ISCO International Inc. 10Q 9-30-2006
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, 2006.
o
|
TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934.
|
For
the
transition period from __________ to __________
Commission
file number 001-22302
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 Area 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 o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer
and large accelerated filer” in Rule
12b-2 of
the Exchange Act).
Large
accelerated filer o
|
Accelerated
filer o
|
Non-accelerated
filer x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.): Yes o 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 November 1, 2006
|
Common
Stock, par value $0.001 per share
Preferred
Stock Purchase Rights
|
186,767,033
|
|
1
|
|
|
|
|
|
1
|
|
|
|
|
|
1
|
|
|
|
|
|
2
|
|
|
|
|
|
3 |
|
|
|
|
|
4
|
|
|
|
|
|
5
|
|
|
|
|
|
14
|
|
|
|
|
|
17
|
|
|
|
|
|
17
|
|
|
|
|
17
|
|
|
|
|
|
17
|
|
|
|
|
|
18
|
|
|
|
|
|
19
|
|
|
|
Certifications
|
|
|
ISCO
INTERNATIONAL, INC.
CONDENSED
CONSOLIDATED BALANCE
SHEETS
|
|
September
30,
2006
|
|
December
31,
2005
|
|
|
|
(unaudited)
|
|
|
|
Assets:
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
4,173,382
|
|
$
|
3,486,430
|
|
Accounts
receivable, net
|
|
|
5,525,774
|
|
|
1,677,334
|
|
Inventories,
net
|
|
|
2,908,698
|
|
|
2,715,170
|
|
Prepaid
expenses and other
|
|
|
120,006
|
|
|
253,167
|
|
Total
current assets
|
|
|
12,727,860
|
|
|
8,132,101
|
|
Property
and equipment:
|
|
|
|
|
|
|
|
Property
and equipment
|
|
|
1,156,434
|
|
|
1,037,432
|
|
Less:
accumulated depreciation and amortization
|
|
|
(785,289
|
)
|
|
(720,142
|
)
|
Net
property and equipment
|
|
|
371,145
|
|
|
317,290
|
|
|
|
|
|
|
|
|
|
Restricted
certificates of deposit
|
|
|
161,766
|
|
|
242,180
|
|
Goodwill
|
|
|
13,370,000
|
|
|
13,370,000
|
|
Intangible
assets, net
|
|
|
837,703
|
|
|
844,062
|
|
Total
assets
|
|
$
|
27,468,474
|
|
$
|
22,905,633
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity:
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
1,609,996
|
|
$
|
416,095
|
|
Inventory-related
material purchase accrual
|
|
|
236,565
|
|
|
530,134
|
|
Employee-related
accrued liabilities
|
|
|
352,451
|
|
|
208,408
|
|
Accrued
professional services
|
|
|
50,443
|
|
|
279,000
|
|
Current
portion of Long Term Debt, including related interest, with related
parties
|
|
|
11,100,457
|
|
|
-
|
|
Other
accrued liabilities
|
|
|
225,875
|
|
|
301,923
|
|
Total
current liabilities
|
|
|
13,575,787
|
|
|
1,735,560
|
|
|
|
|
|
|
|
|
|
Deferred
facility reimbursement
|
|
|
106,250
|
|
|
118,988
|
|
Notes
and related accrued interest with related parties
|
|
|
5,066,255
|
|
|
10,520,369
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
Preferred
stock; 300,000 shares authorized; No shares issued and outstanding
at
September 30, 2006 and December 31, 2005
|
|
|
—
|
|
|
—
|
|
Common
stock ($.001 par value); 250,000,000 shares authorized; 186,597,533
and
183,252,036 shares issued and outstanding at September 30, 2006 and
December 31, 2005, respectively
|
|
|
186,597
|
|
|
183,252
|
|
Additional
paid-in capital (net of unearned compensation)
|
|
|
171,671,854
|
|
|
170,387,752
|
|
Accumulated
deficit
|
|
|
(163,138,269
|
)
|
|
(160,040,288
|
)
|
Total
stockholders’ equity
|
|
|
8,720,182
|
|
|
10,530,716
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
27,468,474
|
|
$
|
22,905,633
|
|
NOTE:
The
condensed consolidated balance sheet as of December 31, 2005 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.
ISCO
INTERNATIONAL, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF
OPERATIONS
(UNAUDITED)
|
|
Three
Months Ended
September
30,
|
|
Nine
Months Ended
September
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Net
sales
|
|
$
|
6,433,439
|
|
$
|
2,037,369
|
|
$
|
11,205,308
|
|
$
|
7,814,649
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
3,850,012
|
|
|
772,406
|
|
|
6,739,266
|
|
|
3,888,088
|
|
Research
and development
|
|
|
452,435
|
|
|
419,713
|
|
|
1,390,374
|
|
|
1,320,873
|
|
Selling
and marketing
|
|
|
989,329
|
|
|
450,444
|
|
|
2,472,426
|
|
|
1,262,315
|
|
General
and administrative
|
|
|
1,093,683
|
|
|
824,342
|
|
|
3,152,763
|
|
|
2,587,643
|
|
Total
costs and expenses
|
|
|
6,385,460
|
|
|
2,466,905
|
|
|
13,754,830
|
|
|
9,058,919
|
|
Operating
income / (loss)
|
|
|
47,979
|
|
|
(429,536
|
)
|
|
(2,549,522
|
)
|
|
(1,244,270
|
)
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
45,872
|
|
|
28,872
|
|
|
97,885
|
|
|
37,326
|
|
Interest
expense
|
|
|
(261,007
|
)
|
|
(195,500
|
)
|
|
(646,344
|
)
|
|
(681,960
|
)
|
|
|
|
(215,135
|
)
|
|
(166,628
|
)
|
|
(548,459
|
)
|
|
(644,634
|
)
|
Net
loss
|
|
$
|
(167,156
|
)
|
$
|
(596,164
|
)
|
$
|
(3,097,981
|
)
|
$
|
(1,888,904
|
)
|
Basic
and diluted loss per share
|
|
$
|
(0.00
|
)
|
$
|
(0.00
|
)
|
$
|
(0.02
|
)
|
$
|
(0.01
|
)
|
Weighted
average number of common shares outstanding
|
|
|
186,105,594
|
|
|
176,030,424
|
|
|
184,705,066
|
|
|
167,158,764
|
|
See
the
accompanying Notes which are an integral part of the Condensed Consolidated
Financial Statements.
ISCO
INTERNATIONAL, INC.
CONDENSED
CONSOLIDATED STATEMENT OF STOCKHOLDERS’
EQUITY
Nine
Months ended September 30, 2006
(UNAUDITED)
|
|
Common
Stock
|
|
Additional
Paid-In
Capital
|
|
Accumulated
Deficit
|
|
Total
|
|
|
|
Number
of
Shares
|
|
Amount
|
|
|
|
|
|
|
|
Balance
at December 31, 2005
|
|
|
183,252,036
|
|
$
|
183,252
|
|
$
|
170,387,752
|
|
$
|
(160,040,288
|
)
|
$
|
10,530,716
|
|
Exercise
of Stock Options and vesting of Restricted Shares
|
|
|
3,345,497
|
|
|
3,345
|
|
|
254,555
|
|
|
—
|
|
|
257,900
|
|
Equity
Compensation Expense
|
|
|
—
|
|
|
—
|
|
|
1,026,423
|
|
|
|
|
|
1,026,423
|
|
Short
Swing Profit Recovery
|
|
|
—
|
|
|
—
|
|
|
3,124
|
|
|
—
|
|
|
3,124
|
|
Net
Loss
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(3,097,981
|
)
|
|
(3,097,981
|
)
|
Balance
at September 30, 2006
|
|
|
186,597,533
|
|
$
|
186,597
|
|
$
|
171,671,854
|
|
$
|
(163,138,269
|
)
|
$
|
8,720,182
|
|
See
the
accompanying Notes which are an integral part of the Condensed Consolidated
Financial Statements.
ISCO
INTERNATIONAL, INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH
FLOWS
(UNAUDITED)
|
|
Nine
Months Ended
September
30,
|
|
|
|
2006
|
|
2005
|
|
Operating
Activities:
|
|
|
|
|
|
Net
loss
|
|
$
|
(3,097,981
|
)
|
$
|
(1,888,904
|
)
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization, excluding goodwill
|
|
|
105,990
|
|
|
103,774
|
|
Patent-related
charge
|
|
|
0
|
|
|
199,819
|
|
Non-cash
compensation expense
|
|
|
1,026,423
|
|
|
784,563
|
|
Changes
in operating assets and liabilities
|
|
|
(2,535,432
|
)
|
|
(739,120
|
|
Net
cash used in operating activities
|
|
|
(4,501,000
|
)
|
|
(1,539,868
|
)
|
Investing
Activities:
|
|
|
|
|
|
|
|
Decrease
/ (Increase) in restricted certificates of deposit
|
|
|
80,414
|
|
|
51,027
|
|
Payment
of patent costs
|
|
|
(32,547
|
)
|
|
(28,503
|
)
|
Acquisition
of property and equipment
|
|
|
(120,939
|
)
|
|
(65,717
|
)
|
Net
cash used in investing activities
|
|
|
(73,072
|
)
|
|
(43,193
|
)
|
Financing
Activities:
|
|
|
|
|
|
|
|
Proceeds
from equity issuance
|
|
|
0
|
|
|
4,300,000
|
|
Proceeds
from Section16b recovery
|
|
|
3,124
|
|
|
607,223
|
|
Proceeds
from debt issuance
|
|
|
5,000,000
|
|
|
1,000,000
|
|
Exercise
of stock options/vesting of restricted stock grants
|
|
|
257,900
|
|
|
267,117
|
|
Net
cash provided by financing activities
|
|
|
5,261,024
|
|
|
6,174,340
|
|
Increase
in cash and cash equivalents
|
|
|
686,952
|
|
|
4,591,279
|
|
Cash
and cash equivalents at beginning of period
|
|
|
3,486,430
|
|
|
402,391
|
|
Cash
and cash equivalents at end of period
|
|
$
|
4,173,382
|
|
$
|
4,993,670
|
|
See
the
accompanying Notes which are an integral part of the Condensed Consolidated
Financial Statements.
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
“we,” “us,” the “Company,” or “ISCO”). All significant intercompany balances and
transactions have been eliminated in consolidation.
The
accompanying unaudited condensed consolidated financial statements have been
prepared by us 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
USGAAP for complete financial statements. In our opinion, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation of results for the interim periods have been included. These
financial statements and notes included herein should be read in conjunction
with our audited financial statements and notes for the year ended December
31,
2005 included in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission (“SEC”). The results of operations for the interim periods
presented are not necessarily indicative of the results to be expected for
any
subsequent quarter of for the entire year ending December 31, 2006. For further
information, refer to the financial statements, including the notes thereto,
included in our Annual Report on Form 10-K for the fiscal year ended December
31, 2005.
Recent
Accounting Pronouncements
In
November 2004, the FASB issued SFAS No.151, “Inventory Costs - an amendment of
ARB No.43, Chapter 4.” This statement amends the guidance in Accounting Research
Bulletin (ARB) No.43, Chapter 4, “Inventory Pricing,” to clarify the accounting
for abnormal amounts of idle facility expense, freight, handling costs and
wasted material (spoilage) and requires that those items be recognized as
current-period charges regardless of whether they meet the criterion of “so
abnormal.” The statement also requires that allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production facilities. The provisions of this statement are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005
(as
of January 1, 2006 for the Company) and are to be applied prospectively. The
adoption of SFAS No.151 did not have a material effect on our results
of operations or financial position.
In
June
2005, the FASB issued SFAS No.154 “Accounting Changes and Error Corrections”
(“SFAS No.154”), which will require entities that voluntarily make a change in
an accounting principle to apply that change retrospectively to prior periods’
financial statements, unless such retrospective application would be
impracticable. SFAS No.154 supersedes Accounting Principles Board Opinion No.20,
Accounting Changes (“APB No.20”), which previously required that most voluntary
changes in accounting principle be recognized by including in the current
period’s net income the cumulative effect of changing to the new accounting
principle. SFAS No.154 also makes a distinction between “retrospective
application” of an accounting principle and the “restatement” of financial
statements to reflect the correction of an error. Another significant change
in
practice under SFAS No.154 will be the requirement that if an entity changes
its
method of depreciation, amortization, or depletion for long-lived, non-financial
assets, the change must be accounted for as a change in accounting estimate.
Under APB No.20, such a change would have been reported as a change in
accounting principle. SFAS No.154 applies to accounting changes and error
corrections that are made in fiscal years beginning after December 15, 2005
and
will have an effect on us to the extent we make an accounting change or correct
an error.
In
September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108,
“Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements.” SAB No. 108 provides
interpretive guidance on how the effects of prior-year uncorrected misstatements
should be considered when quantifying misstatements in the current year
financial statements. SAB No. 108 requires registrants to quantify misstatements
using both an income statement (“rollover”) and balance sheet (“iron curtain”)
approach and evaluate whether either approach results in a misstatement that,
when all relevant quantitative and qualitative factors are considered, is
material. If prior year errors that had been previously considered immaterial
now are considered material based on either approach, no restatement is required
so long as management properly applied its previous approach and all relevant
facts and circumstances were considered. If prior years are not restated,
the
cumulative effect adjustment is recorded in opening accumulated earnings
as of
the beginning of the fiscal year of adoption. SAB No. 108 is effective for
ISCO
Inc. at December 31, 2006. The Company is currently reviewing the provisions
of
SAB No. 108, but does not expect it to have a material impact on its financial
statements.
During
June 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes,”
which will impact the recognition, measurement, and disclosure of positions
taken for income tax purposes. The Interpretation is effective for fiscal years
beginning after December 15, 2006 (2007 in ISCO’s case). Because ISCO has
historically posted losses and has maintained a full valuation allowance on
its
available future income tax benefit, we do not expect this Interpretation to
have a material effect on our results of operations or financial
position.
In
December 2004, the FASB issued SFAS No.123 (revised 2004), “Share-Based Payment”
(SFAS No.123R). This statement requires that the compensation cost relating
to
share-based payment transactions be recognized in the financial statements.
Compensation cost is to be measured based on the estimated fair value of the
equity-based compensation awards issued as of the grant date. The related
compensation expense will be based on the estimated number of awards expected
to
vest and will be recognized over the requisite service period (often the vesting
period) for each grant. The statement requires the use of assumptions and
judgments about future events and some of the inputs to the valuation models
will require considerable judgment by management.
SFAS
No.123(R) replaces FASB Statement No.123 (SFAS No.123), “Accounting for
Share-Based Compensation,” and supersedes APB Opinion No.25, “Accounting for
Stock Issued to Employees.” The provisions of SFAS No.123(R) are required to be
applied by public companies that do not file as small business issuers, as
of
the first interim or annual reporting period that begins after June 15, 2005,
and all other public companies as of the first interim or annual reporting
period that begins after December 15, 2005. On April 14, 2005, the SEC adopted
a
new rule amending the effective date for Statement 123(R). The amended rule
allows registrants to implement Statement 123(R) as of the first annual period
beginning after June 15, 2005, which was January 1, 2006 for the
Company.
On
January 1, 2006 the Company adopted SFAS No.123(R), under the modified
prospective application transition method without restatement of prior interim
periods. This will result in the Company recognizing compensation cost based
on
the requirements of SFAS No.123(R) for all equity-based compensation awards
issued after the effective date of this statement. For all equity-based
compensation awards that were unvested as of that date, compensation cost is
recognized for the unamortized portion of compensation cost not previously
included in the SFAS No.123 pro forma footnote disclosure. The adoption of
SFAS
No.123(R) is expected to have a material effect on the Company’s results of
operations with respect to equity issuances during 2006 and beyond, beginning
with a non-cash charge expected to total in excess of $1.5 million throughout
2006.
The
effects on earnings and earnings per share if the value recognition provisions
of FAS 123(R) were applied to the three-month and nine-month periods ended
September 30, 2005 is presented in the following tables:
|
|
Three
months ended
September
30, 2005
|
|
Nine
months ended
September
30, 2005
|
|
Net
loss, as reported
|
|
$
|
(596,000
|
)
|
$
|
(1,889,000
|
)
|
Deduct
net change in stock-based employee compensation expense determined
under
fair-value-based method of all rewards, net of tax
|
|
$
|
22,000
|
|
$
|
(270,000
|
)
|
Pro
forma net loss
|
|
$
|
(574,000
|
)
|
$
|
(2,159,000
|
)
|
Pro
forma net loss per share (basic)
|
|
$
|
(0.00
|
)
|
$
|
(0.01
|
)
|
Pro
forma net loss per share (diluted)
|
|
$
|
(0.00
|
)
|
$
|
(0.01
|
)
|
The
following table
summarizes the stock option activity during the nine months ended September
30,
2006:
Outstanding,
December 31, 2005
|
|
|
8,146,436
|
|
Granted
|
|
|
—
|
|
Forfeited
or canceled
|
|
|
(635,000
|
)
|
Exercised
|
|
|
(1,335,000
|
)
|
Outstanding,
September 30, 2006
|
|
|
6,176,436
|
|
The
fair
value of each option grant was estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in the first nine months of 2005: no dividend yield,
expected volatility of 105%, risk-free interest rate of 3.8%, and an expected
life of 4 years. No options were granted during 2006.
At
September 30, 2006, a total of 6,176,000 stock options were outstanding under
the Company’s equity compensation plans virtually all of which are fully vested.
Stock-based compensation expense recognized during the three months ended
September 30, 2006 includes compensation expense for stock options granted
prior
to this period but not yet vested, based on the grant date fair value estimated
in accordance with the pro forma provisions of FAS 123. Included in stock-based
compensation expense in the three and nine month periods ended September 30,
2006 were $1,000 and $79,000, respectively, related to stock
options.
Restricted
Share Rights
Restricted
share grants offer employees the opportunity to earn shares of the Company’s
stock over time. These grants generally vest over two years for employees and
one year for non-employee directors. The Company recognizes the issuance of
the
shares related to these stock-based compensation awards and the related
compensation expense on a straight-line basis over the vesting period. Included
within these grants are also performance-based shares, that is, shares that
vest
based on accomplishing particular objectives as opposed to vesting over time.
No
performance-based shares were vested during the three month and nine month
periods ended September 30, 2006.
The
following table summarizes the restricted stock award activity during the first
nine months of 2006.
|
|
Shares
|
|
Weighted
Average
Grant Date
Fair
Value (per share)
|
|
Outstanding,
December 31, 2005
|
|
|
None
|
|
|
None
|
|
Granted
|
|
|
13,330,000
|
|
$
|
0.35
|
|
Forfeited
or canceled
|
|
|
150,000
|
|
$
|
0.39
|
|
Vested
|
|
|
2,010,000
|
|
$
|
0.35
|
|
Outstanding,
September 30, 2006
|
|
|
11,170,000
|
|
$
|
0.35
|
|
The
total
fair value of restricted shares vested during the three and nine month periods
ended September 30, 2006 was $215,000 and $722,000, respectively. Total non-cash
equity compensation expense recognized during the three and nine month periods
ended September 30, 2006 were $395,000 and $1,026,000, respectively. Non-cash
equity expense for the three and nine month periods ended September 30, 2006,
included $215,000 and $722,000 for vested restricted share grants, $1,000 and
$79,000, respectively, for the vesting of stock options awarded prior to 2006,
and $179,000 and $225,000, respectively, for the straight-line amortization
of
restricted share grants that did not vest during the three and nine month
periods ended September 30, 2006.
Note
2. Realization of Assets
The
accompanying financial statements have been prepared in conformity with US
GAAP,
which contemplate continuation of the Company as a going concern. However,
the
Company has sustained substantial losses from operations in recent years, and
such losses have continued through the (unaudited) three and nine month period
ended September 30, 2006. 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, 2005, 2004, and 2003, the Company incurred net losses
of $3 million, $7 million, and $7.2 million, respectively. Although financial
performance has improved, the Company incurred additional net losses of $0.2
million and $3.1 million, respectively, during the three and nine month periods
ended September 30, 2006. The Company’s strategy included the consolidation of
its manufacturing and research and development facilities, increasing the
efficiency of the Company’s processes, focusing development efforts on products
with a greater probability of commercial sales, reducing professional fees
and
discretionary expenditures, and negotiating favorable payment arrangements
with
suppliers and service providers. More importantly, the Company configured itself
along an outsourcing model, thus allowing for relatively large, efficient
production without the associated overhead. The combination of these factors
has
been highly effective in bringing the Company closer to profitability (from
a
net loss as high as $28 million during 2001) while enabling it to deliver
significant quantities of solutions. Beginning in 2005, the Company began to
invest in additional product development (engineering) and sales and marketing
resources as it began to increase its volume of business. While viewed as a
positive development, these expenditures have added to the funding requirements
listed above.
To
date,
the Company has financed its operations primarily through public and private
equity and debt financings. Projected increases in working capital requirements
from larger expected quarterly revenues during 2006 and beyond, and also the
expected deployment of additional financial resources in the expansion of the
Company’s business and product offering that are expected to provide additional
revenue opportunities, required the $5 million of capital that was added during
June 2006 (see Note 6 — Debt and Financial Position). The Company believes it
has sufficient financial resources to operate its business as intended during
the remainder of 2006 and into 2007. The Company’s uncommitted line of credit
facility matures during August 2007, an event which will require the Company
to
have additional capital available, whether in the form of an extension of this
arrangement or a new arrangement, by that date. The primary covenant in the
Company’s existing uncommitted line of credit involves the right of the lenders
to receive debt repayment from the proceeds of new financing activities. This
covenant may restrict the Company’s ability to apply the proceeds of a financing
event toward operations until the debt is repaid in full.
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,
2006
|
|
December
31,
2005
|
|
Raw
materials
|
|
$
|
1,717,000
|
|
$
|
1,368,000
|
|
Work
in process
|
|
|
696,000
|
|
|
443,000
|
|
Finished
product
|
|
|
496,000
|
|
|
904,000
|
|
|
|
$
|
2,909,000
|
|
$
|
2,715,000
|
|
Inventory
balances are reported net of a reserve for obsolescence. This reserve is
computed by taking into consideration the components of inventory, the recent
usage of those components, and anticipated usage of those components in the
future. This reserve was approximately $217,000 and $160,000 as of September
30,
2006 and December 31, 2005, respectively.
Note
5 - Stock Options and Equity Transactions
On
August
19, 1993, the Board of Directors adopted the 1993 Stock Option Plan for
employees, consultants, and directors who were 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. Unissued options from the 1993 plan were used to fund the 2003 plan.
During the 2005 annual meeting of shareholders, the Company’s shareholders
approved 12 million additional shares of stock to be included in the 2003 Plan,
and clarified the ability for the 2003 Plan to utilize up to 5 million unused
shares originally allocated to the 1993 Plan. During the 2006 annual meeting
of
shareholders, the Company’s shareholders approved a grant of up to 6 million
shares to the Company’s President and CEO, John Thode and approved a
corresponding increase of 6 million shares in the 2003 Plan. The maximum number
of shares issuable under these plans is 32,011,468. These Plans are collectively
referred to as the “Plan”.
For
employees and consultants, the Plan provides for granting of restricted shares
of stock (RSGs), 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 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 and may differ from the
default period. In addition, the Committee may authorize option and restricted
stock grants with vesting provisions that are not based solely on employees’
rendering of additional service to the Company. Beginning in 2006, the
Compensation Committee of the Board approved grants of RSGs to be used as
compensation for outside directors in lieu of NSOs.
For
outside directors, the Company’s non-employee director compensation policy
provides that each outside director will be automatically granted RSGs 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 RSGs. RSGs or NSOs granted typically vest ratably over the service
period, which is usually one year, and expire after ten years from the grant
date.
During
2005, the Board elected to utilize a transition rule provided under FAS 123(R),
and accelerated the vesting to December of 2005 a total of 364,198 options
that
were priced above the Company’s stock price (i.e., “out of the money” options)
and scheduled to vest after 2005. There was no compensation expense recognized
upon the acceleration of the options in 2005. The majority of these accelerated
options were scheduled to vest during the first quarter 2006. By employing
this
method, these options were excluded from the Company’s FAS 123(R) calculation in
the first quarter 2006. Beginning in 2006, the Board has indicated an interest
in providing restricted stock grants in lieu of stock options in many
circumstances, and indeed has begun doing so within both employee and
non-employee compensation programs. The impact of the new accounting standard,
industry trends, and the ability to use fewer shares to achieve intended results
are a few of the reasons behind this change in view. The Board has also
expressed an intention to continue to utilize performance-based equity
incentives for more cases of equity compensation than in years
past.
On
October 31, 2003, the Board of Directors authorized the re-pricing of certain
“out of the money” stock options granted to directors. A new strike price of
$0.24 per share was established. Due to the adoption of FAS123(R), these options
are now accounted for under the new standard, and as such not automatically
adjusted on a quarterly basis based solely on changes in share
price.
On
January 2, 2003, the Board of Directors granted 2,800,000 new stock options
to
six of the Company’s employees, including officers. 950,000 of these options
vested immediately, while the remaining 1,850,000 vested monthly in 12
installments. All of the options granted on January 2, 2003 were granted at
a
discount based on 25% of the average closing price of the Company’s common stock
as reported on the American Stock Exchange over ten trading days and ultimately
valued at a $0.22 discount to the closing price of the Company’s common stock as
of the date of the grant. During July 2003, the Board of Directors cancelled
approximately 2.8 million outstanding options held by certain Company employees,
including officers. During January 2004, a total of 3.7 million options were
granted to the employees of the Company, including officers, at a similar 25%
discount. Such options vested for 1 or 2 years. An expense was recognized for
the value of the discount through the vesting period. Additionally, certain
of
these 2003 options were accounted for using variable accounting. Due to the
adoption of FAS123(R), these options are now accounted for under the new
standard, and as such not automatically adjusted on a quarterly basis based
solely on changes in share price.
On
August
2, 2005, the Company completed a financing transaction with its two largest
shareholders (including their affiliates). These entities, including affiliates,
are also the Company’s lenders, with a total of $16.2 million in principal and
interest due as of September 30, 2006. In exchange for 20 million shares of
common stock, the Company received $4.4 million. In addition, the parties agreed
to an extension of what was then $10.3 million in debt, including accrued
interest and which was due April 2006, to become due in August 2007. Finally,
the lenders agreed to waive their right to be repaid with new financing
proceeds, allowing the Company to utilize the funds for product development
or
otherwise as it chooses. Pursuant to the provisions of Section 16 of the
Securities Exchange Act of 1934, these entities also remitted approximately
$0.6
million in profits from sales of Company common stock during the six months
preceding this financing.
During
the three and nine month periods ended September 30, 2006, the Company’s Board
of Directors granted none and 330,000 RSGs, respectively, to the Company’s
non-employee board members, and 50,000 and 7,000,000 RSGs, respectively, to
the
Company’s employees, most of which are scheduled to vest over a two year period.
The latter figure includes grants to Dr.Amr Abdelmonem, the Company’s Chief
Technology Officer, of 1.5 million RSGs that will vest over a two year period
and 2 million RSGs that will only vest as a result of certain performance
objectives being met. During the June 2006 annual meeting of shareholders,
referred above, the Company’s shareholders approved a grant of 6 million RSGs to
the Company’s President and Chief Executive Officer, John Thode. Two million of
these RSGs will vest over a two year period and the other 4 million will only
vest as a result of certain performance objectives being met.
Note
6 - Debt and Financial Position
2002
Credit Line
As
of the
reporting date, the Company has drawn $8.5 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 initially 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 initial
interest rate of 9.5% and were 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 April15, 2004. The credit line was to
mature and be due, including accrued interest thereon, on March 31, 2004. Due
to
a subsequent agreement between the parties no warrants were issued with
subsequent borrowings.
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 recorded a non-cash charge
of $1.2 million through the outstanding term of the warrants (April, 2004).
$250,000 and $862,000 of that amount were recorded during 2004 and 2003,
respectively. These warrants were valued at $1.2 million of the $2 million
debt
instrument based on a Black-Scholes valuation that included the difference
between the value of the Company’s common stock and the exercise price of the
warrants on the date of each warrant issuance and a 30% discounted face value
of
the notes, leaving the remaining $0.8 million as the underlying value of the
debt. This $1.2 million was amortized over the vesting period of the warrants
(six quarters from the fourth quarter 2002 through the first quarter
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 subsequently 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. 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, the credit line was 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 this extension. Additionally, 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 aggregate loan
commitments under the credit line from $6,000,000 to $6,500,000. Simultaneously,
the Company drew the remaining $1,500,000 of the financing.
During
November 2004, the Company and its lenders agreed to increase the line of credit
to up to an additional $2 million to an aggregate loan commitment of $8,500,000,
$1 million of which was drawn immediately by the Company with the remaining
$1
million drawable upon the Company’s request and subject to the approval of the
lenders, which occurred during January 2005.
During
February 2005, the credit line was extended until April1, 2006. Interest during
the extension period was to be charged at 9%. No warrants or other inducements
were issued with respect to this extension.
On
August
2, 2005, the Company and its lenders agreed to extend the due date from April
2006 until August 2007, and the lenders also agreed to waive the Company’s
obligation to repay its debt with proceeds from an equity financing transaction
with its lenders, including affiliates, in August 2005. No warrants or other
inducements were issued as a result of this transaction.
2006
Convertible Debt
During
June 2006 the Company entered into a Securities Purchase Agreement (the
“Agreement”) and convertible notes (the “Notes”) with Alexander Finance, L.P.,
and Manchester Securities Corporation L.P. (together, the “Lenders”), pursuant
to which the Lenders have agreed, to each loan the Company $2,500,000, or an
aggregate of $5,000,000, in convertible debt. The Lenders, including affiliates,
are the Company’s two largest shareholders and the lenders of the 2002 Credit
Line referenced above. The transaction is structured as a private placement
of
securities pursuant to Section4(2) of the Securities Act of 1933, as amended
(the “Securities Act”) and Rule 506 promulgated thereunder.
The
Notes
will mature on June 22, 2010 and bear an interest rate of 5% due at maturity.
Both the principal amount and any accrued interest on the Notes is convertible
into the Company’s common stock at a rate of $0.33 per share, subject to certain
anti-dilution adjustments. The Lenders have the right to convert the Notes,
both
principal and accrued interest, into shares of common stock at the rate of
$0.33
per share at any time. The Company has the right to redeem the Notes in full
in
cash at any time beginning two years after the date of the Agreement. The
conversion rate of the Notes will be subject to customary anti-dilution
protections, provided that the number of additional shares of common stock
issuable as a result of changes to the conversion rate will be capped so that
the aggregate number of shares of common stock issuable upon conversion of
the
Notes will not exceed 19.99% of the aggregate number of shares of common stock
presently issued and outstanding.
The
Notes
are secured on a first priority basis by all of the Company’s intangible and
tangible property and assets. Payment of the Notes are guaranteed by the
Company’s two subsidiaries, Spectral Solutions, Inc. and Illinois Superconductor
Canada Corporation. The Agreement contains customary representations, warranties
and covenants. The Company was required to file a registration statement
covering the resale of the shares of common stock issuable upon conversion
of
the Notes with the Securities and Exchange Commission within 45 days following
the issuance of the Notes, which it did. Concurrently with the execution of
the
Agreement, the Lenders have waived their right under the Company’s existing line
of credit arrangement to receive the financing proceeds from the issuance of
the
Notes, allowing the Company to use the funds for product development or general
working capital purposes. No fees were paid to any financial advisor, placement
agent, broker or finder in connection with the transactions contemplated by
the
Agreement and the Notes.
Assuming
the Notes are held for the full four year term, 18,505,719 shares of common
stock would be required upon settlement, for both principal and interest. This
amount is approximately 10% of the approximately 186 million shares of common
stock currently issued and outstanding. As of September 30, 2006, the Lenders,
including their affiliates, owned approximately 43% of the Company’s outstanding
shares. As a result of this transaction, the combined holdings of the Lenders
would be approximately 48% of the Company’s outstanding common
stock.
|
Management’s
Discussion and Analysis of Financial Conditions and Results of
Operations.
|
Forward
Looking Statements
Because
we want to provide investors with more meaningful and useful information, this
Quarterly Report on Form 10-Q contains, and incorporates by reference, certain
forward-looking statements that reflect our current expectations regarding
future results of operations, performance and achievements. We have tried,
wherever possible, to identify these forward-looking statements by using words
such as “anticipates,” “believes,” “estimates,” “expects,” “designs,” “plans,”
“intends,” “looks,” “may,” and similar expressions. These statements reflect our
current beliefs and are based on information currently available to us.
Accordingly, these statements are subject to certain risks, uncertainties and
contingencies, including the factors set forth under Item1A, Risk Factors of
our
Annual Report on Form 10-K for the year ended December 31, 2005 and in the
Registration Statement on Form S-3 filed by the Company with the Securities
and
Exchange Commission on August 14, 2006, which could cause our actual results,
performance or achievements for 2006 and beyond to differ materially from those
expressed in, or implied by, any of these statements. You should not place
undue
reliance on any forward-looking statements. Except as otherwise required by
federal securities laws, we undertake no obligation to release publicly the
results of any revisions to any such forward-looking statements that may be
made
to reflect events or circumstances after the date of this report or to reflect
the occurrence of unanticipated events.
General
We
have
shifted from manufacturing in-house to an outsourced manufacturing model wherein
we supply parts and raw materials to third parties, who then complete the
products to our specifications. This system has allowed us to begin to outsource
procurement and realize additional manufacturing efficiencies. Our 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,
have significantly reduced overhead costs since 2002 and allowed us to realize
consistently improved margins. In addition, because we have built upon and
expanded upon our earlier developed technology, based on substantial input
from
customers, to launch the RF² product family and consider additional solutions,
we have generally controlled total research and development (“R&D”)
costs.
The
wireless telecommunications market has experienced significant merger activity
in recent years, a trend which may continue. These activities often result
in
operators attempting to manage and maintain disparate technologies and spectrum
assets, and the need to integrate those assets. In addition, the deployment
of
data applications is adding to the industry requirement to integrate disparate
technologies into base stations and other fixed points of access, resulting
in
the need to manage multiple wireless signals and keep them from interfering
with
each other. We are focused on providing complete solutions that address these
types of requirements and, as a result of this focus, we have bid on larger
and
more diverse business opportunities during 2005 and 2006 than we had in recent
years. These proposals often are accompanied by long approval cycles and
up-front product development costs. We believe the potential benefits to
outweigh these costs, and expect to continue to pursue these types of business
opportunities.
We
announced several significant events to date during 2006. For instance, we
recorded record revenues in the second quarter 2006, and then nearly doubled
that amount in the third quarter 2006. In January and February 2006, we entered
into employment agreements with three executive officers: an agreement with
Mr.
John Thode, to continue to serve as our President and Chief Executive Officer,
an agreement with Dr. Amr Abdelmonem, to continue to act as our Executive Vice
President and Chief Technology Officer, and an agreement with Mr.
Frank Cesario, to continue to serve as our Chief Financial Officer. During
October 2006 we added Dr. Martin Singer, Chairman and CEO of PCTEL, Inc.
(NASDAQ: PCTI), to our Board of Directors. We also announced sales and product
developments such as increased international sales and sourcing activities,
the
expansion of our customer base, and significant new product development
including the launch of our first digital platform, the digital ANF (dANF),
which is designed for use in multiple bands (PCS, Cellular, AWS, UMTS). The
second quarter of 2006 saw more than $5 million of customer orders received
- a
record for quarterly orders and revenue and a substantial increase over previous
periods - as well an infusion of $5 million in capital through the issuance
of
convertible notes to affiliates of our two largest stockholders who are also
our
existing lenders. Our third quarter of 2006 saw even higher customer orders
and
a record $6.4 million in revenue, with a positive cash flow from operations.
Despite these improvements, the wireless telecommunications industry is subject
to risks beyond our control that can negatively impact customer capital spending
budgets (as occurred during 2003) and/or spending patterns (as occurred during
2004 and the first quarter of 2006). For these and other reasons, and despite
our expectation that 2006 revenue has already exceeded full year 2005 revenue,
our financial statements have been prepared assuming we will continue as a
going
concern.
As
an
after-market vendor, we have experienced uneven revenue, reflecting the buying
patterns of wireless telecommunications carriers. We and other after-market
vendors historically have experienced a “fourth quarter effect” in which
operators used a disproportionately large percentage of their capital budgets
at
the end of their fiscal year rather than lose it going forward. More recently,
as operators have embarked on significant projects such as the deployment of
and
upgrades to data networks, wireless operators have often reallocated funds
from
their voice networks to other activities, and from fiscal year planning to
project planning. We have been adjusting our product line and sales strategy
to
try to take advantage of these trends and, thus, realize a higher, more stable
revenue stream. We have seen a measure of success with this strategy as
quarterly revenues have grown during the past two quarters and we are now
certain to show significant revenue growth on an annual basis in 2006.
As
indicated above, we are also pursuing digital technologies, including the
deployment of our dANF platform. We believe that by producing solutions in
digital format, we will extend coverage across additional wireless
telecommunications spectrum and technologies as well as start to address new
opportunities in the non-cellular market. If we are successful in this effort,
we expect to open a much broader addressable market and thus have the
opportunity to enjoy substantially larger revenues.
We
were
founded in 1989 by ARCH Development Corporation, an affiliate of the University
of Chicago, to commercialize superconductor technologies initially developed
by
Argonne National Laboratory. We were incorporated in Illinois on October 18,
1989 and reincorporated in Delaware on September 24, 1993. Our facilities and
principal executive offices are located at 1001 Cambridge Drive, Elk Grove
Village, IL 60007 and our telephone number is (847)391-9400.
Results
of Operations
Three
Months Ended September 30, 2006 and 2005
Our
net
sales increased $4,396,000, or 216%, to $6,433,000 for the three months ended
September 30, 2006 from $2,037,000 for the same period in 2005. This increase
was due to a number of factors including the shipment of more ANF products,
the
expansion of the RF² product family to include Ground-Mounted Amplifiers (GMA’s)
and other solutions, and expansion of our customer base relative to the third
quarter of 2005. We anticipate that unit volume and related revenue to increase
during the fourth quarter of 2006 as compared to the fourth quarter of 2005,
due
to existing and/or anticipated customer orders. Our order backlog entering
the
fourth quarter of 2006 was approximately $1 million, as compared to a minimal
backlog at the same time in 2005, and we are pursuing substantial potential
revenue.
Cost
of
sales increased by $3,078,000, or 399%, to $3,850,000 for the three months
ended
September 30, 2006 from $772,000 for the same period in 2005. The increase
in
cost of sales was due to the increase in sales volume, but also impacted by
product mix. The third quarter of 2005 was the highest quarterly gross margin
in
company history (62%), which included substantial cost efficiencies realized
during the period. 2006 enjoyed similarly strong cost efficiencies, but realized
a different product mix and other competitive pressures. Gross margin during
the
third quarter 2006 was a more typical 40%, consistent with prior quarters of
2006, which we view as very strong in the industry, and indicative of an
efficient and flexible cost structure.
Research
and development (“R&D”) expenses increased by $32,000, or 7%, to $452,000
for the three months ended September 30, 2006, from $420,000 for the same period
in 2005. We added a significant number of products to our RF² product family
during 2006, including a Ground Mounted Amplifier (GMA) expansion during the
third quarter, but focused most of our spending on the digital ANF platform
(dANF). The first dANF product for PCS was completed during the first half
of
2006, and additional products within this platform are expected to come out
during the next several quarters. Finally, we are developing a fully digital
ANF
platform, which we expect to be applicable beyond the base station in wireless
telecommunications. We expect to continue to invest more in R&D during the
fourth quarter of 2006 than we did during the same period of 2005 as we develop
these products, although, as a percentage of sales, we are achieving significant
leverage of our R&D investment.
Selling
and marketing expenses increased by $539,000, or 120%, to $989,000 for the
three
months ended September 30, 2006, from $450,000 for the same period in
2005. The increase in expense was attributable to the continued addition
of personnel in this area as we pursue additional customers and larger, more
diverse opportunities (indicative of 200% quarterly revenue growth). We have
also performed extensive customer development activities as we have added new
customers and launched new products, including a very detailed and comprehensive
interference study over a wide geographic range. We expect to continue to incur
approximately the current level of selling and marketing expenses in future
periods.
General
and administrative expenses increased by $270,000, or 33%, to $1,094,000 for
the
three months ended September 30, 2006, from $824,000 for the same period in
2005. This increase was attributable primarily to an increase in cash and
non-cash equity compensation charges as compared to the prior period. Other
than
an expected increase in non-cash equity compensation charges, General and
Administrative costs are expected to stay approximately the same during the
fourth quarter 2006 as they were during the third quarter of 2006.
Nine
Months Ended September30, 2006 and 2005
Our
net
sales increased $3,390,000, or 43%, to $11,205,000 for the nine months ended
September 30, 2006 from $7,815,000 for the same period in 2005. This increase
was due to a number of factors, including the expansion of our customer base
during 2006, addition of resources to our sales team during 2006, and expansion
of product offerings in 2006. We have already exceeded full year 2005 revenue
of
$10.3 million. Our order backlog entering the fourth quarter of 2006 was
approximately $1 million, as compared to a minimal backlog at the same time
in
2005, and we are pursuing substantial potential revenue.
Cost
of
sales increased by $2,851,000, or 73%, to $6,739,000 for the nine months ended
September 30, 2006 from $3,888,000 for the same period in 2005. The increase
in
cost of sales was due to the increase in sales volume partially impacted by
a
decrease in gross margins from 50% in 2005 to 40% during 2006. Our gross margins
are impacted by product and sales mix, as well as case by case competitive
situations. We have been able to reduce our production costs over time to
maintain a relatively high gross margin, and expect to continue to do so going
forward.
R&D
expenses increased by $69,000, or 5%, to $1,390,000 for the nine months ended
September 30, 2006, from $1,321,000 for the same period in 2005. We expensed
$200,000 of capitalized patent-related charges during the second quarter 2005,
as we deemed such items unlikely to generate significant future revenues, so
a
more comparable 2005 figure would be $1,121,000, which would result in an
increase during 2006 of $269,000, or 24%. We added a significant number of
products to our RF² product family during 2006, including a Ground Mounted
Amplifier (GMA), but focused most of our spending on the digital ANF platform
(dANF). The first dANF product for PCS was completed during the first half
of
2006, and additional products within this platform are expected to come out
during the next several quarters. Finally, we are developing a fully digital
ANF
platform, which we expect to be applicable beyond the base station in wireless
telecommunications. We expect to continue to invest more in R&D than during
2006 as we develop these products although, as a percentage of sales, we are
achieving significant leverage of our R&D investment.
Selling
and marketing expenses increased by $1,210,000, or 96%, to $2,472,000 for the
nine months ended September 30, 2006, from $1,262,000 for the same period in
2005. The increase in expense was attributable to the continued addition of
personnel in this area as we pursue additional customers and larger, more
diverse opportunities (see revenue growth, above). We have also performed
extensive customer development activities as we have added new customers and
launched new products, particularly the dANF product platform. These activities
are expected to continue during the fourth quarter. Thus, we expect to continue
to incur approximately the current level of selling and marketing expenses
in
future periods.
General
and administrative expenses increased by $565,000, or 22%, to $3,153,000 for
the
nine months ended September 30, 2006, from $2,588,000 for the same period in
2005. This increase was attributable to an increase in cash and non-cash equity
compensation charges as compared to the prior period. Other than non-cash equity
compensation charges, General and Administrative costs are expected to stay
approximately the same during the remainder of 2006.
Liquidity
and Capital Resources
At
September 30, 2006, our cash and cash equivalents were $4,173,000, an increase
of $687,000 from the balance at December 31, 2005 of $3,486,000.
During
the first nine months of 2006, we realized $5 million from the issuance of
convertible debt, funded a $3.9 million increase in accounts receivable due
to
the highest quarterly revenue in our history recorded during the third quarter,
offset in part by a $0.7 million increase in payables and accrued expenses,
and
spent roughly $1.4 million in cash on the business, including the planning,
development and marketing of next generation products.
The
continuing development and expansion of sales of our RF management solutions
product lines will require a commitment of additional funds. The actual amount
of those 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 our commercialization plans, the magnitude of our research
and product development programs, our ability to improve product margins, the
amount and timing of any merger and acquisition plans, and the costs involved
in
protecting our patents or other intellectual property.
To
date,
we have financed our operations primarily through public and private equity
and
debt financings. Projected increases in working capital requirements from larger
expected quarterly revenues during 2006 and beyond, and also the expected
deployment of additional financial resources in the expansion of our business
and product offering that are expected to provide additional revenue
opportunities, required the $5 million of capital that was added during June
2006 (see Note 6 - Debt and Financial Position). We believe we have sufficient
financial resources to operate our business as intended during the remainder
of
2006 and into 2007. Our uncommitted line of credit facility matures during
August 2007, an event which will require us to have additional capital
available, whether in the form of an extension of this arrangement or a new
arrangement, by that date. The primary covenant in our existing uncommitted
line
of credit involves the right of the lenders to receive debt repayment from
the
proceeds of new financing activities. This covenant may restrict our ability
to
apply the proceeds of a financing event toward operations until the debt is
repaid in full.
Contractual
Obligations, Commitments, and Off Balance Sheet
Arrangements
The
following table lists the contractual obligations and commitments that existed
as of September 30, 2006:
Contractual
Obligations
|
|
Payments
Due by Period
|
|
|
|
|
|
|
|
Year
|
|
Total
|
|
Less
than 1
Year
|
|
1-3
Years
|
|
3-5
Years
|
|
More
than
5
Years
|
|
Long
Term Debt Obligations
|
|
$
|
17,852,000
|
|
|
—
|
|
$
|
11,746,000
|
|
$
|
6,106,000
|
|
|
—
|
|
Operating
Lease Obligations
|
|
$
|
1,459,000
|
|
$
|
167,000
|
|
$
|
348,000
|
|
$
|
374,000
|
|
$
|
570,000
|
|
Total
|
|
$
|
19,311,000
|
|
$
|
167,000
|
|
$
|
12,094,000
|
|
$
|
6,480,000
|
|
$
|
570,000
|
|
As
a
subsequent event, during October 2006, we entered into an operating lease
arrangement for nearly 4,000 square feet of additional engineering facilities
in
Elk Grove Village, IL, intended to house our digital interference management
platform development effort. That lease will bear the same terms and conditions
of our existing lease for 15,100 square feet nearby, and will be added to the
Operating Lease Obligations disclosure prospectively.
|
Quantitative
and Qualitative Disclosures About Market
Risk.
|
The
Company does not have any material market risk sensitive
instruments.
|
(a)
|
An
evaluation was performed under the supervision and with the participation
of our management, including our 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, 2006. Based on that
evaluation, we, including the CEO and CFO, concluded that our 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 changes in our internal control over financial reporting
identified in connection with the evaluation of such controls that
occurred during the most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company’s
internal control over financial
reporting.
|
PART
II.
OTHER INFORMATION
There
have been no material changes to prior disclosures in our 2005 Annual Report
on
Form 10-K.
Exhibits:
A list of exhibits is set forth in the Exhibit Index found on page 20 of
this report.
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 14th day of November
2006.
|
ISCO
International, Inc.
|
|
|
|
|
By:
|
/s/
JOHN THODE
|
|
|
Mr.John
Thode
|
|
|
President
and Chief Executive
|
|
|
Officer
(Principal Executive Officer)
|
|
|
|
|
By:
|
/s/
FRANK CESARIO
|
|
|
Frank
Cesario
|
|
|
Chief
Financial Officer (Principal
|
|
|
Financial
and Accounting Officer)
|
EXHIBIT
INDEX
Exhibit
Number
|
|
Description
of Exhibit
|
|
|
|
|
|
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.
|
|
|
|
|
|
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.
|
|
|
|
|
|
Certification
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002.
|
20