**UnitedStatesSecurities and Exchange Commission**

**Washington, D.C.  20549**

 

**FORM10-QSB**

 

**ý****        Quarterly Report pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934**

 

**For the Quarter Ended September30, 2005**

 

 

**o****                                ****Transitionreport pursuant to Section 13 or 15(d) of the Securities Exchange Act of 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 400Salt Lake City, Utah 84111**

(Address of PrincipalExecutive Offices)

 

Issuer’s telephonenumber, including area code:  **(801) 431-9200**

 

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

 

Yes ý     No  o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act)

 

Yes o    No ý

 

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

 
| **Class**                            | ** ** | **Outstanding at October 31, 2005** | ** ** |
|--------------------------------------|------------|-------------------------------------|------------|
| Common capital stock  $.25 par value |       | 3,878,002                           |       |

 

Transitional Small Business Disclosure Format (check one):

 

Yes o     No ý

 

 

----

 

**SENTO CORPORATION**

Quarterly Report on Form10-QSB

Quarter ended September30, 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.                                         | Unregistered Sales of Equity  Securities and Use of Proceeds    |   |
| Item  6.                                        | Exhibits                                                        |   |
| SIGNATURES                                      |                                                            |

 

1

----

 

# **PART I. FINANCIAL INFORMATION**

## Item 1.             Financial Statements

 

**SENTO CORPORATIONAND SUBSIDIARIES**

 

**Condensed Consolidated BalanceSheets**

 
| ** **                                                                                    | ** ** | **September 30,  2005** | ** ** | **March 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                                                                    | ** ** | **(Unaudited)**         | ** ** | ** **          | ** ** |
| **ASSETS**                                                                                    |       |                    |       |                |       |
|                                                                                          |       |                    |       |                |       |
| Current assets:                                                                               |       |                    |       |                |       |
| Cash and cash equivalents                                                                     |       | $                       | 4,778,846  |                | $          | 5,698,195 |   |
| Accounts receivable, net                                                                      |       | 4,411,477               |       | 4,326,315           |       |
| Other current assets                                                                          |       | 684,525                 |       | 643,059             |       |
| Total current assets                                                                          |       | 9,874,848               |       | 10,667,569          |       |
|                                                                                          |       |                    |       |                |       |
| Property and equipment, net                                                                   |       | 4,162,987               |       | 4,031,632           |       |
| Intangible assets, net                                                                        |       | 1,092,984               |       | 1,229,607           |       |
| Other assets                                                                                  |       | 283,836                 |       | 296,775             |       |
| Total Assets                                                                                  |       | $                       | 15,414,655 |                | $          | 16,225,583 |   |
|                                                                                          |       |                    |       |                |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                |       |                    |       |                |       |
|                                                                                          |       |                    |       |                |       |
| Current liabilities:                                                                          |       |                    |       |                |       |
| Current portion of long-term debt and capital leases                                          |       | $                       | 724,106    |                | $          | 745,699 |   |
| Accounts payable                                                                              |       | 2,034,270               |       | 2,110,013           |       |
| Accrued payroll and payroll taxes                                                             |       | 1,901,834               |       | 1,559,676           |       |
| Current portion of accrued restructuring expenses                                             |       | 68,771                  |       | 118,793             |       |
| Accrued liabilities and other                                                                 |       | 838,892                 |       | 635,834             |       |
| Total current liabilities                                                                     |       | 5,567,873               |       | 5,170,015           |       |
|                                                                                          |       |                    |       |                |       |
| Long-term debt and capital  leases, net of current portion                                    |       | 1,140,851               |       | 959,259             |       |
| Accrued restructuring  expenses, net of current portion                                       |       | 146,797                 |       | —              |       |
| Accrued contingent  consideration from business acquisition                                   |       | 897,338                 |       | 907,898             |       |
| Total liabilities                                                                             |       | 7,752,859               |       | 7,037,172           |       |
|                                                                                          |       |                    |       |                |       |
| Stockholders’ equity:                                                                    |       |                    |       |                |       |
| Common stock                                                                                  |       | 969,480                 |       | 965,077             |       |
| Additional paid-in capital                                                                    |       | 20,622,521              |       | 20,662,508          |       |
| Treasury stock                                                                                |       | (259,620                | )          | (203,681            | )          |
| Accumulated other comprehensive income (loss) – foreign currency  translation adjustment |       | (37,418                 | )          | 42,670              |       |
| Accumulated deficit                                                                           |       | (13,633,167             | )          | (12,278,163         | )          |
| Total stockholders’ equity                                                               |       | 7,661,796               |       | 9,188,411           |       |
| Total Liabilities and Stockholders’ Equity                                               |       | $                       | 15,414,655 |                | $          | 16,225,583 |   |

 

*See accompanying notes.*

 

2

----

 

**SENTO CORPORATION**

**AND SUBSIDIARIES**

 

**Condensed Consolidated Statementsof Operations**

**(Unaudited)**

 
| ** **                                                                          | ** ** | **Three  Months Ended**    | ** ** | **Six  Months Ended**      | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                                                          | ** ** | **September  30,****2005** | ** ** | **September  30,****2004** | ** ** | **September  30,****2005** | ** ** | **September  30,****2004** | ** ** |
|                                                                                |       |                       |       |                       |       |   |   |   |   |
| Revenue                                                                             |       | $                          | 9,862,546  |                       | $          | 6,168,960 |   | $ | 18,623,131 |   | $ | 12,735,708 |   |
|                                                                                |       |                       |       |                       |       |   |   |   |   |
| Cost of sales                                                                       |       | 7,901,150                  |       | 5,639,975                  |       | 15,898,203 |   | 11,415,927 |   |
|                                                                                |       |                       |       |                       |       |   |   |   |   |
| Gross profit                                                                        |       | 1,961,396                  |       | 528,985                    |       | 2,724,928 |   | 1,319,781 |   |
|                                                                                |       |                       |       |                       |       |   |   |   |   |
| Product development                                                                 |       | 48,608                     |       | 114,963                    |       | 48,608 |   | 233,976 |   |
| Selling, general and administrative expenses                                        |       | 1,707,704                  |       | 911,623                    |       | 3,594,210 |   | 1,738,104 |   |
| Collection of fully-reserved  doubtful account                                      |       | (181,593                   | )          | —                     |       | (181,593 | ) | — |   |
| Amortization of intangible assets                                                   |       | 68,311                     |       | —                     |       | 136,623 |   | — |   |
| Restructuring charge                                                                |       | —                     |       | —                     |       | 477,575 |   | — |   |
| Non-cash charge for valuation of warrants issued for services                       |       | —                     |       | 74,909                     |       | — |   | 186,501 |   |
| Stock-based compensation benefit                                                    |       | (14,080                    | )          | (15,659                    | )          | (68,652 | ) | (166,408 | ) |
| Operating income (loss)                                                             |       | 332,446                    |       | (556,851                   | )          | (1,281,843 | ) | (672,392 | ) |
|                                                                                |       |                       |       |                       |       |   |   |   |   |
| Other income (expense), net                                                         |       | (15,954                    | )          | 1,962                      |       | (55,500 | ) | (37,167 | ) |
|                                                                                |       |                       |       |                       |       |   |   |   |   |
| Net income (loss) before income taxes                                               |       | 316,492                    |       | (554,889                   | )          | (1,337,343 | ) | (709,559 | ) |
| Income taxes                                                                        |       | 6,431                      |       |                       |       | 17,661 |   |   |   |
| Net income (loss)                                                                   |       | 310,061                    |       | (554,889                   | )          | (1,355,004 | ) | (709,559 | ) |
| Deemed dividend as a result of warrant modification                                 |       |                       |       |                       |       |   |   | (37,875 | ) |
| Net income (loss) attributable to common stockholders                               |       | $                          | 310,061    |                       | $          | (554,889 | ) | $ | (1,355,004 | ) | $ | (747,434 | ) |
|                                                                                |       |                       |       |                       |       |   |   |   |   |
| Basic net income (loss) per share                                                   |       | $                          | 0.08       |                       | $          | (0.15 | ) | $ | (0.36 | ) | $ | (0.20 | ) |
|                                                                                |       |                       |       |                       |       |   |   |   |   |
| Diluted net income (loss) per share                                                 |       | $                          | 0.08       |                       | $          | (0.15 | ) | $ | (0.36 | ) | $ | (0.20 | ) |
|                                                                                |       |                       |       |                       |       |   |   |   |   |
|                                                                                |       |                       |       |                       |       |   |   |   |   |
| Basic weighted average number of common and common equivalent shares  outstanding   |       | 3,800,343                  |       | 3,732,326                  |       | 3,795,401 |   | 3,680,006 |   |
| Diluted weighted average number of common and common equivalent shares  outstanding |       | 3,870,079                  |       | 3,732,326                  |       | 3,795,401 |   | 3,680,006 |   |

 

*See accompanying notes.*

 

3

----

 

**SENTO CORPORATION**

**AND SUBSIDIARIES**

 

**Condensed Consolidated Statementsof Cash Flows**

**(Unaudited)**

 
| ** **                                                                       | ** ** | **Six Months Ended**    | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                       | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Cash flows from operating activities:                                            |       |                    |       |   |   |
| Net loss                                                                         |       | $                       | (1,355,004 | ) | $ | (709,559 | ) |
| Adjustments to reconcile net loss to net cash provided by operating  activities: |       |                    |       |   |   |
| Depreciation and amortization                                                    |       | 997,693                 |       | 799,944 |   |
| Non-cash interest expense related to warrants issued with debt                   |       | 6,381                   |       | 7,326 |   |
| Stock-based compensation                                                         |       | (68,652                 | )          | (166,408 | ) |
| Restructuring charge                                                             |       | 477,575                 |       | — |   |
| Revaluation of non-employee warrants issued for services                         |       | —                  |       | 186,501 |   |
|                                                                             |       |                    |       |   |   |
| Changes in operating assets and liabilities:                                     |       |                    |       |   |   |
| Accounts receivable                                                              |       | (85,162                 | )          | 1,882,517 |   |
| Other assets                                                                     |       | (56,946                 | )          | (82,095 | ) |
| Accounts payable                                                                 |       | (75,743                 | )          | (284,281 | ) |
| Accrued liabilities and other                                                    |       | 276,600                 |       | (365,681 | ) |
| Net cash provided by operating activities                                        |       | 116,742                 |       | 1,268,264 |   |
| Cash flows used in investing activities:                                         |       |                    |       |   |   |
| Purchase of property and equipment                                               |       | (1,086,750              | )          | (778,629 | ) |
|                                                                             |       |                    |       |   |   |
| Cash flows from financing activities:                                            |       |                    |       |   |   |
| Proceeds from issuance of long-term debt, capital leases and credit  line        |       | 1,097,108               |       | 720,173 |   |
| Principal payments of long-term debt, capital leases and credit line             |       | (943,490                | )          | (510,093 | ) |
| Payment of accrued offering costs                                                |       | —                  |       | (627,364 | ) |
| Proceeds from exercise of stock options, warrants and employee stock  purchases  |       | 33,068                  |       | 220,483 |   |
| Repurchase of common stock                                                       |       | (55,939                 | )          | — |   |
| Net cash provided by (used in) financing activities                              |       | 130,747                 |       | (196,801 | ) |
| Effect of foreign currency translations                                          |       | (80,088                 | )          | — |   |
| Net increase (decrease) in cash and cash equivalents                             |       | (919,349                | )          | 292,834 |   |
| Cash and cash equivalents at beginning of period                                 |       | 5,698,195               |       | 6,567,811 |   |
| Cash and cash equivalents at end of period                                       |       | $                       | 4,778,846  |   | $ | 6,860,645 |   |

 

*Seeaccompanying notes.*

 

4

----

 

**SENTO CORPORATION**

**AND SUBSIDIARIES**

 

**Supplemental Disclosures of CashFlow Information**

**(Unaudited)**

 
| ** **                                   | ** ** | **Six Months Ended**    | ** ** |
|----------------------------------------------|------------|-------------------------|------------|
| ** **                                   | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|                                         |       |                    |       |   |   |
| Cash paid for:                               |       |                    |       |   |   |
| Interest                                     |       | $                       | 89,144     |   | $ | 58,241 |   |
| Income taxes                                 |       | 4,309                   |       | — |   |
|                                         |       |                    |       |   |   |
| Non-cash investing and financing activities: |       |                    |       |   |   |
|                                         |       |                    |       |   |   |
| Equipment financed through  long-term note   |       | $                       | —     |   | $ | 157,136 |   |

 

*Seeaccompanying notes.*

 

5

----

 

#### **SENTO CORPORATION**

**AND SUBSIDIARIES**

 

### **Notesto Condensed Consolidated Financial Statements**

**September 30, 2005**

**(Unaudited)**

 

A.                                   BASISOF PRESENTATION

 

The accompanyingunaudited condensed consolidated financial statements of Sento Corporation (the“Company”) have been prepared in accordance with the instructions to Form10-QSB and do not include all of the information and footnotes required by U.S.generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring entries) considerednecessary for a fair presentation have been included.

 

Operating results for thethree and six month periods ended September 30, 2005 are not necessarilyindicative of the results that may be expected for the full fiscal year.  The unaudited condensed consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements and footnotes thereto included in the Company’sAnnual Report on Form 10-KSB for the year ended March 31, 2005.

 

The Company’s operationsare carried out by its two wholly-owned subsidiaries, Sento Technical ServicesCorporation, a Utah corporation, and Xtrasource Acquisition Inc., a Delawarecorporation.  The Company’s operations arelocated in Utah, Wyoming, North Carolina, the Netherlands and France.  The Company also is constructing anadditional facility in Albuquerque, New Mexico. In addition, the Company has contractual relations with a third-partyprovider in India.

 

Effective October 1,2005, the Company adopted Statement of Financial Accounting StandardsNo. 123R, *Share-Based Payment* (SFAS 123R)(see note K).  However, as of September30, 2005, the Company followed 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 values of stock option grants for the periods presented in the following condensedconsolidated 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.

 

6

----

 

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 income (loss)would have been changed to the pro forma amounts indicated below for the threeand six month periods ended September 30, 2005 and 2004:

 

Three-month periods ended September 30, 2005 and 2004:

 
| ** **                                             | ** ** | ** **  | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------|------------|-------------|------------|----------|------------|----------|------------|
| Net income (loss) attributable to common  stockholders |       | As reported |       | $        | 310,061    |     | $          | (554,889 | ) |
|                                                   |       | Pro forma   |       | $        | (694,667   | )        | $          | (664,377 | ) |
| Basic and diluted income (loss) per share              |       | As reported |       | $        | 0.08       |     | $          | (0.15 | ) |
|                                                   |       | Pro forma   |       | $        | (0.18      | )        | $          | (0.18 | ) |
|                                                   |       |        |       |     |       |     |       |
| Six-month periods ended September 30, 2005 and 2004:   |       |        |       |     |       |     |       |
|                                                   |       |        |       |     |       |     |       |
| ** **                                             | ** ** | ** **  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss attributable to common stockholders           |       | As reported |       | $        | (1,355,004 | )        | $          | (747,434 | ) |
|                                                   |       | Pro forma   |       | $        | (2,466,280 | )        | $          | (1,010,454 | ) |
| Basic and diluted loss per share                       |       | As reported |       | $        | (0.36      | )        | $          | (0.20 | ) |
|                                                   |       | Pro forma   |       | $        | (0.65      | )        | $          | (0.27 | ) |

 

B.                                     LONG-TERMDEBT AND CAPITAL LEASES

 

Effective March 31, 2005,the Company renewed its line of credit with a bank that allows the Company toborrow up to****$3,000,000 or 80% of eligibleaccounts receivable.  The line of creditaccrues interest at 1% over of the bank’s prime rate (6.75% as of September 30,2005) and matures on March 31, 2007.  Asof September 30, 2005, the Company had no outstanding balance against the line.

 

EffectiveMarch 31, 2005, the Company also entered into a term debt agreement with a bankfor equipment financing.  The loan allowsfor minimum draws of $100,000 per draw with a maximum of $1,000,000 to be drawnthrough March 31, 2006.  The Company is requiredto make interest only payments equal to 1.5% over the bank’s prime rate duringthe draw-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 six months ended September 30, 2005, the Company drew a totalof $597,108 on this facility which was all outstanding at September 30, 2005.

 

C.                                     COMMONSTOCK

 

Six months ended September 30, 2005

 

During the six monthsended September 30, 2005, options to purchase 1,858 shares of common stock wereexercised and 15,757 shares of common stock were purchased by employees underthe Company’s Employee Stock Purchase Plan, resulting in $33,068 of netproceeds to the Company.

 

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 the cancellation of optionsto purchase 377,342 shares of the Company’s common stock at exercise prices inexcess of $2.00 per share.  The newoptions issued under the Exchange Program are subject to variable planaccounting in accordance with Financial Accounting Standards BoardInterpretation No. 44, *Accounting for CertainTransactions 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, which wasthe 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 six

 

7

----

 

months ended September 30,2005, the Company recorded $68,652 of stock-based compensation benefit forthese options since the value of the Company’s common stock decreased between March31, 2005 and September 30, 2005.

 

Effective October 1,2005, the Company adopted Statement of Financial Accounting StandardsNo. 123R, *Share-Based Payment* (SFAS123R).  Under SFAS 123R, the variableaccounting treatment for the options repriced under the Exchange Program willno longer be required.

 

On February 28, 2005, theCompany’s Board of Directors approved a stock repurchase plan authorizing theCompany to repurchase up to 10% of its then outstanding common stock over aone-year period.  The purchase price,amount of shares per purchase, and the specific purchase dates are subject toapproval by the Company’s Board of Directors and compliance with regulations ofthe Securities and Exchange Commission. During the six months ended September 30, 2005, the Company repurchased16,938 shares of common stock at a cost of $55,939.  As of September 30, 2005, a total of 76,737shares had been repurchased under the stock buy-back plan and are accounted foras treasury stock in the accompanying financial statements.

 

Six months ended September 30, 2004

 

During the six monthsended September 30, 2004, options to purchase 127,462 shares of common stockwere exercised and 14,820 shares of common stock were purchased by employeesunder the Company’s Employee Stock Purchase Plan.

 

During the six monthsended September 30, 2004, warrants to purchase 204,250 shares of common stockwere exercised under cashless provisions of the underlying warrant agreementsresulting in the Company issuing 167,853 shares of common stock.

 

Duringthe six months ended September 30, 2004, the Company recorded $166,408 ofstock-based compensation benefit from marking to market the options repricedunder the Exchange Program.

 

In January 2004, theCompany entered into a consulting agreement with terms that required theCompany to issue the consultant warrants to purchase 5,000 shares of commonstock each month.   As of September 30,2005 warrants to purchase 45,000 shares of common stock were outstanding underthis agreement, of which warrants to purchase 30,000 shares were issued duringthe six months ended September 30, 2004. The warrants vest 25% every threemonths from the date of issuance, have a term of three and one-half years, andhave an exercise price of $3.00 per share. On October 31, 2004, the Company terminated the consultingagreement.  Accordingly, subsequent toOctober 31, 2004 no further warrants have been 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 performance hasended.

 

Effective May 21, 2004,the Company’s 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” onthe accompanying statement of operations and in determining net lossattributable to common stockholders.  OnAugust 31, 2004, the subject warrants expired unexercised.

 

8

----

 

D.                                    INCOME(LOSS) PER SHARE

 

Income (loss) per shareis computed in accordance with Statement of Financial Accounting Standards No.128, *Earnings Per Share*.  Basic income (loss) per share is computed bydividing net income (loss) by the weighted average number of shares of commonstock outstanding for the period. Diluted income or loss per share reflects the potential dilution thatcould occur from shares of common stock issuable through stock options,warrants and other convertible securities, if dilutive.  Options and warrants to purchase 69,736 sharesof common stock have been included in the calculation of basic common stockoutstanding for the three-month period ended September 30, 2005.  Options and warrants to purchase 70,217shares of common stock have not been included in the calculation of dilutedcommon stock outstanding for the six-month period ended September 30, 2005,because to do so would be anti-dilutive. Options and warrants to purchase 285,592 and 345,455 shares of commonstock, respectively, have not been included in the calculation of dilutedcommon stock outstanding for the three and six months ended September 30, 2004,because to do so would be anti-dilutive.

 

E.                                      FACILITIESCONSOLIDATION

 

In January 2005, Sento approved a plan to consolidate its Utah contactcenter facilities from three locations into one “super center” by July 2005.  The Company completed this plan and ceasedusing the second of the centers that was to be abandoned under the plan in June2005.  Costs incurred with closing thisfacility, including the impairment of leasehold improvements and the accrual offuture lease obligations, have been recorded as a restructuring charge in theCompany’s condensed consolidated statement of operations for the six monthsended September 30, 2005.  In addition,management determined that it was not economically feasible to open its contactcenter in Green River, Wyoming, which has been and is currently idle.  Therefore, the cost of future lease paymentsfor the Green River facility has also been included in the restructuring chargein the accompanying condensed consolidated statement of operations for the sixmonths ended September 30, 2005.  Thefollowing summarizes the costs recorded as a restructuring charge during the sixmonths ended September 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 areconciliation of accrued restructuring expense for the six months ended September30, 2005:

 
| Accrued  restructuring expenses at March 31, 2005                       |   | $        | 118,793 |   |
|-------------------------------------------------------------------------|--------|----------|---------|--------|
| Accrual of future facilities lease obligations,  moving and other costs |   | 354,831  |    |
| Accretion of discount on future rent of abandoned  Green River facility |   | (1,620   | )       |
| Costs paid during period                                                |   | (256,436 | )       |
| Accrued restructuring expenses at September 30, 2005                    |   | 215,568  |    |
| Less current  portion of accrued restructuring expenses                 |   | (68,771  | )       |
| Long-term accrued restructuring expenses                                |   | $        | 146,797 |   |

 

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

 

9

----

 

Xtrasource’s earnings through September 2009.  The actual amounts eventually paid for the Earnout could differ materially from management’s estimate.

 

The acquired assetsconsist of call center operations with facilities in the United States, theNetherlands and France.  Assets acquiredalso include intangible assets consisting primarily of the Xtrasource assignedcustomer contracts and related customer base. These intangible assets are being amortized over the expected usefullife of five years.  As of September 30,2005 and March 31, 2005, the Company’s intangible assets consist entirely ofthe intangible assets acquired through this transaction.  The carrying value of intangible assets at September30, 2005 totaled $1,092,984, net of $273,217 of accumulated amortization.  The carrying value of intangible assets atMarch 31, 2005 totaled $1,229,607, net of $136,594 of accumulated amortization.

 

G.                                     INCOMETAXES

 

Even though the Companyhad a consolidated net loss for the six months ended September 30, 2005, theCompany’s operations are located in different tax jurisdictions and may requirethe payment of income taxes in specific jurisdictions.  Income tax expense for the three and six monthperiods ended September 30, 2005 consists of the provision for income taxes onthe Company’s European operations.  TheCompany has net operating loss carry-forwards for U.S. income tax purposessufficient to offset taxable U.S. income generated during the three monthsended September 30, 2005.

 

H.                                    GEOGRAPHICINFORMATION

 

The following geographicarea data includes net revenue and long-lived assets based on physical location:

 
| ** **             | ** ** | **Three Months Ended  September 30,** | ** ** | **Six Months Ended  September 30,** | ** ** |
|------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **             | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenue:**           |       |                                  |       |                                |       |   |   |   |   |
| United States          |       | $                                     | 7,720,000  |                                | $          | 6,169,000 |   | $ | 14,311,000 |   | $ | 12,736,000 |   |
| Europe                 |       | 2,143,000                             |       | —                              |       | 4,312,000 |   | — |   |
| Consolidated  total    |       | $                                     | 9,863,000  |                                | $          | 6,169,000 |   | $ | 18,623,000 |   | $ | 12,736,000 |   |
|                   |       |                                  |       |                                |       |   |   |   |   |
| ** **             | ** ** | **September 30,  2005**               | ** ** | **March 31,  2005**                 | ** ** | ** ** | ** ** | ** ** | ** ** |
|                   |       |                                  |       |                                |       |   |   |   |   |
| **Long-lived assets:** |       |                                  |       |                                |       |   |   |   |   |
| United States          |       | $                                     | 4,419,000  |                                | $          | 4,246,000 |   |   |   |   |   |
| Europe                 |       | 1,121,000                             |       | 1,312,000                           |       |   |   |   |   |
| Consolidated  total    |       | $                                     | 5,540,000  |                                | $          | 5,558,000 |   |   |   |   |   |

 

I.                                         NEWMEXICO EXPANSION

 

On September 20, 2005,the Company entered into a five-year lease agreement with Centurion SW, LLC, anunrelated third party, commencing November 1, 2005, for approximately 15,000square feet in the Compass Bank Plaza at 505 Marquette Avenue, N.W.,Albuquerque, New Mexico. Under the terms of the lease, the Company will pay abase rent of approximately $18,000 a month, with the monthly payment obligationincreasing to approximately $20,000 per month by the end of the five-year leaseterm, plus any incremental increase in operating expenses. The Company has twooptions to extend the lease for an additional five years, plus any incrementalincrease in operating expenses. The lease also provides the Company the rightto obtain additional space in the building under the same terms and conditionson a prorated basis for the remainder of the lease term.  The Company intends on beginning contactcenter operations in this facility during November 2005.

 

10

----

 

J.                                        RECENTLYISSUED ACCOUNTING PRONOUNCEMENTS

 

In December 2004,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No. 123R, *Share-Based Payment*(SFAS 123R), which requires the measurement of all share-based payments toemployees, including grants of employee stock options, using a fair-value-basedmethod and the recording of such expense in the consolidated statements ofoperations. The Company’s pro forma disclosures currently permitted underSFAS 123 will no longer be an alternative to financial statementrecognition under SFAS 123R.

 

Under the provisions ofSFAS 123R, the variable accounting treatment of certain of the Company’soptions that were repriced in April 2003 will no longer be required.  From the repricing date through September 30,2005, the Company has been required to record an expense or (benefit) from “marking-to-market”the outstanding exercisable repriced options. Although the Company has recorded a benefit of $68,652 during the sixmonths ended September 30, 2005, a cumulative net expense of $1,147,000 hasbeen recorded by the Company from April 2003 through September 2005 frommarking these options to market.  This ismainly due to net increases in the price of the Company’s common stock from the$1.60 market value per share on the date of the repricing.  Under the amended transition provisions ofSFAS 123R, the Company would have been required to adopt SFAS 123R on April 1,2006, the first day of its next fiscal year; however, the Company has electedto early adopt SFAS 123R effective October 1, 2005.  Management believes that the elimination ofthe variable accounting treatment of these options under the provisions of SFAS123R will be a benefit to the Company in future periods due to the pricevolatility of the Company’s common stock.

 

  The Company took steps in September 2005 toreduce the cost exposure of implementing SFAS 123R, including accelerating thevesting of all outstanding stock options with exercise prices above the fairmarket value of a share of the Company’s common stock (“under-water” options) asof September 30, 2005.  The Companyintends to use the modified prospective method of adopting the provisions ofSFAS 123R.  Under this method, theunamortized value of non-vested awards granted prior to the adoption of SFAS123R would be required to be expensed by the Company in its consolidated statementsof operations over the remaining vesting period.  By accelerating the vesting of the Company’soutstanding under-water options prior to the adoption of SFAS 123R, the Companywas able to significantly reduce the amount of future expense that it otherwisewould have been required to recognize on these options after adopting SFAS123R.  The Company will be required torecord up to $59,000 of expense on its remaining outstanding options as ofSeptember 30, 2005 over the next four years. Options granted after the adoption of SFAS 123R will be expensed overtheir vesting period, which could have a material impact on the financialstatements depending on the estimated value of the options at the date ofgrant. As of September 30, 2005, there were 34,460 options available for grantunder the Company’s stock option plan. Management is currently analyzing theprovisions of SFAS 123R to determine the best strategies for any potentialfuture share-based awards to its employees.

 

K.                                    SEASONALITY

 

The Company’s operatingresults have historically been affected by the seasonal variances experiencedby some of its significant clients. Historically, the third and fourth quarters have been favorably affectedby a significant increase in service requests experienced from the Company’ssupport of certain clients’ products and/or services. The Company anticipatesthat it will continue to have seasonal variances.

 

11

----

 

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

 

**Forward-LookingStatements**

 

*The statements contained in this Quarterly Reporton Form 10-QSB that are not purely historical are “forward-looking statements”within the meaning of Section 27A of the Securities Act of 1933, as amended,and Section 21E of the Securities Exchange Act of 1934, as amended.  All forward-looking statements involvevarious risks and uncertainties. Forward-looking statements contained in this Report include statementsregarding our plans to develop and deliver integrated information technologyservices, market opportunities and acceptance, expectations, goals, revenues,financial performance, 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,” “intends,”“ believes,” “anticipates,” “should,” and “likely” also identifyforward-looking statements. All forward-looking statements included in thisReport are made as of the date hereof, based on information available to us asof such date, and we assume no obligation — and specifically disclaim anyobligation - 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 Operation-Risks Related to Existing andProposed Operations.”  All subsequentwritten and oral forward-looking statements attributable to Sento or personsacting on our behalf are expressly qualified in their entirety by this sectionand other factors included elsewhere in this Report.  Unless otherwise indicated “we,” “us,” “our,”  and “the Company” refer to Sento Corporationand its subsidiaries.*

 

### **Overview**

 

We are a global provider of custom solutions thatleverage “Right Channeling,” a methodology for ensuring that companies makeinformed choices for multi-channel communication that support their businessgoals and customer expectations.  Weoffer call and contact center solutions for customer acquisition, customerservice, service intervention and technical support.  We use modern customer contact centers,coupled with our state-of-the-art proprietary software systems and othernon-proprietary technology, to provide domestic and international supportservices and technology solutions to our primary target markets consisting of:(1) small to mid-sized companies or divisions of large companies that outsourcecustomer and technical support; and/or (2) companies which may or may not outsourcebut are interested in deploying our Right Channeling and other uniqueofferings.  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 reductions and offset rights including reductions for debt payments (to secured and unsecured creditors) and net working capital adjustment.  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 for which 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 and six months ended September 30, 2005.

 

On January 27, 2005, we announced our intention toconsolidate our Utah call center operations from three centers into a singlecombined center.  We completed this moveduring June 2005.  We believe thisconsolidation will enable us to increase our efficiencies and reduce the costof providing our services over the long-term. During the quarter ended June 30, 2005, we incurred moving costs ofapproximately $25,000 and a write-down of subsequently unneeded property andequipment of $123,000.  In addition, weaccrued rent expense for the remaining lease term on the vacated Utah centers(approximately $62,000) during the three months ended June 30, 2005.  The

 

12

----

 

above costs are identified as restructuring charges in our statement ofoperations for the six months ended September 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, wedetermined that it would not be economically feasible to reopen this facilityin the future and therefore have included the future costs associated with thisfacility ($268,000) in our restructuring accrual during the three-month periodended June 30, 2005.  The restructuringcharges discussed above had a negative impact on our operating results duringthe six months ended September 30, 2005.

 

### **Critical Accounting Policies**

 

Oursignificant accounting policies are described in Note 2 to our ConsolidatedFinancial Statements included in our Annual Report on Form 10-KSB for the yearended March 31, 2005. Those financial statements were prepared in accordancewith U.S. generally accepted accounting principles.  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 could differ materially fromthese estimates.  The development andselection of these critical accounting policies have been discussed, and arereviewed each year, with the Audit Committee of our Board of Directors.

 

*Revenue Recognition.* Revenue is recognized whenpersuasive evidence of an arrangement exists, delivery of services hasoccurred, the fee is fixed or determinable, and collection of the resultingreceivable is reasonably assured.  Wegenerate revenue by delivering customer support and/or technical assistance tousers of our clients’ products and/or services by providing communicationsutilizing live chat, Web collaboration, 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-contact rate. We also provide licenses to a limited number of our clients for the useof our customer contact software tools that we host.  In these arrangements, we charge our client amonthly fee based on the number of users. Revenue under those arrangements is recognized as the service is provided.

 

Revenuesgenerated from professional and consulting services are recognized as theservice is provided, based on time and materials incurred at contractuallyagreed 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 recent client communications.  Our credit losses have generally been withinour expectations; however, we have experienced exceptions from time totime.  During fiscal 2005, we establisheda specific reserve of $475,000 for a financially distressed client.  During the three months endedSeptember 30, 2005, this customer was able to acquire additional funding andpaid us $181,593 against their receivable and gave us a note for $400,000 that maturesin fiscal 2007 for the remaining balance. However, therecan be no assurance that our future credit losses will be within ourexpectations.  In addition, our revenuesand accounts receivable are concentrated in a relatively few number ofcustomers.  A significant change in theliquidity or financial position of any one of these customers or a furtherdeterioration in the economic environment, in general, could have an adverseimpact on the collectibility of our accounts receivable and our futureoperating results.

 

*Stock–Based Compensation.* InDecember 2004, the Financial Accounting Standards Board issued Statementof Financial Accounting Standards No. 123R, *Share-BasedPayment* (SFAS 123R), which requires the measurement of allshare-based payments to employees, including grants of employee stock options,using a fair-value-based method and the recording of such expense in theconsolidated statements of operations. Our pro forma disclosures currentlypermitted under Statementof Financial Accounting Standards No. 123, *Accountingfor Stock Based Compensation* (SFAS 123) no longer willbe an alternative to financial statement recognition under SFAS 123R.

 

13

----

 

Under the provisions of SFAS 123R, the variableaccounting treatment of certain of our options that were repriced in April 2003will no longer be required.  Since the repricingand through September 2005, we have been required to record an expense orbenefit from “marking-to-market” exercisable and outstanding repricedoptions.  Although we recorded a benefitof $68,652 during the six months ended September 30, 2005, we have recorded acumulative net expense of $1,147,000 from April 2003 through September 2005from marking these options to market. This cumulative charge is mainly due to net increases in the price ofour common stock from the $1.60 market value per share on the date of there-pricing.  We believe the eliminationof the variable accounting treatment of these options under the provisions ofSFAS 123R will benefit us in future periods due to the expected continuation ofprice volatility of our common stock. Therefore we elected to adopt the accounting provisions ofSFAS 123R for the reporting period beginning October 1, 2005.

 

  We took stepsin September 2005 to reduce the cost exposure of implementing SFAS 123R,including accelerating the vesting of all outstanding stock options withexercise prices above the fair market value (“under-water” options) as ofSeptember 30, 2005.  We intend to use themodified prospective method of adopting the provisions of SFAS 123R.  Under this method, the unamortized value ofnon-vested awards granted prior to the adoption of SFAS 123R would be requiredto be expensed in our consolidated statement of operations over the remainingvesting period.  By accelerating thevesting of our outstanding under-water options prior to the adoption of SFAS123R, we were able to significantly reduce the amount of future expense thatotherwise would have been required to recognize on these options after adoptingSFAS 123R.  We will be required to recordup to $59,000 of expense over the next four years on the remaining outstandingoptions as of September 30, 2005.  Optionsgranted after the adoption of SFAS 123R will be expensed over their vestingperiod, which could have a material impact on the financial statementsdepending on the estimated value of the options at the date of grant. As ofSeptember 30, 2005, there were 34,460 options available for grant under theCompany’s stock option plan. We are currently analyzing the provisions of SFAS123R to determine the best strategies for any potential future share-basedawards to our employees.

 

For the three and six month periods that endedSeptember 30, 2005 and 2004, we applied the provisions of SFAS 123.  SFAS 123 encourages entities to adopt afair-value-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, *Accountingfor Stock Issued to Employees* (APB 25).  We elected to continue to apply theprovisions of APB 25 and provide pro forma disclosures required by SFAS 123 inthe footnotes to the consolidated financial statements.  We use the Black Scholes option-pricing modelto determine the amount of additional pro forma expense related to theseoptions as presented in our disclosures. Had we adopted a fair-value-based method of accounting for stockoptions, the pro forma expense for these options in our disclosures would havebeen recorded as expense in our statements of operations and could have materiallyaffect our operating results.

 

### **Results ofOperations**

 

**Three months ended September 30, 2005 compared tothree months ended September 30, 2004**

 

*Revenues.*  Our revenues increased 60%, or $3,694,000,from $6,169,000 for the three months ended September 30, 2004 to $9,863,000 forthe three months ended September 30, 2005. The primary reason for the increase was $2,894,000 of revenue generatedfrom the operations we acquired from Xtrasource.  The remaining $800,000 of increased revenuewas due to volume growth from existing customers and revenue from newcustomers.

 

*Cost ofSales.*  Our cost ofsales increased $2,261,000, or 40%, from $5,640,000 for the three months ended September30, 2004 to $7,901,000 for the three months ended September 30, 2005.  The primary reason for this increase in costof sales was the increased business as discussed above.  Our gross profit as a percentage of sales increasedfrom 9% for the three months ended September 30, 2004 to 20% for the threemonths ended September 30, 2005.  Threeprimary factors led to the improvement in margin.  The first factor was the facilitiesconsolidation that occurred during the quarters ended March 2005 and June 2005,thereby significantly improving our facilities utilization.  The second factor was the renegotiation oftelecom contracts and certain facilities leases.  The third factor was the implementation of anew workforce management system that allows us to improve employee utilizationand scheduling.

 

14

----

 

*ProductDevelopment*.  Our productdevelopment cost decreased 57% or $66,000, from $115,000 during the threemonths ended September 30, 2004 to $49,000 during the three months endedSeptember 30, 2005.  During the threemonths ended September 30, 2004, we were working on two significant projects relatedto enhancements of our Right-Channeling technology and the development of ourproprietary business intelligence system. These projects were completed during fiscal 2005.  We began a new project in fiscal 2006 relatedto our customer interaction technology, which to this point has required noadditional development costs.  Weanticipate that we will continue to incur product development costs as wecontinue to enhance our technology.

 

*Selling, General and Administrative Expenses.*  Our selling, general and administrativeexpenses increased by 87%, or $796,000, from $912,000 for the three monthsended September 30, 2004 to $1,708,000 for the three months ended September 30,2005.  This increase was mainly due to theexpenses associated with the Xtrasource business and planned increase inselling and marketing efforts that we believe will help us continue to increaseour business.

 

*Collection of fully-reserved doubtful account*.  During the quarter ended December 31, 2004,we determined it was necessary to specifically reserve for a receivable duefrom a financially distressed customer. During the three months ended September 30, 2005, this customer was ableto acquire additional funding.  As a resultof that funding they paid us $181,593 against the receivable and gave us a notefor $400,000 that matures in fiscal 2007. The $181,593 has been included in our statement of operations for thethree months ended September 30, 2005. The note receivable, which is fully reserved, will not be recognized inincome until paid.

 

*Stock-BasedCompensation.*  In April2003, our Board of Directors approved an employee stock option exchangeprogram.  Under this program, options topurchase 377,342 shares of common stock with exercise prices above $2.00 pershare were cancelled in exchange for options to purchase 313,592 shares ofcommon stock at an exercise price equal to the then current market price of$1.60.  This exchange program wasconsidered to be an effective “repricing” of stock options, which requires usto adjust the amount of compensation expense we recognize each quarter untilthe stock options are exercised, forfeited or expire (see Note C to ourunaudited condensed consolidated financial statements).  The cumulative amount of this charge iscalculated by multiplying the exercisable number of options as of the applicable measurement dateby the difference between the market price of the stock on such date and the exercise price of $1.60, less any amountspreviously recognized.

 

During the three months ended September 30, 2005 werecorded a non-cash stock-based compensation benefit of $14,000 related to therepriced options, a $2,000 decrease from $16,000****of non-cash stock-based compensation benefit that we recordedduring the three months ended September 30, 2004.  This decrease was primarily a result of smallerfluctuations in the market value of our common stock from June 30, 2005 to September30, 2005 than the fluctuations in the market value of our common stock from June30, 2004 to September 30, 2004.

 

Effective October 1, 2005, we adopted Statement ofFinancial Accounting Standards No. 123R, *Share-BasedPayment* (SFAS 123R).  UnderSFAS 123R, the variable accounting treatment for these repriced options will nolonger be required.

 

*Amortizationof intangible assets.* Effective October 1, 2004, we acquired substantially all of the assetsand operations of Xtrasource.  Weallocated the purchase price over the assets acquired, including an allocationof $1,366,000 to intangible assets which primarily represent the acquiredcustomer base and the related assigned contracts.  We have determined that the expected life ofthese intangible assets is five years and accordingly, we recorded an expense of$68,000 for the amortization of these intangibles during the three months endedSeptember 30, 2005.  There was nocomparable expense during the three months ended September 30, 2004.

 

*Income tax expense.*  Our operations are located in different taxjurisdictions and may require the payment of income taxes in specificjurisdictions.  Income tax expense forthe three month period ended September 30, 2005 consists of the provision forincome taxes for our European operations that were acquired through theXtrasource acquisition.  We believe we havesufficient net operating loss carry-forwards to offset any income tax expensethat would have otherwise been charged to our U.S. operations for the threemonths ended September 30, 2005.

 

15

----

 

**Six months ended September 30, 2005 compared tosix months ended September 30, 2004**

 

*Revenues.*  Our revenues increased 46%, or $5,887,000,from $12,736,000 for the six months ended September 30, 2004 to $18,623,000 forthe six months ended September 30, 2005. The primary reason for the increase was $5,520,000 of revenue generatedfrom the operations we acquired from Xtrasource.

 

*Cost ofSales.*  Our cost ofsales increased $4,482,000, or 39%, from $11,416,000 for the six months endedSeptember 30, 2004 to $15,898,000 for the six months ended September 30,2005.  Of this increase, $4,383,000relates to the cost of revenue generated from the operations we acquired fromXtrasource.  Our gross profit as apercentage of sales increased from 10% for the six months ended September 30,2004 to 15% for the six months ended September 30, 2005.  Three primary factors led to the improvementin margin.  The first factor was the facilitiesconsolidation that occurred during the quarters ended March 2005 and June 2005,thereby significantly improving our facilities utilization.  The second factor was the renegotiation oftelecom contracts and certain of our facilities leases.  The third factor was the implementation ofour new workforce management system that allows us to improve our employeeutilization and scheduling.

 

*ProductDevelopment*.  Ourproduct development cost decreased 79% or $185,000, from $234,000 during thesix months ended September 30, 2004 to $49,000 during the six months endedSeptember 30, 2005.  During the sixmonths ended September 30, 2004, we were working on two significant projectsrelated to enhancements of our Right-Channeling technology and the developmentof our proprietary business intelligence system.  These projects were completed during fiscal2005.  We began a new project in fiscal2006 related to our customer interaction technology which to this point hasrequired no additional development costs. We anticipate that we will continue to incur product development costsas we continue to enhance our technology.

 

*Selling, General and Administrative Expenses.*  Our selling, general and administrativeexpenses increased by 107%, or $1,856,000, from $1,738,000 for the six monthsended September 30, 2004 to $3,594,000 for the six months ended September 30,2005.  This increase was mainly due tothe expenses associated with the Xtrasource business and planned increase inselling and marketing efforts that we believe will help us continue to increaseour revenue.  During the six months endedJune 30, 2005, we completed a re-branding of our technology and services whichincluded the creation of a new company logo and web site.

 

*Collection of fully-reserved doubtful account*.  During the quarter ended December 31, 2004,we determined it was necessary to specifically reserve for a receivable duefrom a financially distressed customer. During the six months ended September 30, 2005, this customer was ableto acquire additional funding.  As aresult of that funding they paid us $181,593 against the receivable and gave usa note for $400,000 that matures in fiscal 2007.  The $181,593 has been included in our statementof operations for the six months ended September 30, 2005.  The note receivable, which is fully reserved,will not be recognized in income until paid.

 

*Stock-BasedCompensation.*  In April2003, our Board of Directors approved an employee stock option exchangeprogram.  Under this program, options topurchase 377,342 shares of common stock with exercise prices above $2.00 pershare were cancelled in exchange for options to purchase 313,592 shares ofcommon stock at an exercise price equal to the then current market price of$1.60.  This exchange program wasconsidered to be an effective “repricing” of stock options, which required usto adjust the amount of compensation expense we recognized each quarter untilthe stock options are exercised, forfeited or expired (see Note C to ourunaudited condensed consolidated financial statements).  The cumulative amount of this charge iscalculated by multiplying the exercisable number of options as of the applicable measurement dateby the difference between the market price of the stock on such date and the exercise price of $1.60, less any amountspreviously recognized.

 

During the six months ended September 30, 2005 werecorded a non-cash stock-based compensation benefit of $69,000 related to therepriced options, a $97,000 decrease from $166,000****of non-cash stock-based compensation benefit that we recordedduring the six months ended September 30, 2004. This decrease was primarily a result of smaller fluctuations in themarket value of our common stock from March 31, 2005 to September 30, 2005 thanthe fluctuations in the market value of our common stock from March 31, 2004 toSeptember 30, 2004.

 

*Amortizationof intangible assets.* Effective October 1, 2004, we acquired substantially all of the assetsand operations of Xtrasource.  Weallocated the purchase price over the assets acquired, including an allocationof $1,366,000 to intangible assets which primarily represent the acquiredcustomer base and the related assigned

 

16

----

 

contracts.  We have determinedthat the expected life of these intangible assets is five years. Accordingly,we recorded an expense of $137,000 for the amortization of these intangiblesduring the six months ended September 30, 2005. There was no comparable expense during the six months ended September30, 2004.

 

*Restructuringcharge*.  In January 2005 we approved a plan to consolidateour three Utah contact centers into a single combined 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.

 

                                                *Income tax expense.* Our operations are located in different tax jurisdictions and mayrequire the payment of income taxes in specific jurisdictions.  Income tax expense for the six month periodended September 30, 2005 consists of the provision for income taxes for ourEuropean operations that were acquired through the Xtrasource acquisition.

 

### **Liquidityand Capital Resources**

 

Our workingcapital decreased $1,191,000, or 22%, from $5,498,000 at March 31, 2005 to$4,307,000 at September 30, 2005.  Ourchange in working capital was primarily the result of a decrease in cashbalances of $919,000, from $5,698,000 as of March 31, 2005 to $4,779,000 as ofSeptember 30, 2005, and an increase in accrued payroll and payroll taxes of$342,000, from $1,560,000 at March 31, 2005 to $1,902,000 at September 30,2005.  The increase in accrued payrolland payroll taxes was due to increased headcount needed to service additionalclient contractual requirements.

 

 The decrease in cash was mainly due to$1,087,000 of cash used for capital expenditures.  We also incurred $597,000 of debt under ourequipment line with a bank and repaid $443,000 of principal owed on ourlong-term debt.  We generated $117,000 ofcash flow from operations during the six months ended September 30, 2005 andhad a $80,000 decrease in cash from the effect of foreign currencytranslations.

 

Effective March 31, 2005, we renewed our line ofcredit with a bank that allows us to borrow up to****$3,000,000or 80% of eligible accounts receivable. The line of credit accrues interest at 1% over of the bank’s prime rate(6.75% as of September 30, 2005) and matures on March 31, 2007.  As of September 30, 2005, we had no balancesoutstanding against the line.

 

Effective March 31, 2005, we also entered into a termdebt agreement with a bank for equipment financing.  The loan allows for a per draw minimum of$100,000 with a total maximum draw 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 the sixmonths ended September 30, 2005, we drew and had outstanding a total of$597,108 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 quartershave been favorably affected by a significant increase in service requests weexperienced from our support of certain clients’ products and/or services.  Going forward, we anticipate that we willcontinue to have seasonal variances.

 

17

----

 

### **RisksRelated to Existing and Proposed Operations**

 

There are a number of factors that may affect ouroperating results, including the risks and uncertainties identified in thefollowing paragraphs.  In addition toother information set forth in this Report, readers should review and carefullyconsider the following factors.

 

***We have a historyof losses and may continue to experience losses******.***

 

We experienced net losses in four of our last sixfiscal years and during our most recent six months ended September 30, 2005 andwe had an accumulated deficit of $(13,633,000) as of September 30, 2005.  Although we reached operating profitability forthe quarter ended September 30, 2005, we cannot provide any assurances that wewill be able to continue to do so and we may incur losses in future periods,particularly if we lose clients, are unable to attract and retain new clientsor do not properly utilize our resources. We cannot ensure that we will be able to achieve or maintain consistentlyprofitable operations.

 

***We are experiencingrevenue growth and our future operations will require skilled management ofgrowth******.***

 

Our current and future revenue growth must beconsidered in light of the risks, expenses, delays, problems and difficultiesfrequently encountered in the establishment of a new business, the developmentand commercialization of products based on new technologies, and thecompetitive environment in which we will operate.  As our operationsexpand, our success will depend on our ability to manage continued growth,including integration of our executive officers, directors and consultants intoan effective management and technical team; to formulate strategic alliances,joint ventures, or other collaborative arrangements with third parties; tocommercialize and market our proposed products and services; and to monitor andmanage these relationships on a long-term basis.  If our management isunable to integrate these resources and manage growth effectively, the qualityof our products and services, our ability to retain key personnel, and theresults of our operations could be materially and adversely affected.

 

***Implementation ofour growth plans will be dependent on our ability to market and sell ourservices to new and existing clients.***

 

Our growth plans are dependent upon our ability to attractand retain new clients and to generate additional business from existingclients.  Our efforts to market and sellour services will be affected by fluctuations in technology and industrystandards, changes in customer requirements and preferences, increasedcompetition and general economic conditions, among other factors.  Many of these factors are beyond ourcontrol.  If we are incorrect in ourassessment of the feasibility of our growth plans, if we are not effective inour efforts to market and sell our services or if circumstances change in a waythat we did not foresee or anticipate, we may not grow as planned or our growthstrategy may have an adverse effect on business operations and ourprofitability.

 

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

 

Individual client revenue transactions can constitute asubstantial percentage of our quarterly revenue, and some revenue transactionsmay generate a substantial portion of the operating profits for a quarter.  Our revenues also are a function of thenumber of support requests we receive, and the time we spend on suchrequests.  Thus, if we receive fewersupport requests than anticipated or the time spent in resolving inquiries isgreater than anticipated, our revenues may fluctuate.  Further, delays in the receipt of customerorders can cause significant fluctuations in revenues from quarter to quarter.

 

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.

 

***Several key clientsrepresent a significant portion of our revenues, and the loss of a key clientcould affect our revenues and profitability.***

 

Three clients accounted for approximately 57% of ourrevenues for the six months ended September 30, 2005.  These three clients accounted forapproximately 29%, 17% and 11%, respectively, of our revenues for the sixmonths ended September 30, 2005.

 

18

----

 

Some of our clients can generally cancel theircontracts on short notice.  It can take asignificant amount of time to develop and obtain new clients and retrainemployees to replace revenue from a lost client.  Thus, the loss of any of our key clientscould have a significant effect on our revenues and profitability.  In addition, our future revenue growth isdependent upon our ability to attract and retain new clients.

 

***We are subject tocredit risks and may be unable to collect our accounts receivable balances.***

 

We provide unsecured credit terms to our clients.  Based on credit evaluations and otherinformation gathered by our management, we establish credit terms for eachclient; however, there can be no assurance that our future credit losses willbe consistent with management’s expectations. A significant change in the liquidity or financial condition of one ormore key clients, or a larger number of smaller clients, or furtherdeterioration in the economic environment, in general, could have an adverseimpact on the collectibility of our accounts receivable and our futureoperating results.

 

***Market volatilityand fluctuations in our stock price and trading volume may cause suddendecreases in the value of an investment 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 $1.35 and $17.89 during the 30 months ended September 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.

 

***Managing theutilization level of our resources is necessary in order to achieve our desiredprofitability.***

 

Our business strategy requires us to fully utilizepersonnel and physical facilities 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 keepup with the rapid technological change experienced by the customer contactservice market, our products and services may become obsolete and we may loseclients.***

 

The customer contact service industry is characterizedby rapid technological change, alterations in customer requirements andpreferences, and the emergence of new industry standards and practices.  Our operating results and financial conditionwill depend, in part, on our ability to develop solutions that keep pace withcontinuing changes in information technology, evolving industry standards, andchanging client requirements.  There canbe no assurance that we will be successful in adequately addressing thesedevelopments on a timely basis or that, if these developments are addressed, wewill be successful in the marketplace. In addition, products or technologies developed by others could renderour services non-competitive or obsolete. Our failure to address these developments could have a material negativeeffect on our business and financial condition.

 

***We are susceptible to business and political risks frominternational operations that could result in reduced revenues or earnings.***

 

We operatebusinesses or have contractual relationships in the Netherlands, France andIndia and are looking to expand in other countries.  Additionally, there is increasing demand foroffshore customer care outsourcing 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 beadversely affected and our revenues and/or earnings could be reduced.

 

19

----

 

***Volatile economicconditions have affected and will likely continue to affect our operations andfinancial results.***

 

Volatile economic conditions have adversely affectedour operations and financial results.  Incertain sectors serviced by us in recent years, economic slowdowns have causedus to lose some clients and also resulted in increased pricing pressures andlower call volumes from some existing clients. Slower economic conditions may limit our ability to attract new clientsor retain existing clients.  The slowereconomy also resulted 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.

 

***If companies reducetheir reliance on outsourced services, our revenues and financial condition maybe adversely affected.***

 

Our business depends in large part on the trend withinthe IT industry to outsource certain services. We cannot provide any assurance that this trend will continue or that,if the trend continues, it will continue at the same rate of growth.  The failure of this trend to continue couldhave a material adverse effect on our business, financial condition, andresults of operations.

 

***Competitivepressures could harm our financial performance.***

 

The market for customer contact services is highlyfragmented and very competitive.  Incertain segments of the industry, however, the customer contact servicesindustry has begun to experience a degree of consolidation, and the developmentof major customer contact center companies has resulted in an additional levelof competition from service providers that have greater name recognition,larger installed customer bases, and significantly greater financial,technical, and marketing resources than we have.  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 toattract, train and retain key management, technical and marketing personnel.***

 

Our success will depend, in large part, on our abilityto attract, retain and train highly qualified technical, managerial andmarketing personnel with the expertise 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 ourcomputers, telecommunications equipment or software systems could interrupt ourability to provide our services******.***

 

Our business depends to a large extent on computers,telecommunications equipment and software systems (both equipment and systems maintainedby us and equipment and systems maintained by third parties).  A natural disaster, human error, equipmentmalfunction or inadequacy or multiple other events could result in a prolongedinterruption in our ability to provide support services to clients or theircustomers.  The temporary or permanentloss of computer or telephone equipment or systems, through casualty, operatingmalfunctions or otherwise, could have a material adverse effect on ouroperations, property or financial condition, and business interruptioninsurance may not be adequate to compensate for all losses that may beincurred.

 

20

----

 

***We rely on two third-partysoftware companies for our chat, email applications and CRM case logging*.**

 

We contract with a third-party software company toprovide chat and email tools used with our CRM software, reporting andmanagement services.  Additionally, weuse a third party software company to do our CRM case logging for some of ourmajor clients.  If either of thesesoftware companies fail in their business efforts, we may lose our access tothese software tools.  Our failure toobtain adequate replacement software tools would cause us to experience servicedelays, interruptions or cancellations.

 

***Provisions of our Articles of Incorporation, Bylaws andShareholder Rights Plan could impair or delay shareholders’ ability to replaceor remove our management and could discourage takeover transactions thatshareholders might consider to be in their best interests.***

 

OurArticles of Incorporation and Bylaws, the Utah Revised Business CorporationAct, and the Utah Control Shares Acquisition Act each contain certainprovisions that may have the effect of inhibiting a non-negotiated merger orother business combination.  Our Articlesof Incorporation grant to our Board of Directors the authority, without furtheraction by our shareholders, to fix the rights and preferences of, and issueshares of preferred stock.  Our recentlyadopted Bylaws provide advance notice requirements that may limit theopportunity for our shareholders to advance nominees for election to our Boardof 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 a dividend on our common stockand we do not anticipate paying dividends in the foreseeable future.***

 

Nodividends have 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 our commonstock 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 September 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 September 30, 2005.

 

21

----

 

# **PART II.**                                                 OTHER INFORMATION

 

## Item 2.             Unregistered sale ofEquity Securities and Use of Proceeds

 

There were no sales ofunregistered securities during the six months ended September 30, 2005.  However, during the six months ended September30, 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 (1)** | ** ** | **Maximum  number  of shares that may  yet be purchased  under the plan (2),(3)** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|------------------------------------|------------|---------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
|                        |       |                                   |       |                               |       |                                                                            |       |                                                                              |       |
| Month  ended April 30, 2005 |       | 16,938                                 |       | $                                  | 3.30       |                                                                            | 76,737     |                                                                              | 309,293    |   |
| Total                       |       | 16,938                                 |       | $                                  | 3.30       |                                                                            | 76,737     |                                                                              | 309,293    |   |

 

----

(1)           OnFebruary 28, 2005, we announced the commencement of the stock repurchase plan.

(2)           OurBoard of Directors has approved the repurchase of up to 385,862 shares of ourcommon stock, representing ten percent of the number of shares of common stockoutstanding at the time the repurchase plan was approved.

(3)           Thestock repurchase plan expires on February 28, 2006.

 

## Item 6.             Exhibits

 

Exhibit 10.1 Office Lease With Centurion SW LLC

Exhibit 10.2 Lease Amendment Number Three with APSoutheast Portfolio Partners L.P.

Exhibits 31.1 and 32.1 – Certifications of the Company’sChief Executive Officer

Exhibits 31.2 and 32.2 – Certifications of the Company’sChief Financial Officer

 

## SIGNATURES

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this Quarterly Report onForm 10-QSB to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                     | 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 November 11, 2005. |              |   |
|                          |                   |  |  |  |

 

22

----