** ** | **March 31, 2004** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|--------------------|------------|
| ** **                                                 | ** ** | **(Unaudited)**        | ** ** | ** **         | ** ** |
| **ASSETS**                                                 |       |                   |       |               |       |
| ** **                                                 |       |                   |       |               |       |
| Current assets:                                            |       |                   |       |               |       |
| Cash                                                       |       | $                      | 6,860,645  |               | $          | 6,567,811 |   |
| Accounts receivable, net                                   |       | 2,749,594              |       | 4,632,111          |       |
| Other current assets                                       |       | 464,487                |       | 456,182            |       |
| Total current assets                                       |       | 10,074,726             |       | 11,656,104         |       |
|                                                       |       |                   |       |               |       |
| Property and equipment, net                                |       | 4,377,190              |       | 4,220,560          |       |
| Other assets                                               |       | 185,877                |       | 132,896            |       |
| Total Assets                                               |       | $                      | 14,637,793 |               | $          | 16,009,560 |   |
|                                                       |       |                   |       |               |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**             |       |                   |       |               |       |
|                                                       |       |                   |       |               |       |
| Current liabilities:                                       |       |                   |       |               |       |
| Current portion of long-term debt and  capital leases      |       | $                      | 814,234    |               | $          | 728,357 |   |
| Accounts payable                                           |       | 1,050,128              |       | 1,334,409          |       |
| Accrued liabilities and other                              |       | 1,456,353              |       | 2,394,204          |       |
| Total current liabilities                                  |       | 3,320,715              |       | 4,456,970          |       |
|                                                       |       |                   |       |               |       |
| Long-term debt and capital leases, net of  current portion |       | 943,768                |       | 656,324            |       |
| Total liabilities                                          |       | 4,264,483              |       | 5,113,294          |       |
|                                                       |       |                   |       |               |       |
| Stockholders’ equity:                                 |       |                   |       |               |       |
| Common stock                                               |       | 940,318                |       | 863,225            |       |
| Additional paid-in capital                                 |       | 20,622,429             |       | 20,512,919         |       |
| Accumulated deficit                                        |       | (11,189,437            | )          | (10,479,878        | )          |
| Total stockholders’ equity                            |       | 10,373,310             |       | 10,896,266         |       |
| Total Liabilities and Stockholders’ Equity            |       | $                      | 14,637,793 |               | $          | 16,009,560 |   |

 

*Seeaccompanying notes.*

 

1

----

 

**SENTO CORPORATIONAND SUBSIDIARY**

** **

**Condensed Consolidated Statements of Operations****(Unaudited)**

 
| ** **                                                                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                    | ** ** | **September 30,**      | ** ** | **September 30,**    | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                                    | ** ** | **2004**               | ** ** | **2003**             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                          |       |                   |       |                 |       |   |   |   |   |
| Revenue                                                                                       |       | $                      | 6,168,960  |                 | $          | 4,085,034 |   | $ | 12,735,708 |   | $ | 8,239,665 |   |
|                                                                                          |       |                   |       |                 |       |   |   |   |   |
| Cost of sales                                                                                 |       | 5,639,975              |       | 3,742,276            |       | 11,415,927 |   | 7,695,432 |   |
|                                                                                          |       |                   |       |                 |       |   |   |   |   |
| Gross profit                                                                                  |       | 528,985                |       | 342,758              |       | 1,319,781 |   | 544,233 |   |
|                                                                                          |       |                   |       |                 |       |   |   |   |   |
| Product development                                                                           |       | 114,963                |       | —               |       | 233,976 |   | — |   |
| Selling, general and administrative  expenses                                                 |       | 911,623                |       | 663,586              |       | 1,738,104 |   | 1,264,933 |   |
| Non-cash charge for valuation of warrants                                                     |       | 74,909                 |       | —               |       | 186,501 |   | — |   |
| Stock-based compensation expense (benefit)                                                    |       | (15,659                | )          | 35,341               |       | (166,408 | ) | 49,558 |   |
| Operating loss                                                                                |       | (556,851               | )          | (356,169             | )          | (672,392 | ) | (770,258 | ) |
|                                                                                          |       |                   |       |                 |       |   |   |   |   |
| Non-cash charge for valuation of warrants  and conversion of debentures                       |       | (3,069                 | )          | (46,154              | )          | (7,326 | ) | (102,546 | ) |
| Other income (expense), net                                                                   |       | 5,031                  |       | (75,583              | )          | (29,841 | ) | (144,691 | ) |
| Net loss                                                                                      |       | (554,889               | )          | (477,906             | )          | (709,559 | ) | (1,017,495 | ) |
| Deemed divided as a result of warrant  modification                                           |       | —                 |       | —               |       | (37,875 | ) | — |   |
| Net loss attributable to common  stockholders                                                 |       | $                      | (554,889   | )                    | $          | (477,906 | ) | $ | (747,434 | ) | $ | (1,017,495 | ) |
|                                                                                          |       |                   |       |                 |       |   |   |   |   |
| Basic and diluted net loss per share                                                          |       | $                      | (0.15      | )                    | $          | (0.21 | ) | $ | (0.20 | ) | $ | (0.46 | ) |
|                                                                                          |       |                   |       |                 |       |   |   |   |   |
| Basic and diluted weighted average number  of common and common equivalent shares outstanding |       | 3,732,326              |       | 2,270,162            |       | 3,680,006 |   | 2,201,695 |   |

 

*Seeaccompanying notes.*

 

2

----

 

**SENTO CORPORATION**

**AND SUBSIDIARY**

 

**Condensed Consolidated Statements of Cash Flows****(Unaudited)**

 
| ** **                                                                          | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                          | ** ** | **September 30,**    | ** ** | **September 30,** | ** ** |
| ** **                                                                          | ** ** | **2004**             | ** ** | **2003** | ** ** |
| Cash flows from operating activities:                                               |       |                 |       |   |   |
| Net loss                                                                            |       | $                    | (709,559   | ) | $ | (1,017,495 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities:    |       |                 |       |   |   |
| Depreciation and amortization                                                       |       | 799,944              |       | 831,643 |   |
| Accretion of debenture for warrant and  revaluation of warrants issued for services |       | 193,827              |       | 102,546 |   |
| Stock-based compensation                                                            |       | (166,408             | )          | 49,558 |   |
| Changes in operating assets and  liabilities:                                       |       |                 |       |   |   |
| Accounts receivable                                                                 |       | 1,882,517            |       | 311,610 |   |
| Other assets                                                                        |       | (82,095              | )          | (61,642 | ) |
| Accounts payable                                                                    |       | (284,281             | )          | (234,461 | ) |
| Accrued liabilities and other                                                       |       | (365,681             | )          | 120,203 |   |
| Net cash provided by operating activities                                           |       | 1,268,264            |       | 101,962 |   |
| Cash flows used in investing activities:                                            |       |                 |       |   |   |
| Purchase of property and equipment                                                  |       | (778,629             | )          | (330,362 | ) |
| Cash flows from financing activities:                                               |       |                 |       |   |   |
| Principal payments on long-term debt and  debentures                                |       | (510,093             | )          | (1,292,721 | ) |
| Net borrowings under line of credit                                                 |       | —               |       | 664,934 |   |
| Issuance of long-term debt and debentures                                           |       | 720,173              |       | 540,000 |   |
| Payment of accrued offering costs                                                   |       | (627,364             | )          | — |   |
| Proceeds from stock options exercised                                               |       | 180,617              |       | 7,298 |   |
| Proceeds from stock issued through employee  stock purchase plan                    |       | 39,866               |       | — |   |
| Net cash used in financing activities                                               |       | (196,801             | )          | (80,489 | ) |
| Net increase (decrease) in cash                                                     |       | 292,834              |       | (308,889 | ) |
| Cash at beginning of period                                                         |       | 6,567,811            |       | 2,583,337 |   |
| Cash at end of period                                                               |       | $                    | 6,860,645  |   | $ | 2,274,448 |   |
|                                                                                |       |                 |       |   |   |
| Supplemental disclosures of cash flow  information                                  |       |                 |       |   |   |
| Cash paid for:                                                                      |       |                 |       |   |   |
| Interest                                                                            |       | $                    | 58,241     |   | $ | 115,463 |   |
|                                                                                |       |                 |       |   |   |
| Non-cash investing and financing  activities:                                       |       |                 |       |   |   |
|                                                                                |       |                 |       |   |   |
| Value of warrants issued with long-term  debt and convertible debentures            |       | $                    | —     |   | $ | 179,849 |   |
| Value of warrants issued to placement agent                                         |       | —               |       | 36,031 |   |
| Conversion of debentures (including accrued  interest of $7,483)                    |       | —               |       | 383,554 |   |
| Equipment financed through long-term note                                           |       | 157,136              |       | 23,790 |   |

 

*Seeaccompanying notes.*

 

3

----

 

**SENTO CORPORATION**

**AND SUBSIDIARY**

** **

**Notes to Condensed Consolidated Financial Statements**

**September 30, 2004**

**(Unaudited)**

 

 

A.                                   BASIS OFPRESENTATION

 

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

 

Operating results for the three and six months ended September 30, 2004are not necessarily indicative of the results that may be expected for the fullfiscal year.  The unaudited condensedconsolidated financial statements should be read in conjunction with theaudited consolidated financial statements and footnotes thereto included in theCompany’s Annual Report on Form 10-KSB/A for the year ended March 31, 2004.

 

The Company has adopted the footnote disclosure provisions of Statementof Financial Accounting Standards No. 123, *Accounting for StockBased-Compensation* (SFAS 123). 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 Stock Issued to Employees*(APB 25).  The Company has elected tocontinue to apply the provisions of APB 25 and provide pro forma footnotedisclosures required by SFAS 123, which has been determined as if the Companyhad accounted for its employee stock 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 3.4 percent, expected life of 5 years, and expected stock-price volatilityof 75 percent.

 

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 net losswould have been changed to the pro forma amounts indicated below for the threeand six months ended September 30, 2004:

 
| ** **                                    | ** **  | ** ** | ** ** | **Three Months** | ** ** | **Six Months** | ** ** |
|-----------------------------------------------|-------------|------------|------------|------------------|------------|----------------|------------|
| Net loss attributable to common  stockholders | As reported |       | $          | (554,889         | )          | $              | (747,434   | ) |
|                                          | Pro forma   |       | $          | (664,377         | )          | $              | (1,010,454 | ) |
| Basic and diluted loss per share              | As reported |       | $          | (0.15            | )          | $              | (0.20      | ) |
|                                          | Pro forma   |       | $          | (0.18            | )          | $              | (0.27      | ) |

 

The full impact of calculating compensation cost for stock optionsunder SFAS 123 may not be representative of the effects on reported net lossfor future years.

 

 

B.                                     LONG-TERM DEBT ANDCAPITAL LEASES

 

On May 11, 2004, the Company refinanced itsline of credit and existing term loans with a bank, wherein the line of creditwas renewed and the three existing term loans were combined into one termloan.  The line of credit was increasedfrom a maximum of $2,500,000 to $3,000,000 (subject to a limit of 80% of

 

4

----

 

eligible accounts receivable), has an interest rate equal to the bank’sprime rate plus 1% and has a two-year term, including provisions for annualextension, subject to the approval of the bank. The line of credit terms also contain an annual commitment fee of0.75%.  The new term loan for $750,000includes the repayment of the three existing term loans plus $316,140 inadditional equipment financing.  Theterms of this loan include a 1.0% commitment fee, an interest rate of 7.4%,monthly payments of $23,260 including interest, and a term of three years.

 

The Company also has a commitment from thebank for a term loan of up to $1,500,000 for future equipment financing.  The Company may take advances on this loan ina minimum amount of $100,000 through March 31, 2005. The underlying term loanswill have a term of three years, will require monthly principal and interestpayments, have a fixed interest rate determined at the date of the advancebased on the three-year U.S. Treasury Bond rate plus 4.5%, and have acommitment fee of 1%.  During the sixmonths ended September 30, 2004, the Company was advanced $404,033 under thisterm loan.

 

Duringthe six months ended September 30, 2004, the Company purchased $157,136 ofsoftware under a note payable.  The notecalls for quarterly payments of $13,773 through April 2007.

 

C.            COMMON STOCK

 

Six months endedSeptember 30, 2004

 

Duringthe six months ended September 30, 2004, options to purchase 127,462 shares ofcommon stock were exercised and 14,820 shares of common stock were purchased byemployees under the Company’s Employee Stock Purchase Plan.

 

Duringthe six months ended September 30, 2004, warrants to purchase 204,250 shares ofcommon stock were exercised under cashless provisions of the underlying warrantagreements resulting in the Company issuing 167,853 shares of common stock.

 

OnApril 23, 2003, the Company’s Board of Directors approved an employee stockoption exchange program (the “Exchange Program”), pursuant to which the Companygranted options to purchase 313,592 shares of the Company’s common stock at anexercise price of $1.60 per share in exchange for 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 withFASB Interpretation No. 44, *Accounting for CertainTransactions Involving Stock Compensation* (“Interpretation 44”).  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 Company’s common stock andis calculated as the difference between the fair market value of the commonstock and $1.60 (the market price at April 23, 2003, which was the effectivedate of the exchange).  This compensationadjustment must be recorded on a quarterly basis until the new options issuedunder the Exchange Program are exercised, forfeited or expire unexercised.  During the six months ended September 30,2004, the Company recorded $166,408 of stock-based compensation benefit forthese options since the value of the Company’s common stock decreased betweenMarch 31, 2004 and September 30, 2004.

 

Theimpact of the new options issued under the Exchange Program on the Company’sconsolidated financial statements will depend on quarterly fluctuations in theprice of the Company’s common stock and the dates of exercises, forfeitures orcancellations of the new options. 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 (benefit) related to these options that it will incur inany future period.  As of September 30,2004, options to purchase 149,098 shares of common stock remain outstandingunder the Exchange Program.

 

In January 2004, the Company entered into a two­—year consultingagreement with terms that required the Company to issue the consultant warrantsto purchase 5,000 shares of common stock each month.  As of September 30, 2004 warrants to purchase45,000 shares of common stock were outstanding under this agreement, of which,warrants to purchase 30,000 shares of common stock were issued during the sixmonths ended September 30, 2004. The warrants vest 25% every three months fromthe date of

 

5

----

 

issuance, havea term of three and one-half years, and have an exercise price of $3.00 pershare.  The consulting agreement can beterminated by either party****upon 60 days written notice,subject to various cancellation provisions. During the six months ended September 30, 2004, the Company recorded$186,501 of expense for the value of warrants issued during the six-monthperiod.  The agreement with thisconsultant was terminated in October 2004. Under the termination provisions of the agreement, the Company issuedwarrants to purchase an additional 15,000 shares of common stock in October2004.

 

Effective May 21, 2004, the Company’s board of directors modifiedcertain warrants to extend the expiration date from May 31, 2004 to August 31,2004.  The value of this warrantmodification, as determined using the Black-Scholes valuation model, was$37,875 (which is the difference between the value of the original warrantsimmediately 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. As of September 30, 2004, all of these warrants had expired.

 

Six months endedSeptember 30, 2003

 

Duringthe six months ended September 30, 2003, options to purchase 4,561 shares ofcommon stock were exercised.

 

Additionalpaid-in-capital increased $215,872 relating to the warrants issued inconjunction with convertible debentures. In addition, debentures with a face value of $376,695, together withassociated accrued interest of $6,859, were converted into 219,167 shares ofthe Company’s common stock.

 

                During thesix months ended September 30, 2003, the Company recorded $49,558 ofstock-based compensation for options under the above-mentioned ExchangeProgram.

 

D.            LOSS PER SHARE

 

Lossper share is computed in accordance with Financial Accounting Standards BoardStandard 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 285,592 and 345,455 shares of common stock, respectively,have not been included in the calculation of diluted common stock outstandingfor the three and six months ended September 30, 2004, because to do so wouldbe anti-dilutive.  Options and warrantsto purchase 204,156 and 111,354 shares of common stock, respectively, have notbeen included in the calculation of diluted common stock outstanding for thethree and six months ended September 30, 2003, because to do so would beanti-dilutive.  Shares issuable pursuantto convertible debentures (345,934 shares as of September 30, 2003) have notbeen included in the calculations of diluted common stock outstanding for the threeand six months ended September 30 2003, as to do so would be anti-dilutive.

 

Thefollowing tables set forth the computation of basic and diluted loss per sharefor the three and six months ended September 30, 2004 and September 30, 2003:

 
| ** **                                                                     | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                     | ** ** | **September 30, 2004** | ** ** | **September 30, 2003** | ** ** |
|                                                                           |       |                   |       |   |   |
| Net loss attributable to common  stockholders                                  |       | $                      | (554,889   | ) | $ | (477,906 | ) |
| Denominator for basic and diluted net loss  per share -weighted average shares |       | 3,732,326              |       | 2,270,162 |   |
|                                                                           |       |                   |       |   |   |
| Basic and diluted net loss per share                                           |       | $                      | (0.15      | ) | $ | (0.21 | ) |

 

6

----

 
| ** **                                                                     | ** ** | **Six  Months Ended**  | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                     | ** ** | **September 30, 2004** | ** ** | **September  30, 2003** | ** ** |
|                                                                           |       |                   |       |   |   |
| Net loss attributable to common  stockholders                                  |       | $                      | (747,434   | ) | $ | (1,017,495 | ) |
| Denominator for basic and diluted net loss  per share -weighted average shares |       | 3,680,006              |       | 2,201,695 |   |
|                                                                           |       |                   |       |   |   |
| Basic and diluted net loss per share                                           |       | $                      | (0.20      | ) | $ | (0.46 | ) |

##  

E.             SUBSEQUENT EVENTS

 

                On November 5, 2004, the Company entered into an Asset Purchase Agreement with Xtrasource, Inc. (“Xtrasource”), a non-affiliated, privately-held Delaware corporation, pursuant to which the Company, through its wholly-owned subsidiary, Xtrasource Acquisition, Inc., a Delaware corporation, proposes to acquire substantially all of Xtrasource’s assets related to Xtrasource’s approximately $10 million annual sales business.  The purchase price is anticipated to include the assumption of net liabilities of approximately $500,000 and a contingent earn-out payment of 30% of EBITDA through September 30, 2009 up to a maximum of $6.5 million.  Xtrasource is a call center provider with facilities in the United States, the Netherlands and France, offering integrated customer solutions, including help desk, technical assistance, and live web chat.  The closing of the proposed aquisition, which remains subject to certain customary conditions including due diligence review, is scheduled for November 30, 2004.  See the Company’s report on Form 8-K filed October 8, 2004 for a more detailed description of the proposed acquisition transaction.

 

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

 

**Overview**

 

SentoCorporation (“**Sento***,*” “**we**,” “**us**” or the “**Company**”)is a leading provider of outsourced customer care and sales support services,managing customer relationships for a growing number of high-profile companiesacross multiple industries.  Through ourCustomer Choice Platform, an integrated suite of multi-channel CRMtechnologies, customers are given a choice of self-service and assisted-serviceoptions — via web, e-mail, chat and phone — for increased customer satisfactionwith significant cost savings to Sento’s clients when compared to traditionalmodels.  We provide this support in 17languages. We conduct our principal business operations through ourwholly-owned subsidiary, Sento Technical Services Corporation.

 

We believethat a significant issue currently facing our company relates to the variablepricing of a significant number of our outstanding employee stock options.  In April 2003, we repriced the majority ofthe then outstanding employee stock options to the then current market price of$1.60 per share.  This repricing was doneto give our employees incentive to grow revenues and improve profitability,with the objective of increasing stockholder value.  We believe this repricing contributed in alarge part to our improved operating results during the fiscal year ended March31, 2004.  Under accounting principlesgenerally accepted in the United States (“**GAAP**”),we are 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 ofincreasing stock prices we may record a significant amount of non-cashcompensation expense.  Conversely, if ourstock price falls in a future period, we may subsequently reverse a portion ofthe expense previously 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 and six months ended September 30, 2004, we recognized non-cashcompensation benefits of $15,659 and $166,408, respectively.  During the three and six months endedSeptember 30, 2003, we recognized net non-cash compensation expense of $35,341and $49,558, respectively.  Thesenon-cash benefits and expense charges reflect adjustments to the value of theoptions due to the changes in market price of our common stock above theexercise price of $1.60 per share.  SeeNote C to our unaudited condensed consolidated financial statements.

 

7

----

 

Because theactual 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 be 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 agreement withRemsen Funding Corporation of New York (“Remsen”), we have agreed to issue toRemsen, as partial consideration for consulting services, a warrant to purchase5,000 shares of our common stock each month during the term of the agreement,which is terminable by either party at any time upon sixty days advance notice.  Through October 31, 2004, we have issued toRemsen 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 have also granted the warrant holder piggyback registration rightswith respect to any registration (other than on Form S-4 or Form S-8) thatpermits the registration of secondary sales. This agreement was terminatedOctober 31, 2004.

 

We will recognize expense based on the fairvalue of the warrants over the period which the consulting services areprovided.  Because the fair value of thewarrants changes based on the changes in the underlying value of the commonstock, the expense related to this agreement could increase or decreasesignificantly based on the changes in the value of the our common stock.

 

Effective May21, 2004, our board of directors modified certain warrants to extend theexpiration 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 any additional stated or unstated rights,privileges, or agreements to the Company. Accordingly, this transaction hasbeen reflected as a “deemed dividend as a result of warrant modification” onour accompanying statement of operations and in determining net lossattributable to common stockholders.

 

OnNovember 5, 2004, we entered into an asset purchase agreement with Xtrasource,Inc. (“Xtrasource”), a nonaffiliated, privately-held Delaware corporation.  We will acquire substantially all ofXtrasource’s assets related to Xtrasource’s approximately $10 million annualsales under this agreement.  The purchaseprice is anticipated to include the assumption of net liabilities ofapproximately $500,000 and a contingent earn-out payment of 30% of EBITDAthrough September 30, 2009 up to a maximum of $6.5 million.  Xtrasource is a call center provider withfacilities in the United States, the Netherlands and France, offeringintegrated customer solutions, including help desk, technical assistance, andlive web chat.  The closing of thisagreement remains subject to certain standard conditions including duediligence review and is scheduled for no later than November 30, 2004.

 

**CriticalAccounting Policies**

 

Oursignificant accounting policies are described in Note 2 to our ConsolidatedFinancial Statements for the year ended March 31, 2004. Those financialstatements were prepared in accordance with accounting principles generallyaccepted in the United States and are included in our Form 10-KSB, as amended,which has been filed with the Securities and Exchange Commission.  Included within these policies are our “criticalaccounting policies.”  Criticalaccounting policies are those policies that are most important to thepreparation of our consolidated financial statements and require management’ssubjective and complex judgments due to the need to make estimates about theeffect of matters that are inherently uncertain.  Our critical accounting policies relate torevenue recognition, credit risk and stock-based compensation.  The application of these accounting policiesinvolves the exercise of judgment and the use of assumptions as to futureuncertainties, and as a result, actual results will differ, and could differmaterially, from such estimates.

 

Thedevelopment and selection of these critical accounting policies have beendiscussed, and are reviewed each year, with the Audit Committee of our Board ofDirectors.

 

8

----

 

*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.  Wealso provide licenses to a limited number of our clients for the use of ourcustomer contact software tools that we host. In these arrangements, we charge our client a monthly fee based on thenumber of users.  Revenue under thosearrangements is recognized as the service is provided.

 

Revenues generated from professional andconsulting services are recognized as the service is provided, based on timeand materials incurred at contractually agreed upon rates.

 

*Credit Risk.* We haveestablished an allowance for doubtful accounts to reserve for uncollectibleaccounts receivable.  Each quarter wereview the receivables on an account-by-account basis and determine the probabilityof collection.  Management judgment isused 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 recent client communications.  Our credit losses have generally been withinour expectations, however, there can be no assurance that our future creditlosses will be within our expectations. In addition, our revenues and accounts receivable are concentrated in arelatively few number of customers.  Asignificant change in the liquidity or financial position of any one of thesecustomers or a further deterioration in the economic environment, in general,could have an adverse impact on the collectability of our accounts receivableand our future operating results.

 

*Stock —BasedCompensation.* Statement of Financial AccountingStandards No. 123, *Accounting for Stock BasedCompensation* (SFAS 123), encourages entities to adopt a fair valuebased 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 Accounting PrinciplesBoard Opinion 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 a fair valuebased method of accounting for stock options, the pro forma expense for theseoptions in our disclosures would be recorded as expense in our statements ofoperations and could materially affect our operating results.

 

In April 2003,we repriced certain of our outstanding employee stock options. We account forstock options that were repriced in accordance with FASB Interpretation No. 44 *Accounting for Certain Transactions Involving Stock Compensation*(“Interpretation 44”), which requires that we adjust thecompensation expense we record on these stock options based on the market priceof our underlying common stock until the options are exercised, forfeited orexpire.  This adjustment to compensationexpense is done quarterly and can fluctuate significantly due to the volatilityof the market price of our common stock.

 

We also issueequity-based incentive compensation to non-employees from time to time.  Pursuant to Emerging Issues Task Force (EITF)96-18, *Accounting for Equity Instruments that are Issuedto Other than Employees for Acquiring or in Conjunction with Selling Goods orServices*, we account for these arrangements based on the fair valueof the equity instrument issued.  Thefair value of these instruments is remeasured each quarter as the related goodsor services are provided and the underlying securities vest.  We use the Black Scholes pricing model todetermine the value of these instruments. The resulting quarterly change in value of these instruments is eithercharged or credited to income and can also fluctuate significantly based on thechange in value of the underlying common stock.

 

**Results of Operations**

** **

**Threemonths ended September 30, 2004 compared to three months ended September 30,2003**

 

*Revenues.*  Our revenues increased 51%, or $2,084,000,from $4,085,000 for the three months ended September 30, 2003 to $6,169,000 forthe three months ended September 30, 2004. The primary reason for the increase was $2,591,000 of revenue generatedfrom four new clients.

 

9

----

 

*Cost ofSales.*  Our costof sales increased $1,898,000, or 51%, from $3,742,000 for the three monthsended September 30, 2003 to $5,640,000 for the three months ended September 30,2004.  This increase in cost was a resultof increased business as discussed in the revenue section above.  Our gross profit as a percentage of salesincreased to 9% for the three months ended September 30, 2004 from 8% for thethree months ended September 30, 2003. This improved gross profit percentage was due mainly to higherutilization of our capacity with increased business.  However, the efficiencies we realized frombetter utilization of our capacity were adversely impacted by upfront trainingand labor costs totaling $79,000 associated with the increase in new andexisting business.

 

*Product Development*.  We spent $115,000 in product developmentduring the three months ended September 30, 2004.  We believe that this product development isnecessary for anticipated new business and to enhance our productofferings.  We incurred no significantproduct development costs during the three months ended September 30, 2003.

 

*Selling,General and Administrative Expenses.*  Our selling, general and administrativeexpenses increased by 37%, or $248,000, from $664,000 for the three monthsended September 30, 2003 to $912,000 for the three months ended September 30, 2004.  This increase was primarily due to anincrease in payroll costs to respond to increased demand for Sento products andservices.  However, as a percentage ofrevenue, our selling, general and administrative expenses decreased from 16% ofrevenue during the three months ended September 30, 2003 to 15% of revenueduring the three months ended September 30, 2004.

 

*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 wereexchanged for options to purchase 313,592 shares of common stock at an exerciseprice 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 condensed consolidatedfinancial statements).  The cumulativeamount of this charge is calculated by multiplying the exercisable number ofoptions by the difference between the market price of the stock and theexercise price of $1.60, less any amounts previously recognized.

 

During thethree months ended September 30, 2004 we recorded non-cash stock-basedcompensation benefit of $16,000, a $51,000 change from $35,000****of non-cash stock-based compensationexpense that we recorded during the three months ended September 30, 2003.  This increase was primarily a result ofchanges in vested and unexercised options under the stock option ExchangeProgram and fluctuations in the market value of our common stock.

 

The marketvalue of our common stock has fluctuated from $1.60 at April 23, 2003, the dateof the exchange program approval, to $12.35 as of March 31, 2004, and to $6.30as of September 30, 2004. Due to the price volatility of our common stock andthe inability to predict when and how many stock options will be exercised or cancelled,we cannot project the impact of options under this exchange program on futurequarters.

 

*Non-CashCharge for Valuation of Warrants*.  This expense relates to recognized chargesfor the value of warrants issued to consultants.  We amortize these costs over the period theconsulting services are provided.  Thiscost was $75,000 for the three months ended September 30, 2004.  There were no warrants issued to consultantsduring the three months ended September 30, 2003.

 

*Non-Cash Charge for Valuation of Warrants andConversion of Debentures (non-operating).*  This expense relates to the amortization ofdebt discount created by allocating a portion of the proceeds received inconjunction with convertible debentures and notes payable financings towarrants issued with the debt.  Weamortize these costs over the life of the corresponding debt.  This cost decreased $43,000, or 93%, from$46,000 for the three months ended September 30, 2003 to $3,000 for the threemonths ended September 30, 2004.  Themajority of the costs recorded during the three months ended September 30, 2003related to the amortization of the debt discount associated with warrantsissued in conjunction with convertible debentures.  All of these debentures were converted tocommon stock during our fiscal year ended March 31, 2004 with all unamortizeddebt discount associated with these debentures being expensed at the time ofconversion.  The costs recorded duringthe three months ended September 30, 2004 relate to warrants that were issued withour bank financing and are being amortized over the life of the associateddebt.

 

10

----

 

*Other income (expense), net. *Other income, net,was $5,000 for the three months ended September 30, 2004, an $81,000 changefrom other expense of $(76,000) for the three months ended September 30,2003.  The most significant reason forthis change was a decrease in net interest expense as a result of a significantimprovement in our cash position and the conversion of debentures.

 

**Six monthsended September 30, 2004 compared to Six months ended September 30, 2003**

 

*Revenues.*  Our revenues increased 55%, or $4,496,000,from $8,240,000 for the six months ended September 30, 2003 to $12,736,000 forthe six months ended September 30, 2004. The primary reason for the increase was $4,662,000 of revenue generatedfrom four new clients.

 

*Cost ofSales.*  Our costof sales increased $3,721,000, or 48%, from $7,695,000 for the six months endedSeptember 30, 2003 to $11,416,000 for the six months ended September 30,2004.  This increase in cost wasprimarily a result of increased business as discussed in the revenue sectionabove.  Our gross profit as a percentageof sales increased to 10% for the six months ended September 30, 2004 from 7%for the six months ended September 30, 2003. This improved gross profit percentage was due mainly to higherutilization of our capacity with increased business.  However, the efficiencies we realized fromincreased utilization of our capacity were adversely impacted by upfronttraining and labor costs totaling $125,000 associated with the increase in newand existing business.

 

*Product Development*.  We spent $234,000 in product developmentduring the six months ended September 30, 2004. We believe that this product development is necessary for anticipatednew business and to enhance our product offerings.  We incurred no significant productdevelopment costs during the six months ended September 30, 2003.

 

*Selling,General and Administrative Expenses.*  Our selling, general and administrativeexpenses increased by 37%, or $473,000, from $1,265,000 for the six monthsended September 30, 2003 to $1,738,000 for the six months ended September 30,2004.  This increase was primarily due toan increase in payroll costs to respond to increased demand for Sento productsand services.  However, as a percentageof revenue, our selling, general and administrative expenses decreased from 15%of revenue during the six months ended September 30, 2003 to 14% of revenueduring the six months ended September 30, 2004.

 

*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 wereexchanged for options to purchase 313,592 shares of common stock at an exerciseprice 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 by the difference between the market price of the stock andthe exercise price of $1.60, less any amounts previously recognized.

 

During the sixmonths ended September 30, 2004 we recorded a non-cash stock-based compensationbenefit of $166,000, a $216,000 change from $50,000 of non-cash stock-basedcompensation expense that we recorded during the six months ended September 30,2003.  This increase was primarily aresult of changes in vested and unexercised options under the stock optionExchange Program and fluctuations in the market value of our common stock.

 

The marketvalue of our common stock has fluctuated from $1.60 at April 23, 2003, the dateof the exchange program approval, to $12.35 as of March 31, 2004, and to $6.30as of September 30, 2004. Due to the price volatility of our common stock andthe inability to predict when and how many stock options will be exercised orcancelled, we cannot project the impact of options under this exchange programon future quarters.

 

*Non-CashCharge for Valuation of Warrants*.  This expense relates to recognized chargesfor the value of warrants issued to consultants.  We amortize these costs over the period theconsulting services are provided.  Thiscost was $187,000 for the six months ended September 30, 2004.  There were no warrants issued to consultantsduring the six months ended September 30, 2003.

 

11

----

 

*Non-Cash Charge for Valuation of Warrants andConversion of Debentures (non-operating).*  This expense relates to the amortization ofdebt discount created by allocating a portion of the proceeds received inconjunction with convertible debentures and notes payable financings towarrants issued with the debt.  Weamortize these costs over the life of the corresponding debt.  This cost decreased $96,000 or 93%, from$103,000 for the six months ended September 30, 2003 to $7,000 for the sixmonths ended September 30, 2004.  Themajority of the costs recorded during the six months ended September 30, 2003related to the amortization of the debt discount associated with warrantsissued in conjunction with convertible debentures.  All of these debentures were converted tocommon stock during our fiscal year ended March 31, 2004 with all unamortizeddebt discount associated with these debentures being expensed at the time ofconversion.  The costs recorded duringthe six months ended September 30, 2004 relate to warrants that were issuedwith our bank financing and are being amortized over the life of the associateddebt.

 

*Other income (expense), net. *Other expense, net,was $30,000 for the six months ended September 30, 2004, a $115,000 change fromother expense of $145,000 for the six months ended September 30, 2003.  The most significant reason for this changewas a decrease in net interest expense as a result of a significant improvementin our cash position and the conversion of debentures.

 

**Liquidityand Capital Resources**

 

Ourworking capital decreased $445,000, or 6%, from $7,199,000 at March 31, 2004 to$6,754,000 at September 30, 2004.  Ourchange in working capital was primarily the result of a decrease in accountsreceivable, partially offset by a decrease in accounts payable and accruedliabilities.  Our cash balances increased$293,000, or 4%, from $6,568,000 at March 31, 2004 to $6,861,000 at September30, 2004.

 

Duringthe six months ended September 30, 2004, we generated $1,268,000 of cash flowfrom operations, used $779,000 of cash flow for investing in property andequipment and used $197,000 of cash flow from financing activities.  The primary reason for the change in theamount of cash generated from operating activities was the timing of cashreceipts and payments on working capital balances, such as accounts receivable,accounts payable and accrued liabilities. The net decrease in receivables from March 31, 2004 to September 30,2004 was $1,883,000. Because our business has historically been seasonal with asignificant increase in business in the fourth quarter of our fiscal year,accounts receivable were higher at March 31 and decreased in the first andsecond fiscal quarters as the receivables were collected.  There was a net decrease in payables and accruedliabilities from March 31, 2004 to September 30, 2004, also primarily due todecreased business volume caused by the seasonality of our business.  The net decrease in accounts payable andaccrued liabilities partially offset the increased cash flow from thecollection of receivables.  Included inour cash flow from financing activities is $627,000 in  payments of offering costs relating to ourMarch 2004 private placement that were accrued and unpaid at March 31, 2004.  This use of cash was offset by $720,000 ofproceeds from new long-term debt issuances. Principal payments of long-term debt and capital leases totaled $510,000for the six months ended September 30, 2004.

 

We havecontractual obligations, including debt agreements and leases, that willrequire the use of cash.   The followingtable sets forth our contractual obligations as of September 30, 2004:

 
| ** **                               | ** ** | **Payments Due by Period** | ** ** |
|------------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations:**             | ** ** | **Under 1 Year**           | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **After 5 Years** | ** ** | **Total** | ** ** |
| Long Term Debt (principal only) (1) |       | $                          | 449,000    |   | $ | 806,000 |   | $ | — |   | $ | — |   | $ | 1,255,000 |   |
| Capital Leases                           |       | 409,000                    |       | 168,000 |   | — |   | — |   | 577,000 |   |
| Operating Leases                         |       | 1,095,000                  |       | 1,066,000 |   | 648,000 |   | — |   | 2,809,000 |   |
| Less: subleases                          |       | (246,000                   | )          | (94,000 | ) | (39,000 | ) | — |   | (379,000 | ) |
| Total Contractual Obligations            |       | $                          | 1,707,000  |   | $ | 1,946,000 |   | $ | 609,000 |   | $ | — |   | $ | 4,262,000 |   |

 

(1)   Our long-term debt carries interest rates of3.5% to 7.4%.

 

At present, we believe we will be able to meet our current obligationsas they come due.

 

12

----

 

On May 11, 2004, we refinanced our line of creditand existing term loans with a bank, wherein the line of credit was renewed andthe existing three term loans were combined into one term loan.  The agreement also allows us to draw on anadditional term loan for up to $1,500,000 of equipment financing.  The line of credit was increased from amaximum of $2,500,000 to $3,000,000 (subject to a limit of 80% of eligibleaccounts receivable), has an interest rate equal to the sum of the bank’s primerate plus 1% and has a two-year term, including provisions for extension,subject to approval.  The line of creditterms also contain an annual commitment fee of 0.75%.  The new term loan for $750,000 includes therepayment of the three existing term loans plus $316,140 in additionalequipment financing.  The terms of thisloan include a 1.0% commitment fee, an interest rate of 7.4%, monthly paymentsof $23,260 including interest, and a term of three years.  We also have a commitment from the bank for aterm loan of up to $1,500,000 for future equipment financing.  During the six months ended September 30,2004, we were advanced $404,000 under this loan.  We may take advances on this loan in a minimumamount of $100,000 through March 31, 2005. The underlying term loans will have a term of three years, requiremonthly principal and interest payments, will have a fixed interest ratedetermined at the date of the advance based on the three-year U.S. TreasuryBond rate plus 4.5%.

 

**Seasonality**

 

Ouroperating results have historically been affected by the seasonal variancesexperienced by some of our significant clients. Historically, our third and fourth quarters have been favorably affectedby a significant increase in service requests we experienced from our supportof certain clients’ products.  Goingforward, we anticipate that we will continue to have seasonal variances.

 

**Forward-Looking Statements**

 

*Thestatements contained in this Quarterly Report on Form 10-QSB that are notpurely historical are “forward-looking statements” within the meaning ofSection 27A of 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 and uncertainties.  Forward-looking statements contained in thisReport include statements regarding our plans to develop and deliver integratedinformation technology services, market opportunities and acceptance,expectations, goals, revenues, financial performance, strategies, mission andintentions for the future.  Suchforward-looking statements are included under “Management’s Discussion andAnalysis 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 statementsincluded in this Report are made as of the date hereof, based on informationavailable to us as of such date, and we assume no obligation to update any forward-lookingstatement.  It is important to note thatsuch statements may not prove to be accurate and that our actual results andfuture events could differ materially from those anticipated in suchstatements.  Among the factors that couldcause actual results to differ materially from our expectations are thosedescribed under “Management’s Discussion and Analysis or Plan ofOperations---Risks Related to Existing and Proposed Operations.”  All subsequent written and oralforward-looking statements attributable to Sento or persons acting on ourbehalf are expressly qualified in their entirety by this section and otherfactors included elsewhere in this Report.*

 

**RisksRelated to Existing and Proposed Operations**

 

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

 

***Volatile economic conditions have affectedand will likely continue to affect our operations and financial results.***

 

Volatileeconomic conditions have adversely affected our operations and financialresults.  The slowing economy in recentyears caused us to lose some clients and also resulted in increased pricingpressures and lower call volumes from some existing clients.  Slower economic conditions may limit ourability to attract new clients or retain existing clients.  These factors contributed to the decline inour revenues and the net losses we experienced during most of Fiscal 2002, 2003and 2004.  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.

 

13

----

 

***We repriced our employee stock options andmay have significant 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 expense werecognize in our financial statements for changes in the stock price until thestock options are exercised, forfeited or expire.  If our stock price is volatile, our futurestock compensation charges may affect our profitability, either positively ornegatively.

 

***Several key clients represent a significantportion of our revenues, and the loss of a key client could affect our revenuesand profitability.***

 

Three clientsaccounted for approximately 62% of our revenues for the three months endedSeptember 30, 2004.  These three clientsaccounted for approximately 27%, 24% and 11%, respectively, of our revenues forthe three months ended September 30, 2004. A key client, who accounted for 28% of revenues in fiscal 2002,cancelled its contract with us early in fiscal 2003.  The loss of this client had a significantnegative impact on our revenue and profitability in fiscal 2003 and for thefirst nine months of fiscal 2004, until this business was replaced.

 

Our clientscan 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 have a history of losses and may continueto experience losses****.*

 

We experiencednet losses in four of our last five fiscal years.  For the six months ended September 30, 2004and 2003, we had net losses of $(709,559) and $(1,017,495), respectively, andwe had an accumulated deficit of $(11,189,437) as of September 30, 2004.  We may continue to incur net losses if we loseclients, are unable to attract and retain new clients or do not properlyutilize our resources.  We cannot ensurethat we will be able to achieve or maintain consistent profitable operations.

 

***We may be unable to attract, train and retainkey management, technical and marketing personnel.***

 

Our successwill depend, in large part, on our ability to attract, retain and train highlyqualified technical, managerial and marketing personnel with the expertiserequired to successfully conduct our operations.  We have not entered into employmentagreements that obligate any of our key managerial or technical personnel toremain with us for any specified period of time. If we lose any key personnelor are unable to attract, retain, train or motivate qualified personnel, ourbusiness operations and financial condition may be materially and adverselyaffected.

 

***A failure of our computers,telecommunications equipment or software systems could interrupt our ability toprovide our services****.*

 

Our businessdepends to a large extent on computers, telecommunications equipment andsoftware systems (both equipment and systems maintained by us and equipment andsystems maintained by third parties).  Anatural disaster, human error, equipment malfunction or inadequacy or multipleother events could result in a prolonged interruption in our ability to providesupport services to clients or their customers. The temporary or permanent loss of computer or telephone equipment orsystems, through casualty, operating malfunctions or otherwise, could have amaterial adverse effect on our operations, property or financial condition, andbusiness interruption insurance may not be adequate to compensate for alllosses that may be incurred.

 

***We rely on third-party software companies forour chat and email applications*.**

 

We contractwith third-party software companies to provide chat and email tools used withour CRM software, reporting and management services.  If one of these software companies fail inits business efforts, we may lose our access to these software tools.  Our failure to obtain adequate replacementsoftware tools could cause us to experience service delays, interruptions orcancellations.

 

14

----

 

***We are subject to collections risks and maybe unable to collect our accounts receivable balances.***

 

We provideunsecured 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.

 

***Managing the utilization levelof our resources is necessary in order to achieve our desired profitability.***

 

Our businessstrategy requires us to fully utilize excess personnel and physical facilitiesin an effort to increase our profits.  Aswe expand our operations, we may not always be able to manage the level ofpersonnel and facilities to reach our desired levels of utilization, which mayaffect our profitability.  Also, if welose existing clients, we may have excess personnel and physical facilitiesthat would have an adverse effect on our business operations and our profitability.

 

***Implementation of our growth plans will bedependent on our ability to market and sell our services to new and existingclients.***

 

Our growthplans are dependent upon our ability to attract and retain new clients and togenerate 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, and general economic conditions,among other factors.  Many of thesefactors are beyond our control.  If weare incorrect in our assessment of the feasibility of our growth plans, if weare not effective in our efforts to market and sell our services or ifcircumstances change in a way that we did not foresee or anticipate, we may notgrow as planned or our growth strategy may have an adverse effect on businessoperations and our profitability.

 

***Competitive pressures could harm ourfinancial performance.***

 

The market forcustomer 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 enterprisesoftware companies may leverage their existing relationships and capabilitiesto offer customer service applications. In other instances, many large companies provide their own in-housecustomer care support and customer training. Also, a number of existing companies have experienced rapid internalgrowth, and several of these companies have been active in acquiring smallerregional customer contact services companies and are becoming major competitorswith a measurable share of this rapidly expanding market.  If our competitors provide more efficient orless expensive services, we may lose market share and revenues.

 

***A delay in market acceptance of our productsand services could negatively impact our business and revenues.***

 

The customercontact services market is extremely competitive.  We were a relatively early entrant in thecustomer self-services and chat markets; however, we have struggled in ourefforts to market and sell our products and services and have been slow todevelop certain business operations. Further delays in the development of our products and services wouldallow our competitors additional time to improve their service or productofferings, and also provide time for new competitors to develop e-businesscustomer service applications and solicit prospective clients within our targetmarkets.  This would increase competitionthat could result in additional pricing pressures, and we may lose market shareand revenues.

 

***If we do not keep up with the rapidtechnological change experienced by the customer contact service market, ourproducts and services may become obsolete and we may lose clients.****.*

 

The customercontact service industry is characterized by rapid technological change,alterations in customer requirements and preferences, and the emergence of newindustry standards and practices.  Ouroperating results and financial condition will depend, in part, on our abilityto develop solutions that keep pace with continuing changes in informationtechnology, evolving industry standards, and changing client requirements.

 

15

----

 

There can be no assurance thatwe will be successful in adequately addressing these developments on a timelybasis or that, if these developments are addressed, we will be successful inthe marketplace.  In addition, productsor technologies developed by others could render our services non-competitiveor obsolete.  Our failure to addressthese developments could have a material negative effect on our business andfinancial condition.

 

***If companies reduce their reliance onoutsourced services, our revenues and financial condition may be adverselyaffected.***

 

Our businessdepends in large part on the trend within the IT industry to outsource certainservices.  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.

 

***Market volatility and fluctuations in ourstock price and trading volume may cause sudden decreases in the value of aninvestment in our common stock.***

 

The marketprice of our common stock has historically been, and we expect it to continueto be, volatile.  This price has rangedbetween $1.94 and $17.89 in the fifteen month period ended September 30,2004.   The market for our common stockhas, from time-to-time, experienced extreme price and volume fluctuations,which have often appeared to be unrelated to our operating performance.  Our stock price has also 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.

 

***Our revenues and quarterly results can bevolatile, which makes evaluating our business difficult.***

 

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 are also 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, our revenues may decline. Further, delays in the receipt of orders can cause significantfluctuation in revenues from quarter to quarter.

 

Because ourstaffing and other operating expenses are based on anticipated revenue levels,and a high percentage of our expenses are fixed, the volatility in our revenuescan cause significant variations in operating results from quarter to quarterand we may not be able to achieve or sustain profitability on a quarterlybasis.  In addition, we may expendsignificant resources pursuing potential sales that will not beconsummated.  Furthermore, we may chooseto reduce prices or to increase spending in response to competition or topursue new market opportunities, which may adversely affect our operatingresults.

 

For thereasons identified above, we believe that period-to-period comparisons of ourrevenues and operating results may not be meaningful and should not beconsidered an indication of future performance.

 

***We may have difficultiescompleting or integrating the proposed Xtrasource acquisition***

 

We haveentered into an asset purchase agreement with Xtrasource, Inc., pursuant towhich we propose to acquire substantially all of the assets of Xtrasource.  The proposed acquisition is subject to anumber of conditions to closing, the failure of any of which could prevent usfrom completing the transaction.  We mayalso encounter unforeseen difficulties in closing the transaction.  Even if we are successful in completing theXtrasource acquisition, of which there can be no assurance, we may experiencedifficulties in post-acquisition integration and operation of the acquiredassets, including retaining existing clients of Xtrasource.  The negotiation, closing and integration ofthe Xtrasource transaction has also required, and will likely continue torequire, significant management time and Sento resources.  The diversion of management time and ourlimited resources could have a material adverse effect on our results ofoperations or financial condition.

 

16

----

 

***Shares eligible for future sale may cause themarket price for our common stock to drop significantly, even if our businessis doing well.***

 

We cannotpredict the effect, if any, that future sales of our common stock or theavailability of shares for future sale will have on the market price of ourcommon stock from time to time.  We haveentered into registration rights agreements which contemplate thatsubstantially all of our outstanding shares of common stock will become freelytradable in the public market.  Othershares of our common stock issued in the future, including shares issued uponexercise of outstanding options and warrants, may become available for resalein the public market from time to time, and the market price of shares of ourcommon stock could drop significantly if the holders of these shares sell themor are perceived by the market as intending to sell them.  In addition, sales of a substantial number ofshares of our common stock in a short period of time could adversely affect themarket price of our shares.

 

***Provisions of our Articles of Incorporationand Bylaws could impair or delay stockholders’ ability to replace or remove ourmanagement and could discourage takeover transactions that stockholders mightconsider to be in their best interests.***

 

Our Articlesof Incorporation and Bylaws, the Utah Revised Business Corporation Act, and theUtah Control Shares Acquisition Act each contain certain provisions that mayhave the effect of inhibiting a non-negotiated merger or other businesscombination.  Our Articles ofIncorporation grant to our Board of Directors the authority, without further actionby our stockholders, to fix the rights and preferences of, and issue shares ofpreferred stock.  These provisions maydeter hostile takeovers or delay or prevent changes in control of us or changesin our management, including transactions in which stockholders might otherwisereceive a premium for their shares over the then-current market prices.  In addition, these provisions may limit theability of stockholders 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 dividendshave ever been declared or paid on our common stock.  We intend to retain any future earnings foruse in our business and do not anticipate paying any dividends on the CommonStock in the foreseeable future.

 

Item 3.    Controls and Procedures

 

An evaluationwas performed under the supervision and with the participation of ourmanagement, including our Chief Executive Officer, or CEO, and our ChiefFinancial Officer, or CFO, of the effectiveness of our disclosure controls andprocedures, as of September 30, 2004. Based on that evaluation, our management,including our CEO and CFO, concluded that our disclosure controls andprocedures are effective to ensure that information required to be disclosed bySento in reports filed or submitted under the Securities Exchange Act of 1934,as amended, is recorded, processed, summarized and reported as specified in theSEC’s rules and forms.  There have beenno significant changes in our internal controls or in other factors that couldsignificantly affect internal controls subsequent to the evaluation.

 

PART II.  OTHERINFORMATION

 

Item 2.    Unregistered Sales of Equity Securities andUse of Proceeds

 

Sales ofUnregistered Securities 

 

Duringthe six months ended September 30, 2004, warrants to purchase 204,250 shares ofcommon stock were exercised under cashless provisions of the underlying warrantagreements resulting in Sento issuing 167,853 shares of common stock.

 

The securitiesissued were restricted securities taken for investment. Certificates for thesecurities issued bore a restrictive legend conspicuously on their face andstop-transfer instructions were noted respecting such certificates on ourtransfer records, except in circumstances in which we received a writtenopinion from legal counsel to the holders of such securities to the effect thatdue to the tacking of holding periods of previously held debentures (given inexchange for the recently issued debentures) such common share certificatesissued on debenture conversion did not need to bear a restrictive legend. Eachof the foregoing transactions was effected in 

 

17

----

 

reliance on the exemption fromregistration provided in Section 4(2) of the Securities Act of 1933and Rule 506 of Regulation D adopted thereunder as transactions notinvolving any public offering.

 

Item 6.    Exhibits

 

a)              Exhibits:

 

Exhibits 31.1and 32.1 — Certifications of the Company’s Chief Executive Officer

Exhibits 31.2and 32.2 — Certifications of the Company’s Chief Financial Officer

 

 

SIGNATURES

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly 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 |
|                           |   |               | Chief Financial  Officer and Secretary |
|                           |   |               | (Principal  financial and accounting officer) |
|                           |   |               |   |
| Dated November  12, 2004. |   |               |   |

 

18

----