** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 
| **ý** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|----------------------------------------------------------------------------------------------|

 

**For the quarterlyperiod ended September 30, 2002**

 

**or**

 
| **o** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**F****or thetransition period from****        to        **

 

**Commission filenumber 0-31807**

 

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| **SureBeam  Corporation**                                           |
|---------------------------------------------------------------------|
| (Exact name of registrant as specified in its charter)              |
|                                                                |   |   |
| **DELAWARE**                                                        |   | **33-0921003** |
| (State or other jurisdiction of incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                                |   |   |
| **9276 Scranton Road, Suite 600  San Diego, California 92121**      |
| (Address of principal executive offices, zip code)                  |
|                                                                |   |   |
| **(858) 795-6300**                                             |
| (Registrant’s telephone number, including area code)           |

 

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Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes  ý    No o

 

The number ofshares of registrant’s Class A common stock, $.001 par value, outstanding as ofNovember 5, 2002, was 67,935,962.

 

The number ofshares of registrant’s Class B common stock, $.001 par value, outstanding as ofNovember 5, 2002, was zero.

 

 

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**SUREBEAM CORPORATION**

**FORM 10-Q**

**FOR THE QUARTER ENDEDSEPTEMBER 30, 2002**

 

**INDEX**

 
| **PART I**   | **FINANCIAL INFORMATION**                                                                                    |
|--------------|--------------------------------------------------------------------------------------------------------------|
|         |                                                                                                         |
| **ITEM 1.**  | FINANCIAL STATEMENTS                                                                                         |
|         | Consolidated Statements  of Operations for the three and nine months ended September 30, 2002 and 2001       |
|         | Consolidated Balance Sheets  as of September 30, 2002 and December 31, 2001                                  |
|         | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2002 and  2001                |
|         | Consolidated  Statements of Stockholders’ Equity for the nine months ended September 30,  2002 and 2001 |
|         | Notes to  Consolidated Financial Statements                                                                  |
|         |                                                                                                         |
| **ITEM  2.** | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                  |
|         |                                                                                                         |
| **ITEM  3.** | QUALITATIVE  AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK                                                  |
|         |                                                                                                         |
| **ITEM 4.**  | CONTROLS AND PROCEDURES                                                                                      |
|         |                                                                                                         |
| **PART  II** | **OTHER  INFORMATION**                                                                                       |
|         |                                                                                                         |
| **ITEM  1.** | LEGAL PROCEEDINGS                                                                                            |
| **ITEM  2.** | CHANGES IN SECURITIES  AND USE OF PROCEEDS                                                                   |
| **ITEM  3.** | DEFAULTS UPON SENIOR  SECURITIES                                                                             |
| **ITEM  4.** | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                         |
| **ITEM  5.** | OTHER INFORMATION                                                                                            |
| **ITEM  6.** | EXHIBITS AND  REPORTS ON FORM 8-K                                                                            |

 

2

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**PARTI-FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**SureBeam Corporationand Subsidiaries**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

**(in thousands, exceptper share data)**

 
|                                        |   | **Three Months Ended September 30,** |    | **Nine Months Ended  September 30,** |   |
|---------------------------------------------|--------|--------------------------------------|---------|--------------------------------------|--------|
|                                        |   | **2002**                             |    | **2001**                             |   | **2002** |   | **2001** |   |
| Revenues:                                   |   |                                 |    |                                 |   |   |   |   |   |
| Non-affiliated parties                      |   | $                                    | 815     |                                 | $      | 3,620 |   | $ | 4,795 |   | $ | 10,404 |   |
| Investee                                    |   | 2,216                                |    | 8,042                                |   | 3,591 |   | 15,350 |   |
| The Titan Corporation                       |   | 3,961                                |    | 2,886                                |   | 16,407 |   | 3,887 |   |
| Total revenues                              |   | 6,992                                |    | 14,548                               |   | 24,793 |   | 29,641 |   |
| Cost of revenues:                           |   |                                 |    |                                 |   |   |   |   |   |
| Non-affiliated parties                      |   | 2,386                                |    | 2,729                                |   | 8,007 |   | 7,145 |   |
| Investee                                    |   | 1,264                                |    | 4,124                                |   | 2,048 |   | 7,872 |   |
| The Titan Corporation                       |   | 3,225                                |    | 2,402                                |   | 9,687 |   | 3,403 |   |
| Total cost of revenues                      |   | 6,875                                |    | 9,255                                |   | 19,742 |   | 18,420 |   |
| Gross profit                                |   | 117                                  |    | 5,923                                |   | 5,051 |   | 11,221 |   |
| Selling, general and administrative expense |   | 11,813                               |    | 11,923                               |   | 31,429 |   | 69,576 |   |
| Research and development                    |   | 55                                   |    | 736                                  |   | 551 |   | 1,849 |   |
| Loss from operations                        |   | (11,751                              | )       | (7,366                               | )      | (26,929 | ) | (60,204 | ) |
| Interest income                             |   | 37                                   |    | 333                                  |   | 164 |   | 1,062 |   |
| Interest expense                            |   | (331                                 | )       | (1,576                               | )      | (1,282 | ) | (4,756 | ) |
| Other income, net                           |   | 1,011                                |    | —                               |   | 2,932 |   | — |   |
| Loss before income tax benefit              |   | (11,034                              | )       | (8,609                               | )      | (25,115 | ) | (63,898 | ) |
| Income tax benefit                          |   | —                               |    | (861                                 | )      | — |   | (6,390 | ) |
| Net loss                                    |   | $                                    | (11,034 | )                                    | $      | (7,748 | ) | $ | (25,115 | ) | $ | (57,508 | ) |
|                                        |   |                                 |    |                                 |   |   |   |   |   |
| Basic loss per share:                       |   |                                 |    |                                 |   |   |   |   |   |
| Net loss                                    |   | $                                    | (0.16   | )                                    | $      | (0.14 | ) | $ | (0.38 | ) | $ | (1.08 | ) |
| Weighted average shares — basic        |   | 67,336                               |    | 56,131                               |   | 65,683 |   | 53,478 |   |
|                                        |   |                                 |    |                                 |   |   |   |   |   |
| Diluted loss per share:                     |   |                                 |    |                                 |   |   |   |   |   |
| Net loss                                    |   | $                                    | (0.16   | )                                    | $      | (0.14 | ) | $ | (0.38 | ) | $ | (1.08 | ) |
| Weighted average shares — diluted      |   | 67,336                               |    | 56,131                               |   | 65,683 |   | 53,478 |   |

 

*The accompanyingnotes are an integral part of these consolidated financial statements*.

 

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**SureBeam Corporationand Subsidiaries**

**CONSOLIDATED BALANCE SHEETS**

**(inthousands, except share information)**

 
|                                                                                                                                                                                                             |   | **September  30,  2002** |       | **December  31,  2001** |       |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-------------------------|------------|
|                                                                                                                                                                                                             |   | **(Unaudited)**          | ** ** |                    | ** ** |
| **Assets (Pledged)**                                                                                                                                                                                             |   |                     |       |                    |       |
| Current Assets:                                                                                                                                                                                                  |   |                     |       |                    |       |
| Cash and cash equivalents                                                                                                                                                                                        |   | $                        | 4,985      |                    | $          | 4,131 |   |
| Investments, available-for-sale                                                                                                                                                                                  |   | —                   |       | 3,766                   |       |
| Accounts receivable-net of allowance of $1,428 at September 30, 2002,  and December 31, 2001                                                                                                                     |   | 16,216                   |       | 12,645                  |       |
| Receivable from The Titan Corporation                                                                                                                                                                            |   | 6,459                    |       | 12,503                  |       |
| Inventories                                                                                                                                                                                                      |   | 19,767                   |       | 19,764                  |       |
| Prepaid expenses and other                                                                                                                                                                                       |   | 4,180                    |       | 5,172                   |       |
| Total current assets                                                                                                                                                                                             |   | 51,607                   |       | 57,981                  |       |
| Property and equipment-net                                                                                                                                                                                       |   | 55,803                   |       | 41,903                  |       |
| Due from The Titan Corporation                                                                                                                                                                                   |   | 2,319                    |       | 2,319                   |       |
| Intangible assets-net                                                                                                                                                                                            |   | 3,476                    |       | 3,549                   |       |
| Other assets                                                                                                                                                                                                     |   | 13,665                   |       | 12,032                  |       |
| Total assets                                                                                                                                                                                                     |   | $                        | 126,870    |                    | $          | 117,784 |   |
|                                                                                                                                                                                                             |   |                     |       |                    |       |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                    |   |                     |       |                    |       |
| Current Liabilities:                                                                                                                                                                                             |   |                     |       |                    |       |
| Accounts payable                                                                                                                                                                                                 |   | $                        | 4,203      |                    | $          | 9,191 |   |
| Accrued compensation and benefits                                                                                                                                                                                |   | 3,028                    |       | 2,664                   |       |
| Due to The Titan Corporation                                                                                                                                                                                     |   | 1,498                    |       | —                  |       |
| Other current liabilities                                                                                                                                                                                        |   | 4,404                    |       | 4,756                   |       |
| Total current liabilities                                                                                                                                                                                        |   | 13,133                   |       | 16,611                  |       |
| Subordinated promissory note to The Titan Corporation                                                                                                                                                            |   | —                   |       | 72,208                  |       |
| Senior credit facility with The Titan Corporation                                                                                                                                                                |   | 22,500                   |       | —                  |       |
| Other long-term liabilities                                                                                                                                                                                      |   | 1,018                    |       | 613                     |       |
| Total liabilities                                                                                                                                                                                                |   | 36,651                   |       | 89,432                  |       |
|                                                                                                                                                                                                             |   |                     |       |                    |       |
| Commitments and Contingencies                                                                                                                                                                                    |   |                     | ** ** |                    | ** ** |
|                                                                                                                                                                                                             |   |                     |       |                    |       |
| Stockholders’ Equity                                                                                                                                                                                        |   |                     |       |                    |       |
| Preferred stock, $.001 par value, 5,000,000 shares authorized, none  issued and outstanding                                                                                                                      |   | $                        | —     |                    | $          | — |   |
| Class A common stock, $.001 par value, 200,000,000 shares authorized,  67,607,505 issued and 67,603,976 outstanding at September 30, 2002 and  11,605,440 issued and 11,601,911 outstanding at December 31, 2001 |   | 66                       |       | 11                      |       |
| Class B common stock, $.001 par value, 50,000,000 shares authorized,  50,000,000 issued and 0 outstanding at September 30, 2002 and 46,774,235  issued and outstanding at December 31, 2001                      |   | —                   |       | 47                      |       |
| Additional paid-in capital                                                                                                                                                                                       |   | 220,816                  |       | 147,607                 |       |
| Deferred compensation                                                                                                                                                                                            |   | (13,106                  | )          | (26,918                 | )          |
| Accumulated other comprehensive income                                                                                                                                                                           |   | —                   |       | 47                      |       |
| Treasury stock, at cost: 3,529 shares at September 30, 2002 and  December 31, 2001                                                                                                                               |   | (42                      | )          | (42                     | )          |
| Accumulated deficit                                                                                                                                                                                              |   | (117,515                 | )          | (92,400                 | )          |
| Total stockholders’ equity                                                                                                                                                                                  |   | 90,219                   |       | 28,352                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                  |   | $                        | 126,870    |                    | $          | 117,784 |   |

 

*The accompanyingnotes are an integral part of these consolidated financial statements*.

 

4

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**SureBeam Corporation and Subsidiaries**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(in thousands)**

 
|                                                                                       |   | **Nine  Months Ended  September 30,** |       |
|--------------------------------------------------------------------------------------------|--------|---------------------------------------|------------|
|                                                                                       |   | **2002**                              |       | **2001** |   |
| **Cash Flows from Operating Activities:**                                                  |   |                                  | ** ** |   | ** ** |
| Net loss                                                                                   |   | $                                     | (25,115    | ) | $ | (57,508 | ) |
| Adjustments to reconcile net loss to net cash provided by (used in)  operating activities: |   |                                  |       |   |   |
| Nonmonetary research consideration                                                         |   | (1,586                                | )          | (3,231 | ) |
| Depreciation and amortization                                                              |   | 3,862                                 |       | 2,956 |   |
| Deferred income taxes                                                                      |   | —                                |       | (6,390 | ) |
| Amortization of deferred compensation                                                      |   | 13,812                                |       | 49,155 |   |
| Loss on disposal of property and equipment                                                 |   | 122                                   |       | — |   |
| Change in operating assets and liabilities:                                                |   |                                  |       |   |   |
| Accounts receivable and receivable from The Titan Corporation                              |   | 2,473                                 |       | (21,658 | ) |
| Inventories                                                                                |   | (3                                    | )          | (5,080 | ) |
| Prepaid expenses and other                                                                 |   | 191                                   |       | 688 |   |
| Other assets                                                                               |   | (1,491                                | )          | (564 | ) |
| Accounts payable                                                                           |   | (4,988                                | )          | 4,858 |   |
| Accrued compensation and benefits                                                          |   | 364                                   |       | 1,762 |   |
| Other accrued liabilities                                                                  |   | 53                                    |       | 3,992 |   |
| Due to The Titan Corporation                                                               |   | 1,498                                 |       | — |   |
| Net cash used in operating activities                                                      |   | (10,808                               | )          | (31,020 | ) |
|                                                                                       |   |                                  |       |   |   |
| **Cash Flows from Investing Activities:**                                                  |   |                                  | ** ** |   | ** ** |
| Sale (purchase) of available-for-sale investments                                          |   | 3,719                                 |       | (12,253 | ) |
| Capital expenditures                                                                       |   | (15,121                               | )          | (16,548 | ) |
| Advances to Tech Ion                                                                       |   | —                                |       | (2,775 | ) |
| Advances to Hawaii Pride                                                                   |   | (445                                  | )          | (911 | ) |
| Net cash used in investing activities                                                      |   | (11,847                               | )          | (32,487 | ) |
|                                                                                       |   |                                  | ** ** |   | ** ** |
| **Cash Flows from Financing Activities:**                                                  |   |                                  | ** ** |   | ** ** |
| Borrowings on senior credit facility with The Titan Corporation                            |   | 22,500                                |       | — |   |
| Net proceeds from issuance of common stock                                                 |   | —                                |       | 59,777 |   |
| Borrowings on subordinated promissory note                                                 |   | 792                                   |       | 14,180 |   |
| Proceeds from exercise of stock options and warrants                                       |   | 217                                   |       | 1,124 |   |
| Net cash provided by financing activities                                                  |   | 23,509                                |       | 75,081 |   |
|                                                                                       |   |                                  |       |   |   |
| Net increase in cash and cash equivalents                                                  |   | 854                                   |       | 11,574 |   |
| Cash and cash equivalents at beginning of period                                           |   | 4,131                                 |       | — |   |
| Cash and cash equivalents at end of period                                                 |   | $                                     | 4,985      |   | $ | 11,574 |   |
|                                                                                       |   |                                  |       |   |   |
| **Supplemental Cash Flow Information:**                                                    |   |                                  |       |   |   |
| **Non-Cash Financing and Investing Activities:**                                           |   |                                  | ** ** |   | ** ** |
| Conversion of subordinated promissory note to common stock                                 |   | $                                     | 73,000     |   | $ | — |   |
| Increase in fair value of investments, available-for-sale                                  |   | 47                                    |       | 122 |   |

 

*The accompanying notes are an integral partof these consolidated financial statements.*

 

5

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**SureBeam Corporation and Subsidiaries**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**(Unaudited)**

**(in thousands)**

 
|                                                                                               |   | **Shares of  Common Stock** |        | **Common Stock** |        | **Additional  Paid-in  Capital** |   | **Deferred  Compensation** |   | **Accumulated  Other  Comprehensive  Income  (Loss)** |   | **Accumulated  Deficit** |    | **Treasury  Stock** |   | **Total** |   |
|----------------------------------------------------------------------------------------------------|--------|-----------------------------|-------------|------------------|-------------|----------------------------------|--------|----------------------------|--------|-------------------------------------------------------|--------|--------------------------|---------|---------------------|--------|-----------|--------|
| **Class A**                                                                                        |   | **Class B**                 | **Class A** |             | **Class B** |
| **Nine Months Ended September 30, 2002:**                                                          |   |                        |        |             |        |                             |   |                       |   |                                                  |   |                     |    |                |   |      |   |   |   |   |   |
| Balances at December 31, 2001                                                                      |   | 11,602                      |        | 46,774           |        | $                                | 11     |                       | $      | 47                                                    |   | $                        | 147,607 |                | $      | (26,918   | )      | $ | 47 |   | $ | (92,400 | ) | $ | (42 | ) | $ | 28,352 |   |
| Net loss                                                                                           |   | —                      |        | —           |        | —                           |   | —                     |   | —                                                |   | —                   |    | —              |   | (25,115   | )      | — |   | (25,115 | ) |
| Issuance of common stock in conjunction with conversion of  subordinated promissory note to equity |   | 4,441                       |        | 3,226            |        | 4                                |   | 3                          |   | 72,993                                                |   | —                   |    | —              |   | —    |   | — |   | 73,000 |   |
| Proceeds from issuance of common stock in conjunction with exercise  of stock options              |   | 1,561                       |        | —           |        | 1                                |   | —                     |   | 216                                                   |   | —                   |    | —              |   | —    |   | — |   | 217 |   |
| Amortization of deferred compensation                                                              |   | —                      |        | —           |        | —                           |   | —                     |   | —                                                |   | 13,812                   |    | —              |   | —    |   | — |   | 13,812 |   |
| Unrealized loss on investments                                                                     |   | —                      |        | —           |        | —                           |   | —                     |   | —                                                |   | —                   |    | (47                 | )      | —    |   | — |   | (47 | ) |
| Conversion of stock associated with the spin-off from Titan                                        |   | 50,000                      |        | (50,000          | )           | 50                               |   | (50                        | )      | —                                                |   | —                   |    | —              |   | —    |   | — |   | — |   |
| Balances at September 30, 2002                                                                     |   | 67,604                      |        | —           |        | $                                | 66     |                       | $      | —                                                |   | $                        | 220,816 |                | $      | (13,106   | )      | $ | — |   | $ | (117,515 | ) | $ | (42 | ) | $ | 90,219 |   |
|                                                                                               |   |                        |        |             |        |                             |   |                       |   |                                                  |   |                     |    |                |   |      |   |   |   |   |   |
| **Nine Months Ended September 30, 2001:**                                                          |   |                        |        |             |        |                             |   |                       |   |                                                  |   |                     |    |                |   |      |   |   |   |   |   |
| Balances at December 31, 2000                                                                      |   | 233                         |        | 46,584           |        | $                                | — |                       | $      | 47                                                    |   | $                        | 5,687   |                | $      | (2,584    | )      | $ | — |   | $ | (18,025 | ) | — |   | $ | (14,875 | ) |
| Net loss                                                                                           |   | —                      |        | —           |        | —                           |   | —                     |   | —                                                |   | —                   |    | —              |   | (57,508   | )      |   |   | (57,508 | ) |
| Issuance of common stock in IPO, net of issuance costs                                             |   | 6,700                       |        | —           |        | 7                                |   | —                     |   | 59,770                                                |   | —                   |    | —              |   | —    |   | — |   | 59,777 |   |
| Proceeds from issuance of common stock in conjunction with exercise  of stock options              |   | 2,726                       |        | —           |        | 2                                |   | —                     |   | 1,122                                                 |   | —                   |    | —              |   | —    |   | — |   | 1,124 |   |
| Deferred compensation related to the issuance of stock options                                     |   | —                      |        | —           |        | —                           |   | —                     |   | 78,604                                                |   | (78,604                  | )       | —              |   | —    |   | — |   | — |   |
| Amortization of deferred compensation                                                              |   | —                      |        | —           |        | —                           |   | —                     |   | —                                                |   | 49,155                   |    | —              |   | —    |   | — |   | 49,155 |   |
| Unrealized loss on investments                                                                     |   | —                      |        | —           |        | —                           |   | —                     |   | —                                                |   | —                   |    | 122                 |   | —    |   | — |   | 122 |   |
| Balances at September 30, 2001                                                                     |   | 9,659                       |        | 46,584           |        | $                                | 9      |                       | $      | 47                                                    |   | $                        | 145,183 |                | $      | (32,033   | )      | $ | 122 |   | $ | (75,533 | ) | $ | — |   | $ | 37,795 |   |

 

*The accompanyingnotes are an integral part of these consolidated financial statements*.

 

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**SureBeam Corporation and Subsidiaries**

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**SEPTEMBER 30, 2002**

**(Unaudited)**

 

**Note (1)Basis of Financial Statement Preparation**

 

Theaccompanying consolidated financial information of SureBeam Corporation(“SureBeam” or the “Company”) should be read in conjunction with the Company’saudited consolidated financial statements and notes thereto for the year endedDecember 31, 2001 included in its Form 10-K filed with the Securities andExchange Commission on April 1, 2002. The information as of September 30, 2002,and for the three and nine months ended September 30, 2002 and 2001 isunaudited. The accompanying consolidated financial information includes allnormal recurring adjustments, which are considered necessary by the Company’smanagement for a fair presentation of the consolidated financial position,results of operations and cash flows for the periods presented. However, theseresults are not necessarily indicative of results for a full fiscal year.Certain prior year amounts have been reclassified to conform to the 2002financial statement presentation.

 

Thepreparation of consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the consolidated financial statements and the reported amountsof revenues and expenses during the reporting period. Actual results coulddiffer from those estimates.

 

On October 16, 2001,The Titan Corporation, or Titan, adopted a definitive plan to spin-off itsownership interest in SureBeam in the form of a tax-free dividend to Titan’sstockholders. Effective August 5, 2002, Titan distributed all of its shares of theCompany’s common stock to the stockholders of Titan. Holders of record of Titan common stock asof the close of business on July 26, 2002, the record date for thedistribution, received 0.6986 shares of SureBeam’s common stock for every shareof Titan common stock held. Previously,Titan held over eighty percent of the Company’s common stock and held a higherpercentage of the voting power due to Titan’s ownership of shares ofClass B common stock, which had ten votes per share, as compared to theClass A common stock, which has one vote per share and is traded on theNasdaq under the symbol SURE. Prior to the distribution of shares of SureBeam’scommon stock, Titan converted all of its shares of SureBeam’s Class Bcommon stock, into shares of SureBeam’s Class A common stock. Therefore,stockholders of Titan receiving shares of SureBeam common stock received onlyshares of Class A common stock. The Class B common stock has now beenretired and cannot be reissued. The Company has negotiated other agreementswith Titan in connection with the Company’s spin-off including a tax sharing anddisaffiliation agreement that will subject the Company to liability if it sellsthe Company’s equity or equity linked securities in a manner that causes achange in the Company’s ownership of 50% or more in voting power or value aspart of Titan’s spin-off plan.

 

Also onOctober 16, 2001, Titan purchased a perpetual and exclusive, non-royaltybearing license to use the Company’s intellectual property for all applicationsand fields other than the food (excluding water), animal hide and flowermarkets in consideration of the following: 1) to make available to theCompany a $50.0 million senior credit facility, 2) to exchange theoutstanding $75.0 million debt owed by the Company to Titan for additionalshares of the Company’s Class B common stock and Class A common stock,and 3) a cash payment of $8.0 million, with a $4.0 millionpayment on September 30, 2001 and four installments of $1.0 millionpayable on each of March 31, 2002, June 30, 2002, September 30,2002 and December 31, 2002. With respect to the exchange of the Company’s$75.0 million non-convertible debt for common stock, the Company followedguidance in APB Opinion No. 29, “Accounting For Nonmonetary Transactions,” anddetermined that the use of the fair value of the license on the date of theexchange was appropriate. The Company recognized $1.0 million and $3.0million of the cash payments related to the license agreement as other incomein the three and nine months ended September 30, 2002,respectively.  The Company willrecognize $1.0 million as other income each quarter throughSeptember 30, 2003.

 

The accompanyingconsolidated financial statements contemplate the realization of assets and thesatisfaction of liabilities in the normal course of business. During the threeand nine months ended September 30, 2002, consistent with itsbusiness plan, the Company has incurred substantial losses from operations.

 

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Management believes it will continue to incurlosses through at least 2003, as the Company will continue to make significantinvestments in infrastructure, sales and marketing and it is not anticipatedthat the Company’s revenues will sufficiently offset these investments until atleast 2003. Additionally, the Company’s construction and implementation periodfor systems sales to strategic alliances as well as Company-owned servicecenters and systems require a substantial use of cash for at least 12 to18 months. The Company’s arrangements to sell food irradiation systems tostrategic alliances typically contain milestone provisions for payment, whichare typically based upon time, stage of completion and other factors where nomaterial uncertainties exist. Also in connection with the Company’s agreementswith its customers, it has advanced funds aggregating $5.5 million toHawaii Pride LLC, or Hawaii Pride. Although not obligated, the Company anticipates that it will continue toprovide cash to Hawaii Pride for working capital purposes, as it is needed. Managementdoes not expect significant repayments of the advances to Hawaii Pride untillate 2003. The Company has also entered into a number of commitments to leaseland and facilities in connection with construction of our four company-ownedservice centers of which three are operational with the fourth expected to beoperational in the first quarter of 2003. In addition, based on our customerrequirements, the Company may expend funds to construct and install in-linesystems that the Company will own and operate.

 

In addition to management’scurrent operating plans, which focus on increasing cash flow from operations,the Company is also evaluating a number of alternative plans to meet its futureoperating cash needs. These plans include raising additional funds from thecapital markets and continuing to draw down on the Company’s $50.0 millionsenior secured credit facility with Titan. As of the date of the filing of thisreport, the Company has obtained $25.0 million under its senior securedcredit facility with Titan. If the funds available under the Company’s creditfacility and from the capital markets are not sufficient for the Company or ifit is unable to generate sufficient cash flow from operations, management mayneed to consider additional actions, including reducing or deferring capital expenditures,reducing or deferring research and development projects, curtailingconstruction of systems for customers in advance of payment and reducingmarketing and other expenditures, which actions may have a material adverseimpact on the Company’s ability to meet its business objectives.

 

A variety ofcurrently unanticipated events could require additional capital resources suchas the acquisition of complementary businesses or technologies or increasedworking capital requirements to fund, among other things, construction ofsystems for the Company’s strategic alliances in advance of payment.

 

**Note (2) Initial Public Offering**

 

OnMarch 16, 2001, the Company consummated its initial public offering andissued 6,700,000 shares of Class A common stock at a price of $10.00 pershare. The Company received proceeds of approximately $59.8 million, netof underwriting discounts, fees and other initial public offering costs.Concurrent with the closing of the offering, warrants aggregating 2,236,023shares of the Company’s Class A common stock were exercised for proceedsof approximately $1.1 million.

 

Also inconnection with the completion of the Company’s initial public offering, stockoptions granted under the Nonstatutory Stock Option Plan were converted from variableplan options to fixed plan options. Accordingly, stock-based compensation of$78.6 million was recorded, representing the extent to which the $10.00per share offering price exceeded the exercise price of the options.Additionally, since a substantial portion of these options was vested at thetime of completion of the offering, approximately $38.7 million wasrecognized as compensation expense at that time. Included in selling, generaland administrative expense for the three and nine months ended September 30,2002, is $6.0 million and $13.2 million, respectively, ofcompensation expense associated with these options. In conjunction with thecompletion of our spin-off from Titan on August 5, 2002, all optionsheld by Titan employees and directors under this plan became fully vested andas a result, the stock-based compensation charges for this plan increased forthe three months ended September 30, 2002 by $2.9 million.

 

8

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The remainingstock-based compensation balance related to these options will be recognized ascompensation expense over the remaining three-year vesting period of theoptions. Included in selling, general and administrative expense for the threeand nine months ended September 30, 2002 and 2001, is $202,000 and $606,000,respectively, of compensation expense related to options granted prior tocompletion of the Company’s initial public offering under the 2000 Stock Optionand Incentive Plan for which the fair market value on the date of grantexceeded the exercise price.

 

**Note (3) Other Financial Information**

 

During thequarter ended September 30, 2002, the Company had no elements of comprehensiveincome. The Company had comprehensive income resulting from unrealized losseson investments in available-for-sale securities of $122,000, which arereflected in the statement of stockholders’ equity for the nine months endedSeptember 30, 2001.

 

The followingdata summarizes information relating to the per share computation (inthousands, except per share data):

 
|                                               |   | **Three  Months Ended September 30,** |    | **Nine  Months Ended September 30,** |   |
|----------------------------------------------------|--------|---------------------------------------|---------|--------------------------------------|--------|
|                                               |   | **2002**                              |    | **2001**                             |   | **2002** |   | **2001** |   |
|                                               |   |                                  |    |                                 |   |   |   |   |   |
| Net loss                                           |   | $                                     | (11,034 | )                                    | $      | (7,748 | ) | $ | (25,115 | ) | $ | (57,508 | ) |
|                                               |   |                                  |    |                                 |   |   |   |   |   |
| Weighted average shares outstanding                |   |                                  |    |                                 |   |   |   |   |   |
| Basic                                              |   | 67,336                                |    | 56,131                               |   | 65,683 |   | 53,478 |   |
| Effective diluted securities:   stock options |   | —                                |    | —                               |   | — |   | — |   |
| Diluted                                            |   | 67,336                                |    | 56,131                               |   | 65,683 |   | 53,478 |   |
|                                               |   |                                  |    |                                 |   |   |   |   |   |
| Net loss per common share — basic             |   | $                                     | (0.16   | )                                    | $      | (0.14 | ) | $ | (0.38 | ) | $ | (1.08 | ) |
|                                               |   |                                  |    |                                 |   |   |   |   |   |
| Net loss per common share — diluted           |   | $                                     | (0.16   | )                                    | $      | (0.14 | ) | $ | (0.38 | ) | $ | (1.08 | ) |

 

In the threeand nine months ended September 30, 2002, respectively, the weightedaverage number of options to purchase approximately 4,080,000 and 4,748,000shares of common stock at prices ranging from $0.14 to $16.09 per share werenot included in the computation of diluted EPS, as the effect would have beenanti-dilutive due to the loss from continuing operations. Similarly, theweighted average number of options and warrants to purchase approximately6,702,000 and 7,368,000 shares of common stock at prices ranging from $0.14 to$16.09 per share were not included in the computation of diluted EPS for thethree and nine month periods ended September 30, 2001, respectively.

 

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Following aredetails concerning certain balance sheet data as ofSeptember 30, 2002 and December 31, 2001:

 
|                                                |   | **September  30,  2002** |   | **December  31,  2001** |   |
|-----------------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                                                |   |                     |   |                    |   |
| **Investments, available-for-sale (in thousands):** |   | $                        | — |                    | $      | 3,766 |   |
|                                                     |        |                          |        |                         |        |  |  |

 

The Company invests itsexcess cash primarily in mortgage-backed securities. The Company hasestablished guidelines relative to diversification and maturities that maintainsafety and liquidity. These guidelines are periodically reviewed and modifiedto take advantage of trends in yields and interest rates. Cash equivalents areshort-term, highly liquid investments with original maturities of less thanthree months. Cash and cash equivalents of $5.0 million and$4.1 million at September 30, 2002 and December 31, 2001,respectively, are primarily invested in commercial paper and money marketfunds.

 

The Company classifies itsmarketable securities as available-for-sale and records the unrealized holdinggains or losses as a separate component of stockholders’ equity. Realizedlosses for the three and nine months ended September 30, 2002, were$0 and $47,000, respectively. There were no realized gains or losses recordedin the three and nine months ended September 30, 2001.

 
|                                    |   | **September  30,  2002** |   | **December  31,  2001** |   |
|-----------------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                                    |   |                     |   |                    |   |
| **Accounts receivable (in thousands):** |   |                     |   |                    |   |
| Billed                                  |   | $                        | 111    |                    | $      | 53 |   |
| Unbilled                                |   | 17,533                   |   | 14,020                  |   |
| Less allowance for doubtful accounts    |   | (1,428                   | )      | (1,428                  | )      |
|                                    |   | $                        | 16,216 |                    | $      | 12,645 |   |
| The Titan Corporation                   |   |                     |   |                    |   |
| Billed                                  |   | $                        | 5,988  |                    | $      | 12,503 |   |
| Unbilled                                |   | 471                      |   | —                  |   |
|                                    |   | $                        | 6,459  |                    | $      | 12,503 |   |

 

Unbilledreceivables primarily represent work-in-process that will be billed inaccordance with contract terms and delivery schedules. Also included inunbilled receivables are amounts billable upon final execution of contracts,contract completion or milestones. Unbilled receivables are generally expectedto be collected within one year.

 
|                            |   | **September  30,  2002** |   | **December  31,  2001** |   |
|---------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                            |   |                     |   |                    |   |
| **Inventories (in thousands):** |   |                     |   |                    |   |
| Materials                       |   | $                        | 8,895  |                    | $      | 15,510 |   |
| Work-in-process                 |   | 10,872                   |   | 4,254                   |   |
|                            |   | $                        | 19,767 |                    | $      | 19,764 |   |

 

Generally, theCompany’s systems are customized and are produced on a made-to-orderbasis.  The Company does, however,maintain a stock of long lead-time and general stock items. Inventories includethe cost of material, labor and overhead, and are stated at the lower of cost,determined on the first-in, first-out (FIFO) method,

 

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or market. The Companyperiodically evaluates its on-hand stock and makes appropriate disposition ofany stock deemed excess or obsolete.

 
|                                           |   | **September  30,  2002** |   | **December  31,  2001** |   |
|------------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                                           |   |                     |   |                    |   |
|                                           |   |                     |   |                    |   |
| **Property and equipment (in thousands):**     |   |                     |   |                    |   |
| Machinery and equipment                        |   | $                        | 18,648 |                    | $      | 9,937 |   |
| Furniture, fixtures and leasehold improvements |   | 8,963                    |   | 1,252                   |   |
| Construction in progress                       |   | 32,066                   |   | 33,390                  |   |
|                                           |   | 59,677                   |   | 44,579                  |   |
| Less accumulated depreciation                  |   | (3,874                   | )      | (2,676                  | )      |
| Property and equipment, net                    |   | $                        | 55,803 |                    | $      | 41,903 |   |

 

Constructionin progress primarily represents costs incurred for the construction of twofood irradiation service center facilities in the Rio de Janeiro and LosAngeles areas. Such costs will remain in construction in progress until thefacilities are completed and placed in service.

 
|                                     |   | **September  30  2002** |   | **December  31,  2001** |   |
|------------------------------------------|--------|-------------------------|--------|-------------------------|--------|
|                                     |   |                    |   |                    |   |
|                                     |   |                    |   |                    |   |
| **Other assets (in thousands):**         |   |                    |   |                    |   |
| Texas A&M                            |   | $                       | 8,399  |                    | $      | 7,210 |   |
| Advances to Hawaii Pride — net      |   | 3,892                   |   | 3,674                   |   |
| Prepaid rent                             |   | 728                     |   | 796                     |   |
| Investment in SureBeam Middle East, LLC. |   | 272                     |   | —                  |   |
| Loan receivable from officer             |   | 168                     |   | 225                     |   |
| Other                                    |   | 206                     |   | 127                     |   |
|                                     |   | $                       | 13,665 |                    | $      | 12,032 |   |

 

The long-termasset arising from the transaction with Texas A&M represents thelong-term portion of the cumulative revenues recognized related to the design,construction, installation, integration and delivery of the system forTexas A&M, net of amortization related to discounted servicesreceived. See Note (5).

 

The Companyhas advanced $5.5 million to Hawaii Pride, which is included in theaccompanying consolidated balance sheet as other assets, net of impairmentcharges of $1.6 million. The impairment charges reflect the Company’sestimate of the erosion of the collateral basis in Hawaii Pride. The moniesadvanced in 1999 and 2000 were utilized for costs relating to the acquisitionof land, construction of the building and infrastructure, equipment (excludingthe SureBeam system) and other start-up costs. Monies advanced to Hawaii Prideduring 2002 and 2001 have been used primarily for working capital purposes. TheCompany advanced Hawaii Pride $445,000 during the nine months ended September30, 2002. Management does not expect significant repayments of theadvances to Hawaii Pride until late 2003.

 

In April 2002,the Company formed a joint venture under the name SureBeam Middle East, LLC.with RESAL Saudi Corp., or RESAL. As of September 30, 2002, SureBeamowns a 19.9% interest in SureBeam Middle East, LLC. and RESAL and otherSaudi nationals own the remaining 80.1%. See Note (5). The Company will

 

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account for its ownershipinterest in SureBeam Middle East, LLC. using the equity method of accountingunder APB Opinion No. 18 “The Equity Method of Accounting for Investments inCommon Stock.”

 
|                                          |   | **September  30,  2002** |   | **December  31,  2001** |   |
|-----------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                                          |   |                     |   |                    |   |
| **Other current liabilities (in thousands):** |   |                     |   |                    |   |
| Deferred revenue – The Titan Corporation |   | $                        | 3,000  |                    | $      | 3,000 |   |
| Other                                         |   | 1,404                    |   | 1,756                   |   |
|                                          |   | $                        | 4,404  |                    | $      | 4,756 |   |

 

**Note (4) Recent AccountingPronouncements**

 

In June 2001,the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”(“SFAS No. 143”).  This statementaddresses financial accounting and reporting for obligations associated withthe retirement of tangible long-lived assets and the associated assetretirement costs.  It applies to (a) allentities and (b) legal obligations associated with the retirement of long-livedassets that result from the acquisition, construction, development and/ornormal operation of long-lived assets, except for certain obligations ofleasees.  This statement amends FASBStatement No. 19, “Financial Accounting and Reporting by Oil and Gas ProducingCompanies,” and is effective for financial statements issued for fiscal yearsbeginning after June 15, 2002.  Managementdoes not believe that the adoption of this statement will have a materialimpact on its financial position or results of operations.

 

In April 2002,the FASB issued Statement No. 145, “Rescission of FASB Statements No. 4, 44,and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFASNo. 145”). SFAS No. 145 updates, clarifies and simplifies existingaccounting pronouncements including: rescinding Statement No. 4, whichrequired all gains and losses from extinguishments of debt to be aggregatedand, if material, classified as an extraordinary item, net of related incometax effect and amending Statement No. 13 to require that certain leasemodifications that have economic effects similar to sale-leaseback transactionsbe accounted for in the same manner as sale-leaseback transactions. SFASNo. 145 is effective for fiscal years beginning afterMay 15, 2002, with early adoption of the provisions related to therescission of Statement No. 4 encouraged. The Company does not expect theadoption of this statement to have a material impact on its financial positionor results of operations.

 

In July 2002, the FASBissued Statement No. 146, “Accounting for Costs Associated with Exit orDisposal Activities” (“SFAS No. 146”), which addresses financial accounting andreporting for costs associated with exit or disposal activities. SFAS No. 146nullifies EITF Issue No. 94-3, “Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring).” The principal difference between SFAS No.146 and Issue No. 94-3 relates to the recognition of a liability for a costassociated with an exit or disposal activity. SFAS No. 146 requires that aliability be recognized for those costs only when the liability is incurred,that is, when it meets the definition of a liability in the FASB’s conceptualframework. In contrast, under Issue No. 94-3, a company recognized a liabilityfor an exit cost when it committed to an exit plan. SFAS No. 146 alsoestablishes fair value as the objective for initial measurement of liabilitiesrelated to exit or disposal activities. The Statement is effective for exit ordisposal activities that are initiated after December 31, 2002although earlier application is encouraged. The Company is unable to determine impact on its financial position orresults of operations from the adoption of this statement.

 

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**Note (5)Strategic Transactions**

 

In connectionwith the Company’s agreement with Texas A&M, SureBeam agreed to providethree electronic food irradiation systems, which are referred to collectivelyas the system, pursuant to a ten-year lease with title passing to Texas A&Mat the end of the ten-year term. The agreement provides the Company access toTexas A&M employees for a variety of free or discounted services, as wellas rights to use the system for performing irradiation services for itscustomers.  The Company is currentlyworking with Texas A&M on several research projects which include studieson shelf life extension, food products application testing, and theeffectiveness of SureBeam’s technology versus other technologies.  Since the Company retains the right to usethe system through the end of the term of the arrangement, it has accounted forthis transaction as a sale-leaseback.

 

As theconsideration in this lease is nonmonetary, the Company has accounted for thiselement of the agreement in accordance with APB No. 29, “Accounting forNonmonetary Transactions.” Sales are recorded on a percentage-of completionbasis at the fair market value of the electronic food irradiation system soldto Texas A&M and total system profits of $518,000 will be deferred andrecognized ratably over the remaining term of the arrangement commencing upondelivery of the system.

 

Under thepercentage-of-completion method, the Company recorded revenues of $50,000 and$1.9 million for the three and nine months ended September 30, 2002,respectively, and recorded $2.0 million and $3.3 million for thethree and nine months ended September 30, 2001, respectively. The assetarising from the total cumulative revenues of $10.0 million, net of$322,000 of amortization, has been recorded as a short-term and long-term assetat September 30, 2002. As of September 30, 2002, the Company had deferredprofits amounting to $518,000, which are included as other short-term andlong-term liabilities in the accompanying consolidated balance sheet. Thesedeferred profits will be amortized ratably to reduce cost of sales over the remainingterm of the ten-year term of the arrangement commencing upon delivery of thesystem to Texas A&M. The short-term and long-term assets arising from thistransaction represents the cumulative revenues recognized related to thedesign, construction, installation, integration and delivery of the system forTexas A&M, net of amortization. In August 2001, the Company agreed topurchase research and development services from Texas A&M forapproximately $200,000, reflecting a discount of approximately $300,000. Thediscount has been amortized against the long-term asset arising from thecumulative revenues recorded under this agreement over a period ofapproximately ten months. During the three and nine months ended September30, 2002, the Company has recorded $0 and $150,000, respectively, ofamortization expense related to the research and development services it hasreceived to date. The deferred profit of $518,000 as ofSeptember 30, 2002, represents the difference between the cumulativecosts incurred and the cumulative revenues recognized. As of September 30,2002, $6,000 of the deferred profit had been amortized to income.

 

With respectto the impact of the transaction with Texas A&M on the Company’s liquidity,the Company has expended funds of approximately $9.5 million related tothe construction of the system through September 30, 2002. Thesecosts have been incurred primarily related to the design of the system,construction of and modification to the physical structure, which house thesystem, and for the manufacture of the linear accelerators and x-ray componentsas well as the material handling and conveyor systems. During the third quarterof 2002, the Company completed the delivery of the system to Texas A&M.

 

InJune 2001, the Company received a purchase order with an aggregate valueof $50.0 million from RESAL for ten electronic food irradiation systems tooperate in three service centers in the Saudi Arabia region for irradiatingpoultry and disinfesting and prolonging shelf life of dates. The Companycommenced construction of these systems for RESAL and has recognized, under thepercentage-of-completion method of accounting, $2.2 million and$3.6 million in revenue for the three and nine months endedSeptember 30, 2002, respectively. 

 

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In April 2002,the Company formed a joint venture under the name SureBeam Middle East, LLC.with RESAL. As of September 30, 2002, SureBeam owns a 19.9% interest inSureBeam Middle East, LLC. and RESAL and other Saudi nationalsown the remaining 80.1%. The Company accounts for its ownership interest inSureBeam Middle East, LLC. using the equity method of accounting under APBOpinion No. 18 “The Equity Method of Accounting for Investments in CommonStock.”  In accordance with the jointventure agreement, RESAL’s purchase order dated June 2001 may be assigned toSureBeam Middle East, LLC. at such time as the joint venture receivessufficient funds from third party investors. As of September 30, 2002, a portion of the purchase order has beenassigned to SureBeam Middle East, LLC. As a result, revenue recognized under the contract is presented in theconsolidated statements of operations as revenues from investee and the Companyhas eliminated its 19.9% interest in the profit recognized under thepercentage-of-completion method of accounting in connection with the originalpurchase order.  The Company received apayment of $1.5 million from SureBeam Middle East, LLC. in the secondquarter of 2002 based on milestone payments and expects to continue to receivemilestone payments as they become due and payable until the contract iscomplete.  The Company estimates thatthe total profit under the original contract that will be eliminated as aresult of SureBeam’s equity interest in SureBeam Middle East, LLC. will beapproximately $2.0 million to $3.0 million. The joint venture will govern the strategic relationship with theoperator of these systems, including royalty and management fees and a minorityequity ownership of the operator that will operate the service centers.

 

In October2001, the Company contracted to manufacture eight SureBeam systems for anaggregate of $26.0 million for Titan in connection with Titan’s agreementwith the United States Postal Service, or USPS. During the three months endedJune 30, 2002, the Company’s purchase order from Titan related to theUnited States Postal Service was closed out at $19.5 million. Under thisagreement, Titan had arranged to provide electron beam systems and services tosanitize mail by eliminating the threat of anthrax. The Company worked withTitan and Titan’s business units, in providing the systems to the United StatesPostal Service. The Company was the principal subcontractor to build systemsfor Titan under Titan’s prime contract. For the three and nine months endedSeptember 30, 2002, the Company recognized $50,000 and $7.0 million,respectively, as revenues from The Titan Corporation under thiscontract. In accordance with the milestone payments of the contract, theCompany received $19.5 million in cash from Titan during the nine monthsended September 30, 2002.

 

In June 2002, theCompany entered into a contract with Son Son Company, a private foodprocessing corporation headquartered in Vietnam, for one electronic food irradiation system to operate in Vietnam forirradiating shrimp, seafood, and frog legs and prolonging shelf life of foods.The Company commenced construction on the system and has recognized, under thepercentage-of-completion method of accounting, $503,000 and $2.1 millionin revenue for the three and nine months ended September 30, 2002,respectively. The Company received a $2.0 million milestone payment inNovember 2002 and expects to receive future milestone payments as they becomedue and payable until the contract is complete.

 

In September2002, the Company received an order from Titan for $6.0 million inconnection with a new contract with the USPS. Under this agreement, the Companyis to provide two linear accelerators to sanitize the mail. During the threemonths ended September 30, 2002, the Company recorded revenue of$500,000. It expects to receive milestone payments as they become due andpayable on this contract.

 

**Note (6)Subordinated Promissory Note**

 

In August 2000, inconnection with the contribution by Titan to SureBeam of its electronic foodirradiation business, the Company assumed the cumulative advances of$39.0 million and due to additional advances the balance was$72.2 million as of December 31, 2001. These advances were evidencedby a subordinated promissory note payable to Titan. On February 13, 2002,the Company exchanged the outstanding balance, including principal and accruedinterest, of $73.0 million, under its subordinated promissory note payableto Titan for 3,225,765 and 4,441,496 shares of Class B and Class Acommon stock, respectively, of the Company.

 

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**Note (7) Senior Secured Credit Facilitywith The Titan Corporation**

 

Titan hasextended a $50.0 million senior secured credit facility to SureBeam thatallows SureBeam to borrow, in addition to its previous borrowings, up to$12.5 million per quarter during the fourth quarter of 2002 through thefourth quarter of 2003, subject to the $50.0 million limitation on borrowing.The amount available for borrowing in each of the second, third and fourthquarters of 2003 is based upon SureBeam’s earnings before interest, taxes,depreciation and amortization (EBITDA) for the prior quarter as a percentage ofthe EBITDA target in its annual operating plan. If EBITDA is less than 25% oftarget EBITDA, then the amount available in the applicable quarter is$5.0 million, provided that no amounts are available unless the Companycovenants during the current quarter to limit its total operating expenses(defined as research and development and selling, general and administrativeexpenses) to $5.0 million. If EBITDA is 25% of target, then the amountavailable is $6.25 million or 50% of the quarterly maximum and for eachpercentage of EBITDA above 25% of target, the percentage of the quarterlymaximum above 50% will be increased on a pro rata basis. To the extent SureBeamdoes not fully borrow the maximum amount during any quarter of 2002, theunutilized amount can be borrowed in the subsequent quarter. As of September30, 2002, SureBeam had borrowed $22.5 million on this facility and had$4.5 million in unutilized amounts. SureBeam borrowed an additional$2.5 million on October 31, 2002 bringing the total borrowingson this senior secured credit facility to $25.0 million as of the filing dateof this report. If SureBeam is unable to receive funds as anticipated under this credit facilityor if its capital requirements vary from its current plans, it may requireadditional financing sooner than it anticipates. In such circumstance noassurance can be made that the Company would be able to obtain additionalfinancing on terms reasonable to the Company, or at all, which could have a material adverse effect on its resultsof operations and financial condition.

 

Under the new senior securedcredit facility the Company is obligated to make quarterly principal paymentsas follows: 13.75% of the outstanding principal balance as of December 31,2003 during each quarter in 2004; 25% of the outstanding principal balance asof December 31, 2004 during each quarter in 2005; and all remainingprincipal by December 31, 2005. In addition, with some exceptions, theCompany is obligated to use net proceeds from the sale of assets and itssecurities to repay amounts advanced under this facility. The interest rate isTitan's effective weighted average term debt rate under Titan's creditagreement plus three percent. Interest is payable monthly beginning inJanuary 2003. The credit agreement contains affirmative and negativecovenants, including covenants limiting the Company’s incurrence of debt,capital expenditures, operating expenses, investments, declaration of dividendsand other restricted payments, sale of stock of subsidiaries and consolidationsand mergers. The credit agreement, however, does not contain any financialcovenants requiring the Company to maintain specific financial ratios. Thecredit agreement is secured by a first priority lien on all of the Company’sassets.

 

**Note(8) Acquisitions**

 

In May 2000, Tech IonIndustrial Brasil S.A., or Tech Ion, placed purchase orders with the Companyfor eleven electronic food irradiation systems for $55.0 million, of which$22.4 million was recognized as revenue through September 30, 2001.SureBeam Brasil Ltda., or SureBeam Brasil, which was jointly establishedby Tech Ion, the Company’s exclusive partner in Brazil, and Titan SureBeamBrazil Ltd., the Company’s wholly owned subsidiary, planned to provide,among other things, food irradiation services through four planned servicecenters to various food companies in Brazil. In October 2001, in order toensure the completion of the project with Tech Ion to build service centers inBrazil that were under construction, the Company entered into a stock purchase agreementwith Tech Ion to purchase an additional 60.1% of SureBeam Brasil bringing theCompany’s total equity ownership to 80% in SureBeam Brasil. In connection withthe additional equity interest, the Company paid Tech Ion $750,000 upon theexecution of the agreement and will pay an additional $250,000 upon thetransfer of title of the linear accelerators and material handling systems forthe Rio de Janeiro service center from Tech Ion to SureBeam Brasil. The Companyalso exchanged its trade receivables of $22.4 million due from Tech Ionand forgave $3.5 million of a loan the Company had previously made to TechIon for building improvements and equipment. The Company has recorded anintangible asset of $2.5 million that represents the total considerationamount of the agreement that exceeded the fair market value of the assetspurchased. The intangible asset will be amortized over five years. Prior to theacquisition, the Company was building eleven linear accelerators for Tech Ionfor $55.0 million. This contract 

 

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began in May 2000, and was at variousstages of completion at the date the Company began to negotiate to acquire theabove described assets. Through the date the Company began negotiations, theCompany recognized revenues of $6.8 million in fiscal year 2001 and$22.4 million in total related to this contract.  On April 1, 2002, the Company exchanged the remaining $1.5million owed by Tech Ion in consideration for its remaining 20% interest inSureBeam Brasil.  The $1.5 million wasincluded in prepaid expense and other current assets in the accompanyingbalance sheet at December 31, 2001.  Dueto the exchange the Company has recorded an additional $700,000 as anintangible asset which will be amortized over the remaining 54 month life ofthe existing intangible asset.  Theremaining $800,000 was recorded as part of the service center building cost.

 

**Note (9) Commitments and Contingencies**

 

The Companyperiodically is a defendant in cases incidental to its business activities.Furthermore, providers of products and services to the U.S. government aregenerally subject to multiple levels of audit and investigation by various U.S.government agencies. Any liabilities arising from audits by the federal governmentare being retained by Titan as part of the contribution by Titan to SureBeam.In the opinion of management, the amount of ultimate liability, if any, withrespect to these actions will not materially affect the financial position orresults of operations of the Company.

 

**Note (10) Related Party Transactions**

 

In connectionwith the contribution agreement with Titan, the Company entered into a numberof other agreements with Titan for such items as corporate services,facilities, filing of income tax returns and employee benefit plans. Theseagreements provided for, among other things, continuation of services, whichwere historically provided by Titan to SureBeam while the Company built itscorporate infrastructure on a stand-alone basis. As consideration for theseservices, Titan charged to the Company an allocation of the cost for theseservices to the extent that they pertained to SureBeam.  All service agreements with Titan terminatedeffective as of the spin-off distribution of SureBeam on August 5, 2002, andthe Company will no longer receive services from Titan.  During the three and nine months endedSeptember 30, 2002, the Company recorded an allocation for general andadministrative expense of $0 and $1.1 million, respectively.

 

Titan has subcontracted theCompany to design and construct SureBeam systems for Titan’s various contractswith third parties. These systems are designed for applications other than thefood (excluding water), animal hide and flower markets. Revenues derived fromsales to Titan are recognized under cost plus 20% or fixed price contracts andwere $4.0 million and $16.4 million for the three and nine monthsended September 30, 2002, respectively. Of the revenue from Titan,$550,000 and $7.5 million for the three and nine months ended September30, 2002, respectively, related to the subcontract the Company has withTitan on the United States Postal Service contracts, and the remaining$3.4 million and $8.9 million for the three and nine months endedSeptember 30, 2002, respectively, was recorded in relation to Titan’smedical sterilization business and government linear accelerator business.

 

EffectiveAugust 5, 2002, Titan distributed all of its shares of the common stock ofSureBeam to the stockholders of Titan. Titan announced that holders of recordof Titan common stock as of the close of business on July 26, 2002, the recorddate for the distribution, were to receive 0.6986 shares of SureBeam commonstock for every share of Titan common stock held.

 

Previously,Titan held over eighty percent of the common stock of SureBeam and held ahigher percentage of the voting power of SureBeam due to Titan’s ownership ofshares of Class B common stock, which had ten votes per share, as compared toSureBeam’s Class A common stock, which has one vote per share and is traded onthe Nasdaq under the symbol SURE.

 

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In September2002, the Company received an order from Titan for $6.0 million inconnection with a new contract with the USPS. Under this agreement, the Companyis to provide two linear accelerators to sanitize the mail. During the threemonths ended September 30, 2002, the Company recorded revenue of$500,000 related to this contract. It expects to receive milestone payments asthey become due and payable on this contract.

 

In April 2002,the Company formed a joint venture under the name SureBeam Middle East, LLC.with RESAL. As of September 30, 2002, SureBeam owns a 19.9% interestin SureBeam Middle East, LLC. and RESAL and other Saudi nationals own theremaining 80.1%. The Company has a purchase order with an aggregate value of$50.0 million from RESAL. In accordance with the joint venture agreement,RESAL’s purchase order dated June 2001 may be assigned to SureBeam MiddleEast, LLC. at such time as the joint venture receives sufficient funds from thethird party investors. Revenues are derived using the percentage-of-completionmethod of accounting and are classified as revenues from investee on theconsolidated statements of operations.

 

**Note (11) Subsequent Events**

 

In November2002, the Company entered into an equipment purchase agreement with SalubrisLimited Partnership, or Salubris, to sell a SureBeam system for$8.9 million. The purchase of this system will allow Salubris to build andoperate a new service center in the Forth Worth, Texas area. The Company willreceive per pound processing royalties once the service center is operational.

 

This agreementallows Fort Worth-San Diego Investments, LLC, the general partner in Salubris,the right of first negotiation on certain future opportunities in thefive-state area of Texas, New Mexico, Oklahoma, Arkansas and Louisiana topurchase SureBeam systems and to provide SureBeam processing.

 

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**ITEM 2. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The followingdiscussion of the financial condition and results of operations of SureBeamCorporation should be read in conjunction with the unaudited financialstatements and the related notes thereto included elsewhere in thisForm 10-Q, the audited financial statements and notes thereto andManagement’s Discussion and Analysis of Financial Condition and Results ofOperations included in the Company’s Form 10-K for the year endedDecember 31, 2001.

 

When you readthis section of this Form 10-Q, it is important that you also read thefinancial statements and related notes included elsewhere in thisForm 10-Q. This section of this Form 10-Q contains forward-lookingstatements that involve risks and uncertainties, such as statements of ourplans, objectives, expectations and intentions. We use words such as “may,”“will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,”“estimate,” “predict,” “potential,” or “continue,” the negative of such termsor other terminology to identify forward-looking statements. Our actual resultscould differ materially from those anticipated in these forward-lookingstatements for many reasons. These forward-looking statements involve risks anduncertainties including, but not limited to, those referred to in this reportas well as in the Company’s public filings with the SEC, including theCompany’s Annual Report on Form 10-K for the year ended December 31, 2001, regardingthe risk of gaining consumer acceptance, risks relating to the Company’shistory of losses and liquidity and risks of international operations.

 

**Overview**

 

We are aleading provider of electronic irradiation systems and services for the foodindustry. We were formed in August 2000 in connection with thecontribution by Titan of the assets, liabilities and operations related to itselectronic food irradiation business. Titan’s electronic food irradiationbusiness had previously been operated as part of a division of Titan, togetherwith Titan’s medical equipment sterilization business and its government linearelectron beam accelerator business. References to SureBeam, the Company or usin this discussion and analysis section and in the historical financialstatements refer to this division of Titan prior to the date of thecontribution of the electronic food irradiation business to us by Titan. Ourspin-off from Titan was completed on August 5, 2002 when Titandistributed all of its shares of the common stock of SureBeam to thestockholders of Titan.

 

**Results of Operations**

 

*Revenues*

 

We have threeclassifications of revenues on the face of our consolidated statements ofoperations: revenues from non-affiliated parties, revenues from investee andrevenues from The Titan Corporation, or Titan. Revenues from non-affiliated parties represent all revenue generatedfrom food processing and all electronic food irradiation system sales notassociated with SureBeam Middle East, LLC. or Titan.  Revenues from investee represent electronic food irradiationsystem sales generated from SureBeam Middle East, LLC.  To date, all of the revenues from investeerelate to our $50.0 million Saudi RESAL purchase order.  Revenues from Titan represents sales of ourelectronic irradiation systems and services related to Titan Scan Technologiesmedical sterilization business, Titan’s government linear accelerator businessand revenues in support of Titan’s United States Postal Service contracts.Although Titan has not been an affiliate of SureBeam sinceAugust 5, 2002, we classify revenues from Titan separately to provideeasier comparability to earlier periods.

 

Our totalrevenues decreased from $14.5 million and $29.6 million in the three and ninemonths ended September 30, 2001, respectively, to $7.0 million and$24.8 million in the three and nine months ended September 30, 2002,respectively. The decrease of $7.5 million in total revenue for the threemonths ended September 30, 2002 compared to the same period last yearwas a result of a decrease of $2.8 million of revenues from non-affiliatedparties and a decrease of $5.8 million of revenues from investee which wasoffset by an increase of $1.1 million of revenues from Titan. For the threemonths ended September 30, 2002 and 2001, we had electronic foodirradiation system sales and food processing revenue from non-affiliatedparties of $815,000 or 12% of total revenues and $3.6 million or 25% oftotal revenues, respectively. For the nine months ended September 30, 2002and 2001, we had electronic food irradiation system sales and food processingrevenue from non-affiliated parties of 

 

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$4.8 million or 19% oftotal revenues and $10.4 million or 35% of total revenues, respectively.For the three months ended September 30, 2002, 68%, or $552,000, of the$815,000 of revenues from non-affiliated parties, was derived from sales ofelectronic food irradiation systems to two customers and 32%, or $263,000, wasderived from food processing services. For the three months ended September 30,2001, 92%, or $3.3 million, of the $3.6 million of revenues fromnon-affiliated parties was derived from sales of electronic food irradiationsystems to two customers and 8%, or $280,000, was derived from food processingservices. For the nine months ended September 30, 2002, 83%, or$4.0 million, of the $4.8 million of revenues from non-affiliated partieswas derived from sales of electronic food irradiation systems to two customersand 17%, or $810,000, was derived from food processing services. For the ninemonths ended September 30, 2001, 92%, or $9.6 million, of the $10.4million of revenues from non-affiliated parties was derived from sales ofelectronic food irradiation systems to three customers and 8%, or $802,000, wasderived from food processing services.

 

The 2002revenues from non-affiliated parties were related to revenue recognized fromsales of our electronic food irradiation systems, using thepercentage-of-completion method of accounting, to Texas A&M University, orTexas A&M, (see discussion below) and Son Son Company, a private foodprocessing corporation headquartered in Vietnam. The 2001 revenues fromnon-affiliated parties were primarily related to revenue recognized from salesof our electronic food irradiation systems, using the percentage-of-completionmethod of accounting, principally to Texas A&M and Tech Ion IndustrialBrasil, S.A., a Brazilian food irradiation company. Food processing servicerevenues were primarily derived in connection with our customer production runsas well as test marketing programs. We expect that both the systems sales andthe processing revenues from non-affiliated parties will increase as newcontracts are signed for systems sales and as the production increases at ourcompany-owned services centers as demand for products processed using SureBeamtechnology increases.

 

Our revenuesfrom investee decreased from $8.0 million and $15.4 million in thethree and nine months ended September 30, 2001, respectively, to $2.2million and $3.6 million in the three and nine months ended September30, 2002, respectively. The revenues from investee are related to revenuerecognized from sales of our electronic food irradiation systems, using thepercentage-of-completion method of accounting from RESAL Saudi Corp., or RESAL,a subsidiary of a private Saudi conglomerate headquartered in Riyadh, SaudiArabia.  The decrease in revenuesof $11.8 million from 2001 to 2002 is due to the timing of the work performedon the contract.

 

Our revenuesfrom Titan increased from $2.9 million and $3.9 million in the threeand nine months ended September 30, 2001, respectively, to $4.0million and $16.4 million in the three nine months endedSeptember 30, 2002, respectively. For the three and nine months endedSeptember 30, 2002, $550,000 or 14% and $7.5 million or 46%, respectively,of revenues from Titan were from sales of our electronic irradiationsystems using the percentage of completion method of accounting, in support ofTitan’s two United States Postal Service contracts for which we are the mainsubcontractor. The remaining $3.4 million and $8.9 million of revenuesfrom Titan for the three and nine months ended September 30, 2002,respectively, were for the sale of equipment and services related to Titan ScanTechnologies’ medical sterilization business and Titan’s government linearaccelerator business.

 

In connection with ouragreement with Texas A&M, we agreed to provide three electronic foodirradiation systems (collectively, “the system”) pursuant to a ten-year leasewith title passing to Texas A&M at the end of the ten-year term. Theagreement provides us access to Texas A&M employees for a variety of freeor discounted services, as well as rights to use the system for performingirradiation services for our customers. We are currently working with TexasA&M on several research projects which include studies on shelf lifeextension, food products application testing, and the effectiveness of SureBeam’s technology versus other technologies. Since we retain the right to usethe system through the end of the term of the arrangement, we have accountedfor this transaction as a sale-leaseback.

 

As the consideration in thislease is nonmonetary, we have accounted for this element of the agreement inaccordance with APB No. 29, “Accounting for Nonmonetary Transactions.”Sales are recorded on a percentage-of-completion basis at the fair market valueof the electronic food irradiation system sold to Texas A&M and totalsystem profits of $518,000 will be deferred and recognized ratably over theremaining term of the arrangement commencing upon delivery of the system.

 

Under thepercentage-of-completion method, we recorded revenues of $50,000 and$1.9 million for the three and nine month periods ended September30, 2002, respectively, and recorded $2.0 million and$3.3 million

 

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for the three and nine month periods endedSeptember 30, 2001, respectively. The asset arising from the total cumulativerevenues of $10.0 million, net of $322,000 of amortization, has beenrecorded as a short-term and long-term asset at September 30, 2002. As ofSeptember 30, 2002, we had deferred profits amounting to $518,000, which areincluded as other short-term and long-term liabilities in the accompanyingconsolidated balance sheet. These deferred profits will be amortized ratably toreduce cost of sales over the remaining term of the ten-year term of thearrangement commencing upon delivery of the system to Texas A&M. Theshort-term and long-term assets arising from this transaction represents thecumulative revenues recognized related to the design, construction,installation, integration and delivery of the system for Texas A&M, net ofamortization. In August 2001, we agreed to purchase research anddevelopment services from Texas A&M for approximately $200,000,reflecting a discount of approximately $300,000. The discount has beenamortized over a period of approximately ten months from the long-term assetarising from the cumulative revenues recorded under this agreement. For thethree and nine months ended September 30, 2002, we have recorded $0 and$150,000, respectively, of amortization expense related to the research anddevelopment services we have received to date. The deferred profit of $518,000as of September 30, 2002, represents the difference between the cumulativecosts incurred and the cumulative revenues recognized. DuringSeptember 2002, the final delivery of the system had taken place and thefacility became operational and $6,000 of deferred profit has been amortized toincome.

 

With respect to the impactof the transaction with Texas A&M on our liquidity, we have expended fundsof approximately $9.5 million related to the construction of the system throughSeptember 30, 2002, which includes $50,000 and $1.9 million expendedduring the three and nine months ended September 30, 2002, respectively.These costs have been incurred primarily in relation to the design of thesystem, construction of and modification to the physical structure that willhouse the system, and for the manufacture of the linear accelerators and x-raycomponents as well as the material handling and conveyor systems.

 

Our cost of revenuesconsists primarily of the components and materials associated with the linearaccelerator, material handling system and controls and direct labor toassemble, install and integrate the medical equipment sterilization andelectronic food irradiation systems, as well as overhead such as travel, indirectlabor and fringe benefits related to the production of the systems and themanufacturing of linear electron beam accelerators. Also included in cost ofrevenues are all direct and indirect costs associated with providing medicalequipment sterilization and electronic food irradiation services. These costsare comprised of direct and indirect labor, depreciation, rent, dosimetrysupplies, maintenance and utilities as well as other related costs to operate aservice center. Dosimetry supplies are consumables used during facilityoperations to monitor performance and to ensure the integrity of the dose ofthe irradiation delivered to the product for quality assurance purposes and tosatisfy federal requirements.

 

Our grossmargins decreased from 41% and 38% for the three and nine months endedSeptember 30, 2001, respectively, to 2% and 20% for the three andnine months ended September 30, 2002, respectively. The decrease is due to alow gross margin on food processing due to underutilization of the servicecenters and higher percentage of revenues from Titan, which have a lower grossmargin than systems sales from non-affiliated parties and systems sales to theinvestee. We anticipate that our gross margins will increase as the utilizationat the service centers increases and the percentage of revenue from Titan,which has a lower gross profit, decreases as a percentage of total revenue.

 

*Selling, General and Administrative*

 

Our selling,general and administrative expense decreased from $11.9 million and $69.6 millionin the three and nine months ended September 30, 2001, respectively, to$11.8 million and $31.4 million in the three and nine months endedSeptember 30, 2002, respectively. The decrease of $110,000 for thethree months ended September 30, 2002 compared to the same periodlast year is attributed to an increase of $1.1 million in stock-basedcompensation as a result of our spin-off from Titan, an increase of $735,000 insales and marketing spending, and was offset by a decrease of $689,000 of amortizationrelated to intangible assets acquired from Applied Power Associates, Inc., orAPA, in May 2002, which are fully amortized, and a decrease of $263,000 ofcorporate allocation from Titan as a result of our spin-off on August 5, 2002.The decrease of $38.1 million for the nine months ended September 30, 2002compared to the same period last year is attributed to a decrease of$35.3 million in stock-based compensation, $570,000 in sales and marketingspending, $1.1 million of amortization related to the APA intangibleassets and $266,000 in corporate allocation from Titan.  See the discussion of stock-based

 

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compensation below. We expectgeneral and administrative expenses will increase due to higher sales andmarketing expense associated with new customer product rollouts into newregions.

 

*Stock-based Compensation*

 

In connectionwith the completion of our initial public offering in March 2001, stock optionsgranted under our Nonstatutory Stock Option Plan were converted from variableplan options to fixed plan options. Accordingly, stock-based compensation of$78.6 million was recorded, representing the extent to which the $10.00per share offering price exceeded the exercise price of the options. Werecognized $4.9 million and $48.5 million as compensation expense includedin selling, general and administrative expense in the accompanying consolidatedstatements of operations for the three and nine months ended September30, 2001, respectively.  Since substantialportions of these options were vested at the time of completion of theoffering, we recognized $38.7 million as compensation expense at that time.For the three and nine months ended September 30, 2002, $6.0 millionand $13.2 million was recognized, respectively, as compensation expenseand included in selling, general and administrative expense. In conjunctionwith the completion of our spin-off from Titan on August 5, 2002, alloptions held by Titan employees and directors under this plan became fullyvested and as a result increased the amortization of the stock-basedcompensation charges for this plan for the three months endedSeptember 30, 2002 by $2.9 million. The remaining stock-basedcompensation balance of the remaining participants related to these optionswill be recognized as expense over the remaining four-year vesting period ofthe options. Additional stock-based compensation expense is included inselling, general and administrative expense related to options granted prior tothe completion of the Company’s initial public offering under the 2000 StockOption and Incentive Plan for which the fair market value on the date of grantexceeded the exercise price. Stock-basedcompensation expense related to these options was $202,000 and $606,000 for thethree and nine months ended September 30, 2001 and 2002, respectively.

 

*Research and Development*

 

Our research and developmentexpense decreased from $736,000 and $1.8 million in the three and ninemonths ended September 30, 2001, respectively, to $55,000 and $551,000 inthe three and nine months ended September 30, 2002, respectively. Thedecrease of our research and development expense in the current year is due toour extensive ongoing research and development work performed for Titan, thecosts of which we bill to Titan based on the work performed. As these effortsfor Titan decrease and our internal efforts increase, we expect the researchand development expense to increase in the future. Our current research anddevelopment activities are focused on increasing the capability and efficiencyof our existing technology, minimizing the space occupied by our SureBeamsystems and developing new food product applications. We have assembled a teamof experts in our industry to enhance and drive our research and developmentefforts. Our research and development experts have many years of experience inthe area of enhancing food safety and extending shelf life using irradiation inaddition to their broad experience with linear accelerators and chargedparticle beams. In addition, we have an agreement with Texas A&M Universityand the Texas Agricultural Experiment Station for the purpose of researchingand developing product applications for our technology. We are currentlyworking with Texas A&M on several research projects which include studieson shelf life extension, food products application testing, and theeffectiveness of SureBeam’s technology versus other technologies. In addition,we often benefit from the research and development efforts of our componentsuppliers.

 

*InterestIncome*

 

Our interest incomedecreased from $333,000 and $1.1 million in the three and nine monthsended September 30, 2001, respectively, to $37,000 and $164,000 inthe three and nine months ended September 30, 2002, respectively. Thedecrease is due to the reduced cash and marketable securities on hand for thethree and nine months ended September 30, 2002.  Due to our initial public offering in March 2001, our cash andmarketable securities balances were $39.6 million at September 30, 2001 ascompared to $5.0 million at September 30, 2002.  See Note (2) inNotes to Consolidated Financial Statements.

 

*InterestExpense*

 

Our interest expensedecreased from $1.6 million and $4.8 million in the three and nine monthsended September 30, 2001, respectively, to $331,000 and$1.3 million in the three and nine months ended

 

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September 30, 2002, respectively.The decrease is due to the exchange of $73.0 million of our subordinatedpromissory note payable to Titan for our common stock. See Note (6) inNotes to Consolidated Financial Statements. This exchange of debt resulted in a decrease in our interest expense.However, as we require additional financing, either drawing down on the seniorsecured credit facility with Titan or obtaining other financing, we will likelyincur increased interest expense in the future.

 

*OtherIncome (Expense), Net*

 

During the three and ninemonths ended September 30, 2002, we recorded $1.0 million and $2.9 million,respectively, of other income, net. For the three and nine months endedSeptember 30, 2002 we recorded $1.0 million and $3.0 million,respectively, of license fee income from Titan that was reduced by realizedlosses from the sale of available-for-sale marketable securities and othermiscellaneous expenses. During the fourth quarter of 2001, Titan agreed topurchase a perpetual and exclusive, non-royalty bearing license to use ourintellectual property for all applications and fields other than food(excluding water), animal hide and flower markets for $8.0 million. Aspart of this agreement, we are recording $1.0 million of license feeincome in each quarter for eight quarters, which began in the fourth quarter of2001.  There was no other income, net for the three and nine months endedSeptember 30, 2001.

 

*IncomeTaxes*

 

Incometaxes reflect an effective rate of 0% for the three and nine months endedSeptember 30, 2002, compared to 10% for the three months and ninemonths ended September 30, 2001. Pursuant to our tax sharing agreement, Titanwill compensate us for any tax benefit received by Titan from the use of ourlosses in their consolidated return. The amount is payable on the earlier ofwhen we could have used the loss ourselves or when the losses expire (20years). We had an operating loss for the first nine months of 2002 and 2001 andexpect to continue to incur losses for the remainder of 2002. Our tax benefitis dependent upon the usage of our losses by Titan. The amount expected to be receivedfrom Titan under the tax sharing agreement related to losses incurred for thetwelve months ended December 31, 2001 is $2.3 million and is reflected asdue from Titan in the accompanying balance sheet.  In conjunction with the spin-off, we have been subsequentlydeconsolidated from Titan and Titan will no longer have the right to use ourlosses. Accordingly, we have not recorded any benefit for income taxes for thethree and nine months ended September 30, 2002.

 

*Net Loss*

 

Our net loss increased from$7.7 million and decreased from $57.5 million in the three and ninemonths ended September 30, 2001, respectively, to $11.0 millionand $25.1 million in the three and nine months endedSeptember 30, 2002, respectively. The increased loss of $3.3 millionfor the three months ended September 30, 2002 over the same periodlast year primarily related to $5.8 million of lower gross profit offset by areduction of $681,000 of research and development expense, $1.2 million ofinterest expense and $861,000 of income tax benefit. The decreased loss of$32.3 million for the nine months ended September 30, 2002 over the same periodlast year for the quarter was primarily due to a reduction of stock-basedcompensation amortization expense of approximately $35.3 million for ninemonths ended September 30, 2002.

 

**Liquidity and Capital Resources**

 

We have used cashprincipally to construct systems for our strategic alliances and fund workingcapital advances for these strategic alliances, to construct company-ownedservice centers and systems, to construct systems for Texas A&M, to expandour manufacturing capacity and to fund our working capital requirements. AtSeptember 30, 2002, we had available cash, cash equivalents andinvestments available-for-sale of $5.0 million. Our future cashobligations consist primarily of current liabilities and our fixed lease costsassociated with the operation of our service centers. As of September 30, 2002,we expect to pay approximately $2.8 million in lease obligations during thenext 12 months.

 

Since ourinitial public offering on March 16, 2001, our cash requirements have been metprimarily through proceeds of approximately $59.8 million, net ofunderwriting commissions, fees and other offering costs, from our

 

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initial public offering,advances under the $75.0 million credit facility and the $50.0 millionsenior secured credit facility with Titan discussed below, payments from Titanfor work performed on medical sterilization, $19.5 million associated withmail sanitation system sales and payments totaling $7.0 million from Titanassociated with the perpetual license related to non-food items. In connectionwith the contribution by Titan to SureBeam in August 2000, we assumed thecumulative advances of approximately $39.0 million, as evidenced by asubordinated, unsecured promissory note payable to Titan. Under this note,Titan agreed to lend us a maximum amount of $75.0 million, includingaccrued interest, and we borrowed $75.0 million. The promissory note wasdue in August 2005 and bore interest at the greater of the rate of 10% perannum or Titan’s effective weighted average interest rate under its seniorcredit facility. On December 31, 2001, $2.0 million of thesubordinated note payable to Titan was exchanged by Titan for 190,385 shares ofour Class B common stock. Additionally, the remaining $73.0 millionof the subordinated note payable to Titan was exchanged onFebruary 13, 2002 for 4,441,496 shares of our Class A commonstock and 3,225,765 shares of our Class B common stock.

 

Titan hasextended a $50.0 million senior secured credit facility to us that allowsus to borrow, in addition to our previous borrowing, up to $12.5 millionper quarter during in the fourth quarter of 2002 through the fourth quarter of2003, subject to the $50.0 million limitation on borrowing. The amountavailable for borrowing in the second, third and fourth quarters of 2003 isbased upon our earnings before interest, taxes, depreciation and amortization (EBITDA)for the prior quarter as a percentage of the EBITDA target in our annualoperating plan. If EBITDA is less than 25% of target EBITDA, then the amountavailable is $5.0 million, provided that no amounts are available unlesswe covenant during the current quarter to limit our total operating expenses(defined as research and development and selling, general and administrativeexpenses) to $5.0 million. If EBITDA is 25% of target EBITDA, then theamount available is $6.25 million or 50% of the quarterly maximum and foreach percentage of EBITDA above 25% of target EBITDA, the percentage of thequarterly maximum above 50% will be increased on a pro rata basis. To theextent we do not fully borrow the maximum amount during any quarter of 2002,the unutilized amount can be borrowed in the subsequent quarters. As ofSeptember 30, 2002, we had borrowed $22.5 million on this facility and had$4.5 million in unutilized amounts. We borrowed an additional$2.5 million on October 31, 2002, bringing our total borrowingson this senior secured credit facility to $25.0 million. If we areunable to receive funds as anticipated under this credit facility or if ourcapital requirements vary from our current plans, we may require additionalfinancing sooner than we anticipate. An inability in such circumstance toobtain additional financing on terms reasonable to us, or at all, could have amaterial adverse effect on our results of operations and financial condition.

 

Under the senior securedcredit facility we are obligated to make quarterly principal payments asfollows: 13.75% of the outstanding principal balance as of December 31,2003 during each quarter in 2004; 25% of the outstanding principal balance asof December 31, 2004 during each quarter in 2005; and all remainingprincipal by December 31, 2005. In addition, with some exceptions, we areobligated to use net proceeds from the sale of assets and securities to repayamounts advanced under this facility. Interest is payable monthly beginning inJanuary 2003. The credit agreement contains affirmative and negativecovenants, including covenants limiting our incurrence of debt, capitalexpenditures, operating expenses, investments, declaration of dividends andother restricted payments, sale of stock of subsidiaries and consolidations andmergers. The credit agreement, however, does not contain any financialcovenants requiring us to maintain specific financial ratios. The creditagreement is secured by a first priority lien on all of our assets.

 

In addition, Titan hasguaranteed some of our lease obligations, and we are obligated to reimburseTitan for any payments they make under these guaranties. Any guarantee paymentsTitan makes reduces amounts available for future borrowing under the creditagreement.  We will pay Titan a monthlyfee of 10% of the guaranteed monthly payments. Some of the guaranteed leases have longer terms than the creditfacility.  If Titan remains a guarantorat the maturity date for the credit facility, then we plan to enter into areimbursement agreement with Titan covering the outstanding guarantees.

 

Our operating activitiesused cash of $10.8 million for the nine months ended September30, 2002, primarily due to a decrease in accounts receivable andreceivable from Titan of $2.5 million, amortization and depreciationexpense of $17.6 million, which was offset by a decrease of $4.6 millionrelated to accounts payable and accrued compensation. The decrease in accountsreceivable principally relates to collection of $19.5 million from Titan relatedto the United States Postal Service and the collection of $1.5 million from theRESAL contract

 

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during the nine months endedSeptember 30, 2002. The $21.0 million, collected during the ninemonths ended September 30, 2002, was received in accordance with themilestone payments of the contracts.

 

Our investing activitiesused cash of $11.8 million for the nine months ended September30, 2002, primarily due to the sale of available-for-sale investments of$3.7 million, offset by capital expenditures of $15.1 millionprimarily related to our service centers under construction. Also included incash used for investing activities for the nine months ended September 30, 2002were advances to Hawaii Pride aggregating $445,000 for working capitalrequirements.

 

In June 2001, wereceived an order in the aggregate amount of $50.0 million from RESAL forten electronic food irradiation systems to operate in three service centers inthe Saudi Arabia region for irradiating poultry and disinfesting and prolongingshelf life of dates. We commenced construction on eight of these systems forRESAL and have recognized, under the percentage-of-completion method ofaccounting, $15.8 million in revenue, which has been recorded on thiscontract through September 30, 2002, of which $3.6 million wasrecognized during the nine months ended September 30, 2002. Revenuesderived from this order are classified as revenues from investee in theaccompanying consolidated statements of operations. Three electronic foodirradiation systems are scheduled to be shipped in early 2003, with theremainder being shipped within twelve months thereafter. We received a paymentof $1.5 million in the second quarter of 2002 based on milestone payments andexpect to continue to receive milestone payments as they become due and payableuntil the contract is complete.

 

In April 2002,we formed a joint venture under the name SureBeam Middle East, LLC. withRESAL.  SureBeam Middle East, LLC. willprovide, among other things, food irradiation services through planned servicecenters in the Saudi Arabia region. As of September 30, 2002, we own a 19.9%interest in SureBeam Middle East, LLC. and RESAL and other Saudi nationals ownthe remaining 80.1%. We account for our ownership interest in SureBeam MiddleEast, LLC. using the equity method of accounting under APB OpinionNo. 18 “The Equity Method of Accounting for Investments in Common Stock.” Inaccordance with the joint venture agreement, RESAL’s purchase order dated June2001 may be assigned to SureBeam Middle East, LLC. at such time as the jointventure receives sufficient funds from the third party investors.  As of September 30, 2002, a portion of thepurchase order has been assigned to SureBeam Middle East, LLC.  As a result, revenue recognized under thecontract is presented in the consolidated statements of operations as revenuefrom investee and we have eliminated our 19.9% interest in the profitrecognized under the percentage-of-completion method of accounting inconnection with the original purchase order. We estimate that the total profitunder the original contract that will be eliminated as a result of our equityinterest in SureBeam Middle East, LLC. will be approximately $2.0 million to$3.0 million. Pursuant to the joint venture agreement, for five years followingthe date of SureBeam Middle East, LLC.’s commercial registration, SureBeamMiddle East, LLC. has an exclusive right of first negotiation to negotiate andenter into agreements to provide irradiation services for the treatment of foodproducts (excluding water), animal hides and flowers in Saudi Arabia, Egypt,Lebanon, Syria, Iraq, Iran, Libya, Tunisia and Algeria. The joint venture willgovern our strategic relationship with the operator of these systems, includingroyalty and management fees and a minority equity ownership of the operatorthat will operate the service centers.

 

In October 2001, wecontracted to manufacture eight SureBeam systems for $26.0 million forTitan in connection with Titan’s agreement with the United States PostalService, or USPS. During the three months ended September 30, 2002, ourpurchase order from Titan related to the USPS was closed out at$19.5 million dollars.  Under thisagreement, Titan arranged to provide electron beam systems and services tosanitize mail by eliminating the threat of anthrax. We worked with Titan andTitan’s business units in providing the systems to the USPS. We were aprincipal subcontractor to Titan under its prime contract. In accordance withthe milestone payments of the contract, we received $19.5 million in cashfrom Titan during the nine months ended September 30, 2002.

 

In June 2002, wereceived an order in the aggregate amount of approximately $5.3 million from SonSon Company, a private food-processing corporation headquartered in Vietnam, for one electronic food irradiation systemto operate in Vietnam for irradiating shrimp, seafood, and frog legs andprolonging shelf life of foods. We commenced construction on the system andhave recognized, under the percentage-of-completion method of accounting,$2.1 million in revenue, which has been recorded on this contract throughSeptember 30, 2002, of which $503,000 was recognized during the three months,ended September 30, 2002. In November 2002, we received a $2.0 millionmilestone payment on this contract. We expect to receive milestone payments asthey become due and payable until the contract is complete.

 

In September2002, we received an order from Titan for $6.0 million in connection witha new contract with the USPS. Under this agreement, we are to provide twolinear accelerators to sanitize the mail. During the three

 

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months endedSeptember 30, 2002, we recorded revenue of $500,000. We expect toreceive milestone payments as they become due and payable on this contract.

 

Theaccompanying consolidated financial statements contemplate the realization ofassets and the satisfaction of liabilities in the normal course of business.During the nine months ended September 30, 2002, we have incurred substantiallosses from operations and investments in infrastructure. Management believesthat as we continue to make significant investments in infrastructure, salesand marketing, it is not anticipated that our revenues will sufficiently offsetthese investments until at least 2003. Additionally, our constructionand implementation period for systems sales to strategic alliances as well asour service centers and systems require a substantial use of cash for at least12 to 18 months. Our arrangements to sell food irradiation systems tostrategic alliances typically contain milestone provisions for payment, whichare typically based upon time, stage of completion, and other factors. As aresult, our unbilled receivables from our customers have increased$4.0 million during the nine months ended September 30, 2002.Also in connection with our agreements with our customers, we have advancedfunds aggregating $5.5 million to Hawaii Pride, which was used primarilyfor land acquisition and for working capital purposes. Although not obligated,we anticipate that we will continue to provide cash to Hawaii Pride for workingcapital purposes, as it is needed. We do not expect significant repayments ofthe advances from Hawaii Pride until at least late 2003. We also have enteredinto a number of commitments to lease land and facilities in connection withconstruction of our four company-owned service centers of which three areoperational with the fourth expected to be operational in the first quarter of2003. In addition, based on our customer requirements, we may expend funds toconstruct and install in-line systems that we will own and operate.

 

In addition toour current operating plans, which focus on increasing cash flow fromoperations, we are also evaluating a number of alternative plans to meet ourfuture operating cash needs. These plans include raising additional funds fromthe capital markets and drawing down on our $50.0 million senior secured creditfacility with Titan. As of the date of the filing of this report, we haveobtained $25.0 million under the senior secured credit facility with Titan. Ifthe funds available under the credit facility and from the capital markets arenot sufficient for us or if we are unable to generate sufficient cash flow fromoperations, we may need to consider additional actions, including reducing ordeferring capital expenditures, reducing or deferring research and developmentprojects, curtailing construction of systems for customers in advance ofpayment and reducing marketing expenditures, which actions may have a materialadverse impact on our ability to meet our business objectives.

 

On October 16, 2001,Titan adopted a definitive plan to spin-off its ownership interest in SureBeamin the form of a tax-free dividend to Titan’s stockholders. EffectiveAugust 5, 2002, Titan distributed all of its shares of our common stock toits stockholders.  Titan announced thatholders of record of Titan common stock as of the close of business onJuly 26, 2002, the record date for the distribution, were to receive0.6986 shares of our common stock for every share of Titan common stock held.Previously, Titan held over eighty percent of the our common stock and held a higherpercentage of the voting power due to Titan’s ownership of shares ofClass B common stock, which had ten votes per share, as compared to theClass A common stock, which has one vote per share and is traded on theNasdaq under the symbol SURE. Prior to the distribution of shares of our commonstock, Titan converted all of its shares of our Class B common stock, intoshares of our Class A common stock. Stockholders of Titan receivingSureBeam shares in its distribution received only shares of Class A commonstock. Under the terms of the Class B common stock, it has now beenretired and cannot be reissued. As of November 5, 2002, there were67,297,362 shares of common stock issued and outstanding, all of which areClass A common stock. We have negotiated other agreements with Titan inconnection with our spin-off including a tax sharing and disaffiliationagreement that will subject us to liability if we sell our equity or equitylinked securities in a manner that causes a change in our ownership of 50% ormore in voting power or value as part of Titan’s spin-off plan. This risk couldlimit our ability to access public equity markets. In addition, the recentdownturn in the capital markets may limit our ability to raise capital throughpublic equity or debt offerings. If funds from our senior secured creditfacility or other sources are not sufficient to us and/or if we are unable togenerate sufficient cash flow from operations, we may need to consideradditional actions, including reducing or deferring capital expenditures,reducing or deferring research and development projects, reducing constructionof systems for customers in advance of payment and reducing marketingexpenditures. The deferral or cancellation of these projects may have amaterial adverse impact on our ability to meet our short-term businessobjectives. In order to borrow funds under our senior secured creditfacility, we must be in compliance with our operating expense and capitalexpenditure covenants and we may have to curtail these activities to be incompliance with these covenants.

 

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At September 30, 2002,we had $5.0 million of cash, cash equivalents and investmentsavailable-for-sale. We believe that this balance along with the remainingavailability on the $50.0 million senior secured credit facility from Titanwill be sufficient to meet our cash needs through 2003. However, a variety ofcurrently unanticipated events could require additional capital resources suchas the acquisition of complementary businesses or technologies or increasedworking capital requirements to fund, among other things, construction ofsystems for our strategic alliances in advance of payment. Additionally, if weare unable to receive funds under the credit facility with Titan or if ourrequirements vary from our current plans, we may require additional financingsooner than we anticipate. An inability in such circumstance to obtainadditional financing on terms reasonable to us, or at all, could have a materialadverse effect on our results of operations and financial condition.

 

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**ITEM 3. QUALITATIVE AND QUANTITATIVEDISCLOSURES ABOUT MARKET RISK**

 

We currentlyare exposed to market risks related to changes in interest rates. Titan hasextended us a $50.0 million senior secured credit facility, which bearsinterest equal to Titan’s effective weighted average term debt rate underTitan's credit agreement plus three percent. As of November 14, 2002, we have drawn $25.0 millionagainst this credit facility. See Note (7) in Notes to Consolidated Financial Statements. At September30, 2002, the effective interest rate on this credit facility was 8.5%. Weanticipate our future borrowings will have a variable component that willfluctuate as interest rates change. If market interest rates were to increaseimmediately and uniformly by 10%, there would not be a material impact on ourfinancial condition or results of operations.

 

**RiskFactors**

 

**RisksRelated to Our Business**

 

**We willrequire significant additional capital to fund operations, which may not beavailable on acceptable terms or at all.**

 

We will require additionalfunds to execute our current business plan which includes building newSureBeam® in-line systems and service centers, funding working capital,including in relation to our international and domestic strategic alliances,and funding our ongoing operations, including our corporate infrastructure, asa stand-alone entity. However, our future capital requirements will depend onmany factors, including:

 

•                  Fluctuations in our working capitalrequirements, including the continued or increased demand to build our systemsin advance of payment;

 

•                  Unexpected delays in collecting accountsreceivable from sales of our systems;

 

•                  The volume of food processed at our servicecenters and the fixed costs of operating these facilities at substantially lessthan current capacity;

 

•                  The costs of components for our systems, andthe production cost of assembling our systems;

 

•                  The adequacy of our manufacturing and otherfacilities to meet demand for our products and services;

 

•                  The size and complexity of, and the progressin, our research and development programs;

 

•                  The costs of filing and prosecuting patentapplications, and maintaining, defending and enforcing our patents; and

 

•                  The timing, scope and results of markettesting by food processors.

 

**Ifour revenues from operations do not meet our expectations, we may have aheightened need for additional capital from a source other than our currentcredit facility.**

** **

Titan has extended to us a$50.0 million senior secured credit facility secured by substantially all ofour assets. It allows us to borrow up to a maximum of $12.5 million per quarterbeginning in the fourth quarter of 2002 through the fourth quarter of 2003,subject to the $50.0 million aggregate limitation on borrowing. The amountavailable for borrowing in each of the second, third and fourth quarters of2003 is based upon our earnings before interest, taxes, depreciation andamortization (EBITDA) for the prior quarter as a percentage of the EBITDAtarget in our annual operating plan. If our operating revenues do not meet ourexpectations, it is likely that (i) our EBITDA will not meet our EBITDA target,which will limit the amount which we can borrow under the Titan creditfacility; and (ii) because of the shortfall in revenues, we will have a greaterneed to borrow funds to fulfill our current business plan. Therefore, failureto meet our expected operating revenues could have a compounded effect, whichcould require us to obtain additional financing sooner than currentlyanticipated in order to fulfill our current business plan. In suchcircumstance, no assurance can be made that we would be able to obtainadditional financing on terms reasonable to us, or at all, which could have amaterial adverse effect upon our results of operations and financial condition.

 

**Our currentcredit facility may not be sufficient for our capital requirements.**

 

In the past, Titan financeda significant portion of our working capital and other capital requirements andTitan has extended to us a new $50.0 million senior secured credit facilitysecured by substantially all of our assets. This facility is subject to limitsin the amounts that can be drawn each quarter, and subject to certain financialcovenants and affirmative and negative covenants. As ofNovember 14, 2002, we have borrowed $25.0 million under thissenior secured credit facility. We cannot give assurance that the $50.0 millionsenior secured credit facility will be adequate for our liquidity needs or thatwe will be able to obtain any additional credit on as favorable terms or atall.  We believe our current liquidity,including the senior secured credit facility with Titan, will allow us tocontinue our operations through 2003; however, if our capital requirements varyfrom our current plans, we may require additional financing sooner than weanticipate. We expect we will need to obtain additional debt or equity financingin order to execute our business strategy. Future equity financings would be dilutive to the existing holders ofour

 

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common stock. Future debt financings wouldmost likely involve restrictive covenants and would need to be approved byTitan. Additional financing from Titan or from third parties may be unavailableto us when needed. If we are unable to obtain future equity financing or debtfinancing or obtain additional funding from Titan or other financing sources onterms acceptable to us or at all or if we are unable to generate sufficientcash flow from operations, we believe we would have sufficient funds tocontinue our operations through 2003, but we would have to significantly reduceour current business plan and delay, curtail or eliminate some of ouroperations or capital expenditures in 2004 and beyond, which could have amaterial adverse effect on our results of operations and financial condition.

 

**Ourbusiness is at an early stage of development. We are subject to the risks ofnew enterprises and the commercialization of a technology that requiresconsumer acceptance.**

 

Our early stage ofdevelopment makes it difficult to assess our prospects or predict our futureoperating results. We are subject to risks and uncertainties frequentlyencountered by early stage companies that involve the new application of anexisting technology. These risks include our inability to:

 

•                  Build consumer confidence in the benefits offood irradiation and establish the acceptance of our SureBeam electronicirradiation technology;

 

•                  Establish and maintain a sufficient number offood industry customers and strategic relationships; and

 

•                  Obtain substantial capital to support thefurther development of our technology and the commercialization of our systemsand services.

 

If we do not successfullyaddress these risks, we may not be able to increase revenues or commercializeour SureBeam system.

 

**If we areunable to successfully achieve broad market acceptance of our SureBeam system,we may not be able to generate enough revenues in the future to achieve orsustain profitability.**

 

We are dependent on thesuccessful commercialization of our SureBeam system. The market forelectronically irradiated food is at an early stage of development and hasdeveloped slower than we had originally expected. As of September 30, 2002,eleven food processors were selling food electronically irradiated by us andthe volume of food being processed is still a very small percentage of themarket of ground beef. To date, no market has developed for chicken.  The FDA still has not approved theirradiation of processed food, which represents a substantial potential market.We processed 11.1 million pounds of food products in 2001, up from 5.9 millionpounds processed in 2000. Through September 30, 2002, we have processed10.3 million pounds of food products. Other food processors are testing our technology and it is uncertainwhether or when they will begin commercial production, which in some casesdepends on obtaining regulatory approval. We also do not know whether or whenmore fast food or other national chain restaurants or food retailers willdecide to offer irradiated meat and create demand for our electronicirradiation systems. We expect that some food processors will not irradiatefood unless industry leaders first commit to distribute irradiated food.

 

The markets for our SureBeamsystem are unproven. Our SureBeam technology may not gain adequate commercialacceptance or success. A variety of the risk factors discussed in this sectionwill determine the success of our market development and commercializationefforts and the rate and extent of market acceptance of our SureBeam system.

 

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**Publicconcerns over the irradiation of food could negatively impact market acceptanceof our SureBeam process and SureBeam® branded food products.**

 

Irradiation of food by anytechnology, whether using an electron beam or radioactive isotopes, is opposedby several organized and vocal consumer groups who claim that irradiated foodproducts are unsafe for consumption or pose a danger to the environment. Thesegroups attempt to influence public policy and promote consumer opposition toirradiated food through activities such as picketing stores that offerirradiated food and by lobbying politicians. Because irradiation of foods byelectron beam technology is a new process, consumers need to be informed aboutthe benefits and safety of food irradiation. Since irradiation of food by anymethod, whether using electron beam or radioactive isotopes, must be disclosedunder the same label “Treated with Radiation” or “Treated by Irradiation,”consumers may fear that our process makes food unsafe for consumption, hasunknown future health effects or poses a danger to the environment. We risk notbeing able to overcome these fears through our educational efforts or todistinguish our process from gamma irradiation. If the public or our potentialcustomers perceive our systems and services as unsafe or undesirable, oursystems and services may not gain market acceptance, which would severely limitour ability to market and sell our products. In addition, negative publicattitudes may prompt state legislatures to prohibit the sale of irradiatedfood. Further, consumers may be unwilling to pay for the higher cost of foodproducts processed by our SureBeam system, which could negatively impact themarket acceptance of our process.

 

**We have ahistory of losses and we may not achieve or sustain profitability.**

 

We have incurred operatinglosses in each quarter since we commenced operations. As of September30, 2002, we had an accumulated deficit of approximately$117.5 million, and our net loss for the first three quarters of 2002 was$25.1 million. Our net loss for the year ended December 31, 2000 wasapproximately $1.8 million, and our net loss for the year endedDecember 31, 2001 was approximately $74.4 million, includingapproximately $54.3 million of non-cash stock-based compensation expense.At the time of our initial public offering, we recorded stock-basedcompensation of approximately $78.6 million, of which $53.5 millionwas recognized as an expense during the year ended December 31, 2001. Wewill recognize this charge in accordance with the vesting provisions of therelated options through 2004. This charge will have a significant adverseimpact on our earnings from 2002 through 2004. We expect to derive our futurerevenues from sales of our SureBeam systems and related food processingservices. However, these revenues are highly uncertain. We expect to devotesubstantial resources to continue our sales and marketing activities, includingour consumer branding efforts, further develop our administrative infrastructureand expand our research and development activities. As a result, we expect thatour operating losses will increase and that we will incur operating lossesthrough at least 2003.

 

**Revenuesfrom system sales may decline in the future if we fail to make new system salesor the timing of expected contract execution is delayed.**

 

Our system sales revenuesare dependent on a few large contracts and the recognition of revenues underthese long-term contracts is based upon work performed. Consequently, thetiming of the execution of these contracts and the timing of work performedunder them, which is partially outside of our control, could cause us togenerate lower than expected revenues. To date, our revenues have beenprimarily attributable to the design and construction of systems for a limitednumber of customers, for which revenues are recognized under thepercentage-of-completion method. For example, for the year endedDecember 31, 1999 revenue from three customers represented approximately40% of our total revenues, for the year ended December 31, 2000 revenuefrom three customers represented approximately 79% of our total revenues, andfor the year ended December 31, 2001 revenue from three customersrepresented approximately 89% of our total revenues.  During the first three quarters of 2002, approximately 81% of ourrevenues were from two customers.  Mostof these systems are not yet fully constructed, installed or integrated and weexpect to continue to derive system sales revenue as we complete construction,installation and integration of these systems. A reduction or delay of systemsales to one or more significant customers could significantly reduce ourrevenues. Once the food irradiation systems become operational, we will nolonger derive revenue from these system sales, but expect to derive income fromfood processing revenues commensurate with our existing or potential equityownership in the entities that own and operate the third party service centers.In addition, we expect to derive revenue from processing by company-ownedservice centers and in-line systems. There are no assurances that we willcontinue to derive revenues from these customers, that revenues from thesecustomers will continue at current or historical levels, that we will be able toderive revenue from new

 

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customers or that we will be able to deriveincome from significant food processing revenues in the future at anticipatedlevels.

 

**We may berequired to take impairment charges for receivables if a customer defaults onits payment obligations.**

 

We account for our revenuesderived from sales of electronic food irradiation systems under fixed-pricecontracts using the percentage-of-completion method. These systems currentlytake a total of approximately 12 to 18 months to design, construct,install, integrate and deliver. Our unbilled receivables from our contracts forsystems have increased substantially over the past twelve months. If a customerdefaults on its payment obligations under a contract accounted for using thepercentage-of-completion method or if we determine that the contract isotherwise impaired, we would take an impairment charge to earnings for thereceivable arising from previously recorded revenues in respect of suchcontract at that time. We cannot assure you that one or more of our customerswill not default on its payment obligations. For example, inDecember 1999, we agreed to sell a SureBeam system to a new entity, ZeroMountain SureBeam, to be formed by Zero Mountain Cold Storage. Under theagreement, a facility was to be constructed and the entity would operate anelectronic food irradiation service center in Arkansas. Management of ZeroMountain Cold Storage had not moved forward with its obligation under thecontract. Accordingly, in December 2001, we recorded an allowance fordoubtful accounts of $1.2 million against our receivable from ZeroMountain Cold Storage.

 

**We have notgenerated positive cash flow from operations and our cash flow from operations maybe insufficient to meet operating requirements for the foreseeable future.**

 

We used net cash fromoperations of $17.8 million in 2000 and $49.0 million in 2001.Through September 30, 2002, we used net cash from operations of$10.8 million.  Also, in connectionwith our agreements with our customers, we have advanced funds aggregating$5.5 million to a strategic alliance entity in Hawaii Pride to be usedprimarily for land acquisition, building construction, and for working capitalpurposes. We do not expect significant repayments of these advances until 2003.We received a progress payment of $1.5 million on the RESAL contract inthe second quarter of 2002 and will continue to receive payments based on thepayment schedule in the contract. In addition, we have entered into a number ofcommitments to lease land and facilities in connection with construction of ourfour company-owned service centers of which three are operational with thefourth to be operational in the first quarter of 2003. Based on our customerrequirements, we may expend funds to construct and install in-line systems thatwe will own and operate. We have limited sources of committed liquidityincluding our cash resources. Titan has extended to us a new $50.0 millionsenior credit facility secured by all of our assets.  As of November 14, 2002, we have obtained$25.0 million under this credit facility. This facility will be subject to limits in the amounts that can be drawneach quarter, subject to financial covenants and affirmative and negativecovenants.  No assurance can be giventhat we will be able to generate sufficient positive cash flow from operationsto meet operating requirements for the foreseeable future.

 

**Ourcustomer contracts for processing can be cancelled on short notice with littlepenalty and these contracts allow the customers to use other electronicirradiation providers in limited circumstances.**

 

While our customer contractsfor processing generally provide for a term of more than one year, thecustomers may terminate such contracts with a nominal termination fee and uponshort notice, typically one month. If one or more customers that are processinga significant volume of products decide to terminate their contracts, ourresults of operations would be adversely affected. While a termination of acontract by a customer would not generally release a customer from theexclusive provider arrangement in the customer’s contract, we generally mustrelease a customer from the exclusive provider arrangement if they can find analternative food irradiation source that can provide a comparable service at alower price, or if we cannot fully meet the customer’s demand.

 

**Ourcustomer contracts for processing do not obligate our customers to use aminimum amount of irradiation services, only to use us for their irradiationneeds, if any.**

 

Our customer contracts forprocessing generally provide that the customer is obligated to use ourirradiation services for their food irradiation need, if any. No assurance canbe made, however, that our customers will require a significant amount, or anyfood irradiation services during the term of their respective contracts.

 

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**If wecannot establish and maintain relationships with food processors, distributors,retailers and food service operators, we may not be able to increase revenuesor commercialize our SureBeam system.**

 

In order to increase ourrevenues and successfully commercialize our SureBeam system, we must establishand maintain relationships with our existing and potential customers andstrategic partners. A reduction, delay or cancellation of orders from one ormore significant customers or the loss of one or more key customers couldsignificantly reduce our revenues and could damage our reputation among ourcurrent and potential customers as well as with consumers. We cannot assure youthat our current customers will continue to place orders with us, that ourcurrent customers evaluating the technology will elect to enter into commercialproduction, that orders by existing commercial customers will increase, or thatwe will be able to obtain orders from new customers or continue to secureadditional strategic relationships.

 

**If weexperience quality control problems or supply shortages from componentsuppliers, our revenues and profit margins may suffer.**

 

Our dependence on thirdparty suppliers for components of our systems involves several risks, includinglimited control over pricing, availability of materials, quality and deliveryschedules. These components include the microwave cavities of our linearaccelerators, which we currently obtain from a single source. We may experiencequality control problems or supply shortages with respect to these componentsin the future. Any quality control problems or interruptions in supply withrespect to one or more components or increases in component costs couldmaterially adversely affect our customer relationships, revenues and profitmargins.

 

**The use ofour systems to irradiate food is subject to significant government regulationthat could prohibit the sale of irradiated food in various jurisdictions,increase the cost of using our products and delay or prevent the use of oursystems and services by our customers.**

 

Food irradiation is subjectto significant regulation as a food additive by the FDA. Use of our SureBeamsystem, including product labeling, is also subject to regulation by the U.S.Department of Agriculture’s Food Safety and Inspection Service and by healthand environmental safety departments within various states. The FDA hasapproved the use of irradiation for beef, poultry, pork, fruits and vegetables.The FDA has not yet approved the use of irradiation for two of the primary foodmarkets we expect to target: processed foods and seafood. The failure of theFDA to approve irradiation of processed foods and seafood would prevent us fromgenerating revenues from the application of our technology in these significantmarkets. Furthermore, the FDA could remove or restrict its approval of the useof irradiation for currently approved food products, which would severely limitour ability to provide services and systems.

 

In addition, FDA regulationsrequire that all food that has been irradiated must carry the Radura symbol, aninternational symbol for irradiation, and state that the product has been“Treated with Radiation” or “Treated by Irradiation” on the label. States suchas Vermont have similar labeling requirements. These labeling regulations mayincrease the risk that consumers will not purchase goods that have been treatedby our products or services, which could negatively impact our revenues.

 

FDA regulations also requireapproval for packaging materials used by our customers. While the FDA hasapproved a number of packaging materials, many other materials commonly usedfor packaging food have not been approved. Failure or delay in receiving suchapprovals could have a material adverse effect on our customer relationshipsand revenues.

 

We also are required toobtain regulatory approval from foreign regulatory authorities before we canoffer our systems and services in those jurisdictions. These jurisdictions mayapply different criteria than the U.S. regulatory agencies in connection withtheir approval processes. Monitoring changes in, and our compliance with,diverse and numerous foreign regulatory requirements may increase our costs.Regulatory approvals in foreign countries that regulate irradiation are subjectto similar risks and uncertainties as are regulatory approvals in the UnitedStates. If we are unable to obtain approval to sell our products and servicesin these markets, our ability to generate revenues from these markets would beadversely affected.

 

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Our service centers also aresubject to various other federal, state and municipal regulations regardinghealth, safety and environmental issues. Our service centers are subject tocontinuous supervision, in the case of the USDA, or periodic inspection byother regulators.

 

**Efforts tochange the labeling requirements with respect to electronic food irradiationmay not be successful and may result in consumer confusion.**

 

Along with food industrygroups and others, we are seeking to change the labeling requirements for foodstreated with electronic irradiation to allow the use of words like “coldpasteurization” or “electronic pasteurization” instead of “irradiation” or“radiation.” Although we believe that the proposed changes may improve theoverall acceptance of our SureBeam process, we cannot assure you that theproposed changes will be accepted, or if accepted, that we will recognize anybenefit from such changes. Additionally, a continued reference to our SureBeamprocess as “irradiation” or “radiation” could adversely affect the consumeracceptance of our process.

 

**Internationalexpansion will subject us to risks associated with international operationsthat could increase our costs and decrease our profit margins in both ourdomestic and our international operations.**

 

Our success will depend inpart on our ability to expand internationally as we obtain regulatory approvalsto market and sell our SureBeam® systems in other countries. We have receivedan order to install systems in Saudi Arabia and we are building a servicecenter in Brazil for extending the shelf life of fruits and vegetables.Expansion of our international operations could impose substantial burdens onour resources, divert management’s attention from domestic operations andotherwise adversely affect our business. Furthermore, international operationsare subject to several inherent risks that could increase our costs anddecrease our profit margins including:

 

•                  Reduced protection of intellectual propertyrights;

** **

•                  Changes in foreign currency exchange rates;

 

•                  Changes in a specific country’s or region’spolitical or economic conditions, including military action or war in ornear countries containing our international operations;

 

•                  Trade protective measures and import orexport licensing requirements or other restrictive actions by foreigngovernments;

 

•                  Laws affecting the enforceability of ourcontracts and our ability to collect accounts receivable; and

 

•                  Changes in tax laws.

 

**If wecannot effectively manage our internal growth, our business prospects, revenuesand profit margins may suffer.**

 

If we fail to effectivelymanage our internal growth in a manner that minimizes strains on our resources,we could experience disruptions in our operations and ultimately be unable togenerate revenues or profits. We expect that we will need to significantlyexpand our operations to successfully implement our business strategy. As weadd manufacturing, marketing, sales, and other personnel, both domestically andinternationally, and expand our manufacturing, irradiation processing andresearch and development capabilities, we expect that our operating expensesand capital requirements will increase. To effectively manage our growth, wemust continue to expend funds to improve our operational, financial and managementcontrols, and our reporting systems and procedures. In addition, we musteffectively expand, train and manage our employee base. If we fail in ourefforts to manage our internal growth, our business prospects, revenues andprofit margins may suffer.

 

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**We intendto continue to pursue strategic transactions, which could disrupt ouroperations, increase our costs and negatively impact our earnings.**

 

We intend to continue topursue strategic transactions that provide access to new technologies, productsor markets. These transactions could include acquisitions, partnerships, jointventures, business combinations and investments. Any transaction may require usto incur non-recurring or ongoing charges and may pose significant integrationchallenges and/or management and business disruptions, any of which couldincrease our costs and negatively impact our earnings. In addition, we may notsucceed in retaining key employees of any business that we acquire. We may notconsummate these transactions on favorable terms or obtain the benefits weanticipate from a transaction.

 

**Ourtechnology competes against other food irradiation technologies. Competition inour market may result in pricing pressures, reduced margins or the inability ofour products and services to achieve market acceptance.**

 

We compete against severalcompanies seeking to address the food safety market. Our electronic foodirradiation technology competes against gamma ray technology and alternativesto irradiation, such as thermal sterilization, fumigation, lactoferrin andchemical washes. We may be unable to compete successfully against our currentand potential competitors, which may result in price reductions, reducedmargins and the inability to achieve market acceptance for our products.

 

The current level of marketpenetration for food irradiation products is relatively low when compared tothe overall size of the food markets to which we are targeting our foodirradiation services and products. If food irradiation gains consumeracceptance and the market increases, we expect competition to growsignificantly. Our competitors include Flow International Corporation, Ion BeamApplications, S.A., MDS/Nordion Food Technologies Service, Inc. and STERISCorporation. These organizations may have significantly more capital, researchand development, regulatory, manufacturing, marketing, human and otherresources than we do. As a result, they may be able to devote greater resourcesto the manufacture, promotion and sale of their products, initiate or withstandsubstantial price competition, or take advantage of acquisition or otheropportunities more readily.

 

**Ourinability to protect our patents and proprietary rights in the United Statesand foreign countries could materially adversely affect our business prospectsand competitive position.**

 

Our success depends on ourability to obtain and maintain patent and other proprietary-right protectionfor our technology and systems and services in the United States and othercountries. The laws of some foreign countries do not protect proprietary rightsto the same extent as the laws of the United States, and many companies haveencountered significant problems and costs in protecting their proprietaryrights in these foreign countries. If we are unable to obtain or maintain theseprotections, we may not be able to prevent third parties from using ourproprietary rights. In addition, we may incur significant expense in protectingour intellectual property and defending or assessing claims with respect tointellectual property owned by others.

 

Weperiodically assess the strength of our patent and intellectual propertyprotection for our technologies and products. Our electronic food irradiationsystem combines our patented conveyor and shielding systems and proprietarysoftware with publicly available electron beam, x-ray and linear acceleratortechnology. Despite our assessments and our belief in the strength of ourpatent protection for particular technologies or products, our patents may notprovide effective barriers to entry against competitors because our competitorsmay develop competing technologies and products that do not infringe upon ourpatents. Further, our patents do not cover electron beam, x-ray or linearaccelerator technology, which are publicly available. We also could choose tomodify or abandon one or more planned or current products because of theseassessments or actual or threatened claims by other companies. Our patents orpending patent applications may be challenged, narrowed or invalidated. Inaddition, we are not certain that our pending patent applications will beissued.

 

We also rely on tradesecrets, proprietary know-how and continuing technological innovation to remaincompetitive. We have taken measures to protect our trade secrets and know-how,including the use of confidentiality agreements with our employees, consultantsand advisors. It is possible that these agreements may be breached and that anyremedies for a breach will not be sufficient to compensate us for damagesincurred. We generally control

 

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and limit access to, and the distribution of,our product documentation and other proprietary information. Despite ourefforts to protect these proprietary rights, unauthorized parties may copyaspects of our products and obtain and use information that we regard asproprietary. We also cannot guarantee that other parties will not independentlydevelop our know-how or otherwise obtain access to our technology.

 

**Companiesmay claim that we infringe their intellectual property or proprietary rights,which could cause us to incur significant expenses or prevent us from sellingour products.**

 

Our success depends on ourability to operate without infringing the patents and proprietary rights ofthird parties. Product development is inherently uncertain in a rapidlyevolving technological environment in which there may be numerous patentapplications pending, many of which are confidential when filed, with regard tosimilar technologies. Future patents issued to third parties may contain claimsthat conflict with our patents. Although we believe that our current productdoes not infringe the proprietary rights of any third parties, third partiescould assert infringement claims against us in the future. Any litigation orinterference proceedings, regardless of their outcome, would probably be costlyand require significant time and attention of our key management and technicalpersonnel. Litigation or interference proceedings could also force us to:

 

•                  Stop or delay selling, manufacturing or usingproducts that incorporate the challenged intellectual property;

 

•                  Pay damages; or

 

•                  Enter into licensing or royalty agreementsthat may be unavailable on acceptable terms.

 

**Productliability claims could materially adversely affect our customer relationshipsand costs.**

 

Our involvement in theprocessing of food results in a significant risk that we will be subject toproduct liability claims resulting from the consumption of contaminated food.We may be held liable or incur costs to settle or defend liability claims ifany of our systems cause, or are claimed to cause, injury or are foundunsuitable during product testing, manufacturing, marketing, sale or use. Theserisks exist even with respect to products that have received, or may in thefuture receive, regulatory approval, registration or clearance for commercialuse. Also, we may be liable to our customers for the costs they incur from productrecalls. We cannot guarantee that we will be able to avoid product liabilityexposure.

 

While we currently maintainproduct liability insurance at levels that we believe are sufficient andconsistent with industry standards for companies at our stage of development,we cannot guarantee that our product liability insurance is adequate. It isalso possible that at any time our insurance coverage may become unavailable oncommercially reasonable terms or at all. A product liability claim or productrecall could result in liability to us greater than our assets and/or insurancecoverage. Moreover, product liability claims, recalls and expenses associatedwith defending against claims or recalls could have an adverse impact on useven if we have adequate insurance coverage. Further, a product liability claimagainst us, whether merited or not, or a product recall claim against us woulddamage our reputation and severely undermine our branding campaign and ourefforts to gain consumer acceptance.

 

**If wecannot retain key personnel or attract qualified personnel, our customerrelationships, competitive position and revenues could suffer.**

 

Our success depends to asignificant extent upon the efforts of our key management, sales and marketing,technical support and research and development personnel, none of whom haveentered into agreements not to compete with us.  The loss of any key personnel could adversely affect us. Webelieve that our future success will depend in large part upon our continuingability to attract and retain highly skilled managerial, sales and marketing,technical support and research and development personnel. Like other emerginggrowth companies, we face intense competition for our personnel needs, and wehave at times experienced and continue to experience difficulty in recruitingqualified personnel.  We face theadditional challenge of carefully balancing the growth of our employeescommensurate with our anticipated revenue growth.  If our revenue growth or attrition levels vary significantly, our

 

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results of operations or financial conditioncould be adversely affected.  Further,our common stock price has been, and may continue to be extremelyvolatile.  When our common stock priceis less than the exercise price of stock options granted to employees, turnoveris likely to increase, which could adversely affect our results of operationsor financial condition.  Additionally,there are several proposals in the United States Congress and in the accountingindustry to require corporations to include a compensation expense in theirstatement of operations relating to the issuance of employee stockoptions.  If such a measure is approved,we may decide to issue fewer stock options. As a result, we may be impaired inour efforts to attract and retain necessary personnel.  We cannot assure you that we will besuccessful in attracting, assimilating and retaining additional qualifiedpersonnel in the future.  If we were tolose the services of one or more of our key personnel, or if we failed toattract and retain additional qualified personnel, it could materially andadversely affect our customer relationships, competitive position and revenues.

 

**Delays inthe construction and installation of our systems could negatively affect ourrevenues.**

 

Our business model dependson the successful deployment of our systems, whether the systems areconstructed and installed in our company-owned service centers or in acustomer’s production line. A number of factors beyond our control can slow ordelay the deployment of our systems such as site preparation, zoning andpermitting requirements, the availability of skilled construction personnel andconstruction equipment, and adverse weather conditions.

 

**If our stock price becomes less than $1.00 per sharefor an extended period, we could be delisted from the Nasdaq.**

 

Maintaining the listing ofour common stock on the Nasdaq National Market is important to us.  The delisting of our common stock from theNasdaq would have a material adverse effect upon the marketability of ourcommon stock and could, among other things, materially and adversely affect ourability to raise additional equity capital or to obtain financing through othersources.  The Nasdaq has numerous requirementswhich must be complied with for a company to maintain its security’s listing onthe Nasdaq, one of which is that the minimum bid price of the security must be$1.00 or greater per share.  If theprice of our common stock were below $1.00 per share for a period of 30 or moreconsecutive business days, the Nasdaq could take action to delist our commonstock from the Nasdaq.  While the priceof our common stock on the Nasdaq has not traded below $1.00 since our initialpublic offering, we cannot assure you that the price of our common stock willnot fall below $1.00 in the future.  OnNovember 11, 2002, the closing price per share of our common stockwas $5.00.

 

If our common stock weredelisted from the Nasdaq, trading would thereafter be reported in the NationalAssociation of Securities Dealers Over the Counter Bulletin Board or in the“pink sheets.”  The investing insecurities traded in the Bulletin Board or in the pink sheets is generallyconsidered to be subject to more risk than comparable investing in securities,which are traded on one of the major national securities exchanges such as theNasdaq or the New York Stock Exchange. In the event of delisting from the Nasdaq, our common stock may beclassified as a “penny stock” by the SEC and would become subject to rulesadopted by the SEC regulating broker-dealer practices in connection withtransactions in “penny stocks.” Broker-dealers recommending a penny stock must,among other things, document the suitability of the investment for the specificcustomer, obtain a written agreement of the customer to purchase the pennystock, identify such broker-dealer’s role, if any, as a market maker in theparticular stock, and provide information with respect to market prices of thecommon stock and the amount of compensation that the broker-dealer will earn inthe proposed transaction.  Thesedisclosure requirements may have the effect of reducing the level of tradingactivity in the market for our common stock. If our common stock became subject to the penny stock rules, manybroker-dealers may be unwilling to engage in transactions in our securitiesbecause of the added disclosure requirements, thereby making it more difficultfor purchasers of our common stock to dispose of their shares of our common stock.  The ownership of penny stock is generallyconsidered to subject the owner to greater risks than the ownership of commonstock as a whole due, among other things, to the smaller trading volume in suchstocks and to the substantial impact upon the stock’s overall value whichresults from small stock price variations.

 

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**Risksrelated to our relationship with Titan**

 

**Ourindependent status from Titan involves a variety of risks for SureBeam,including risks related to access to financing sources and corporate servicesand facilities previously provided by Titan. Our inability to successfullyaddress these risks could negatively impact the operation of our business andfinancial results.**

 

Titan has distributed itsshares of our common stock to Titan stockholders following its receipt of afavorable ruling from the Internal Revenue Service.  We now have substantially complete separation from Titan, otherthan our various contracts with Titan. While the continued control of our company by Titan involved a varietyof risks, our separation from Titan also involves numerous risks.

 

If we require additionalfinancing other than that provided by our credit facility with Titan, we wouldbe required to develop our own credit and other liquidity sources.  Titan had historically provided for ourgeneral corporate and administrative support, which was principally comprisedof administrative and clerical functions necessary to implement our managementdecisions and operations, including benefits administration and informationtechnology support, through a corporate services agreement.  In connection with the spin-off, variousagreements with Titan have terminated and we have developed our own systems andservices. However, we may not be able to retain these services successfully orat a comparable cost to that as provided by Titan.

 

**Ourbusiness may suffer because we have entered into affiliate agreements withTitan that may not have been based on arms’ length negotiations.**

 

We haveentered into various agreements with Titan including a tax allocationagreement, tax sharing and disaffiliation agreement, license agreement, andcredit agreement. Because we were a majority-owned subsidiary of Titan at thetime these agreements were entered into, these agreements were negotiatedbetween related parties, and the results may differ from results obtained fromarms-length third parties.  Under thelicense agreement, Titan purchased a perpetual and exclusive, non-royaltybearing license to use our intellectual property on all applications other thanthe food, animal hide and flower markets in return for the following: 1) tomake available to us a $50.0 million line of credit, 2) to convert the current$75.0 million debt owed Titan to equity via an exchange for our stock, and 3) acash payment of $8.0 million.

 

Under the taxallocation agreement, Titan will determine the amount of separate taxableincome and tax liability that we would realize if we filed a separate taxreturn. In addition, because we have filed a consolidated tax return withTitan, we may be obligated to pay taxes for the entire group of Titan companiesif those companies defaulted in the payment of their taxes.  If Titan offsets taxable gains with ourlosses, Titan will have to compensate us in cash for the benefit it receivesfor its use of our losses when we demonstrate we are able to utilize thoselosses or they would have otherwise expired. In addition, any benefit from ourlosses used to offset Titan profits resulting in a tax savings, is subject toTitan’s position at that time.

 

**Wehave entered into a license agreement with Titan that prevents us fromcapitalizing on newly discovered uses of our technology in applications thatare not related to food (excluding water), animal hides and flowers exceptthrough a manufacturing contract.**

 

Titanpurchased from us a perpetual and exclusive non-royalty bearing license to useour intellectual property in all applications and fields other than in thefields of food (excluding water), animal hides and flowers. Because Titan’slicense is an exclusive license, we cannot use our intellectual property inapplications other than food (excluding water), animal hides and flowers.Applications which we believe are reserved for Titan’s use include medicalequipment sterilization and sterilization of mail to eliminate the threat ofanthrax contamination.

 

Under theterms of the license agreement with Titan, future sales of electronicirradiation equipment to Titan, if any, will be sold on a cost plus 20% markupbasis, unless otherwise negotiated. Titan is obligated to purchase electronicirradiation equipment it requires, if any, from SureBeam until December 31,2003, after which it may purchase equipment from any source. Therefore, afterDecember 31, 2003, we anticipate we will receive no revenue from anycommercialization of our licensed technology by Titan or any new applicationsfor our licensed technology developed by Titan unless Titan chooses to purchaseequipment from us or enter into other arrangements with us under which we wouldreceive revenue. Titan is not obligated to purchase any electronic irradiation 

 

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equipment from us in thefuture, and should Titan not purchase any electronic irradiation equipment fromus, it could have a material adverse effect upon our financial condition andresults of operations.

 

**One of ourdirectors is also a director of Titan, which could cause Titan’s interests toreceive priority over our interests.**

 

One of our directors, SusanGolding, also is a director of Titan. During 2001, Ms. Golding was a consultant to Titan.  Titan is currently our primary creditorbecause it has extended to us a $50.0 million secured credit facility, underwhich we have obtained $25.0 million as of November 14, 2002.Therefore, Ms. Golding may consider not only the short-term and long-termimpact of financial and operating decisions on us, but also the impact of thesedecisions on Titan’s consolidated financial results and its stockholders. Insome instances, the impact of these decisions could be disadvantageous to uswhile advantageous to Titan. We cannot guarantee that all conflicts will beresolved in a manner that is favorable to us or that such conflicts will notresult in harmful consequences to our business or prospects.

 

**Maintainingthe tax-free status of the distribution of our common stock by Titan to itsstockholders restricts certain of our activities.**

 

For the distribution of ourstock by Titan to qualify as tax-free to Titan, there must not be a change inownership of 50% or more in either the voting power or value of either ourstock or Titan’s stock that is considered to be part of a plan or a series ofrelated transactions related to Titan’s intended distribution of our stock toits stockholders. Accordingly, we may be significantly limited in our abilityto raise additional equity financing, use our stock for acquisitions and othersimilar strategic transactions or for compensation of employees and others.Further, in connection with the spin-off, we have entered into a tax sharingand disaffiliation agreement that provides for, among other things, anagreement with Titan that if we take any action that causes Titan’srepresentations with respect to the letter ruling to be untrue or engage intransactions after the distribution that cause the spin-off to be taxable toTitan, we would be required to indemnify Titan for any and all taxes resultingfrom the failure of the spin-off to qualify as a tax-free transaction. Inaddition, we may be required to indemnify Titan for half of any taxes incurredas a result of the spin-off if the spin-off is taxable for reasons that werenot caused by actions taken by either Titan or us and to share proportionatelywith Titan such taxes if they are caused by actions by both us and Titan, inproportion to our relative contribution to the imposition of these taxes. Anyindemnification payments by us would most likely be material.

 

**Our salesthrough Titan generally produce lower profit margins than our sales to otherparties. A higher percentage of sales through Titan could reduce our overallprofit margins.**

 

Historically, Titan haspurchased a substantial amount of equipment from us as a subcontractor, inorder to allow Titan to fulfill various contracts. These sales have typicallybeen structured on a fixed price basis or cost plus basis. Therefore, sales toor through Titan have historically, and likely will in the future, carry alower profit margin than comparable sales to other parties. A higher percentageof sales through Titan could reduce our overall profit margins.

 

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**Risksrelated to the securities markets and ownership of our common stock**

 

**Oursecurities have not been publicly traded very long and our stock price may besubject to significant fluctuations and volatility.**

 

The marketprice of our common stock has been subject to significant fluctuations sincethe date of our initial public offering on March 16, 2001. These fluctuationscould continue. Among the factors that could affect our stock price are:

 

•              Quarterlyvariations in our operating results;

 

•              Changesin revenue or earnings estimates or publication of research reports byanalysts;

 

•              Speculationin the press or investment community;

 

•              Strategicactions by us such as new joint ventures, acquisitions or restructuring;

 

•              Actionsby institutional stockholders;

 

•              Generalmarket conditions; and

 

•              Domesticand international economic factors unrelated to our performance.

 

The stockmarkets in general have experienced extreme volatility that has often beenunrelated to the operating performance of particular companies. These broadmarket fluctuations may adversely affect the trading price of our common stock.

 

**Provisionsin our charter documents and Delaware law may delay or prevent acquisition ofus, which could decrease the value of your shares.**

 

Ourcertificate of incorporation and bylaws and Delaware law contain provisionsthat could make it harder for a third party to acquire us without the consentof our board of directors. These provisions include a classified board ofdirectors and limitations on actions by our stockholders by written consent. Inaddition, our board of directors has the right to issue preferred stock withoutstockholder approval, which could be used to dilute the stock ownership of apotential hostile acquirer. Delaware law also imposes some restrictions onmergers and other business combinations between us and any holder of 15% ormore of our outstanding common stock. Although we believe these provisionsprovide for an opportunity to receive a higher bid by requiring potentialacquirers to negotiate with our board of directors, these provisions apply evenif the offer may be considered beneficial by some stockholders.

 

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**ITEM 4. CONTROLS AND PROCEDURES**

 

We maintain asystem of disclosure and procedures designed to ensure the reliability of ourconsolidated financial statements and other disclosures.  Within the 90 day period prior to the dateof filing of this quarterly report, our President and Chief Executive Officerand our Senior Vice President and Chief Financial Officer carried out, underthe supervision and with the participation of our management, an evaluation ofthe effectiveness of design and operation of our disclosure controls andprocedures (as defined in Rules 13a-14(c) and 15d-14(c) under the SecuritiesExchange Act of 1934, as amended). Our President and Chief Executive Officerand our Senior Vice President and Chief Financial Officer concluded that, as ofthe date of the evaluation, our disclosure controls and procedures wereeffective in all material respects in alerting them in a timely manner to thematerial information about us that we are required to include in the periodicreports that we file with the Securities and Exchange Commissions. There havebeen no significant changes in our internal controls or, to our knowledge, inother factors that could significantly affect internal controls subsequent tothat evaluation.

 

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**PART II-OTHER INFORMATION**

 

**Item1.****Legal Proceedings**

 

Periodically, we are adefendant in cases incidental to our business activities. Furthermore, providersof products and services to the U.S. government are generally subject tomultiple levels of audit and investigation by various U.S. government agencies.Any liabilities arising from audits by the federal government are beingretained by Titan as part of the contribution by Titan to SureBeam. In theopinion of management, the amount of ultimate liability, if any, with respectto these actions will not materially affect the financial position or resultsof operations.

 

**Item2.****Changes inSecurities and Use of Proceeds**

 

Not applicable.

 

**Item3.****Defaults UponSenior Securities**

 

Not applicable.

 

**Item4.****Submissionof Matters to a Vote of Security Holders**

 

Not applicable.

 

**Item5.****Other Information**

 

Not applicable.

 

**Item 6.****Exhibits andReports on Form 8-K**

 
| (a)    | Exhibits:                                                                                                                                                            |   |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                                                                                 |   |   |
|   | 10.48*                                                                                                                                                               |   | Agreement  for Purchase of a SureBeam X-Ray System dated effective March 27, 2002  between the Company and Son Son Co., Ltd. |
|   | 10.49*                                                                                                                                                               |   | Letter  Agreement dated October 1, 2002, amending Agreement dated effective March 27,  2002 between the Company and Son Son Co., Ltd. |
|   | 10.50*                                                                                                                                                               |   | Agreement  for Purchase of a SureBeam Electronic Beam System dated August 1, 2002  between Salubris Limited Partnership and the Company. |
|   | 99.1                                                                                                                                                                 |   | Periodic  Report Certification by Chief Executive Officer of Quarterly Report on Form  10-Q for the quarterly period ended September 30, 2002. |
|   | 99.2                                                                                                                                                                 |   | Periodic  Report Certification by Chief Financial Officer of Quarterly Report on Form  10-Q for the quarterly period ended September 30, 2002. |
|   |                                                                                                                                                                 |   |   |
|   |                                                                                                                                                                 |   |   |
| (b)    | Reports on  Form 8-K:                                                                                                                                           |
|   |                                                                                                                                                                 |   |   |
|   | (1) Current  report on Form 8-K dated August 5, 2002 describing the spin-off of  Titan’s ownership interest in SureBeam to Titan’s stockholders. |
|        |                                                                                                                                                                      |        |  |  |

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*      Confidential treatment hasbeen requested for certain portions of this exhibit.  Omitted portions have been filed separately with the Securitiesand Exchange Commission.

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
| Dated:  November  14, 2002 |                  |                                              |
|---------------------------------|-----------------------|---------------------------------------------------|
|                            |                  |                                              |
|                            |                  |                                              |
|                            | SUREBEAM  CORPORATION |
|                            |                  |                                              |
|                            |                  |                                              |
|                            | By:                   | /s/ Lawrence A. Oberkfell                         |   |
|                            |                  | Lawrence  A. Oberkfell                            |
|                            |                  | *President and Chief Executive Officer*           |
|                            |                  |                                              |
|                            |                  |                                              |
|                            | By:                   | /s/ David A. Rane                                 |   |
|                            |                  | David  A. Rane                                    |
|                            |                  | *Senior Vice President,  Chief Financial Officer* |
|                            |                  | *(Principal Accounting Officer)*                  |

 

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**CERTIFICATION OF CHIEF EXECUTIVE OFFICER**

 

I, Lawrence A. Oberkfell,certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q of SureBeam Corporation;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report.

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)  designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

b)  evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)  presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and procedures basedon our evaluation as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)  all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)  any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Dated:  November 14, 2002 | By:    | /s/ Lawrence  A. Oberkfell                                                            |   |
|---------------------------|--------|---------------------------------------------------------------------------------------|--------|
|                      |   | Lawrence A.  Oberkfell  President, Chief Executive Officer  and Chairman of the Board |   |

 

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## **CERTIFICATION OF CHIEF FINANCIAL OFFICER**

 

I, David A. Rane, certify that:

 

1.                                       Ihave reviewed this quarterly report on Form 10-Q of SureBeam Corporation;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterly report;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report.

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)  designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

b)  evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

c)  presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)  all significant deficiencies in the designor operation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

b)  any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

 
| Dated:  November 14, 2002 | By:    | /s/ David A.  Rane                                              |   |
|---------------------------|--------|-----------------------------------------------------------------|--------|
|                      |   | David A.  Rane  Senior Vice President,  Chief Financial Officer |   |

 

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