**UNITED STATES**

**SECURITIES 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 thequarterly period ended June 30, 2002**

 

**or**

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

 

**F****or the transition period from                    **** to                     **

 

**Commissionfile number 0-31807**

 

**SureBeamCorporation**

(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)                  |
|                                                                                                 |
| **3033 Science Park Road, San Diego, CA 92121-1199**

(Former  address if changed since last report) |

 

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes  ý       No  o

 

Thenumber of shares of registrant’s Class A common stock, $.001 par value,outstanding as of August 9, 2002, was 67,297,362.

 

Thenumber of shares of registrant’s Class B common stock, $.001 par value,outstanding as of August 9, 2002, was zero.

 

OnApril 9, 2002, SureBeam dismissed Arthur Andersen LLP as its independent publicaccountant and, on April 15, 2002, SureBeam appointed KPMG LLP as itsindependent public accountant.  KPMG LLPdid not complete its review of SureBeam’s financial statements for the quarterended March 31, 2002, prior to the deadline for filing SureBeam’s Form 10-Q andForm 10-Q/A containing such financial statements.  Therefore, as permitted by the guidance issued by the Securitiesand Exchange Commission in Release Nos. 33-8070/34-45590, SureBeam’s Form 10-Qand Form 10-Q/A for the quarter ended March 31, 2002 was filed with financialstatements which had not been reviewed by an independent public accountantaccording to Rule 10-01(d) under the Securities Exchange Act of 1934, asamended.  The review of SureBeam’sfinancial statements for the quarter ended March 31, 2002 has now beencompleted by KPMG LLP in conjunction with its review of SureBeam’s financialstatements for the quarter and cumulative interim period ending June 30, 2002.

 

 

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**SUREBEAMCORPORATION**

**FORM 10-Q**

**FOR THEQUARTER ENDED JUNE 30, 2002**

 

**INDEX**

 

| **PART I**   | **FINANCIAL INFORMATION**                                                                              |   |
|--------------|--------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                   |   |
| **ITEM 1.**  | FINANCIAL STATEMENTS                                                                                   |   |
|         | Consolidated  Statements of Operations for the three and six months ended June 30, 2002 and  2001      |
|         | Consolidated Balance Sheets  as of June 30, 2002 and December 31, 2001                                 |
|         | Consolidated  Statements of Cash Flows for the six months ended June 30, 2002 and 2001                 |
|         | Consolidated  Statements of Stockholders’ Equity for the six months ended June 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.** | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                            |
|         |                                                                                                   |   |
| **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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**PART I-FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**SureBeamCorporation and Subsidiaries**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

**(in thousands, except per sharedata)**

 

|                                         |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|----------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                         |   | **2002**                         |   | **2001**                       |   | **2002** |   | **2001** |   |
| Revenues                                     |   | $                                | 2,841  |                           | $      | 8,616 |   | $ | 5,355 |   | $ | 14,092 |   |
| Revenues from  affiliate                     |   | 7,944                            |   | 1,001                          |   | 12,446 |   | 1,001 |   |
| Total revenues                               |   | 10,785                           |   | 9,617                          |   | 17,801 |   | 15,093 |   |
| Cost of revenues                             |   | 3,388                            |   | 5,214                          |   | 6,405 |   | 8,164 |   |
| Cost of revenues  from affiliate             |   | 3,631                            |   | 1,001                          |   | 6,462 |   | 1,001 |   |
| Total cost of  revenues                      |   | 7,019                            |   | 6,215                          |   | 12,867 |   | 9,165 |   |
| Gross profit                                 |   | 3,766                            |   | 3,402                          |   | 4,934 |   | 5,928 |   |
| Selling, general  and administrative expense |   | 9,663                            |   | 12,036                         |   | 19,616 |   | 57,653 |   |
| Research and  development                    |   | 181                              |   | 776                            |   | 496 |   | 1,113 |   |
| Loss from  operations                        |   | (6,078                           | )      | (9,410                         | )      | (15,178 | ) | (52,838 | ) |
| Interest income                              |   | 102                              |   | 636                            |   | 127 |   | 729 |   |
| Interest expense                             |   | (65                              | )      | (1,434                         | )      | (951 | ) | (3,180 | ) |
| Other income,  net                           |   | 939                              |   | —                         |   | 1,921 |   | — |   |
| Loss before  income tax benefit              |   | (5,102                           | )      | (10,208                        | )      | (14,081 | ) | (55,289 | ) |
| Income tax  benefit                          |   | —                           |   | (1,021                         | )      | — |   | (5,529 | ) |
| Net loss                                     |   | $                                | (5,102 | )                              | $      | (9,187 | ) | $ | (14,801 | ) | $ | (49,760 | ) |
|                                         |   |                             |   |                           |   |   |   |   |   |
| Basic loss per  share:                       |   |                             |   |                           |   |   |   |   |   |
| Net loss                                     |   | $                                | (0.08  | )                              | $      | (0.16 | ) | $ | (0.22 | ) | $ | (0.95 | ) |
| Weighted average  shares — basic        |   | 66,869                           |   | 55,841                         |   | 64,842 |   | 52,144 |   |
|                                         |   |                             |   |                           |   |   |   |   |   |
| Diluted loss per  share:                     |   |                             |   |                           |   |   |   |   |   |
| Net loss                                     |   | $                                | (0.08  | )                              | $      | (0.16 | ) | $ | (0.22 | ) | $ | (0.95 | ) |
| Weighted average  shares — diluted      |   | 66,869                           |   | 55,841                         |   | 64,842 |   | 52,144 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*.

 

 

3

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**SureBeamCorporation and Subsidiaries**

**CONSOLIDATED BALANCE SHEETS**

**(in thousands, except shareinformation)**

 
|                                                                                                                                                                                                         |   | **June  30,**   |       | **December  31,** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|------------|-------------------|------------|
|                                                                                                                                                                                                         |   | **2002**        |       | **2001**          |       |
|                                                                                                                                                                                                         |   | **(Unaudited)** | ** ** |              | ** ** |
| **Assets  (Pledged)**                                                                                                                                                                                        |   |            |       |              |       |
| Current Assets:                                                                                                                                                                                              |   |            |       |              |       |
| Cash and cash  equivalents                                                                                                                                                                                   |   | $               | 6,443      |              | $          | 4,131 |   |
| Investments,  available-for-sale                                                                                                                                                                             |   | —          |       | 3,766             |       |
| Accounts  receivable-net of allowance of $1,428 at June 30, 2002, and December 31, 2001                                                                                                                      |   | 13,420          |       | 12,645            |       |
| Receivable from  affiliate                                                                                                                                                                                   |   | 7,336           |       | 12,503            |       |
| Inventories                                                                                                                                                                                                  |   | 20,557          |       | 19,764            |       |
| Prepaid expenses  and other                                                                                                                                                                                  |   | 4,200           |       | 5,172             |       |
| Total current  assets                                                                                                                                                                                        |   | 51,956          |       | 57,981            |       |
| Property and equipment-net                                                                                                                                                                                   |   | 51,505          |       | 41,903            |       |
| Due from  affiliate                                                                                                                                                                                          |   | 2,319           |       | 2,319             |       |
| Intangible  assets-net                                                                                                                                                                                       |   | 3,516           |       | 3,549             |       |
| Other assets                                                                                                                                                                                                 |   | 13,408          |       | 12,032            |       |
| Total assets                                                                                                                                                                                                 |   | $               | 122,704    |              | $          | 117,784 |   |
|                                                                                                                                                                                                         |   |            |       |              |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                               |   |            |       |              |       |
| Current  Liabilities:                                                                                                                                                                                        |   |            |       |              |       |
| Accounts payable                                                                                                                                                                                             |   | $               | 4,543      |              | $          | 9,191 |   |
| Accrued  compensation and benefits                                                                                                                                                                           |   | 2,106           |       | 2,664             |       |
| Due to affiliate                                                                                                                                                                                             |   | 5,970           |       | —            |       |
| Other current  liabilities                                                                                                                                                                                   |   | 4,311           |       | 4,756             |       |
| Total current  liabilities                                                                                                                                                                                   |   | 16,930          |       | 16,611            |       |
| Subordinated  promissory note to affiliate                                                                                                                                                                   |   | —          |       | 72,208            |       |
| Senior credit  facility with affiliate                                                                                                                                                                       |   | 10,000          |       | —            |       |
| Other long-term  liabilities                                                                                                                                                                                 |   | 820             |       | 613               |       |
| Total  liabilities                                                                                                                                                                                           |   | 27,750          |       | 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, 16,944,370 issued and  16,990,841 outstanding at June 30, 2002 and 11,605,440 issued and 11,601,911  outstanding at December 31, 2001 |   | 16              |       | 11                |       |
| Class B common  stock, $.001 par value, 50,000,000 shares authorized, 50,000,000 issued and  outstanding at June 30, 2002 and 46,774,235 issued and outstanding at  December 31, 2001                        |   | 50              |       | 47                |       |
| Additional  paid-in capital                                                                                                                                                                                  |   | 220,729         |       | 147,607           |       |
| Deferred  compensation                                                                                                                                                                                       |   | (19,318         | )          | (26,918           | )          |
| Accumulated  other comprehensive income                                                                                                                                                                      |   | —          |       | 47                |       |
| Treasury stock,  at cost: 3,529 shares at June 30, 2002 and December 31, 2001                                                                                                                                |   | (42             | )          | (42               | )          |
| Accumulated  deficit                                                                                                                                                                                         |   | (106,481        | )          | (92,400           | )          |
| Total  stockholders’ equity                                                                                                                                                                             |   | 94,954          |       | 28,352            |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                             |   | $               | 122,704    |              | $          | 117,784 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*.

 

 

4

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**SureBeam Corporation and Subsidiaries**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(in thousands)**

 

|                                                                                       |   | **Six  Months Ended  June 30,** |       |
|--------------------------------------------------------------------------------------------|--------|---------------------------------|------------|
|                                                                                       |   | **2002**                        |       | **2001** |   |
| **Cash  Flows from Operating Activities:**                                                 |   |                            | ** ** |   | ** ** |
| Net loss                                                                                   |   | $                               | (14,081    | ) | $ | (49,760 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |   |                            |       |   |   |
| Nonmonetary  research consideration                                                        |   | (1,558                          | )          | (1,253 | ) |
| Depreciation and  amortization                                                             |   | 1,908                           |       | 1,910 |   |
| Deferred income  taxes                                                                     |   | —                          |       | (5,529 | ) |
| Deferred  compensation charge                                                              |   | 7,600                           |       | 44,040 |   |
| Change in  operating assets and liabilities:                                               |   |                            |       |   |   |
| Accounts  receivable and receivable from affiliate                                         |   | 4,392                           |       | (12,263 | ) |
| Inventories                                                                                |   | (793                            | )          | (4,482 | ) |
| Prepaid expenses  and other                                                                |   | 124                             |       | 663 |   |
| Other assets                                                                               |   | (39                             | )          | (79 | ) |
| Accounts payable                                                                           |   | (4,648                          | )          | 6,155 |   |
| Accrued  compensation and benefits                                                         |   | (558                            | )          | 1,060 |   |
| Other accrued  liabilities                                                                 |   | (238                            | )          | (1,453 | ) |
| Due to affiliate                                                                           |   | 5,970                           |       | — |   |
| Net cash used in  operating activities                                                     |   | (1,921                          | )          | (20,991 | ) |
|                                                                                       |   |                            |       |   |   |
| **Cash  Flows from Investing Activities:**                                                 |   |                            | ** ** |   | ** ** |
| Sale (purchase)  of available-for-sale investments                                         |   | 3,719                           |       | (25,077 | ) |
| Capital  expenditures                                                                      |   | (10,063                         | )          | (10,119 | ) |
| Advances to Tech  Ion                                                                      |   | —                          |       | (2,320 | ) |
| Advances to  Hawaii Pride                                                                  |   | (345                            | )          | (686 | ) |
| Net cash used in  investing activities                                                     |   | (6,689                          | )          | (38,202 | ) |
|                                                                                       |   |                            | ** ** |   | ** ** |
| **Cash  Flows from Financing Activities:**                                                 |   |                            | ** ** |   | ** ** |
| Borrowings on  senior credit facility with affiliate                                       |   | 10,000                          |       | — |   |
| Net proceeds  from issuance of common stock                                                |   | —                          |       | 60,831 |   |
| Borrowings on  subordinated promissory note                                                |   | 792                             |       | 13,365 |   |
| Proceeds from  exercise of stock options and warrants                                      |   | 130                             |       | 26 |   |
| Net cash  provided by financing activities                                                 |   | 10,922                          |       | 74,222 |   |
|                                                                                       |   |                            |       |   |   |
| Net change in  cash and cash equivalents                                                   |   | 2,312                           |       | 15,029 |   |
| Cash and cash  equivalents at beginning of period                                          |   | 4,131                           |       | — |   |
| Cash and cash  equivalents at end of period                                                |   | $                               | 6,443      |   | $ | 15,029 |   |
|                                                                                       |   |                            |       |   |   |
| **Supplemental  Cash Flow Information:**                                                   |   |                            |       |   |   |
| **Non-Cash  Financing and Investing Activities:**                                          |   |                            | ** ** |   | ** ** |
| Conversion of  subordinated promissory note to common stock                                |   | $                               | 73,000     |   | $ | — |   |
| Increase  (decrease) in fair value of investments, available-for-sale                      |   | 47                              |       | (555 | ) |

 

*The accompanying notes are an integral part of theseconsolidated financial statements.*

 

 

5

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**SureBeam Corporation andSubsidiaries**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**(Unaudited)**

**(in thousands)**

 

|                                                                                               |   |             |       |             |   |        |   |           |   |        |   |              |    | **Accumulated  Other** |   |        |   |      |   |      |   |
|----------------------------------------------------------------------------------------------------|--------|------------------|------------|------------------|--------|-------------|--------|----------------|--------|-------------|--------|-------------------|---------|------------------------|--------|-------------|--------|-----------|--------|-----------|--------|
|                                                                                               |   | **Shares of**    |       |             |   |        |   | **Additional** |   |        |   | **Comprehensive** |    |                   |   |        |   |      |   |
|                                                                                               |   | **Common Stock** | ** ** | **Common Stock** |   | **Paid-in** |   | **Deferred**   |   | **Income**  |   | **Accumulated**   |    | **Treasury**           |   |        |   |
|                                                                                               |   | **Class A**      |       | **Class B**      |   | **Class A** |   | **Class B**    |   | **Capital** |   | **Compensation**  |    | **(Loss)**             |   | **Deficit** |   | **Stock** |   | **Total** |   |
|                                                                                               |   |             |       |             |   |        |   |           |   |        |   |              |    |                   |   |        |   |      |   |      |   |
| **Six Months Ended June 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                                                                                           |   | —           |       | —           |   | —      |   | —         |   | —      |   | —            |    | —                 |   | (14,081     | )      | —    |   | (14,081   | )      |
| 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              |   | 781              |       | —           |   | 1           |   | —         |   | 129         |   | —            |    | —                 |   | —      |   | —    |   | 130       |   |
| Amortization of deferred   compensation                                                       |   | —           |       | —           |   | —      |   | —         |   | —      |   | 7,600             |    | —                 |   | —      |   | —    |   | 7,600     |   |
| Unrealized loss on investments                                                                     |   | —           |       | —           |   | —      |   | —         |   | —      |   | —            |    | (47                    | )      | —      |   | —    |   | (47       | )      |
| Balances at June 30, 2002                                                                          |   | 16,824           |       | 50,000           |   | $           | 16     |           | $      | 50          |   | $                 | 220,729 |                   | $      | (19,318     | )      | $         | — |      | $      | (106,481 | ) | $ | (42 | ) | $ | 94,954 |   |
|                                                                                               |   |             |       |             |   |        |   |           |   |        |   |              |    |                   |   |        |   |      |   |      |   |
| **Six Months Ended June 30, 2001:**                                                                |   |             |       |             |   |        |   |           |   |        |   |              |    |                   |   |        |   |      |   |      |   |
| Balances at December 31, 2000                                                                      |   | 233              |       | 46,584           |   | $           | — |           | $      | 47          |   | $                 | 5,687   |                   | $      | (2,584      | )      | $         | — |      | $      | (18,025 | ) | $ | — |   | $ | (14,875 | ) |
| Net loss                                                                                           |   | —           |       | —           |   | —      |   | —         |   | —      |   | —            |    | —                 |   | (49,760     | )      | —    |   | (49,760   | )      |
| 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              |   | 2,236            |       | —           |   | 2           |   | —         |   | 1,078       |   | —            |    | —                 |   | —      |   | —    |   | 1,080     |   |
| Deferred compensation related to the issuance of stock options                                     |   | —           |       | —           |   | —      |   | —         |   | 78,604      |   | (78,604           | )       | —                 |   | —      |   | —    |   | —    |   |
| Amortization of deferred   compensation                                                       |   | —           |       | —           |   | —      |   | —         |   | —      |   | 44,040            |    | —                 |   | —      |   | —    |   | 44,040    |   |
| Unrealized loss on investments                                                                     |   | —           |       | —           |   | —      |   | —         |   | —      |   | —            |    | (555                   | )      | —      |   | —    |   | (555      | )      |
| Balances at June 30, 2001                                                                          |   | 9,169            |       | 46,584           |   | $           | 9      |           | $      | 47          |   | $                 | 145,139 |                   | $      | (37,148     | )      | $         | (555   | )         | $      | (67,785 | ) | $ | — |   | $ | 39,707 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*.

 

 

6

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**SureBeam Corporation and Subsidiaries**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**JUNE 30,2002**

**(Unaudited)**

 

**Note (1) Basis of FinancialStatement 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 June 30, 2002, andfor the three and six months ended June 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.

 

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 ofits shares of the Company’s common stock to the shareholders of Titan. Titan previously announced that holders of record of Titan common stockas of the close of business on July 26, 2002, the record date for thedistribution, were to receive 0.6986 shares of SureBeam’s common stock forevery share of Titan common stock held. Previously, Titan held over eighty percent of theCompany’s common stock and held a higher percentage of the voting power due toTitan’s ownership of shares of Class B common stock, which had ten votesper share, as compared to the Class A common stock, which has one vote pershare and is traded on the Nasdaq under the symbol SURE. Prior to thedistribution of shares of SureBeam’s common stock, Titan converted all of itsshares of SureBeam’s Class B common stock, into shares of SureBeam’sClass A common stock. Shareholders of Titan receiving shares of SureBeam’sshares in Titan's distribution received only shares of Class A commonstock.  The Class B common stockhas now been retired and cannot be reissued. The Company has negotiated otheragreements with Titan in connection with the Company’s spin-off including a taxsharing and disaffiliation agreement that will subject us to liability ifSureBeam sells the Company’s equity or equity linked securities in a mannerthat causes a change in the Company’s ownership of 50% or more in voting poweror value as part of Titan’s spin-off plan.

 

Alsoon October 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 commonstock, and 3) a cash payment of $8.0 million, with a$4.0 million payment on September 30, 2001 and four installments of$1.0 million payable on each of March 31, 2002, June 30, 2002,September 30, 2002 and December 31, 2002. With respect to theexchange of the Company’s $75.0 million non-convertible debt for commonstock, the Company followed guidance in APB Opinion No. 29, “Accounting ForNonmonetary Transactions,” and determined that the use of the fair value of thelicense on the date of the exchange was appropriate. The Company recognized$1.0 million and $2.0 million of the cash payments related to the licenseagreement as other income in the three and six months ended June 30, 2002,respectively.  The Company will recognize$1.0 million as other income each quarter through September 30, 2003.

 

The accompanyingconsolidated financial statements contemplate the realization of assets and thesatisfaction of liabilities in the normal course of business. During the threeand six months ended June 30, 2002,

 

 

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consistent with its business plan, the Company hasincurred substantial losses from operations. Management believes it willcontinue to incur losses through at least 2003, as the Company will continue tomake significant investments in infrastructure, sales and marketing and it isnot anticipated that the Company’s revenues will sufficiently offset theseinvestments until at least 2003. Additionally, the Company’s construction andimplementation period for systems sales to strategic alliances as well asCompany-owned service centers and systems require a substantial use of cash forat least 12 to 18 months. The Company’s arrangements to sell food irradiationsystems to strategic alliances typically contain milestone provisions forpayment, which are typically based upon time, stage of completion and otherfactors where no material uncertainties exist. Also in connection with theCompany’s agreements with its customers, it has advanced funds aggregating$5.4 million to Hawaii Pride LLC, or Hawaii Pride. Management does notexpect significant repayments of the advances to Hawaii Pride until at leastlate 2003. The Company has also entered into a number of commitments to leaseland, facilities and equipment in connection with construction of two servicecenters for which the Company has and will continue to expend significant fundsfor construction of the facilities and food irradiation systems. The Company alsoexpects to expend costs to complete and deliver the system for Texas A&MUniversity, or Texas A&M. In addition, the Company expects to expend coststo construct and install two in-line systems for Cargill Incorporated’s Excelsubsidiary that the Company will own and operate.

 

In addition tomanagement’s current operating plans, which focus on increasing cash flow fromoperations, the Company is also evaluating a number of alternative plans tomeet its future operating cash needs. These plans include raising additionalfunds from the capital markets and drawing down the Company’s$50.0 million senior secured credit facility with Titan. As of the date ofthe filing of this report, the Company has obtained $15.0 million underits senior secured credit facility with Titan. If the funds available under theCompany’s credit facility and from the capital markets are not sufficient forthe Company or if it is unable to generate sufficient cash flow fromoperations, management may need to consider additional actions, includingreducing or deferring capital expenditures, reducing or deferring research anddevelopment projects, curtailing construction of systems for customers inadvance of payment and reducing marketing expenditures, which actions may havea material adverse impact on the Company’s ability to meet its businessobjectives.

 

Avariety of currently unanticipated events could require additional capitalresources such as the acquisition of complementary businesses or technologiesor increased working capital requirements to fund, among other things,construction of systems for the Company’s strategic alliances in advance ofpayment.

 

**Note (2) Initial PublicOffering**

 

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 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.

 

Alsoin connection with the completion of the Company’s initial public offering,stock options granted under the Nonstatutory Stock Option Plan were convertedfrom variable plan options to fixed plan options. Accordingly, stock-basedcompensation of $78.6 million was recorded, representing the extent towhich the $10 per 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 six

 

 

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months ended June 30, 2002,is $3.6 million and $7.6 million, respectively, of compensation expenseassociated with these options.

 

Theremaining stock-based compensation balance related to these options will berecognized as compensation expense over the remaining three-year vesting periodof the options. Included in selling, general and administrative expense for thethree and six months ended June 30, 2002 and 2001, is $202,000 and $404,000,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 FinancialInformation**

 

Duringthe quarter ended June 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 $555,000, which arereflected in the statement of stockholders’ equity for the six months endedJune 30, 2001.

 

Thefollowing data summarize information relating to the per share computation (inthousands, except per share data):

 

|                                                |   | **Three  Months Ended  June 30,** |   | **Six  Months Ended  June 30,** |   |
|-----------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                |   | **2002**                          |   | **2001**                        |   | **2002** |   | **2001** |   |
|                                                |   |                              |   |                            |   |   |   |   |   |
| Net loss                                            |   | $                                 | (5,102 | )                               | $      | (9,187 | ) | $ | (14,081 | ) | $ | (49,760 | ) |
|                                                |   |                              |   |                            |   |   |   |   |   |
| Weighted average  shares outstanding                |   |                              |   |                            |   |   |   |   |   |
| Basic                                               |   | 66,869                            |   | 55,841                          |   | 64,842 |   | 52,144 |   |
| Effective dilutive  securities:  stock options |   | —                            |   | —                          |   | — |   | — |   |
| Dilutive                                            |   | 66,869                            |   | 55,841                          |   | 64,842 |   | 52,144 |   |
|                                                |   |                              |   |                            |   |   |   |   |   |
| Net loss per  common share — basic             |   | $                                 | (0.08  | )                               | $      | (0.16 | ) | $ | (0.22 | ) | $ | (0.95 | ) |
|                                                |   |                              |   |                            |   |   |   |   |   |
| Net loss per  common share — dilutive          |   | $                                 | (0.08  | )                               | $      | (0.16 | ) | $ | (0.22 | ) | $ | (0.95 | ) |

 

Inthe three and six months ended June 30, 2002, respectively, theweighted average number of options to purchase approximately 4,469,000 and4,844,000 shares of common stock at prices ranging from $.14 to $16.06 and $.14to $16.09 per share were not included in the computation of diluted EPS, as theeffect would have been anti-dilutive due to the loss from continuingoperations. Similarly, the weighted average number of options and warrants topurchase approximately 6,906,000 and 7,347,000 shares of common stock at pricesranging from $.14 to $16.09 per share were not included in the computation ofdiluted EPS for the three and six month periods ended June 30, 2001,respectively.

 

 

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Followingare details concerning certain balance sheet data as of June 30, 2002 andDecember 31, 2001:

 

|                                                 |   | **June  30,  2002** |       | **December  31,  2001** |       |
|------------------------------------------------------|--------|---------------------|------------|-------------------------|------------|
|                                                 |   | **(Unaudited)**     | ** ** |                    | ** ** |
|                                                 |   |                |       |                    |       |
| **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 $6.4 million and $4.1 millionat June 30, 2002 and December 31, 2001, respectively, areprimarily invested in commercial paper and money market funds.

 

The Company classifiesits marketable securities as available-for-sale and records the unrealizedholding gains or losses as a separate component of stockholders’ equity.Realized losses for the three and six months ended June 30, 2002, were$18,000 and $47,000, respectively. There were no realized gains or lossesrecorded in the three and six months ended June 30, 2001.

 

|                                     |   | **June  30,  2002** |       | **December  31,  2001** |       |
|------------------------------------------|--------|---------------------|------------|-------------------------|------------|
|                                     |   | **(Unaudited)**     | ** ** |                    | ** ** |
|                                     |   |                |       |                    |       |
| **Accounts  receivable (in thousands):** |   |                |       |                    |       |
| Billed                                   |   | $                   | 7,431      |                    | $          | 12,556 |   |
| Unbilled                                 |   | 14,753              |       | 14,020                  |       |
| Less allowance  for doubtful accounts    |   | (1,428              | )          | (1,428                  | )          |
|                                     |   | $                   | 20,756     |                    | $          | 25,148 |   |

 

Includedin billed receivables is $7.3 million and $12.5 million of receivable fromaffiliate at June 30, 2002 and December 31, 2001, respectively.  Unbilled receivables primarily representwork-in-process that will be billed in accordance with contract terms anddelivery schedules. Also included in unbilled receivables are amounts billableupon final execution of contracts, contract completion or milestones.Generally, unbilled receivables are expected to be collected within one year.

 

|                             |   | **June  30,  2002** |       | **December  31,  2001** |       |
|----------------------------------|--------|---------------------|------------|-------------------------|------------|
|                             |   | **(Unaudited)**     | ** ** |                    | ** ** |
|                             |   |                |       |                    |       |
| **Inventories  (in thousands):** |   |                |       |                    |       |
| Materials                        |   | $                   | 14,734     |                    | $          | 15,510 |   |
| Work-in-process                  |   | 5,823               |       | 4,254                   |       |
|                             |   | $                   | 20,557     |                    | $          | 19,764 |   |

 

Generally,the Company’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, or market. The Companyperiodically evaluates its on-hand stock and makes appropriate disposition ofany stock deemed excess or obsolete.

 

 

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|                                            |   | **June  30,  2002** |       | **December  31,  2001** |       |
|-------------------------------------------------|--------|---------------------|------------|-------------------------|------------|
|                                            |   | **(Unaudited)**     | ** ** |                    | ** ** |
|                                            |   |                |       |                    |       |
| **Property  and equipment (in thousands):**     |   |                |       |                    |       |
| Machinery and  equipment                        |   | $                   | 18,783     |                    | $          | 9,937 |   |
| Furniture,  fixtures and leasehold improvements |   | 8,921               |       | 1,252                   |       |
| Construction in  progress                       |   | 27,735              |       | 33,390                  |       |
|                                            |   | 55,439              |       | 44,579                  |       |
| Less accumulated  depreciation and amortization |   | (3,934              | )          | (2,676                  | )          |
| Property and  equipment, net                    |   | $                   | 51,505     |                    | $          | 41,903 |   |

 

Constructionin progress primarily represents costs incurred for the construction of twofood irradiation service center facilities. Such costs will remain inconstruction in progress until the facilities are completed and placed in service.

 

|                                 |   | **June  30,  2002** |       | **December  31,  2001** |       |
|--------------------------------------|--------|---------------------|------------|-------------------------|------------|
|                                 |   | **(Unaudited)**     | ** ** |                    | ** ** |
|                                 |   |                |       |                    |       |
| **Other  assets (in thousands):**    |   |                |       |                    |       |
| Texas A&M                        |   | $                   | 8,418      |                    | $          | 7,210 |   |
| Advances to  Hawaii Pride — net |   | 3,844               |       | 3,674                   |       |
| Prepaid rent                         |   | 823                 |       | 796                     |       |
| Loan receivable  from officer        |   | 188                 |       | 225                     |       |
| Other                                |   | 135                 |       | 127                     |       |
|                                 |   | $                   | 13,408     |                    | $          | 12,032 |   |

 

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

 

TheCompany has advanced $5.4 million to Hawaii Pride, which is included inthe accompanying balance sheet as other assets, net of impairment charges of$1.6 million. The impairment charges reflect the Company’s estimate of anyerosion of the collateral basis in Hawaii Pride. The monies advanced in 1999and 2000 were utilized for costs relating to the acquisition of land,construction of the building and infrastructure, equipment (excluding theSureBeam 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 $345,000 during the six months endedJune 30, 2002. Management does not expect significant repayments ofthe advances to Hawaii Pride until late 2003.

 

 

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|                                           |   | **June  30,  2002** |       | **December  31,  2001** |       |
|------------------------------------------------|--------|---------------------|------------|-------------------------|------------|
|                                           |   | **(Unaudited)**     | ** ** |                    | ** ** |
|                                           |   |                |       |                    |       |
| **Other  current liabilities (in thousands):** |   |                |       |                    |       |
| Deferred revenue                               |   | $                   | 3,000      |                    | $          | 3,000 |   |
| Other                                          |   | 1,311               |       | 1,756                   |       |
|                                           |   | $                   | 4,311      |                    | $          | 4,756 |   |

 

**Note (4) Recent AccountingPronouncements**

 

In June 2001, the FASBissued SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS No.143”).  This statement addressesfinancial accounting and reporting for obligations associated with theretirement of tangible long-lived assets and the associated asset retirementcosts.  It applies to (a) all entitiesand (b) legal obligations associated with the retirement of long-lived assetsthat result from the acquisition, construction, development and/or normaloperation of long-lived assets, except for certain obligations of leasees.  This statement amends FASB Statement No. 19,“Financial Accounting and Reporting by Oil and Gas Producing Companies,” and iseffective for financial statements issued for fiscal years beginning after June15, 2002.  Management does not believethat the adoption of this statement will have a material impact on itsfinancial position or results of operations.

 

In April 2002, the FASBissued 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 FASB issued Statement No. 146,“Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No.146”), which addresses financial accounting and reporting for costs associatedwith exit or disposal activities. SFAS No. 146 nullifies EITF Issue No. 94-3,“Liability Recognition for Certain Employee Termination Benefits and OtherCosts to Exit an Activity (including Certain Costs Incurred in aRestructuring).” The principal difference between SFAS No. 146 and Issue No.94-3 relates to the recognition of a liability for a cost associated with anexit or disposal activity. SFAS No. 146 requires that a liability be recognizedfor those costs only when the liability is incurred, that is, when it meets thedefinition of a liability in the FASB’s conceptual framework. In contrast,under Issue No. 94-3, a company recognized a liability for an exit cost when itcommitted to an exit plan. SFAS No. 146 also establishes fair value as theobjective for initial measurement of liabilities related to exit or disposalactivities. The Statement is effective for exit or disposal activities that areinitiated after December 31, 2002 although earlier application isencouraged.  The Company is unable todetermine impact on its financial position or results of operations from theadoption of this statement.

 

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**Note (5)Strategic Transactions**

 

Inconnection with the Company’s agreement with Texas A&M, SureBeam agreed toprovide three electronic food irradiation systems, which are referred tocollectively as the system, pursuant to a ten-year lease with title passing toTexas A&M at the end of the ten-year term. The agreement provides theCompany access to Texas A&M employees for a variety of free or discountedservices, as well as rights to use the system for performing irradiationservices for its customers.  The Companyis currently working with Texas A&M on several research projects whichinclude studies on shelf life extension, food products application testing, andthe effectiveness 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.

 

Asthe consideration in this lease is nonmonetary, the Company has accounted forthis element 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 approximately $500,000 will bedeferred and recognized ratably over the remaining term of the arrangementcommencing upon delivery of the system.

 

Underthe percentage-of-completion method, the Company recorded revenues of $702,000and $1.9 million for the three and six months ended June 30, 2002,respectively, and recorded $701,000 and $1.3 million for the three and sixmonths ended June 30, 2001, respectively. The receivable arising fromthe total cumulative revenues of $9.9 million, net of $300,000 ofamortization, has been recorded as a short-term and long-term asset atJune 30, 2002. As of June 30, 2002, the Company had deferred profitsamounting to $482,000, which are included as other short-term and long-termliabilities in the accompanying consolidated balance sheet. These deferredprofits 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 long-term asset arising from this transactionrepresents the cumulative revenues recognized related to the design,construction, installation, integration and delivery of the system for TexasA&M. In August 2001, the Company agreed to purchase research anddevelopment services from Texas A&M for approximately $200,000,reflecting a discount of approximately $300,000. The discount will be amortizedagainst the long-term asset arising from the cumulative revenues recorded underthis agreement over a period of approximately ten months. During the three andsix months ended June 30, 2002, the Company has recorded $60,000 and$150,000, respectively, of amortization expense related to the research and developmentservices it has received to date. The deferred profit of $482,000 as ofJune 30, 2002, represents the difference between the cumulative costsincurred and the cumulative revenues recognized. As of June 30, 2002, none ofthe deferred profit had been amortized to income since final delivery of thesystem had not yet taken place.

 

Withrespect to the impact of the transaction with Texas A&M on the Company’sliquidity, the Company has expended funds of approximately $9.5 millionrelated to the construction of the system through June 30, 2002. These costshave been incurred primarily related to the design of the system, constructionof and modification to the physical structure which will house the system, andfor the manufacture of the linear accelerators and x-ray components as well asthe material handling and conveyor systems. The Company estimates that therewill be minimal additional costs to be incurred to complete and deliver thesystem, which the Company expects to occur in the third quarter of 2002.

 

In June 2001, the Company received a purchaseorder with an aggregate value of $50.0 million from RESAL SaudiCorporation, or RESAL, for ten electronic food irradiation systems to operatein four service centers in the Saudi Arabia region for irradiating poultry anddisinfesting and prolonging shelf life of dates. The Company commencedconstruction of these systems for RESAL and has recognized, under thepercentage-of-completion method of accounting, $300,000 and $1.4 million in sales revenue for the three and sixmonths ended June 30, 2002, respectively.  The Company received a payment of $1.5 million 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.

 

 

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In April 2002, the Companyformed a joint venture under the name SureBeam ME with RESAL.  As of June 30, 2002, SureBeam owns a 19.9%interest in SureBeam ME and RESAL owns the remaining 80.1%.  The Company will account for its ownership interest in SureBeamME using the equity method of accounting under APB Opinion No. 18 “The EquityMethod of Accounting for Investments in Common Stock.”  In accordance with the joint venture agreement,RESAL’s purchase order dated June 2001 may be assigned to the SureBeam ME atsuch time as the joint venture receives sufficient funds from third partyinvestors.  As a result of the Company’sequity interest in SureBeam ME, the Company has eliminated 19.9% of the profitrecognized under the percentage-of-completion method of accounting inconnection with the original purchase order. The Company estimates that the total profit under the original contractthat will be eliminated as a result of SureBeam’s equity interest in SureBeamME will be approximately $2.0 million to $3.0 million.  The joint venture will govern the strategicrelationship with the operator of these systems, including royalty andmanagement fees and a minority equity ownership of the operator that willoperate the service centers.

 

InOctober 2001, the Company contracted to manufacture eight SureBeam systems foran aggregate of $26.0 million for Titan in connection with Titan’sagreement with the United States Postal Service. 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 six months ended June30, 2002, the Company recognized $4.7 million and $6.9 million,respectively, as revenues from affiliate under this contract. In accordance with themilestone payments of the contract, the Company received $19.5 million incash from Titan during the six months ended June 30, 2002.

 

In June 2002, theCompany received an order from Son Son Company, a privatefood processing corporation headquartered in Vietnam, for one electronic food irradiation system tooperate in Vietnam for irradiating shrimp and disinfesting and prolonging shelflife of local fruits. The Company commenced construction on the system and hasrecognized, under the percentage-of-completion method of accounting,$1.6 million in revenue which has been recorded on this contract throughJune 30, 2002, all of which was recognized during the three months ended June30, 2002. The Company expects to receive milestone payments as they becomedue and payable until the contract is complete.

 

**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 millionas of December 31, 2001. These advances were evidenced by a subordinatedpromissory note payable to Titan. On February 13, 2002, the Companyexchanged the outstanding balance, including principal and accrued interest, of$73.0 million, under its subordinated promissory note payable to Titan for3,225,765 and 4,441,496 shares of Class B and Class A common stock,respectively, of the Company.

 

**Note (7) Senior Secured CreditFacility with Affiliate**

 

Titan has extended a $50.0 millionsenior secured credit facility to SureBeam that allows SureBeam to borrow up to$12.5 million in the second quarter of 2002, up to $17.0 million inthe third quarter of 2002 and up to $12.5 million per quarter beginning inthe fourth quarter of 2002 through the fourth quarter of 2003, subject to the$50.0 million limitation on borrowing. The amount available for borrowingin the second, third and fourth quarters of 2003 is based upon SureBeam’searnings before interest, taxes, depreciation and amortization (EBITDA) for theprior quarter as a percentage of the EBITDA target in its annual operatingplan. If EBITDA is less than 25% of target EBITDA, then the amount available is$5.0 million, provided that no amounts are available unless we covenantduring the current quarter to limit our total operating expenses (defined asresearch and development and selling, general and administrative expenses) to$5.0 million. If EBITDA is 25% of target, then the amount available is$6.25 million or 50% of the quarterly maximum and for each percentage ofEBITDA above 25% of target, the percentage of the quarterly maximum above 50%will be increased on a pro rata basis. To the extent SureBeam does not fullyborrow the maximum amount during any quarter of 2002, the unutilized amount canbe borrowed in the subsequent quarter. As of June 30, 2002, SureBeam hadborrowed $10.0 million on this facility and had $2.5 million inunutilized amounts. SureBeam borrowed an additional $5.0 million on July26, 2002 bringing the total borrowings on this senior secured creditfacility to $15.0 million as to the date of this report. If SureBeam is unable to

 

 

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** **

receivefunds as anticipated under this credit facility or if its capital requirementsvary from its current plans, it may require additional financing sooner than itanticipates. In such circumstance no assurance can be made that the Companywould be able to obtain additional financing on terms reasonable to theCompany, or at all, which couldhave a material adverse effect on its results of operations and financialcondition.

 

Under the new seniorsecured credit facility the Company is obligated to make quarterly principalpayments as follows: 13.75% of the outstanding principal balance as ofDecember 31, 2003 during each quarter in 2004; 25% of the outstandingprincipal balance as of December 31, 2004 during each quarter in 2005; andall remaining principal by December 31, 2005. In addition, with someexceptions, the Company is obligated to use net proceeds from the sale ofassets and its securities to repay amounts advanced under this facility.Interest is payable monthly beginning in January 2003. The creditagreement contains affirmative and negative covenants, including covenantslimiting the Company’s incurrence of debt, capital expenditures, operatingexpenses, investments, declaration of dividends and other restricted payments,sale of stock of subsidiaries and consolidations and mergers. The creditagreement, however, does not contain any financial covenants requiring theCompany to maintain specific financial ratios. The credit agreement is securedby a first priority lien on all of the Company’s assets.

 

**Note (8)Acquisitions**

 

In May 2000, TechIon Industrial Brasil S.A., or Tech Ion, placed purchase orders with theCompany for eleven electronic food irradiation systems for $55 million, ofwhich $22.4 million was recognized as revenue through September 30,2001. SureBeam Brasil Ltda., or SureBeam Brasil, which was jointlyestablished by Tech Ion, the Company’s exclusive partner in Brazil, and TitanSureBeam Brazil Ltd., the Company’s wholly owned subsidiary, will 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 purchaseagreement with Tech Ion to purchase an additional 60.1% of SureBeam Brasilbringing the Company’s total equity ownership to 80% in SureBeam Brasil. Inconnection with the additional equity interest, the Company paid Tech Ion$750,000 upon the execution of the agreement and will pay an additional$250,000 upon the transfer of title of the linear accelerators and materialhandling systems for the Rio de Janeiro service center from Tech Ion toSureBeam Brasil. The Company also exchanged its trade receivables of$22.4 million due from Tech Ion and forgave $3.5 million of a loan theCompany had previously made to Tech Ion for building improvements andequipment. The Company has recorded an intangible asset of $2.5 millionthat represents the total consideration amount of the agreement that exceedsthe fair market value of the assets purchased. The intangible asset will beamortized over five years. Prior to the acquisition, the Company was buildingeleven linear accelerators for Tech Ion for $55.0 million. This contractbegan in May 2000, and was at various stages of completion at the date theCompany began to negotiate to acquire the above assets. Through the date theCompany began negotiations, the Company recognized $6.8 million in fiscalyear 2001 and $22.4 million in total related to this contract.  On April 1, 2002, the Company exchanged theremaining $1.5 million owed by Tech Ion in consideration for its remaining 20%interest in SureBeam Brasil.  The $1.5million was included in prepaid expense and other current assets in theaccompanying balance sheet at December 31, 2001.  Due to the exchange the Company has recorded and additional$700,000 as an intangible asset which will be amortized over the remaining 54month life of the existing intangible asset. The remaining $800,000 was recorded as part of the service centerbuilding cost.

 

**Note (9) Commitments andContingencies**

 

TheCompany periodically is a defendant in cases incidental to its businessactivities. Furthermore, providers of products and services to the U.S.government are generally subject to multiple levels of audit and

 

 

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investigation by variousU.S. government agencies. Any liabilities arising from audits by the federalgovernment are being retained by Titan as part of the contribution by Titan toSureBeam. In the opinion of management, the amount of ultimate liability, ifany, with respect to these actions will not materially affect the financialposition or results of operations of the Company.

 

**Note (10)Related Party Transactions**

 

Inconnection with the contribution agreement with Titan, the Company entered intoa number of other agreements with Titan for such items as corporate services,facilities, filing of income tax returns and employee benefit plans. Theseagreements provide, among other things, continuation of services which havehistorically been 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 six months endedJune 30, 2002, the Company recorded an allocation for general andadministrative expense of $6,000 and $1.1 million, respectively.

 

Titan has subcontractedthe Company to design and construct SureBeam systems for Titan’s variouscontracts with third parties. These systems are designed for applications otherthan the food, animal hide and flower markets. Revenues derived from sales toTitan are recognized under cost plus 20% or fixed price contracts and were$7.9 million and $12.4 million for the three and six months endedJune 30, 2002, respectively. Of the revenue from affiliate,$4.7 million and $6.9 million for the three and six months endedJune 30, 2002, respectively, related to the subcontract the Companyhas with Titan on the United States Postal Service contract, and the remaining$3.2 million and $5.5 million for the three and six months endedJune 30, 2002, respectively, was recorded in relation to Titan’smedical sterilization business and government linear accelerator business.

 

**Note (11) Subsequent Events**

 

EffectiveAugust 5, 2002, Titan distributed all of its shares of the common stock ofSureBeam to the shareholders 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 overeighty percent of the common stock of SureBeam and held a higher percentage ofthe voting power of SureBeam due to Titan’s ownership of shares of Class Bcommon stock, which had ten votes per share, as compared to SureBeam’s Class Acommon stock, which has one vote per share and is traded on the Nasdaq underthe symbol SURE.

 

Prior to the distribution ofshares of SureBeam common stock, Titan converted all of its shares ofClass B common stock of SureBeam into shares of Class A common stockof SureBeam. Shareholders of Titan receiving shares of SureBeam in itsdistribution received only shares of Class A common stock. Under the termsof the Class B common stock, it has now been retired and cannot bereissued.

 

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Thefollowing discussion of the financial condition and results of operations ofSureBeam Corporation 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.

 

Whenyou read this section of this Form 10-Q, it is important that you alsoread the financial 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,regarding the risk of gaining consumer acceptance, risks relating to theCompany’s history of losses and liquidity and risks of internationaloperations.

 

**Overview**

 

Weare a leading provider of electronic irradiation systems and services for thefood industry. 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 theshareholders of Titan..

 

**Results of Operations**

 

*Revenues*

 

    Our total revenues increased from$9.6 million in the three months and $15.1 million in the six monthsended June 30, 2001, to $10.8 million in the three months and$17.8 million in the six months ended June 30, 2002. For the threemonths ended June 30, 2002 and 2001, we had electronic foodirradiation system sales and food processing revenue from third parties of $2.8million or 26% of total revenues and $8.6 million or 90% of total revenues,respectively. For the six months ended June 30, 2002 and 2001 we hadelectronic food irradiation system sales and food processing revenue from thirdparties of $5.4 million or 30% of total revenues and $14.1 million or 93%of total revenues, respectively. For the three months endedJune 30, 2002, 90%, or $2.6 million, of the $2.8 million ofrevenue from electronic food irradiation system sales and food processingservices, was derived from sales of electronic food irradiation systems tothree customers and 10%, or $284,000, was derived from food processingservices. For the three months ended June 30, 2001, 96%, or $8.3 million,of the $8.6 million of revenue from electronic food irradiation system salesand food processing services, was derived from sales of electronic foodirradiation systems to three customers and 4%, or $303,000, was derived fromfood processing services. For the six months ended June 30, 2002, 90%, or$4.8 million, of the $5.4 million of revenue from electronic foodirradiation system sales and food processing services, was derived from salesof electronic food irradiation systems to three customers and 10%, or $547,000,was derived from food processing services. For the six months endedJune 30, 2001, 96%, or $13.6 million, of the $14.1 million ofrevenue from electronic food irradiation system sales and food processingservices, was derived from sales of electronic food irradiation systems tothree customers and 4%, or $522,000, was derived from food processing services.

 

 

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The 2002 revenues wereprimarily related to revenue recognized from sales of our electronicfood irradiation systems, using the percentage-of-completion method ofaccounting, principally to Texas A&M University, or Texas A&M, (seediscussion below), Son Son Company, a private food processing corporationheadquartered in Vietnam and RESAL Saudi Corporation, or RESAL, a subsidiary ofa private Saudi conglomerate headquartered in Riyadh, Saudi Arabia. The 2001revenues were primarily related to revenue recognized from sales of ourelectronic food irradiation systems, using the percentage-of-completion methodof accounting, principally to Texas A&M, Tech Ion Industrial Brasil, S.A.,a Brazilian food irradiation company, and RESAL. Food processing servicerevenues were primarily derived in connection with our customer production runsas well as test marketing programs.

 

Our revenues from affiliate increased from $1.0 million in thethree and six months ended June 30, 2001 to $7.9 million in the threemonths and $12.4 million in the six months ended June 30, 2002. Forthe three and six months ended June 30, 2002, $4.7 million or 59% and$6.9 million or 56%, respectively, of revenues from affiliate, were from salesof our electronic irradiation systems using the percentage of completionmethod of accounting, in support of Titan’s United States Postal Servicecontract for which we were the main subcontractor.  The remaining $3.2 million and $5.5 of revenues from affiliatefor the three and six months ended June 30, 2002, respectively, arefor the sale of equipment and services related to Titan Scan Technologies’medical sterilization business and Titan's government linear acceleratorbusiness.

 

Inconnection with our agreement with Texas A&M, we agreed to provide threeelectronic food irradiation systems (collectively, “the system”) pursuant to aten-year lease with title passing to Texas A&M at the end of the ten-yearterm. The agreement provides us access to Texas A&M employees for a varietyof free or discounted services, as well as rights to use the system forperforming irradiation services for our customers. We are currently workingwith Texas A&M on several research projects which include studies on shelflife extension, food products application testing, and the effectiveness ofSureBeam’s technology versus other technologies. Since we retain the right touse the system through the end of the term of the arrangement, we haveaccounted for this transaction as a sale-leaseback.

 

Asthe consideration in this lease is nonmonetary, we have accounted for this elementof 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 approximately $500,000 will bedeferred and recognized ratably over the remaining term of the arrangementcommencing upon delivery of the system.

 

Underthe percentage-of-completion method, we recorded revenues of $702,000 and$1.9 million for the three and six month periods endedJune 30, 2002, respectively, and recorded $701,000 and$1.3 million for the three and six month periods endedJune 30, 2001, respectively. The receivable arising from the totalcumulative revenues of $9.9 million, net of $300,000 of amortization, hasbeen recorded as a short-term and long-term asset at June 30, 2002,and no profit has been recognized. As of June 30, 2002, we had deferredprofits amounting to $482,000, 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 theremaining term of the ten-year term of the arrangement commencing upon deliveryof the system to Texas A&M. The short-term and long-term assets arisingfrom this transaction represents the cumulative revenues recognized related tothe design, construction, installation, integration and delivery of the systemfor Texas A&M. 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 will be amortizedover a period of approximately ten months from the long-term asset arising fromthe cumulative revenues recorded under this agreement. For the three and sixmonths ended June 30, 2002, we have recorded $60,000 and $150,000,respectively, of amortization expense related to the research and developmentservices we have received to date. The deferred profit of $482,000 as ofJune 30, 2002, represents the difference between the cumulative costsincurred and the cumulative revenues recognized. As of June 30, 2002,none of the deferred profit had been amortized to income since final deliveryof the system had not yet taken place.

 

With respect to theimpact of the transaction with Texas A&M on our liquidity, we have expendedfunds of approximately $9.5 million related to the construction of the systemthrough June 30, 2002, which includes

 

 

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$664,000 and $1.9 million expended during the threeand six months ended June 30, 2002, respectively. These costs havebeen incurred primarily in relation to the design of the system, constructionof and modification to the physical structure which will house the system, andfor the manufacture of the linear accelerators and x-ray components as well asthe material handling and conveyor systems. The contract is essentially complete and we expect minimal cost to beincurred during the remainder of the year.

 

Ourcost of revenues consists primarily of the components and materials associatedwith the linear accelerator, material handling system and controls and directlabor to assemble, install and integrate the medical equipment sterilizationand electronic food irradiation systems, as well as overhead such as travel,indirect labor and fringe benefits related to the production of the systems andthe manufacturing of linear electron beam accelerators. Also included in costof revenues 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 areconsumables used during facility operations to monitor performance and toensure the integrity of the dose of the irradiation delivered to the productfor quality assurance purposes and to satisfy federal requirements.

 

Ourgross margins were 35% for the three months ended June 30, 2002 and2001 and decreased from 39% to 28% for the six months endedJune 30, 2001 and 2002, respectively. The decrease is due to a lowgross margin on food processing due to under utilization of the service centersand higher percentage of third party revenue related to the Texas A&Mcontract, which has a zero gross margin.  We anticipate that our gross margins will increase as the Texas A&Mcontract is essentially complete and the production volume at the servicecenters increases.

 

*Selling,General and Administrative*

 

Ourselling, general and administrative expense decreased from $12.0 million in the three months and$57.7 million in the six months ended June 30, 2001, to $9.7million in the three months and $19.6 million in the six months endedJune 30, 2002. The decrease of $2.3 million for the three monthsended June 30, 2002 compared to the same period last year isattributed to a decrease of $1.3 million in stock-based compensation,$744,000 in sales and marketing spending and $460,000 of amortization relatedto intangible assets acquired from Applied Power Associates, Inc., or APA, inMay 2002, which are fully amortized. The decrease of $38.1 million for the sixmonths ended June 30, 2002 compared to the same period last year isattributed to a decrease of $36.4 million in stock-based compensation,$945,000 in sales and marketing spending and $460,000 of amortization related tothe APA intangible assets. See the discussion of stock-based compensationbelow. We expect that selling, general and administrative expense will increasein the next quarter as a result of our spin-off which resulted in acceleratedvesting of options held by Titan employees and directors. In addition, webelieve general and administrative expenses will increase due to higher salesand marketing expense associated with new customer product rollouts into newregions.

 

*Stock-based Compensation*

 

Inconnection with the completion of our initial public offering in March 2001,stock options granted under our Nonstatutory Stock Option Plan were convertedfrom variable plan options to fixed plan options. Accordingly, stock-basedcompensation of $78.6 million was recorded, representing the extent towhich the $10 per share offering price exceeded the exercise price of theoptions. Werecognized $4.9 million and $43.6 million as compensation expense includedin selling, general and administrative expense in the accompanying consolidatedstatements of operations for the three and six months endedJune 30, 2001, respectively. Since a substantial portion of these options were vested at the time ofcompletion of the offering, we recognized $38.7 million as compensation expenseat that time. For the three and six months endedJune 30, 2002, $3.6 million and $7.2 million was recognizedas compensation expense and included in selling, general and administrativeexpense, respectively. In conjunction with the completion of our spin-off fromTitan on August 5, 2002, all options held by Titan employees anddirectors under this plan became fully vested and as a result we expect thedeferred compensation charges for this plan to be approximately$6.0 million for the three months ended September 30, 2002 andreducing in the subsequent quarters until the remaining options held by ouremployees are fully vested. The remaining stock-based compensation balance ofthe remaining participants related to these options will be recognized asexpense over the remaining four-year vesting period of the options. Additionalstock-based compensation expense is included in selling, general andadministrative expense related to

 

 

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options granted prior to thecompletion 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. Stock-based compensation expense related to these options was $202,000for the three months and $404,000 for the six months endedJune 30, 2001 and 2002, respectively.

 

*Research and Development*

 

Our research anddevelopment expense decreased from $776,000 in the three months and$1.1 million in the six months ended June 30, 2001, to $181,000in the three months and $496,000 in the six months endedJune 30, 2002. The decrease of our research and development expensein the current year is due to our extensive ongoing research and developmentwork performed for an affiliate the costs of which we bill to the affiliatebased on the work performed. As these efforts for the affiliate decrease andour internal efforts increase we expect the research and development expense toincrease in the future. Our current research and development activities arefocused on increasing the capability and efficiency of our existing technology,minimizing the space occupied by our SureBeam systems and developing new foodproduct applications. We have assembled a team of experts in our industry toenhance and drive our research and development efforts. Our research anddevelopment experts have many years of experience in the area of enhancing foodsafety and extending shelf life using irradiation in addition to their broadexperience with linear accelerators and charged particle beams. In addition, wehave an agreement with Texas A&M University and the Texas AgriculturalExperiment Station for the purpose of researching and developing productapplications for our technology. We are currently working with Texas A&M onseveral research projects which include studies on shelf life extension, foodproducts application testing, and the effectiveness of SureBeam’s technologyversus other technologies. In addition, we often benefit from the research anddevelopment efforts of our component suppliers.

 

*InterestIncome*

 

Our interest incomedecreased from $636,000 in the three months and $729,000 in the six monthsended June 30, 2001 to $102,000 in the three months and $127,000 inthe six months ended June 30, 2002. The decrease is due to the reduced cash and marketable securities onhand for the three and six months ended June 30, 2002.  Due to our initial public offering in March2001, our cash and marketable securities balances were $39.6 million atJune 30, 2001 as compared to $6.4 million atJune 30, 2002.  See Note (2) in Notes to Consolidated FinancialStatements.

 

*InterestExpense*

 

Our interest expensedecreased from $1.4 million in the three months and $3.2 million in thesix months ended June 30, 2001 to $65,000 in the three months and $951,000in the six months ended June 30, 2002. The decrease is due to theexchange of $73.0 million of our subordinated promissory note payable to Titanfor our common stock. See Note (6) in Notes to Consolidated Financial Statements.  This exchange of debt resulted in a decreasein our interest expense. However, as we require additional financing, eitherdrawing down on the senior secured credit facility with Titan or obtainingother financing, we will likely incur increased interest expense in the future.

 

*OtherIncome (Expense), Net*

 

During the three and sixmonths ended June 30, 2002, we recorded $939,000 and $1.9 million,respectively, of other income, net. For the three and six months endedJune 30, 2002 we recorded $1.0 million and $2.0 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, animalhide and flower markets for $8.0 million. As part of this agreement, wewill be recording $1.0 million of license fee income in each quarter foreight quarters, which began in the fourth quarter of 2001.  There was noother income, net for the three and six months ended June 30, 2001.

 

 

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*IncomeTaxes*

 

Incometaxes reflect an effective rate of 0% for the three and six months ended June30, 2002, compared to 10% for the three months and six months ended June 30,2001. Pursuant to our tax sharing agreement with Titan, Titan will compensateus for any tax benefit received by Titan from the use of our losses in Titan’sconsolidated return. The amount is payable on the earlier of when we could haveused the loss ourselves or when the losses expire (20 years). We had anoperating loss for the first six months of 2002 and 2001 and expect to continueto incur losses for the remainder of 2002. Our tax benefit is dependent uponthe usage of our losses by Titan.  Titanis not expected to fully utilize the SureBeam 2001 and 2002 tax losses.  Accordingly, the amount expected to bereceived from Titan under the tax sharing agreement related to losses incurredfor the six months ended June 30, 2001 is $2,319,000 and is reflected as duefrom affiliate in the accompanying balance sheet.  In conjunction with the spin-off, we have been subsequently deconsolidatedfrom Titan and Titan will no longer have the right to use our losses.  Accordingly, we have not recorded anybenefit for income taxes for the three and six months ended June 30, 2002.

 

*NetIncome (Loss)*

 

Our net loss decreased from $9.2 million in the threemonths and $49.8 million in the six months ended June 30, 2001to $5.1 million in the three months and $14.8 million in the sixmonths ended June 30, 2002. The decrease primarily related to areduction of stock-based compensation amortization expense of approximately$1.3 million and $43.9 million for the three and six months ended June30, 2002, respectively.

 

**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. Wealso are spending significant funds to construct new company-owned servicecenters and systems. At June 30, 2002, we had available cash, cashequivalents and investments available-for-sale of $6.4 million. Our futurecash obligations consist primarily of current liabilities and our fixed leasecosts associated with the operation of our service centers. As of June 30,2002, we expect to pay approximately $2.8 million in lease expenses duringthe next 12 months.

 

Since our initial public offering on March16, 2001, our cash requirements have been met primarily through proceeds ofapproximately $59.8 million, net of underwriting commissions, fees andother offering costs, from our initial public offering, advances under the$75.0 million credit facility and the $50.0 million senior secured creditfacility with Titan discussed below, payments from Titan for work performed onmedical sterilization, $19.5 million associated with mail sanitationsystem sales and payments totaling $6.0 million from Titan associated withthe perpetual license related to non-food items. In connection with thecontribution 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, Titanagreed to lend us a maximum amount of $75.0 million, including accruedinterest, and we borrowed $75.0 million. The promissory note was due inAugust 2005 and bore interest at the greater of the rate of 10% per annumor Titan’s effective weighted average interest rate under its senior creditfacility. On December 31, 2001, $2.0 million of the subordinatednote payable to Titan was exchanged by Titan for 190,385 shares of ourClass B common stock. Additionally, the remaining $73.0 million ofthe 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 has extended a $50.0 millionsenior secured credit facility to us that allows us to borrow up to$12.5 million in the second quarter of 2002, up to $17.0 million inthe third quarter of 2002 and up to $12.5 million per quarter beginning inthe fourth quarter of 2002 through the fourth quarter of 2003, subject to the$50.0 million limitation on borrowing. The amount available for borrowingin the second, third and fourth quarters of 2003 is based upon our earningsbefore interest, taxes, depreciation and amortization (EBITDA) for the priorquarter as a percentage of the EBITDA target in our annual operating plan. IfEBITDA is less than 25% of target EBITDA, then the amount available is$5.0 million, provided that no amounts are available unless we covenantduring the current quarter to limit our total operating expenses (defined asresearch and development and selling, general and administrative expenses) to$5.0 million. If EBITDA is 25% of target, then the amount available is$6.25 million or 50% of the quarterly maximum and for each percentage ofEBITDA above 25% of target, the

 

 

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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 ofJune 30, 2002, we had borrowed $10.0 million on this facility and had$2.5 million in unutilized amounts. We borrowed an additional $5.0 millionon July 26, 2002, bringing our total borrowings on this senior securedcredit facility to $15.0 million. Ifwe are unable to receive funds as anticipated under this credit facility or ifour capital requirements vary from our current plans, we may require additionalfinancing sooner than we anticipate. An inability in such circumstance to obtainadditional 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 as follows:13.75% of the outstanding principal balance as of December 31, 2003 duringeach quarter in 2004; 25% of the outstanding principal balance as ofDecember 31, 2004 during each quarter in 2005; and all remaining principalby December 31, 2005. In addition, with some exceptions, we are obligatedto use net proceeds from the sale of assets and securities to repay amountsadvanced 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 payments Titan makes reducesamounts available for future borrowing under the credit agreement.  We will pay Titan a monthly fee of 10% ofthe guaranteed monthly payments.  Someof the guaranteed leases have longer terms than the credit facility.  If Titan remains a guarantor at the maturitydate for the credit facility, then we will enter into a reimbursement agreementwith Titan covering the outstanding guarantees.

 

Our operating activitiesused cash of $1.9 million for the six months endedJune 30, 2002, primarily due to a decrease in accounts receivable andreceivable from affiliate of $4.4 million, amortization and depreciationexpense of $9.5 million, which was offset by an increase in inventories of$793,000, $6.0 million in payable to affiliate as well as a decrease of $5.2million related to accounts payable and accrued compensation. The decrease inaccounts receivable principally relates to collection of $19.5 million fromTitan related to the United States Postal Service and the collection of $1.5million from the RESAL contract during the six months ended June 30, 2002. The$21.0 million, collected during the six months ended June 30, 2002,was received in accordance with the milestone payments of the contracts.

 

Our investing activitiesused cash of $6.7 million for the six months ended June 30, 2002,primarily due to the sale of available-for-sale investments of$3.7 million, offset by capital expenditures of $10.1 millionprimarily related to our service centers under construction. Also included incash used for investing activities for the six months ended June 30, 2002 wereadvances to Hawaii Pride aggregating $345,000 for working capital requirements.

 

In June 2001, wereceived an order in the aggregate amount of $50.0 million from RESAL forten electronic food irradiation systems to operate in four service centers inthe Saudi Arabia region for irradiating poultry and disinfesting and prolongingshelf life of dates. We commenced construction on six of these systems forRESAL and have recognized, under the percentage-of-completion method ofaccounting, $13.5 million in revenue which has been recorded on thiscontract through June 30, 2002, of which $1.4 million was recognizedduring the six months ended June 30, 2002. Three electronic foodirradiation systems are scheduled to be shipped in 2002, with the remainder tobe shipped in 2003.  We received apayment of $1.5 million in the second quarter of 2002 based on milestonepayments and expect to continue to receive milestone payments as they becomedue and payable until the contract is complete.

 

InApril 2002, we formed a joint venture under the name SureBeam ME withRESAL.  SureBeam ME will provide, amongother things, food irradiation services through planned service centers in theSaudi Arabia region.  As of June 30,2002, we own a 19.9% interest in SureBeam ME and RESAL owns the remaining80.1%.  We will account for ourownership interest in SureBeam ME using the equity method of accounting underAPB Opinion No. 18 “TheEquity Method of Accounting for Investments in Common Stock.”  In accordnace with the joint ventureagreement, RESAL’s purchase order dated June 2001 may be assigned to the SureBeamME at such time as the joint venture receives sufficient funds from the thirdparty investors.  As a result of ourequity interest in SureBeam ME, we have eliminated 19.9% of the profitrecognized under the percentage-of-completion method of accounting inconnection with the original purchase order. We estimate that the total profit under the original contract will beeliminated as a result of our equity interest in SureBeam ME will beapproximately $2.0 million to $3.0 million. Pursuant to the joint venture agreement, for five years following thedate of SureBeam ME’s commercial registration, SureBeam ME has an exclusiveright of first negotiation to negotiate and enter into agreements to provideirradiation services for the treatment of food products, animal hides andflowers in Egypt, Lebanon, Syria, Iraq, Iran, Libya, Tunesia and Algeria.  The joint venture will govern our strategicrelationship with the operator of these systems, including royalty and managementfees and a minority equity ownership of the operator that will operate theservice 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. During the three months ended June 30, 2002, our purchaseorder from Titan related to the United States Postal Service 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

 

 

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systems to the United States Postal Service. 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 six months ended June 30, 2002.

 

In June 2002, wereceived an order in the aggregate amount of approximately $5.3 million from Son SonCompany, a private food-processing corporation headquartered in Vietnam, for one electronic food irradiationsystem to operate in Vietnam for irradiating shrimp and disinfesting andprolonging shelf life of local fruits. We commenced construction on the systemand have recognized, under the percentage-of-completion method of accounting,$1.6 million in revenue which has been recorded on this contract throughJune 30, 2002, all of which was recognized during the three months ended June30, 2002. We expect to receive milestone payments as they become due andpayable until the contract is complete.

 

Theaccompanying consolidated financial statements contemplate the realization ofassets and the satisfaction of liabilities in the normal course of business.During the six months ended June 30, 2002, we have incurred substantial lossesfrom operations and investments in infrastructure. Management believes that aswe continue to make significant investments in infrastructure, sales andmarketing, it is not anticipated that our revenues will sufficiently offsetthese investments until at least 2003. Additionally, our construction and implementationperiod for systems sales to strategic alliances as well as our service centersand systems require a substantial use of cash for at least 12 to18 months. Our arrangements to sell food irradiation systems to strategicalliances typically contain milestone provisions for payment, which aretypically based upon time, stage of completion, and other factors, where nomaterial uncertainties exist. As a result, our unbilled receivables from ourcustomers have increased $733,000 during the six months ended June 30, 2002.Also in connection with our agreements with our customers, we have advancedfunds aggregating $5.4 million to Hawaii Pride, which was used primarilyfor land acquisition and for working capital purposes. We do not expectsignificant repayments of the advances from Hawaii Pride until at least late2003. We also have entered into a number of commitments to lease land, facilitiesand equipment in connection with construction of two service centers for whichwe have and will continue to expend significant funds for construction of thefacilities and food irradiation systems. We also expect to expend a minimalamount to complete and deliver the system for Texas A&M. In addition, in2002, we expect to begin to expend costs to construct and install two in-linesystems for Cargill Incorporated’s Excel subsidiary that we will own andoperate. The plans for these two systems have not been finalized. We expect toexpend approximately $8.0 million on these two systems once the plans arefinalized with installation and cash expenditures occurring over a 12-monthperiod.

 

Inaddition to our current operating plans, which focus on increasing cash flowfrom operations, we are also evaluating a number of alternative plans to meetour future operating cash needs. These plans include raising additional fundsfrom the capital markets and drawing down on our $50.0 million senior securedcredit facility with Titan. As of the date of the filing of this report, wehave obtained $15.0 million under the senior secured credit facility withTitan. If the funds available under the credit facility and from the capitalmarkets are not sufficient for us or if we are unable to generate sufficientcash flow from operations, we may need to consider additional actions,including reducing or deferring capital expenditures, reducing or deferringresearch and development projects, curtailing construction of systems for customersin advance of payment and reducing marketing expenditures, which actions mayhave a material adverse 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 shareholders.  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 ahigher percentage 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,

 

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Titan converted all of its shares of our Class Bcommon stock, into shares of our Class A common stock. Shareholders ofTitan receiving SureBeam shares in its distribution received only shares ofClass A common stock. Under the terms of the Class B common stock, ithas now been retired and cannot be reissued. As of August 9, 2002,there were 67,297,362 shares of common stock issued and outstanding, allof which are Class A common stock. We have negotiated other agreementswith Titan in connection with our spin-off including a tax sharing anddisaffiliation agreement that will subject us to liability if we sell ourequity or equity linked securities in a manner that causes a change in ourownership of 50% or more in voting power or value as part of Titan’s spin-offplan. This risk could limit our ability to access public equity markets. Inaddition, the recent downturn in the capital markets may limit our ability toraise capital through public equity or debt offerings. If funds from our seniorsecured credit facility or other sources are not sufficient to us and/or if weare unable to generate sufficient cash flow from operations, we may need toconsider additional actions, including reducing or deferring capitalexpenditures, reducing or deferring research and development projects, reducingconstruction of systems for customers in advance of payment and reducingmarketing expenditures. The deferral or cancellation of these projects may havea material adverse impact on our ability to meet our short-term businessobjectives. In order to borrow funds under our senior securedcredit facility, we must be in compliance with our operating expense andcapital expenditure covenants and we may have to curtail these activities to bein compliance with these covenants.

 

At June 30, 2002, wehad $6.4 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 amaterial adverse effect on our results of operations and financial condition.

 

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**ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUTMARKET RISK**

 

Wecurrently are exposed to market risks related to changes in interest rates. Weinvest some of our cash in short-term, interest-bearing, investment gradesecurities. The value of these securities is subject to interest rate risk andcould fall in value if interest rates rise. Titan has extended us a $50.0million senior secured credit facility, which bears interest equal to Titan’seffective weighted average debt rate plus 300 basis points. As ofAugust 14, 2002, we have drawn $15.0 million against this creditfacility. See Note (7) in Notes toConsolidated Financial Statements. At June 30, 2002, theeffective interest rate on this credit facility was 8.5%. We anticipate ourfuture borrowings will have a variable component that will fluctuate asinterest rates change. If market interest rates were to increase immediatelyand uniformly by 10%, there would not be a material impact on our financialcondition or results of operations.

 

 

 

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**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 requireadditional funds to execute our current business plan which includes buildingnew SureBeam® 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 capital requirements,including the continued or increased demand to build our systems in advance ofpayment;

 

•      Unexpected delays in collecting accounts receivablefrom sales of our systems;

 

•      The volume of food processed at our service centersand the fixed costs of operating these facilities at substantially less thancurrent capacity;

 

•      The costs of components for our systems, and theproduction cost of assembling our systems;

 

•      The adequacy of our manufacturing and other facilitiesto meet demand for our products and services;

 

•      The size and complexity of, and the progress in, ourresearch and development programs;

 

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

 

•      The timing, scope and results of market testing byfood processors.

 

**Ourcurrent credit facility may not be sufficient for our capital requirements.**

 

In the past, Titanfinanced a significant portion of our working capital and other capitalrequirements and Titan has extended to us a new $50.0 million senior securedcredit facility secured by substantially all of our assets. This facility issubject to limits in the amounts that can be drawn each quarter, and subject tocertain financial covenants and affirmative and negative covenants. As ofAugust 14, 2002, we have obtained $15.0 million under this seniorsecured credit facility. We cannot give assurance that the $50.0 million seniorsecured credit facility will be adequate for our liquidity needs or that we willbe able to obtain any additional credit on as favorable terms or at all.  We believe our current liquidity, includingthe senior secured credit facility with Titan, will allow us to continue ouroperations through 2003; however, if our capital requirements vary from ourcurrent plans, we may require

 

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additional financing sooner than we anticipate. Weexpect we will need to obtain additional debt or equity financing in order toexecute our business strategy.  Futureequity financings would be dilutive to the existing holders of our commonstock. Future debt financings would most likely involve restrictivecovenants.  Additional financing fromTitan or from third parties may be unavailable to us when needed. If we areunable to obtain future equity financing or debt financing or obtain additionalfunding from Titan or other financing sources on terms acceptable to us or atall or if we are unable to generate sufficient cash flow from operations, webelieve we would have sufficient funds to continue our operations through 2003,but we would have to significantly reduce our current business plan and delay,curtail or eliminate some of our operations or capital expenditures in 2004 andbeyond, which could have a material adverse effect on our results of operationsand 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 of foodirradiation and establish the acceptance of our SureBeam electronic irradiationtechnology;

 

•      Establish and maintain a sufficient number of foodindustry 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 weare unable to successfully achieve broad market acceptance of our SureBeamsystem, we may not be able to generate enough revenues in the future to achieveor sustain 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 June 30, 2002, ten foodprocessors were selling food electronically irradiated by us and the volume offood being processed is still a very small percentage of the market of groundbeef. To date, no market has developed for chicken.  The FDA still has not approved the irradiation of processed food,which represents a substantial potential market. We processed 11.1 millionpounds of food products in 2001, up from 5.9 million pounds processed in2000. Through June 30, 2002, we have processed 6.9 million pounds of foodproducts.  Other food processors are testingour technology and it is uncertain whether or when they will begin commercialproduction, which in some cases depends on obtaining regulatory approval. Wealso do not know whether or when more fast food or other national chainrestaurants or food retailers will decide to offer irradiated meat and createdemand for our electronic irradiation systems. We expect that some foodprocessors will not irradiate food unless industry leaders first commit todistribute 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 byany technology, whether using an electron beam or radioactive isotopes, isopposed by several organized and vocal consumer groups who claim thatirradiated food products are unsafe for consumption or pose a danger to theenvironment. These groups attempt to influence public policy and promoteconsumer opposition to irradiated food through activities such as picketingstores that offer irradiated food and by lobbying politicians. Becauseirradiation of foods by electron beam technology is a new process, consumersneed to be informed about the benefits and safety of food irradiation. Sinceirradiation of food by any method, whether using electron beam or radioactiveisotopes, must be disclosed under the same label “Treated with Radiation” or“Treated by Irradiation,” consumers may fear that our process makes food unsafefor consumption, has unknown future health effects or poses a danger to theenvironment. We risk not being able to overcome these fears through oureducational efforts or to distinguish our process from gamma irradiation. Ifthe public or our potential customers perceive our systems and services asunsafe or undesirable, our systems and services may not gain market acceptance,which would severely limit our ability to market and sell our products. Inaddition, negative public attitudes may prompt state legislatures to prohibitthe sale of irradiated food. Further, consumers may be unwilling to pay for thehigher cost of food products processed by our SureBeam system, which couldnegatively impact the market acceptance of our process.

 

**Wehave a history of losses and we may not achieve or sustain profitability.**

 

We have incurredoperating losses in each quarter since we commenced operations. As ofJune 30, 2002, we had an accumulated deficit of approximately$106.5 million, and our net loss for the first two quarters of 2002 was$14.8 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 deferred compensationof approximately $78.6 million, of which $53.5 million was recognizedas an expense during the year ended December 31, 2001. We will recognizethis charge in accordance with the vesting provisions of the related optionsthrough 2004. This charge will have a significant adverse impact on ourearnings from 2002 to 2004. We expect to derive our future revenues from salesof our SureBeam systems and related food processing services. However, theserevenues are highly uncertain. We expect to devote substantial resources tocontinue our sales and marketing activities, including our consumer brandingefforts, further develop our administrative infrastructure and expand ourresearch and development activities. As a result, we expect that our operatinglosses will increase and that we will incur operating losses through at least2003.

 

**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 ended December 31,1999 revenue from three customers represented approximately 40% of our totalrevenues, for the year ended December 31, 2000 revenue from threecustomers represented approximately 79% of our total revenues, and for the yearended December 31, 2001 revenue from three customers representedapproximately 89% of our total revenues. During the first two quarters of 2002, approximately 80% of our revenueswere from two customers.  Most of thesesystems are not yet fully constructed, installed or integrated and we expect tocontinue 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 ableto derive revenue from new customers or that we will be able to derive incomefrom significant food processing revenues in the future at anticipated levels.

 

 

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**We maybe required to take impairment charges for receivables if a customer defaultson its payment obligations.**

 

We account for ourrevenues derived from sales of electronic food irradiation systems underfixed-price contracts using the percentage-of-completion method. These systemscurrently take a total of approximately 12 to 18 months to design,construct, install, integrate and deliver. Our unbilled receivables from ourcontracts for systems have increased substantially over the past twelve months.If a customer defaults on its payment obligations under a contract accountedfor using the percentage-of-completion method or if we determine that thecontract is otherwise impaired, we would take an impairment charge to earningsfor the receivable 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. The $1.2 million represents the portion of revenuenot associated with the manufacturing of the linear accelerator, as managementbelieves the linear accelerator can be utilized on a future contract withoutsignificant modification costs.

 

**We havenot generated positive cash flow from operations and our cash flow fromoperations may be insufficient to meet operating requirements for theforeseeable future.**

 

We used net cash fromoperations of $17.8 million in 2000 and $49.0 million in 2001.  Through June 30, 2002, we used net cash fromoperations of $1.9 million.  Also,in connection with our agreements with our customers, we have advanced fundsaggregating $5.4 million to a strategic alliance entity in Hawaii Pride tobe used primarily for land acquisition, building construction, and for workingcapital purposes. We do not expect significant repayments of these advancesuntil 2003. We received a progress payment of $1.5 million on the RESALcontract in the second quarter of 2002 and will continue to receive paymentsbased on the payment schedule in the contract. In addition, we have enteredinto a number of commitments to lease land, facilities and equipment inconnection with construction of two service centers for which we have and willcontinue to expend significant funds for construction of the facilities andfood irradiation systems. We expect to expend approximately $8.0 millionto construct and install two in-line systems for Cargill’s Excel subsidiarythat we 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 August 14, 2002, we have obtained $15.0 millionunder this credit facility.  Thisfacility will be subject to limits in the amounts that can be drawn eachquarter, 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 customercontracts for processing generally provide for a term of more than one year,the customers may terminate such contracts with a nominal termination fee andupon short notice, typically one month. If one or more customers that areprocessing a significant volume of products decide to terminate theircontracts, our results of operations would be adversely affected. While atermination of a contract by a customer would not generally release a customerfrom the exclusive provider arrangement in the customer’s contract, wegenerally must release a customer from the exclusive provider arrangement ifthey can find an alternative food irradiation source that can provide acomparable service at a lower price, or if we cannot fully meet the customer’sdemand.

 

**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 contractsfor processing 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 useof our systems to irradiate food is subject to significant governmentregulation that could prohibit the sale of irradiated food in variousjurisdictions, increase the cost of using our products and delay or prevent theuse of our systems and services by our customers.**

 

Food irradiation issubject to significant regulation as a food additive by the FDA. Use of ourSureBeam system, including product labeling, is also subject to regulation bythe U.S. Department of Agriculture’s Food Safety and Inspection Service and byhealth and 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, FDAregulations require that all food that has been irradiated must carry theRadura symbol, an international symbol for irradiation, and state that theproduct has been “Treated with Radiation” or “Treated by Irradiation” on thelabel. States such as Vermont have similar labeling requirements. Theselabeling regulations may increase the risk that consumers will not purchasegoods that have been treated by our products or services, which couldnegatively impact our revenues.

 

FDA regulations alsorequire approval for packaging materials used by our customers. While the FDAhas approved a number of packaging materials, many other materials commonlyused for packaging food have not been approved. Failure or delay in receivingsuch approvals could have a material adverse effect on our customerrelationships and revenues.

 

We also are required toobtain regulatory approval from foreign regulatory authorities before we canoffer our systems and services in those jurisdictions. These jurisdictions may applydifferent criteria than the U.S. regulatory agencies in connection with theirapproval processes. Monitoring changes in, and our compliance with, diverse andnumerous foreign regulatory requirements may increase our costs. Regulatoryapprovals in foreign countries that regulate irradiation are subject to similarrisks and uncertainties as are regulatory approvals in the United States. If weare unable to obtain approval to sell our products and services in thesemarkets, our ability to generate revenues from these markets would be adverselyaffected.

 

 

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A segment of the USDA,the Animal and Plant Health Inspection Service, or APHIS, must approve the useof irradiation for disinfestation of foods to be imported into the UnitedStates. APHIS has given approval and has set forth rules for importation ofcertain irradiated foods from Hawaii to the mainland United States. To date,however, APHIS has not given such approval or set forth rules for any foreign countriesto import irradiated foods into the United States. Some of our potentialcustomers may delay, perhaps indefinitely, the entry into agreements with uspending approval by APHIS for irradiated foods to be imported into the UnitedStates from the customers’ countries. This delay, whether temporary orpermanent, could adversely affect the growth of our revenues derived from ourfood irradiation systems sales and food processing in foreign countries.  For example, if APHIS does not approveimportation of foods into the United States from Brazil, the inability to haveaccess to the key United States market would negatively impact our Brazilianoperations and could have a material adverse effect on our revenues.

 

Our service centers alsoare subject 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.

 

**Effortsto change 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 dependin part on our ability to expand internationally as we obtain regulatoryapprovals to market and sell our SureBeam® systems in other countries. We havereceived an order to install systems in Saudi Arabia and we are building aservice center 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 property rights;

 

•      Changes in foreign currency exchange rates;

 

•      Changes in a specific country’s or region’s politicalor economic conditions, including military action or war in or nearcountries containing our international operations

 

•      Trade protective measures and import or exportlicensing requirements or other restrictive actions by foreign governments;

 

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

 

•      Changes in tax laws.

 

 

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**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 to generaterevenues or profits. We expect that we will need to significantly expand ouroperations to successfully implement our business strategy. As we addmanufacturing, 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 andmanagement controls, and our reporting systems and procedures. In addition, wemust effectively expand, train and manage our employee base. If we fail in ourefforts to manage our internal growth, our business prospects, revenues and profitmargins may suffer.

 

**Weintend to 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 againstseveral companies seeking to address the food safety market. Our electronicfood irradiation technology competes against gamma ray technology andalternatives to irradiation, such as thermal sterilization, fumigation,lactoferrin and chemical washes. We may be unable to compete successfullyagainst our current and potential competitors, which may result in pricereductions, reduced margins and the inability to achieve market acceptance forour products.

 

The current level ofmarket penetration for food irradiation products is relatively low whencompared to the overall size of the food markets to which we are targeting ourfood irradiation 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 onour ability to obtain and maintain patent and other proprietary-rightprotection for our technology and systems and services in the United States andother countries. The laws of some foreign countries do not protect proprietaryrights to the same extent as the laws of the United States, and many companieshave encountered 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.

 

We periodically assessthe strength of our patent and intellectual property protection for ourtechnologies and products. Our electronic food irradiation system combines ourpatented conveyor and shielding systems and proprietary software with publiclyavailable electron beam, x-ray and linear accelerator technology. Despite ourassessments and our belief in the strength of our patent protection forparticular technologies or products, our patents

 

 

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may not provide effective barriers to entry againstcompetitors because our competitors may develop competing technologies andproducts that do not infringe upon our patents. Further, our patents do notcover electron beam, x-ray or linear accelerator technology, which are publiclyavailable. We also could choose to modify or abandon one or more planned orcurrent products because of these assessments or actual or threatened claims byother companies. Our patents or pending patent applications may be challenged,narrowed or invalidated. In addition, we are not certain that our pendingpatent applications will be issued.

 

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 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 onour ability 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 using productsthat incorporate the challenged intellectual property;

 

•      Pay damages; or

 

•      Enter into licensing or royalty agreements that may beunavailable 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 fromproduct recalls. We cannot guarantee that we will be able to avoid productliability exposure.

 

While we currentlymaintain product liability insurance at levels that we believe are sufficientand consistent with industry standards for companies at our stage ofdevelopment, we cannot guarantee that our product liability insurance isadequate. It is also possible that at any time our insurance coverage maybecome unavailable on commercially reasonable terms or at all. A productliability claim or product recall could result in liability to us greater thanour assets and/or insurance coverage. Moreover, product liability claims,recalls and expenses associated with defending against claims or recalls couldhave an adverse impact on us even if we have adequate insurance coverage.Further, a product liability claim against us, whether merited or not, or aproduct recall claim against us would damage our reputation and severelyundermine our branding campaign and our efforts to gain consumer acceptance.

 

 

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**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, ourresults of operations or financial condition could be adversely affected.  Further, our common stock price has been,and may continue to be extremely volatile. When our common stock price is less than the exercise price of stockoptions granted to employees, turnover is likely to increase, which couldadversely affect our results of operations or financial condition.  Additionally, there are several proposals inthe United States Congress and in the accounting industry to requirecorporations to include a compensation expense in their statement of operationsrelating to the issuance of employee stock options.  If such a measure is approved, we may decide to issue fewer stockoptions. As a result, we may be impaired in our efforts to attract and retainnecessary personnel.  We cannot assureyou that we will be successful in attracting, assimilating and retainingadditional qualified personnel in the future. If we were to lose the services of one or more of our key personnel, orif we failed to attract and retain additional qualified personnel, it couldmaterially and adversely affect our customer relationships, competitiveposition and revenues.

 

**Delaysin the construction and installation of our systems could negatively affect ourrevenues.**

 

Our business modeldepends on 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.

 

**Ifour stock price becomes less than $1.00 per share for an extended period, wecould be delisted from the Nasdaq.**

 

Maintaining the listingof our 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 numerousrequirements which must be complied with for a company to maintain itssecurity’s listing on the Nasdaq, one of which is that the minimum bid price ofthe security must be $1.00 or greater per share.  If the price of our common stock were below $1.00 per share for aperiod of 30 or more consecutive business days, the Nasdaq could take action todelist our common stock from the Nasdaq. While the price of our common stock on the Nasdaq has not traded below$1.00 since our initial public offering, we cannot assure you that the price ofour common stock will not fall below $1.00 in the future.  On August 13, 2002, the closing price pershare of our common stock was $1.63.

 

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 securitieswhich 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

 

 

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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 commonstock.  The ownership of penny stock isgenerally considered to subject the owner to greater risks than the ownershipof common stock as a whole due, among other things, to the smaller trading volumein such stocks and to the substantial impact upon the stock’s overall valuewhich results from small stock price variations.

 

**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 willbe required to develop our own credit and other liquidity sources.  Titan has historically provided for ourgeneral corporate and administrative support, which is principally comprised ofadministrative 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 are in the process of developingour own systems and services. However, we may not be able to develop thesesystems or retain these services successfully, at a comparable cost to that asprovided by Titan.

 

**Our business may suffer because we have entered intoaffiliate agreements with Titan that may not have been based on arms’ lengthnegotiations.**

 

Wehave entered 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.

 

Underthe tax allocation agreement, Titan will determine the amount of separatetaxable income and tax liability that we would realize if we filed a separatetax return. 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.

 

**We haveentered into a license agreement with Titan that prevents us from capitalizingon newly discovered uses of our technology in applications that are not relatedto food (excluding water), animal hides and flowers except through amanufacturing 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

 

 

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(excluding water), animalhides and flowers. Applications which we believe are reserved for Titan’s useinclude medical equipment sterilization and sterilization of mail to eliminatethe threat of anthrax contamination.

 

Underthe terms 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 irradiationequipment from us in the future, and should Titan not purchase any electronicirradiation equipment from us, it could have a material adverse effect upon ourfinancial condition and results of operations.

 

**One ofour directors is also a director of Titan, which could cause Titan’s intereststo receive priority over our interests.**

 

One of our directors,Susan Golding, 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 $15.0 million as of August 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 itsshareholders restricts certain of our activities.**

 

For the distribution ofour stock by Titan to qualify as tax-free to Titan, there must not be a changein ownership 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.

 

**Oursales through Titan generally produce lower profit margins than our sales toother parties. A higher percentage of sales through Titan could reduce ouroverall profit margins.**

 

Historically, Titan haspurchased a substantial amount of equipment from us as a subcontractor, inorder to allow Titan to fulfill various contracts, which it has entered into,including certain contracts, which Titan has entered into with the UnitedStates Postal Service. These sales have typically been structured on a fixedprice basis or cost plus basis. Therefore, sales to or through Titan havehistorically, and likely will in the future, carry a lower profit margin thancomparable sales to other parties. A higher percentage of sales through Titancould 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.**

 

Themarket price of our common stock has been subject to significant fluctuationssince the date of our initial public offering on March 16, 2001. Thesefluctuations could continue. Among the factors that could affect our stockprice 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.

 

Thestock markets in general have experienced extreme volatility that has oftenbeen unrelated to the operating performance of particular companies. Thesebroad market fluctuations may adversely affect the trading price of our commonstock.

 

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

 

Our certificate ofincorporation and bylaws and Delaware law contain provisions that could make itharder for a third party to acquire us without the consent of our board ofdirectors. These provisions include a classified board of directors and limitationson actions by our stockholders by written consent. In addition, our board ofdirectors has the right to issue preferred stock without stockholder approval,which could be used to dilute the stock ownership of a potential hostileacquirer. Delaware law also imposes some restrictions on mergers and otherbusiness combinations between us and any holder of 15% or more of ouroutstanding common stock. Although we believe these provisions provide for anopportunity to receive a higher bid by requiring potential acquirers tonegotiate with our board of directors, these provisions apply even if the offermay be considered beneficial by some stockholders.

 

 

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**PARTII-OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

Periodically, we are adefendant in cases incidental to our business activities. Furthermore,providers of products and services to the U.S. government are generally subjectto multiple 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.

 

**Item 2. Changes in Securities and Use of Proceeds**

 

Not applicable.

 

**Item 3. Defaults Upon Senior Securities**

 

Not applicable.

 

**Item 4. Submmission of Matters to a Vote of SecurityHolders**

 

At SureBeam’sAnnual Meeting of Stockholders on May 23, 2002, the following proposals wereadopted by the margins indicated.

 

 

|                                                                                                                                                                            |   | **Number of Shares** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|--------|
|                                                                                                                                                                            |   | **Voted For**        |   | **Withheld** |   |
| 1. To elect two Class I  Directors to hold office until SureBeam’s stockholder’s meeting in 2005 or  until their respective successors have been elected or appointed |   |                 |   |   |   |
| Lawrence A. Oberkfell                                                                                                                                                           |   | 513,444,298          |   | 1,689,064 |   |
| John C. Arme                                                                                                                                                                    |   | 515,060,714          |   | 72,648 |   |

 

|                                                                                                                                     |   | **Number of Shares** |   |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|--------|
|                                                                                                                                     |   | **Voted For**        |   | **Voted Against** |   | **Abstain** |   |
| 2. Approval of the  Amendment of the SureBeam 2000 Stock Option and Incentive Plan.                                                      |   | 512,994,849          |   | 2,097,487 |   | 41,026 |   |
| 3. Ratification of  SureBeam’s selection of KPMG LLP as independent auditors for SureBeam for  fiscal year ending December 31, 2002 |   | 515,070,152          |   | 51,669 |   | 11,541 |   |

** **

**Item 5. Other Information**

 

Subsequent Events

 

**Spin-Offof Ownership Interest by The Titan Corporation**

 

Effective August 5, 2002, Titan distributed allof its shares of our common stock to the shareholders of Titan. Titanpreviously announced that holders of record of Titan common stock as of theclose of business on July 26, 2002, the record date for the distribution,were to receive 0.6986 shares of our common stock for every share of Titancommon stock held.

 

Previously, Titan held over eighty percent of ourcommon stock and held a higher percentage of the voting power due to Titan’sownership of shares of Class B common stock, which had ten votes pershare, as compared to the Class A common stock, which has one vote pershare and is traded on the Nasdaq 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 Class A common stock. Shareholders of Titan receiving our shares inits distribution received only shares of Class A common stock. TheClass B common stock has now been retired and cannot be reissued.

 

In order to accomplish the separation of thebusinesses, we and Titan negotiated a number of new agreements in addition tothe senior credit facility previously discussed. These agreements and amendedagreements include the following:

 

•       *Contract for Purchase and Sale of Equipment.* Titan agreed topurchase all of their requirements for electron beam accelerators from usthrough December 31, 2003 and related integration services through December 31,2002 unless we do not offer competitive pricing or cannot meet requireddelivery schedules. The equipment and services are priced at our cost plus a20% markup unless we agree to an alternative pricing arrangement for a purchaseorder. We have supplied equipment and services under this contract inconnection with Titan’s contract with the U.S. Postal Service and in connectionwith Titan’s medical sterilization business and governmental accelerator business.

 

•       *Tax Allocation Agreement and Tax Disaffiliation and Tax SharingAgreement.* Titan has agreed to pay us for any tax benefits Titanrealizes through their use of net operating losses generated by us while wewere a member of Titan’s consolidated group for federal income tax purposes.Payment is due in the first year in which Titan can use our losses to reduceits taxes and we do not know when such payment may become due. We and Titanalso have allocated responsibility for the payment of taxes we each owe andagreed to reimburse the other party for the tax liabilities we assume. We alsoagree to be responsible for taxes imposed on the spin-off under section 355(e)of the Code that result from our respective actions, including the sale of ourrespective equity securities. We have agreed to share equally any tax that isimposed for reasons other than an action by us or Titan.

 

•       *Employee Benefits Agreement.* From and after thedistribution, our employees will no longer participate in Titan benefits plansand we have offered replacement benefits. We and Titan have entered into anagreement that addresses transition issues and responsibility for employeeclaims arising following the distribution.

 

•       *Subleases.* We have subleased from Titan approximately 70,522square feet used for its service center in Sioux City, Iowa, as well asfacilities in Dublin, California, Omaha, Nebraska and Saudi Arabia. Generally,we are paying Titan sublease payments equal to our monthly expense under theseleases plus a 10% markup. We will continue to seek to have SureBeam substitutedas the direct lessee under each master lease so that the sublease can beterminated.

 

Inaddition, Titan has guaranteed some of our lease obligations, and we areobligated to reimburse Titan for any payments Titan makes under theseguaranties. Any guarantee payments Titan makes reduces amounts available forfuture borrowing under the credit agreement. We will pay Titan a monthly fee of10% of the guaranteed monthly payments. Some of the guaranteed leases havelonger terms than the credit facility. If Titan remains a guarantor at thematurity date for the credit facility, then we will enter into a reimbursementagreement with Titan covering the outstanding guarantees. To date, no amountshave been paid under the guarantees.

 

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

 
| (a) | Exhibits: |
|-----|-----------|

 
| 10.38* |   | Joint  Venture Agreement dated April 30, 2002 between RESAL Saudi Corp. and the  Company.                                                                                                                                                                                                                                                                             |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.39* |   | Senior  Secured Credit Agreement, dated as of August 2, 2002, between The Titan  Corporation, as the Lender, and the Company, as the Borrower.                                                                                                                                                                                                                        |
| 10.40  |   | Tax  Sharing and Disaffiliation Agreement dated as of August 2, 2002 between The  Titan Corporation and the Company.                                                                                                                                                                                                                                                  |
| 10.41  |   | Employee  Benefits Agreement dated as of August 2, 2002 between The Titan Corporation  and the Company.                                                                                                                                                                                                                                                               |
| 10.42  |   | Reimbursement  Agreement dated as of August 2, 2002 between The Titan Corporation and the  Company.                                                                                                                                                                                                                                                                   |
| 10.43  |   | Sub-sub-lease  Agreement dated as of August 2, 2002 between The Titan  Corporation, as Sublandlord, and the Company, as Subtenant, for  certain space located at 2640 Murray Street, Sioux City, Iowa.                                                                                                                                                                |
| 10.44  |   | Sublease  Agreement dated as of August 2, 2002 between The Titan Corporation, as  Sublandlord, and the Company, as Subtenant, for certain space located at 9300  Underwood Avenue, Omaha, Douglas County, Nebraska 68114.                                                                                                                                             |
| 10.45  |   | Sublease  Agreement dated as of August 2, 2002 between The Titan Corporation, as  Sublandlord, and the Company, as Subtenant, for certain space consisting of  approximately 133 square meters and located at King Fahed Road, North to King  Fahed Library, Olaya Area, Riyadh, Kingdom of Saudi Arabia, in the building  commonly known as Abraj Atta’awuneya. |
| 10.46  |   | Sub-sub-lease  Agreement dated as of August 2, 2002 between The Titan Corporation, as  Sublandlord, and the Company, as Subtenant, for certain space located at 6780  Sierra Court, Suite A, Dublin, CA.                                                                                                                                                              |
| 10.47  |   | Sublease  Agreement dated as of August 2, 2002 between The Titan Corporation, as Sublandlord,  and the Company, as Subtenant, for certain space located at 6780 Sierra  Court, Suite R, Q, L and O, Dublin, CA.                                                                                                                                                       |
| 99.1   |   | Periodic  Report Certification by Chief Executive Officer of Quarterly Report on Form  10-Q for the quarterly period ended June 30, 2002.                                                                                                                                                                                                                             |
| 99.2   |   | Periodic  Report Certification by Chief Financial Officer of Quarterly Report on Form  10-Q for the quarterly period ended June 30, 2002.                                                                                                                                                                                                                             |

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*              Confidential treatment has beenrequested for certain portions of this exhibit.  Omitted portions have been filed separately with the Securitiesand Exhange Commission.

 
|   |                                                                                                                                                                                                                                                  |   |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |                                                                                                                                                                                                                                                  |
| (b)    | Reports  on Form 8-K:                                                                                                                                                                                                                            |
|   | (1)  Current report on Form 8-K dated April 9, 2002 to report a change  in Registrant’s certifying accountant from Arthur Andersen LLP to KPMG LLP,  to serve as the Company’s principal public accountants for fiscal year 2002. |
|   |                                                                                                                                                                                                                                                  |
|   | (2)  Current report on Form 8-K dated August 5, 2002 describing the  spin-off of Titan’s ownership interest in SureBeam to Titan’s shareholders.                                                                                  |

 

 

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**SIGNATURES**

 

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

 
| Dated: August 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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