Back to GetFilings.com



Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

Form 10-Q

 


 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the quarterly period ended September 30, 2004.

 

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the transition period from              to             

 

Commission file number 000-22302

 


 

ISCO INTERNATIONAL, INC.

(Name of Registrant as Specified in Its Charter)

 


 

Delaware   36-3688459

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

1001 Cambridge Drive, Elk Grove Village, Illinois   60007
(Address of Principal Executive Offices)   (Zip Code)

 

Registrant’s Telephone Number, Including Are Code (847) 391-9400

 


 

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

 

Indicated by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class


 

Outstanding at October 31, 2004


Common Stock, par value $0.001 per share

Preferred Stock Purchase Rights

  160,428,260

 



Table of Contents

Table of Contents

 

Table of Contents

   i

PART I. FINANCIAL INFORMATION

   1

Item 1. Financial Statements.

   1

Note 2. Realization of Assets

   5

Note 6 – Debt and Financial Position

   8

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations.

   10

Overview

   11

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

   13

Item 4. Controls and Procedures.

   13

PART II. OTHER INFORMATION

   14

Item 1. Legal Proceedings.

   14

Item 6. Exhibits.

   15

Signatures

   15

 

i


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

ISCO INTERNATIONAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

     September 30,
2004


    December 31,
2003


 
     (unaudited)        

Assets:

                

Current Assets:

                

Cash and cash equivalents

   $ 653,476     $ 346,409  

Inventories

     838,881       678,361  

Accounts receivable, net

     538,109       1,169,711  

Prepaid expenses, settlement receivable, and other

     148,465       321,147  
    


 


Total current assets

     2,178,931       2,515,628  

Property and equipment:

                

Property and equipment

     8,936,871       8,957,866  

Less: accumulated depreciation

     (8,785,324 )     (8,256,489 )
    


 


Net property and equipment

     151,547       701,377  

Restricted certificates of deposit

     290,527       40,527  

Intangible assets, net

     14,454,214       14,465,503  
    


 


Total assets

   $ 17,075,219     $ 17,723,035  
    


 


Liabilities and Stockholders’ Equity:

                

Current liabilities:

                

Accounts payable

   $ 144,919     $ 243,647  

Accrued liabilities

     1,643,315       1,536,141  

Current debt

     6,500,000       —    
    


 


Total current liabilities

     8,288,234       1,779,788  

Other long-term debt, less current portion

     —         5,000,000  

Stockholders’ equity:

                

Preferred stock; 300,000 shares authorized; No shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively

     —         —    

Common stock ($.001 par value); 250,000,000 shares authorized; 160,428,260 and 150,149,927 shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively

     160,428       150,150  

Additional paid-in capital (net of unearned compensation)

     163,681,105       160,889,202  

Accumulated deficit

     (155,054,548 )     (150,096,105 )
    


 


Total stockholders’ equity

     8,786,985       10,943,247  
    


 


Total liabilities and stockholders’ equity

   $ 17,075,219     $ 17,723,035  
    


 


 

NOTE: The condensed consolidated balance sheet as of December 31, 2003 has been derived from the audited financial statements for that date, but does not include all of the information and accompanying notes required by accounting principles generally accepted in the United States of America for complete financial statements.

 

See the accompanying Notes which are an integral part of the Condensed Consolidated Financial Statements.

 

1


Table of Contents

ISCO INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

(UNAUDITED)

 

    

Three Months Ended

September 30,


   

Nine Months Ended

September 30,


 
     2004

    2003

    2004

    2003

 

Net sales

   $ 706,600     $ 377,500     $ 1,971,850     $ 1,948,952  

Costs and expenses:

                                

Cost of sales

     464,189       297,995       1,231,331       1,259,942  

Research and development

     319,581       232,281       760,827       756,293  

Selling and marketing

     330,067       214,246       803,818       713,545  

General and administrative

     1,045,932       904,395       3,363,852       5,204,238  
    


 


 


 


Total costs and expenses

     2,159,770       1,648,917       6,159,829       7,934,018  
    


 


 


 


Operating loss

     (1,453,170 )     (1,271,417 )     (4,187,979 )     (5,985,066 )

Other income (expense):

                                

Interest income

     2,442       940       5,665       4,104  

Non-cash interest expense

     —         (217,239 )     (250,297 )     (644,632 )

Other Interest expense

     (262,943 )     (85,481 )     (525,832 )     (211,884 )
    


 


 


 


Other income (expense), net

     (260,501 )     (301,780 )     (770,464 )     (852,412 )
    


 


 


 


Net loss

   $ (1,713,671 )   $ (1,573,197 )   $ (4,958,443 )   $ (6,837,478 )
    


 


 


 


Basic and diluted loss per share

   $ (0.01 )   $ (0.01 )   $ (0.03 )   $ (0.05 )
    


 


 


 


Weighted average number of common shares outstanding

     160,428,260       147,986,340       158,369,510       147,972,619  
    


 


 


 


 

See the accompanying Notes which are an integral part of the Condensed Consolidated Financial Statements.

 

2


Table of Contents

ISCO INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Nine Months ended September 30, 2004

 

(UNAUDITED)

 

     Common Stock

  

Additional
Paid-In

Capital


  

Accumulated
Deficit


   

Total


 
     Number of
Shares


   Amount

       

Balance at December 31, 2003

   150,149,927    $ 150,150    $ 160,889,202    $ (150,096,105 )   $ 10,943,247  

Exercise of Stock Options

   278,333      278      41,539      —         41,817  

Exercise of Warrants

   10,000,000      10,000      1,990,000              2,000,000  

Compensation Expense for Discount on Employee Stock Options / Variable Accounting for Stock Options

   —        —        510,067      —         510,067  

Non-cash Warrant Expense

                 250,297              250,297  

Net Loss

   —        —        —        (4,958,443 )     (4,958,443 )
    
  

  

  


 


Balance at September 30, 2004

   160,428,260    $ 160,428    $ 163,681,105    $ (155,054,548 )   $ 8,786,985  
    
  

  

  


 


 

See the accompanying Notes which are an integral part of the Condensed Consolidated Financial Statements.

 

3


Table of Contents

ISCO INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(UNAUDITED)

 

     Nine Months Ended
September 30,


 
     2004

    2003

 

Operating Activities:

                

Net loss

   $ (4,958,443 )   $ (6,837,478 )

Adjustments to reconcile net loss to net cash used in operating activities:

                

Depreciation and amortization, excluding goodwill

     574,863       628,496  

Non-cash warrant expense

     250,297       644,632  

Non-cash compensation expense

     510,068       712,086  

Changes in operating assets and liabilities

     652,209       2,980,040  
    


 


Net cash used in operating activities

     (2,971,006 )     (1,872,224 )
    


 


Investing Activities:

                

Decrease / (Increase) in restricted certificates of deposit

     (250,000 )     23,409  

Payment of patent costs

     (34,740 )     (73,114 )

Proceeds of sale of property and equipment

     55,153       —    

Acquisition of property and equipment

     (34,158 )     (2,956 )
    


 


Net cash used in investing activities

     (263,744 )     (52,661 )
    


 


Financing Activities:

                

Exercise of Warrants

     2,000,000       —    

Credit Line Proceeds

     1,500,000       2,000,000  

Exercise of stock options

     41,817       16,500  

Payments on other long-term debt

     —         —    
    


 


Net cash provided by financing activities

     3,541,817       2,016,500  
    


 


Increase/(Decrease) in cash and cash equivalents

     307,067       91,615  

Cash and cash equivalents at beginning of period

     346,409       216,119  
    


 


Cash and cash equivalents at end of period

   $ 653,476     $ 307,734  
    


 


 

See the accompanying Notes which are an integral part of the Condensed Consolidated Financial Statements.

 

4


Table of Contents

ISCO INTERNATIONAL, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1 - Basis of Presentation

 

The condensed consolidated financial statements include the accounts of ISCO International, Inc. and its wholly owned subsidiaries, Spectral Solutions, Inc. and Illinois Superconductor Canada Corporation (collectively referred to as the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation.

 

The accompanying interim unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by US GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of results for the interim periods have been included. These interim financial statements and notes included herein should be read in conjunction with the Company’s audited financial statements and notes therein for the year ended December 31, 2003 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”). The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending December 31, 2004.

 

Note 2. Realization of Assets

 

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. However, the Company has sustained substantial losses from operations in recent years, and, although reduced, such losses have continued through the (unaudited) period ended September 30, 2004. In addition, the Company has used, rather than provided, cash in its operations.

 

In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company’s ability to meet its operational and financing requirements on a continuing basis, to maintain present financing, and to succeed in its future operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

 

The Company has incurred, and continues to incur, losses from operations. For the years ended December 31, 2003, 2002, and 2001, the Company incurred net losses of $7,156,075, $13,077,832, and $28,189,603, respectively. The Company incurred an additional net loss of $1,713,671 during the third quarter 2004, and $4,958,443 during the nine months ended September 30, 2004. During the past two years, the Company implemented strategies to reduce its cash used in operating activities. The Company’s strategy included the consolidation of its manufacturing and research and development facilities and a targeted reduction of the employee workforce, increasing the efficiency of the Company’s processes, focusing development efforts on products with a greater probability of commercial sales, expanding its outsourcing of manufacturing strategy, reducing professional fees and discretionary expenditures, and negotiating favorable payment arrangements with suppliers and service providers.

 

5


Table of Contents

To date, the Company has financed its operations primarily through public and private equity and debt financings. During July 2004, the Company reported it drew the remaining $1 million of the credit line and increased the available line by $0.5 million, drawing that amount as well. Subsequent to the reporting date, during November 2004, the Company and its lenders agreed to increase the credit line by another $2 million, $1 million of which was drawn immediately and the other $1 million available at the discretion of the lenders. The Company believes that it has sufficient funds to operate its business as identified herein and to meet its obligations through 2004, and into 2005, depending in part on operating results. The Company intends to look into augmenting its existing capital position.

 

Note 3 - Net Loss Per Share

 

Basic and diluted net loss per share is computed based on the weighted average number of common shares outstanding. Common shares issuable upon the exercise of options are not included in the per share calculations since the effect of their inclusion would be antidilutive.

 

Note 4 - Inventories

 

Inventories consisted of the following:

 

     September 30, 2004

   December 31, 2003

Raw Materials

   $ 297,000    $ 357,000

Work in process

     54,000      67,000

Finished product

     488,000      254,000
    

  

     $ 839,000    $ 678,000
    

  

 

Cost of product sales for the nine months ending September 30, 2004, and the twelve months ending December 31, 2003 include approximately $57,000 and $130,000, respectively, of costs in excess of the net realizable value of inventory.

 

Note 5 - Stock Options and Equity Transactions

 

On August 19, 1993, the Board of Directors adopted the 1993 Stock Option Plan (the “1993 Plan”) for employees, consultants, and directors who are not also employees of the Company (outside directors). This plan reached its ten-year expiration during 2003. During the 2003 annual meeting of shareholders, the Company’s shareholders approved a new 2003 Equity Incentive Plan to take the place of the expiring 1993 Plan (the “2003 Plan”). Unissued options from the 1993 Plan were used to fund the 2003 Plan. The maximum number of shares issuable under these plans was 14,011,468. These plans may be described generally as the “Plan”.

 

For employees and consultants, the Plan provides for granting of Incentive Stock Options (ISOs) and Nonstatutory Stock Options (NSOs). In the case of ISOs, the exercise price shall not be less than 100% (110% in certain cases) of the fair value of the Company’s common stock, as determined by the Compensation Committee or full Board as appropriate (the “Committee”), on the date of grant. In the case of NSOs, the exercise price shall be determined by the Committee, on the date of grant. The term of options granted to employees and consultants will be for a period not to exceed 10 years (five years in certain cases). Options granted under the Plan default to vest over a four-year period (one-fourth of

 

6


Table of Contents

options granted vest after one year from the grant date and the remaining options vest ratably each month thereafter), but the vesting period is determined by the Committee. In addition, the Committee may authorize option grants with vesting provisions that are not based solely on employees’ rendering of additional service to the Company.

 

For outside directors, the Plan provides that each outside director will be automatically granted NSOs on the date of their initial election to the board of directors. On the date of the annual meeting of the stockholders of the Company, each outside director who is elected, reelected, or continues to serve as a director, shall be granted additional NSOs, except for those outside directors who are first elected to the board of directors at the meeting or three months prior. The options granted vest ratably over one or two years, based on the date of grant, and expire after ten years from the grant date.

 

On May 10, 1999, the board of directors granted to each employee of the Company (other than the executive officers of the Company) (collectively, the “Non-Executive Employees”) the option to (i) reduce the exercise prices of up to a maximum of 15,000 of the unexercised stock options previously granted to such Non-Executive Employee under the Plan to $.5625 per share (the closing price of the Company’s common stock on May 10, 1999) and (ii) cause all of such stock options not otherwise scheduled to become fully vested on or before May 10, 2000 to become fully vested on such date. As a result thereof, an aggregate of 279,550 stock options previously granted under the Plan were amended as described in the preceding sentence. In addition, on May 10, 1999 the Board of Directors granted to the executive officers and certain Non-Executive Employees of the Company additional non-statutory stock options to purchase an aggregate of 343,575 shares of the Company’s common stock under the Plan. Such stock options became fully vested on the first anniversary of the date of grant, with exercise prices of $.5625 per share and expire 10 years from the date of grant.

 

On July 1, 2000, Financial Accounting Standards Board Interpretation No. 44, “Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25” (“FIN 44”) was adopted by the Company. FIN 44 requires that stock options that have been modified to reduce the exercise price be subject to variable accounting. The Company accounts for employee stock options under APB Opinion No. 25 and non-employee stock options under Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation” (“SFAS No. 123”).

 

On May 10, 1999, as described above, the Company re-priced certain stock options granted to employees and in accordance with US GAAP, at that time, the Company accounted for the re-priced stock options as “fixed”. As a result of adopting FIN 44, the Company is required to apply variable accounting to these options. If the market price of the Company’s common stock increases above the July 1, 2000 market price, the Company will have to recognize additional compensation expense equal to the increase in stock price multiplied by the number of re-priced options. No additional expense will be recognized if the stock does not exceed the July 1, 2000 value. However, the impact cannot be determined as it is dependent on the change in the market price of the common stock from July 1, 2000 until the stock options are exercised, forfeited, or expire unexercised. Because the stock price on September 30, 2004 was below that of July 1, 2000, no expense has been recognized during the period.

 

On February 5, 2001, the Company’s board of directors authorized the re-pricing of certain “out of the money” stock options granted to employees during the calendar year of 2000 to the closing share price on such date, or $1.9375 per share. This re-pricing causes these options to be subject to variable accounting as described in FIN 44. Because the stock price on September 30, 2004, was lower than the re-priced strike price no gain or loss was recognized during the period.

 

On April 1, 2002, the Company’s board of directors authorized the re-pricing of certain “out of the money” stock options granted to employees. A new strike price of $0.81 per share was established, provided the respective employees remain with the Company for at least six months following the re-pricing date. In addition, certain stock options granted to directors were repriced, with a new strike price of $1.00 per share. As the stock price on September 30, 2004 was lower than the re-priced strike price no gain or loss was recognized during the period.

 

7


Table of Contents

On February 15, 2002, the Company completed a Shareholder Rights Offering. Approximately $20 million was raised from existing shareholders as of the recording date in exchange for the issuance of approximately 40 million shares of the Company’s common stock. A portion of the proceeds were then used to repay in full $9.8 million of debt and related accrued interest, as well as the payment of various other accrued expenses.

 

On October 31, 2003, the Company’s board of directors authorized the re-pricing of certain “out of the money” stock options granted to non-employee directors. A new strike price of $0.24 per share was established. This price was based on the closing price of the Company’s common stock as reported on the American Stock Exchange on October 1, 2003. The closing price of the Company’s common stock on October 31, 2003 was $0.20 per share.

 

During 2004, the Company’s board of directors granted 3,975,000 new stock options to the Company’s employees, including officers, and directors. The majority of the grants to employees, including officers, were priced at 25% of the average closing price of the Company’s common stock as reported on the American Stock Exchange over ten trading days prior to the date of grant. Due to the resulting discount, $325,000 and $867,000 of compensation expense was recognized during the third quarter and first nine months, respectively, of 2004.

 

Certain options granted prior to 2004 were deemed subject to variable accounting. As such, a charge of $418,000 was recognized during the fourth quarter 2003 to reflect the $0.55 closing price of the Company’s common stock as of December 31, 2003. Because the closing price of the Company’s common stock on March 31, 2004 was $0.44 per share, $168,000 of this amount was reversed during the first quarter 2004. Due to the closing price of the Company’s common stock on June 30, 2004 of $0.40 per share, an additional $61,000 of this amount was reversed during the second quarter 2004. Because the closing price of the Company’s common stock on September 30, 2004 was $0.28 per share, an additional $128,000 of the original charge was reversed during the third quarter 2004. During July 2003, the board of directors cancelled approximately 2.8 million outstanding options held by certain Company employees, including officers.

 

Note 6 – Debt and Financial Position

 

As of the reporting date, the Company had drawn $6.5 million of debt financing under a credit line, as described below. During October 2002, the Company entered into an Uncommitted Line of Credit with its two largest shareholders, an affiliate of Elliott Associates, L.P. (Manchester Securities Corporation) and Alexander Finance, L.P. This line originally provided up to $4 million to the Company. This line was uncommitted, such that each new borrowing under the facility would be subject to the approval of the lenders. Borrowings on this line bore an interest rate of 9.5% and are collateralized by all the assets of the Company. Outstanding loans under this agreement would be required to be repaid on a priority basis should the Company receive new funding from other sources. Additionally, the lenders were entitled to receive warrants to the extent funds were drawn down on the line. The warrants bore a strike price of $0.20 per share of common stock and were to expire on April 15, 2004. The credit line was to mature and be due, including accrued interest thereon, on March 31, 2004. Due to an agreement between the parties that did not provide warrants with respect to the most recent borrowings, a maximum of 10 million warrants were issued as a result of this transaction. During February 2004, the warrant holders exercised all of their warrants, contributing $2 million to the Company in exchange for 10 million shares of common stock.

 

8


Table of Contents

According to existing accounting pronouncements and SEC guidelines, the Company allocated the proceeds of these borrowings between their debt and equity components. As a result of these borrowings during 2002, the Company has recorded a non-cash charge of $1.2 million through the outstanding term of the warrants (fully exercised as of March 31, 2004). The final $250,000 of that amount was recorded during the quarter ended March 31, 2004.

 

During October 2003, the Company entered into an agreement with its lenders to supplement the credit line with an additional $2 million, $1 million of which was drawn immediately and $1 million available to be drawn upon the Company’s request and subject to the approval of the lenders. This supplemental facility bore a 14% rate of interest and was due October 31, 2004. Unlike the previous credit line, the supplemental facility did not include any stock warrants. The term of the previous credit line was not affected by this supplement, and as such the $4 million borrowed under that line, plus accrued interest, remained due March 31, 2004.

 

During February 2004, these credit lines were extended to a due date of April 2005, with interest after the initial periods to be charged at 14%. No warrants or other inducements were issued with respect to these extensions. Additionally, as noted above, the lenders exercised their 10 million warrants during February 2004, agreeing to let the Company use the funds for general purposes as opposed to repaying debt.

 

During July 2004, the Company and its lenders agreed to increase the amount available under the credit line by $0.5 million, and for the Company to draw the remaining $1.5 million available under the credit line. Subsequent to the reporting date, during November 2004, the Company and its lenders agreed to increase the credit line by another $2 million, $1 million of which was drawn immediately and the other $1 million available at the discretion of the lenders.

 

Note 7 – Stock Based Compensation

 

The Company has a stock-based employee compensation plan, which is more fully described in Note 5. The Company accounts for its stock-based compensation plan under Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, which allows companies to apply the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and provide pro forma net income and net income per share disclosures for employee stock option grants as if the fair value method defined in SFAS No. 123 had been applied. The Company applies the intrinsic value method for accounting for stock-based compensation as outlined in APB Opinion No. 25.

 

Stock expense for the first nine months of 2004 and 2003, respectively, includes the result of options issued with an exercise price below the underlying stock’s market price. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement 123, Accounting for Stock-Based Compensation as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123, using the assumptions described in Note 5, to its stock-based employee plans:

 

($000’s)


   Three Months Ended September 30,

   2004

   2003

Net loss, as reported

   $ 1,714    $ 1,573

Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects

     197      89

Less: Total stock-based employee compensation determined under fair value based method for awards granted, modified, or settled, net of related tax effects

     315      19

Pro forma net loss

   $ 1,832    $ 1,503

Loss per share:

             

Basic – as reported

   $ 0.01    $ 0.01

Basic – pro forma

   $ 0.01    $ 0.01

Diluted – as reported

   $ 0.01    $ 0.01

Diluted – pro forma

   $ 0.01    $ 0.01

 

9


Table of Contents

(. $000’s)


   Nine Months Ended September 30,

   2004

   2003

Net loss, as reported

   $ 4,958    $ 6,837

Add: Stock-based employee compensation expense included in reported net loss, net of related tax effects

     510      712

Less: Total stock-based employee compensation determined under fair value based method for awards granted, modified, or settled, net of related tax effects

     709      1,513

Pro forma net loss

   $ 5,157    $ 7,638

Loss per share:

             

Basic – as reported

   $ 0.03    $ 0.05

Basic – pro forma

   $ 0.03    $ 0.05

Diluted – as reported

   $ 0.03    $ 0.05

Diluted – pro forma

   $ 0.03    $ 0.05

 

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations.

 

General

 

The following is a discussion and analysis of the historical results of operations and financial condition of the Company and factors affecting the Company’s financial resources. This discussion should be read in conjunction with the financial statements, including the notes thereto, set forth herein under “Part I. - Financial Information” and “Item 1. Financial Statements” and in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003. This discussion contains forward-looking statements which involve certain risks, uncertainties and contingencies which could cause the Company’s actual results, performance or achievements to differ materially from those expressed, or implied, by such forward-looking statements. Such factors include those described in “Risk Factors” included in the Company’s Annual Report on Form 10-K. The forward-looking statements included in this report may prove to be inaccurate. In light of the significant uncertainties inherent in these forward-looking statements, you should not consider this information to be a guarantee by the Company or any other person that our objectives and plans will be achieved.

 

10


Table of Contents

The Company provides a wide array of solutions to primarily optimize the reverse link for the wireless telecommunications industry. Reverse link is the signal from the mobile device to the base station. Reverse link problems often lead to dropped calls, ineffective attempts, high mobile transmit power, capacity reduction and coverage “dead zone” areas. The Company solves these problems utilizing its adaptive notch filter (“ANF”) technology, its value-leading Reverse link Radio Frequency Fidelity (“RF²”) technology, and a variety of other products and services.

 

The continuing development of, and expansion in, sales of the Company’s RF product lines, as well as the continued defense of its intellectual property, may require a commitment of funds to undertake product line development and potentially the expansion of manufacturing capabilities and to market and sell its RF front-end products. The actual amount of the Company’s future funding requirements will depend on many factors, including: the amount and timing of future revenues, the level of product marketing and sales efforts to support the Company’s commercialization plans, the magnitude of its research and product development programs, the ability of the Company to improve or maintain product margins, the potential cost of additional plant and equipment for manufacturing and the costs involved in protecting the Company’s patents or other intellectual property.

 

The Company was founded in 1989 by ARCH Development Corporation, an affiliate of the University of Chicago, to commercialize superconductor technologies initially developed by Argonne National Laboratory. The Company was incorporated in Illinois on October 18, 1989 and reincorporated in Delaware on September 24, 1993. Its facilities and principal executive offices are located at 1001 Cambridge Drive, Elk Grove Village, Illinois 60007 and telephone number is (847) 391-9400.

 

Overview

 

The Company has shifted from manufacturing in-house to an outsourced manufacturing model. Its products are designed for efficient production in this manner, emphasizing solid-state electronics over mechanical devices with moving parts. The decrease in cost associated with these developments, coupled with enhanced product functionality, has allowed the Company to realize improved margins. Extensions of developed technology, based on substantial input from customers, have allowed the Company to launch the RF² product family and consider additional solutions while controlling total Research and Development (“R&D”) cost. The Company announced during the first nine months of 2004 the resolution of the Laves litigation, the receipt of $2 million from the exercise of all outstanding warrants (which were related to the credit line), and the expansion of that credit line including the extension of its credit line debt maturity date from March and October 2004 to April 2005. Despite these improvements, the wireless telecommunications industry is subject to risks beyond the Company’s control that can negatively impact customer capital spending budgets and/or spending patterns. Despite cultivating more business opportunities during the first nine months of 2004 than in the past and some improvement in results during the course of the year, total revenue from closed and shipped business was less than expected during the period. While the Company views the varied reasons for this difficulty to be temporary in nature, nonetheless, for these and other reasons the Company’s financial statements have been prepared assuming the Company will continue as a going concern.

 

Results of Operations

 

Three Months Ended September 30, 2004 and 2003

 

The Company’s net sales increased by $329,000, or 87%, to $707,000 for the three months ended September 30, 2004 from $378,000 for the same period in 2003. This increase was due to increased sales of the Company’s RF² product family. The Company anticipates receipt of customer orders to increase over these levels during the fourth quarter of 2004 and beyond due to the expansion of its solutions portfolio and a number of industry developments, including the build-out of high speed data networks.

 

11


Table of Contents

Cost of sales increased by $166,000, or 56%, to $464,000 for the three months ended September 30, 2004 from $298,000 for the same period in 2003. The increase in cost of sales was due primarily to the increase in sales volume.

 

The Company’s R&D expenses increased by $88,000, or 38%, to $320,000 for the three months ended September 30, 2004, from $232,000 for the same period in 2003. The recent addition of personnel and resources in this area to enhance the Company’s portfolio of solutions has caused an increase in R&D expense as compared to the first six months of 2004.

 

Selling and marketing expenses increased by $116,000, or 54%, to $330,000 for the three months ended September 30, 2004, from $214,000 for the same period in 2003. This increase was due to the recent addition of personnel and resources in this area.

 

General and administrative expenses increased by $142,000, or 16%, to $1,046,000 for the three months ended September 30, 2004, from $904,000 for the same period in 2003. This increase was attributable to an increase in non-cash compensation expense and the timing of legal expenses with respect to the patent litigation appeal with Superconductor Technologies, Inc.

 

Nine Months Ended September 30, 2004 and 2003

 

The Company’s net sales increased $23,000, or 1%, to $1,972,000 for the nine months ended September 30, 2004 from $1,949,000 for the same period in 2003. This increase was due to increased sales of the Company’s RF² product family during 2004. The Company expects the receipt of customer purchase orders to increase during the fourth quarter 2004 and beyond due to the expansion of its solutions portfolio and a number of industry developments, including the build-out of high speed data networks.

 

Cost of sales decreased by $29,000, or 2%, to $1,231,000 for the nine months ended September 30, 2004 from $1,260,000 for the same period in 2003. The decrease in cost of sales was due to the continuation of the Company’s outsourced manufacturing program and other cost control measures adopted during the previous year.

 

The Company’s R&D expenses increased by $5,000, or 1%, to $761,000 for the nine months ended September 30, 2004, from $756,000 for the same period in 2003. The Company expects full year R&D expenses to be slightly higher than the prior year due to resource additions to enhance the Company’s portfolio of solutions during 2004 .

 

Selling and marketing expenses increased by $90,000, or 13%, to $804,000 for the nine months ended September 30, 2004, from $714,000 for the same period in 2003. This increase was due to 2004 additions to personnel and activities. The Company expects full year selling and marketing costs to be higher than the prior year for the same reason.

 

General and administrative expenses decreased by $1,840,000, or 35%, to $3,364,000 for the nine months ended September 30, 2004, from $5,204,000 for the same period in 2003. This decrease was attributable largely to a reduction in legal expenses related to the patent litigation with Superconductor Technologies, Inc., and also to a decrease in expenses due to cost management programs.

 

12


Table of Contents

Liquidity and Capital Resources

 

At September 30, 2004, the Company’s cash and cash equivalents were $653,000, an increase of $307,000 from the balance at December 31, 2003 of $346,000. This increase was due to the timing of cash flows and various expenses offset by the draw of $1.5 million on the Company’s credit line during July 2004 and the exercise of $2 million in warrants during February 2004.

 

The continuing development of, and expansion in, sales of the Company’s interference management solutions product lines will require a commitment of additional funds. The actual amount of the Company’s future funding requirements will depend on many factors, including: the amount and timing of future revenues, the level of product marketing and sales efforts to support the Company’s commercialization plans, the magnitude of the Company’s research and product development programs, the ability of the Company to improve product margins, the cost of additional plant and equipment for manufacturing and the costs involved in protecting the Company’s patents or other intellectual property.

 

To date, the Company has financed its operations primarily through public and private equity and debt financings. During July 2004, the Company reported it drew the remaining $1 million of the credit line and increased the available line by $0.5 million, drawing that amount as well. Subsequent to the reporting date, during November 2004, the Company and its lenders agreed to increase the credit line by another $2 million, $1 million of which was drawn immediately and the other $1 million available at the discretion of the lenders. The Company believes that it has sufficient funds to operate its business as identified herein and to meet its obligations through 2004, and into 2005, depending in part on operating results. The Company intends to look into augmenting its existing capital position.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

The Company does not have any material market risk sensitive instruments.

 

Item 4. Controls and Procedures.

 

(a) An evaluation was performed under the supervision and with the participation of the Company’s management, including its Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, of the effectiveness of the Company’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of September 30, 2004. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act, is recorded, processed, summarized and reported as specified in Securities and Exchange Commission rules and forms.

 

(b) There were no significant changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

13


Table of Contents

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

Patent Litigation

 

In July 2001, the Company filed suit in the United States District Court for the District of Delaware against Conductus, Inc. and Superconductor Technologies, Inc. alleging infringement of U.S. Patent No. 6,263,215, entitled “Cryoelectronically Cooled Receiver Front End for Mobile Radio Systems” (“the ‘215 patent”). This suit alleges that Conductus’ and Superconductor Technologies’ base station front-end systems containing cryogenically cooled superconducting filters infringe this patent. The Company seeks a permanent injunction enjoining Conductus and Superconductor Technologies from marketing, selling or manufacturing these products, as well as triple damages and attorneys fees. Conductus and Superconductor Technologies denied these allegations and asked the court to enter a judgment that the patent is invalid and not infringed. Conductus and Superconductor Technologies also asserted the defense of inequitable conduct and a counterclaim for a declaration that the patent is unenforceable as well as federal and state law counterclaims, including claims of unfair competition. Conductus and Superconductor Technologies sought both compensatory and punitive damages as well as attorneys fees and costs.

 

On March 26, 2002, the Company replied to Conductus’ and Superconductor Technologies’ Second Amended Answer and Counterclaims and filed counterclaims alleging that Conductus and Superconductor Technologies also infringe U.S. Patent No. 6,104,934 entitled “Cryoelectronic Receiver Front End” and U.S. Patent No. 6,205,340 B1 entitled “Cryoelectronic Receiver Front End For Mobile Radio Systems”. On April 17, 2002, the court dismissed these (the Company’s) counterclaims without prejudice to the Company’s right to assert these counterclaims in a separate action.

 

On February 10, 2003, the court disposed of various motions for summary judgment filed by each party. The court denied Superconductor Technologies’ motion for summary judgment of invalidity of the ‘215 patent as well as Conductus’ motion for summary judgment limiting computation of damages to a reasonable royalty for sales to Dobson Communications, Inc. On Superconductor Technologies’ motion for summary judgment of non-infringement, the court granted the motion with respect to claim 13 of the ‘215 patent and otherwise denied the motion with respect to each of the other asserted claims. With regard to Conductus’ motion for summary judgment of non-infringement, the court granted the motion with respect to claim 13 of the ‘215 patent and otherwise denied the motion with respect to each of the other asserted claims. In addition, the court denied Conductus’ motion for summary judgment of invalidity of all asserted claims for causes of action existing prior to the date of issuance of the certificate of correction and of invalidity of claim 13. The court also denied the Company’s motions for summary judgment that Superconductor Technologies’ internal projects are not prior art to the ‘215 patent and to dismiss the defendants’ counterclaims alleging unfair competition and interference with business relations.

 

On April 3, 2003, the jury returned with its verdict. The jury rejected the Company’s positions and determined its patent to be invalid. Additionally, the jury determined that inequitable conduct had occurred and subsequently awarded defendants $3.87 million in damages from the Company. The Company was severely disappointed by this verdict and it engaged in the post-trial motion process to overturn it. On August 21, 2003, the court issued its ruling on the post-trial motions. The court overturned the jury’s determination of unfair competition on the part of the Company and denied all requests for damages, including the $3.87 million jury award cited above. The court did not, however, overturn the jury determinations of patent invalidity and unenforceability based on inequitable conduct and denied ISCO’s motion for a new trial.

 

During September 2003, the Company filed an appeal of this verdict requesting the reinstatement of its patent and the rights inherent within that patent, and Superconductor Technologies, Inc. filed a cross-appeal requesting reinstatement of the jury award and attorney’s fees. This process is ongoing.

 

As of the date of this filing each party has filed briefs with the court and an appearance in front of a three-judge panel is scheduled for December 6, 2004.

 

14


Table of Contents

The Company intends to continue to prosecute its claims vigorously on appeal and continue to defend against defendants’ counterclaims. The Company believes the patent to be valid, the counterclaims asserted against the Company to be without merit, and that it is in the best interests of the Company and its shareholders to pursue this matter vigorously.

 

In November 2001, the Company filed suit against Dobson Communications, Inc. for allegedly infringing this patent. The action has been stayed, per agreement between the parties, until resolution of the matter between the Company and Conductus and Superconductor Technologies. The parties have agreed that Dobson Communications will be bound by any and all final, non-appealable determinations, holdings or findings with respect to all liability issues in the Company’s case against Conductus.

 

Item 6. Exhibits.

 

31.1 Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2 Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

Signatures

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on the 15th day of November, 2004.

 

ISCO International, Inc.
By:  

/s/ Amr Abdelmonem


    Amr Abdelmonem
    Chief Executive Officer
    (Principal Executive Officer)
By:  

/s/ Frank J. Cesario


    Frank J. Cesario
    Chief Financial Officer
    (Principal Financial and Accounting Officer)

 

15


Table of Contents

EXHIBIT INDEX

 

31.1 Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2 Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

16