form10q081808.htm
UNITED
STATES
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 June 30,
2008
OR
[ ]
TRANSITION REPORT PURSUANT TO 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.
(Exact
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)
|
(847) 391-9400
(Registrant’s
telephone number, including area code)
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
[ ]
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer”, “accelerated filer”, and “smaller
reporting company” in Rule 12b-2 of the Exchange Act
|
|
|
|
|
Large
accelerated filer [ ]
|
|
Accelerated
filer [ ]
|
|
|
Non-accelerated
filer [ ] (Do not
check if a smaller reporting company)
|
|
Smaller reporting company [ X]
|
Indicate
by check mark whether the registrant is a shell company (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:
|
|
Outstanding
at July 31, 2008
|
Common
Stock, par value $0.001 per share
|
|
224,379,527
|
ISCO
INTERNATIONAL, INC.
|
|
(Unaudited)
|
|
|
|
|
|
|
June
30,
|
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
Assets:
|
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
|
Cash
and Cash Equivalents
|
$
|
337,320
|
|
$
|
1,789,953
|
|
Inventory,
net
|
|
2,908,385
|
|
|
3,043,230
|
|
Accounts
Receivable, net
|
|
1,649,085
|
|
|
2,311,110
|
|
Prepaid
Expenses and Other
|
|
146,821
|
|
|
149,659
|
|
Total
Current Assets
|
|
5,041,611
|
|
|
7,293,952
|
|
Property
and Equipment
|
|
1,757,252
|
|
|
1,437,030
|
|
Less:
Accumulated Depreciation and Amortization
|
|
(1,126,895)
|
|
|
(940,328)
|
|
Net
Property and Equipment
|
|
630,357
|
|
|
496,702
|
|
Restricted
Certificates of Deposit
|
|
131,263
|
|
|
129,307
|
|
Other
Assets
|
|
-
|
|
|
587,824
|
|
Goodwill
|
|
19,565,268
|
|
|
13,370,000
|
|
Intangible
assets, net
|
|
2,823,397
|
|
|
850,811
|
|
Total
Assets
|
$
|
28,191,896
|
|
$
|
22,728,596
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders' Equity:
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
Accounts
Payable
|
$
|
701,842
|
|
$
|
904,910
|
|
Inventory-related
Material Purchase Accrual
|
|
136,114
|
|
|
240,126
|
|
Employee-related
Accrued Liability
|
|
492,400
|
|
|
331,522
|
|
Accrued
Professional Services
|
|
34,645
|
|
|
106,921
|
|
Other
Accrued Liabilities and Current Deferred Revenue
|
|
865,798
|
|
|
452,581
|
|
Total
Current Liabilities
|
|
2,230,799
|
|
|
2,036,060
|
|
|
|
|
|
|
|
|
Deferred
Facility Reimbursement
|
|
80,000
|
|
|
87,500
|
|
Deferred
Revenue - Non Current
|
|
154,275
|
|
|
104,940
|
|
Notes
and Related Accrued Interest with Related Parties
|
|
19,207,981
|
|
|
15,939,229
|
|
Stockholders'
Equity:
|
|
|
|
|
|
|
Preferred
Stock; 300,000 shares authorized; No shares issued and
outstanding
|
|
|
|
|
|
at
June 30, 2008 and December 31, 2007
|
|
-
|
|
|
-
|
|
Common
Stock ($.001 par value); 500,000,000 shares authorized;
224,300,360
|
|
|
|
|
|
|
and
202,259,360 shares issued and outstanding at June 30, 2008
and
|
|
|
|
|
|
|
December
31, 2007, respectively
|
|
229,301
|
|
|
202,260
|
|
Additional
Paid-in Capital
|
|
182,386,077
|
|
|
175,281,340
|
|
Treasury
Stock
|
|
(130,050)
|
|
|
(95,050)
|
|
Accumulated
Deficit
|
|
(175,966,487)
|
|
|
(170,827,683)
|
|
Total
Shareholders' Equity
|
|
6,518,841
|
|
|
4,560,867
|
|
Total
Liabilities and Shareholders' Equity
|
$
|
28,191,896
|
|
$
|
22,728,596
|
|
See the
accompanying Notes which are an integral part of the Condensed Consolidated
Financial Statements.
ISCO
INTERNATIONAL, INC.
(UNAUDITED)
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30,
|
|
June
30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Net
sales
|
$
|
2,485,641
|
$
|
3,422,707
|
$
|
5,242,806
|
$
|
4,375,956
|
|
Costs
and Expenses:
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
1,311,670
|
|
1,702,715
|
|
2,856,971
|
|
2,412,370
|
|
Research
and development
|
|
1,283,713
|
|
661,707
|
|
2,874,090
|
|
1,282,762
|
|
Selling
and marketing
|
|
697,987
|
|
671,062
|
|
1,634,365
|
|
1,254,306
|
|
General
and administrative
|
|
1,195,862
|
|
981,732
|
|
2,444,449
|
|
2,181,379
|
|
Total
Costs and Expenses
|
|
4,489,232
|
|
4,017,216
|
|
9,809,875
|
|
7,130,817
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Loss
|
|
(2,003,591)
|
|
(594,509)
|
|
(4,567,069)
|
|
(2,754,861)
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
2,418
|
|
17,926
|
|
10,199
|
|
36,205
|
|
Interest
(expense)
|
|
(305,086)
|
|
(255,456)
|
|
(582,502)
|
|
(510,789)
|
|
Other
income
|
|
568
|
|
-
|
|
568
|
|
-
|
|
Other
income (expense), net
|
|
(302,100)
|
|
(237,530)
|
|
(571,735)
|
|
(474,584)
|
|
|
|
|
|
|
|
|
|
|
|
Net
Loss
|
$
|
(2,305,691)
|
$
|
(832,039)
|
$
|
(5,138,804)
|
$
|
(3,229,445)
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted loss per share
|
$
|
(0.01)
|
$
|
(0.00)
|
$
|
(0.02)
|
$
|
(0.02)
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of common
|
|
|
|
|
|
|
|
|
shares
outstanding
|
|
222,114,640
|
|
191,240,000
|
|
222,637,715
|
|
190,659,000
|
|
See the
accompanying Notes which are an integral part of the Condensed Consolidated
Financial Statements.
ISCO
INTERNATIONAL, INC.
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
Six
Months Ended
|
|
|
Six
Months Ended
|
|
|
|
|
June
30, 2008
|
|
|
June
30, 2007
|
|
OPERATING
ACTIVITIES
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(5,138,804)
|
|
$
|
(3,229,445)
|
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
397,235
|
|
|
99,983
|
|
Stock-based
compensation charges
|
|
|
369,128
|
|
|
838,775
|
|
Changes
in operating assets and liabilities
|
|
|
2,532,958
|
|
|
1,859,328
|
|
Net
cash used in operating activities
|
|
|
(1,839,483)
|
|
|
(431,359)
|
|
INVESTING
ACTIVITIES
|
|
|
|
|
|
|
|
Increase
in restricted certificates of deposit
|
|
|
(1,956)
|
|
|
(5,898)
|
|
Payment
of patent costs
|
|
|
(68,255)
|
|
|
(32,150)
|
|
Acquisition
of property and equipment, net
|
|
|
(13,407)
|
|
|
(59,638)
|
|
Acquisition
of Clarity
|
|
|
(2,193,432)
|
|
|
-
|
|
Net
cash used in investing activities
|
|
|
(2,277,050)
|
|
|
(97,686)
|
|
FINANCING
ACTIVITIES
|
|
|
|
|
|
|
|
Issuance
of common stock
|
|
|
12,650
|
|
|
-
|
|
Proceeds
from loan
|
|
|
2,200,000
|
|
|
-
|
|
Proceeds
from note payable
|
|
|
1,500,000
|
|
|
-
|
|
Payment
of loan
|
|
|
(1,013,750)
|
|
|
-
|
|
Treasury
stock purchased
|
|
|
(35,000)
|
|
|
(64,600)
|
|
Net
cash provided by financing activities
|
|
|
(2,663,900)
|
|
|
(64,600)
|
|
|
|
|
|
|
|
|
|
(Decrease)/Increase
in cash and cash equivalents
|
|
|
(1,452,633)
|
|
|
(593,645)
|
|
Cash
and cash equivalents at beginning of period
|
|
|
1,789,953
|
|
|
2,886,476
|
|
Cash
and cash equivalents at end of period
|
|
$
|
337,320
|
|
$
|
2,292,831
|
|
See the
accompanying Notes which are an integral part of the Condensed Consolidated
Financial Statements.
ISCO
INTERNATIONAL
Ended
June 30, 2008
|
Common
Stock Shares
|
Common
Stock Amount
|
Additional
Paid-In Capital
|
Treasury
Stock
|
Accumulated
Deficit
|
Total
|
Balance
as of December 31, 2005
|
183,252,036
|
$183,252
|
$170,387,752
|
$ -
|
$
(160,040,288)
|
$
10,530,716
|
Exercise
of Stock Options
|
2,582,826
|
2,583
|
427,330
|
-
|
-
|
429,913
|
Equity
Financing
|
3,787,271
|
3,787
|
(3,787)
|
-
|
-
|
-
|
Section
16b recovery
|
-
|
-
|
3,124
|
-
|
-
|
3,124
|
Stock-Based
Compensation
|
-
|
-
|
1,565,423
|
-
|
-
|
1,565,423
|
Net
Loss
|
-
|
-
|
-
|
-
|
(4,364,984)
|
(4,364,984)
|
Balance
as of December 31, 2006
|
189,622,133
|
$189,622
|
$172,379,842
|
$ -
|
$
(164,405,272)
|
$ 8,164,192
|
Vesting
of Restricted Stock
|
4,303,893
|
4,304
|
(4,304)
|
-
|
-
|
-
|
1.5M
Accrued Interest Converted to Equity
|
8,333,334
|
8,334
|
1,491,666
|
-
|
-
|
1,500,000
|
Stock-Based
Compensation
|
-
|
-
|
1,414,136
|
-
|
-
|
1,414,136
|
Purchase
of Treasury Shares
|
-
|
-
|
-
|
(95,050)
|
- |
(95,050)
|
Net
Loss
|
-
|
-
|
-
|
-
|
(6,422,411)
|
(6,422,411)
|
Balance
as of December 31, 2007
|
202,259,360
|
$202,260
|
$175,281,340
|
$(95,050)
|
$(170,827,683)
|
$4,560,867
|
Vesting
of Restricted Stock
|
1,926,000
|
1,926
|
(1,926)
|
-
|
-
|
-
|
Exercised
of Stock Options
|
115,000
|
115
|
12,535
|
-
|
-
|
12,650
|
Stock-Based
Compensation
|
-
|
-
|
369,128
|
-
|
-
|
369,128
|
Purchase
of Treasury Shares
|
-
|
-
|
-
|
(35,000)
|
-
|
(35,000)
|
Shares
issued for acquisition
|
20,000,000
|
25,000
|
6,725,000
|
-
|
-
|
6,750,000
|
Net
Loss
|
-
|
-
|
-
|
-
|
(5,138,804)
|
(5,138,804)
|
Balance
as of June 30, 2008
|
224,300,360
|
$229,301
|
$182,386,077
|
$(130,050)
|
$(175,966,487)
|
$6,518,841
|
(UNAUDITED)
Note
1 – Organization
ISCO
International Inc. ( together with its subsidiary Clarity Communication Systems
Inc. (“Clarity”), the “Company”) addresses RF (Radio Frequency) and radio link
optimization issues, including interference issues, within wireless
communications, as well as provides product and service offerings based on
Push-To-Talk (“PTT”) and Location-Based Services (“LBS”), including a
proprietary combination of the two technologies in its Where2Talk (“W2T”)
solution. Two inactive subsidiaries, Spectral Solutions, Inc. and Illinois
Superconductor Canada Corporation, were terminated during early 2008 as the
Company’s new subsidiary, Clarity, was acquired in connection with the merger
that closed on January 3, 2008. The Company uses unique products,
including ANF (Adaptive Interference Management, or AIM, family of solutions),
RF², and other solutions, as well as service expertise, in improving the RF
handling of a wireless system, particularly the radio link (the signal between
the mobile device and the base station). A subset of this capability is
mitigating the impact of interference on wireless communications systems. These
solutions are designed to enhance the quality, capacity, coverage and
flexibility of wireless telecommunications services. The Company has
historically marketed its products to cellular, PCS and wireless
telecommunications service providers and original equipment manufacturers
(“OEMs”) located both in the United States and in international
markets.
Note
2 – Basis of Presentation
The
condensed consolidated financial statements include the accounts of ISCO
International, Inc. and its wholly owned subsidiary, Clarity Communication
Systems Inc. (collectively referred to as the “Company”, or “we”,“our”or us”).
All significant intercompany balances and transactions have been eliminated in
consolidation. The two inactive subsidiaries were included in these
results in a similar fashion, up until the time of their
termination. The termination of these subsidiaries had no impact upon
the consolidated financial results.
The
accompanying 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 Rule 8-03 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
financial statements and notes included herein should be read in conjunction
with the Company’s audited financial statements and notes for the year ended
December 31, 2007 included in the Company’s Annual Report on Form 10-K, as
amended, 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 of, or for,
the entire year ending December 31, 2008. For further information, refer to
the financial statements, including the notes thereto, included in the Company’s
Annual Report on Form 10-K, as amended, for the fiscal year ended
December 31, 2007.
Recent
Accounting Pronouncements
In
May 2008, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position (“FSP”) APB 14-1, Accounting for Convertible Debt
Instruments That May Be Settled In Cash upon Conversion (Including Partial Cash
Settlement). FSP APB 14-1 specifies that issuers of such instruments
should separately account for the liability and equity components in a manner
that will reflect the entity’s nonconvertible debt borrowing rate when interest
cost is recognized in subsequent periods. FSP APB 14-1 is effective for
financial statements issued for fiscal years beginning after December 15,
2008 and interim periods within those fiscal years. We are currently in the
process of evaluating the impact of adopting this pronouncement.
In
April 2008, the FASB issued FSP Statement of Financial Accounting Standards
(“SFAS”) No. 142-3, “Determination of the Useful Life of Intangible Assets”
(“FSP SFAS 142-3”). FSP SFAS 142-3 amends the factors that should be considered
in developing renewal or extension assumptions used to determine the useful life
of a recognized intangible asset under SFAS No. 142, “Goodwill and Other
Intangible Assets” (“SFAS 142”). The intent of FSP SFAS 142-3 is to improve the
consistency between the useful life of a recognized intangible asset under SFAS
142 and the period of expected cash flows used to measure the fair value of the
asset under SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS
141R”), and other applicable accounting literature. FSP SFAS 142-3 is effective
for financial statements issued for fiscal years beginning after
December 15, 2008 and must be applied prospectively to intangible assets
acquired after the effective date. We are currently evaluating the provisions of
FSP SFAS 142-3.
In
February 2008, the FASB issued Staff Position No. FAS 157-2 which
provides for a one-year deferral of the effective date of SFAS No. 157,
“Fair Value
Measurements,” for non-financial assets and liabilities that are
recognized or disclosed at fair value in the financial statements on a recurring
basis. We adopted FAS 157-2 upon its issuance.
In
December 2007, the FASB issued SFAS No. 141(R), “Business
Combinations”
(“SFAS No. 141(R)”), and SFAS No. 160, “Noncontrolling
Interests in Consolidated Financial Statements” (“SFAS No. 160”). SFAS No. 141(R) requires an
acquirer to measure the identifiable assets acquired, the liabilities assumed
and any non-controlling interest in the acquiree at their fair values on the
acquisition date, with goodwill being the excess value over the net identifiable
assets acquired. SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary
should be reported as equity in the consolidated financial statements. The
calculation of earnings per share will continue to be based on income amounts
attributable to the parent. SFAS No. 141(R) and SFAS No. 160 are
effective for financial statements issued for fiscal years beginning after
December 15,
2008. Early adoption is
prohibited. We have not yet determined the effect on our consolidated financial
statements, if any, upon adoption of SFAS No. 141(R) or SFAS
No. 160.
In
December 2007, the FASB issued FAS 160, “Noncontrolling Interests in
Consolidated Financials, an Amendment of ARB No. 51”, which is
intended to improve the relevance, comparability and transparency of the
financial information that a reporting entity provides in its consolidated
financial statements by establishing certain required accounting and reporting
standards. FAS 160 is effective for fiscal years beginning on or after
December 15, 2008. The Company is evaluating the options provided under FAS
160 and their potential impact on its financial condition and results of
operations if implemented. The Company does not expect the adoption of FAS 160
to significantly affect its consolidated financial condition or results of
operations.
In
February 2007, the FASB issued SFAS No. “159, The Fair Value Option for Financial
Assets and Financial Liabilities .SFAS No. 159 provides the option to
report certain financial assets and liabilities at fair value, with the intent
to mitigate volatility in financial reporting that can occur when related assets
and liabilities are recorded on different bases. As of January 1,
2008, we elected not to adopt the fair value option under SFAS 159.
In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements This
statement defines fair value as used in numerous accounting pronouncements,
establishes a framework for measuring fair value in US GAAP and expands
disclosure related to the use of fair value measures in financial statements.
SFAS No.157 does not expand the use of fair value measures in financial
statements, but standardizes its definition and guidance in US GAAP. SFAS No.157
is effective for fiscal years beginning after November 15, 2007. We adopted SFAS
157 as of January 1, 2008, with the exception of the application of the
statement to non-recurring nonfinancial assets and nonfinancial liabilities.
Non-recurring nonfinancial assets and nonfinancial liabilities for which we have
not applied the provisions of SFAS 157 include those measured at fair value in
goodwill impairment testing, indefinite lived intangible assets measured at fair
value for impairment testing, asset retirement obligations initially measured at
fair value, and those initially measured at fair value in a business
combination.
SFAS
157 establishes a valuation hierarchy for disclosure of the inputs to valuation
used to measure fair value. This hierarchy prioritizes the inputs into three
broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active
markets for identical assets or liabilities. Level 2 inputs are quoted prices
for similar assets and liabilities in active markets or inputs that are
observable for the asset or liability, either directly or indirectly through
market corroboration, for substantially the full term of the financial
instrument. Level 3 inputs are unobservable inputs based on our own assumptions
used to measure assets and liabilities at fair value. A financial asset or
liability’s classification within the hierarchy is determined based on the
lowest level input that is significant to the fair value measurement.
Note
3 - Realization of Assets
The
accompanying financial statements have been prepared in conformity with US GAAP
which contemplates 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 year ended December 31, 2007 and the
most recent quarter ended June 30, 2008. In addition, the Company has used,
rather than provided, cash in its operations. Consistent with these facts, the
Company’s most recent annual report filed on Form 10-K as amended, reflects that
there is substantial doubt about the Company’s ability to continue as a going
concern.
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 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, 2007, 2006, and 2005, the Company incurred net
losses of $6.4 million, $4.4 million, and $3.0 million, respectively. The
quarter ended June 30, 2008 showed an additional net loss of $2.3 million
bringing the year to date 2008 loss to $5.1 million. In the past, the Company
has implemented strategies to reduce its cash used in operating activities.
Previous changes have 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,
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 and has developed an increasing number of off shore suppliers providing
lower cost components. 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.
In addition, ISCO International, Inc. acquired Clarity in January
2008. While the Company believes this acquisition will bring
additional revenues and improved gross margins, there are many implementation
issues associated with this business that will require substantial investments
of time and incremental cash resources before the value of the business can be
realized. During the second quarter of 2008, the Company launched
several initiatives to refocus the entire organization to become more sales and
market focused. These efforts included the addition of an
industry-recognized Sales Vice President, new sales channels
focused on international customers, focused pursuit of new OEM relationships,
development and implementation of marketing programs targeted as specific
customers and customer applications and sales resources targeted at all major
domestic carriers. While over time, the Company believes that this
refocus will eventually result in increased sales and an improvement in
financial performance there are no guarantees that these strategies will yield
expected results.
The
continuing development of our product lines and operations, ramping up
additional sales channels as well as any required defense of our intellectual
property, will require an immediate commitment and/or availability of funds. The
actual amount of our future funding requirements will depend on many factors,
including: the amount and timing of future revenues, the economy and the impact
on the wireless carriers network deployment plans, customer acceptance of our
software offerings, 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 or maintain product margins, and
the costs involved in protecting our patents or other intellectual
property. We continue to look into augmenting our existing capital
position by evaluating potential short-term and long-term sources of capital
whether from debt, equity, hybrid, or other methods. The primary covenant in our
existing debt arrangement involves the right of the lenders to receive debt
repayment from the proceeds of new financing activities. This covenant may
restrict our ability to obtain additional financing to be used in the operations
of the business.
Note 4-
Business Combinations
During
January 2008, the Company completed its acquisition of Clarity, by merger for a
total of $8.9 million (which includes repayment of Clarity's indebtedness,
transaction expenses and stock issuances).
The Clarity
acquisition has been accounted for as a business combination under, SFAS
No. 141, "Business Combinations". The assets acquired and liabilities assumed
have been recorded at the date of acquisition at their respective fair
values.
The results
of operations of Clarity are included in the accompanying consolidated
statements of operations for the three and six months ended June 30, 2008. The
total purchase for the acquisition subject to the finalization of the working
capital adjustment as defined in the merger agreement, is $8.9million, and is
broken down as follows:
Stock
issuance (25 million shares)
|
$
6,750,000
|
Payment
of Clarity's indebtedness (includes closing costs)
|
1,593,000
|
Acquisition-related
transaction costs
|
600,000
|
Total
purchase price
|
$
8,943,000
|
The above
purchase price has been allocated to the tangible and intangible assets acquired
and liabilities assumed based on management's estimates of their current fair
values. Acquisition-related transaction costs include legal and accounting fees
and other external costs directly related to the Clarity
acquisition.
The purchase
price has been allocated as follows:
Acquired
cash
|
|
$
|
62,000
|
|
Account
receivable, net
|
|
|
425,000
|
|
Prepaids
and other current assets
|
|
|
60,000
|
|
Fixed
assets and other long term assets
|
|
|
289,000
|
|
Goodwill
|
|
|
6,195,000
|
|
Intangible
assets
|
|
|
2,140,000
|
|
Account
payable and accrued liabilities
|
|
|
(228,000)
|
|
Net
assets acquired
|
|
$
|
8,943,000
|
|
Goodwill was
determined based on the residual difference between the purchase cost and the
value assigned to tangible and intangible assets and liabilities, and is not
deductible for tax purposes. Among the factors that contributed to a purchased
price resulting in the recognition of goodwill were Clarity's history of
profitability prior to 2007, strong sales force and overall employee base, and
leadership position in the technology market.
Note
5- Goodwill and Intangible Assets
During
January 2008, the Company acquired Clarity by merger, by issuing up to 40
million shares in the Company’s common stock, par value $0.001 (the “Common
Stock”), in exchange for all of Clarity’s stock and satisfaction of employee
rights and interests. The Company recorded $6.2 million in goodwill and $2.1
million in identifiable intangible assets. Intangible assets are included in the
Company’s condensed consolidated balance sheets. The intangible assets are being
amortized over periods ranging from 2 to 10 years on a straight-line basis.
Amortization expense on intangible assets for the three and six months ended
June 30, 2008 was $86,500 and $173,000, respectively.
As
of the reporting date, the Company had recorded goodwill resulting from the
acquisitions of Spectral Solutions, Inc. and Illinois Superconductor Canada
Corporation in 2000. Beginning January 1, 2002, goodwill was no longer to
be amortized but rather to be tested for impairment on an annual basis and
between annual tests whenever there is an indication of potential impairment.
Impairment losses would be recognized whenever the implied fair value of
goodwill is determined to be less than its carrying value. SFAS No.142
prescribes a two-step impairment test to determine whether the carrying value of
the Company’s goodwill is impaired. The first step of the goodwill impairment
test is used to identify potential impairment, while the second step measures
the amount of the impairment loss. Step one requires the comparison of the fair
value of each reporting unit with its carrying amount, including goodwill. As
the Company is comprised of a single reporting unit, the question of fair value
is centered upon whether the market value, as measured by market capitalization,
of the Company exceeds stockholders’ equity. The excess of the Company’s market
capitalization over its reported stockholders’ equity indicates that the
goodwill of the Company’s sole reporting unit was not impaired as of June 30,
2008.
The
Company’s other intangible assets are derived from patents and trademarks which
represent costs, primarily legal fees and expenses, incurred in order to prepare
and file patent applications related to various aspects of the Company’s
technology and to its current and proposed products. Patents and trademarks are
recorded at cost and are amortized using the straight-line method over the
shorter of their estimated useful lives or 17 years. The recoverability of the
carrying values of patents and trademarks is evaluated on an ongoing basis by
Company management. Factors involved in this evaluation include whether the item
is in force, whether it has been directly threatened or challenged in litigation
or administrative process, continued usefulness of the item in current and/or
expected utilization by the Company in its solution offerings, perceived value
of such material or invention in the marketplace, availability and utilization
of alternative or other technologies, the perceived protective value of the
item, and other factors. Patent and trademarks were reported net of accumulated
amortization of approximately $856,600 at June 30, 2008.
Note
6 - 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.
Note7
- Inventories
Inventories
consisted of the following:
|
|
|
June
30, 2008
|
|
|
December
31, 2007
|
|
Raw
materials
|
|
$
|
1,450,468
|
|
$
|
1,695,745
|
|
Work
in process
|
|
|
779,231
|
|
|
655,676
|
|
Finished
product
|
|
|
678,686
|
|
|
691,809
|
|
Total
|
|
$
|
2,908,385
|
|
$
|
3,043,230
|
|
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 $362,600 and $325,000 as of June 30, 2008
and December 31, 2007, respectively.
Note
8 - Stock Options and Warrants
Effective
January 1, 2006, we adopted SFAS No. 123(R), “Share Based Payments,” as
described in Note 7, in the Notes to the Consolidated Financial
Statements.
At June
30, 2008, a total of 2.8 million stock options were outstanding under the
Company’s equity compensation plans. No options were granted during the first
six months of 2008 or 2007.
Restricted
Share Rights
Restricted
share grants offer employees the opportunity to earn shares of the Company’s
stock over time. For grants that occurred during the periods ended June 30, 2008
and 2007, the typical vesting period for employees is two to
four years while the vesting period of non-employee directors is
linked to the one-year service period. We recognize 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, or on an
accelerated basis in those cases where the actual vesting is faster than the
proportional straight-line value. 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 first six months of
2008.
The
following table summarizes the restricted stock award activity during the first
six months of 2008.
|
|
|
|
Weighted
|
|
|
|
|
|
Average
Grant Date
|
|
|
|
Shares
|
|
Fair
Value (per share)
|
|
|
|
|
|
|
|
Outstanding,
December 31, 2007
|
|
3,557,000
|
|
0.29
|
|
Granted
|
|
6,378,000
|
|
0.17
|
|
Forfeited
or canceled
|
|
(3,262,000)
|
|
0.24
|
|
Vested
|
|
(1,926,000)
|
|
0.22
|
|
Outstanding,
June 30, 2008
|
|
4,747,000
|
|
0.19
|
|
The total
fair value of restricted shares vested during the three months ended June 30,
2008 and 2007 was $202,000 and $383,000, respectively. Total non-cash equity
compensation expense recognized during the second quarter 2008 was $181,000,
including $202,000 for vested restricted share grants and $(21,000) for the
straight-line amortization of restricted share grants that did not vest during
the second quarter 2008.
Note
9 – Debt and Financial Position
2008
Loan Agreement
On May 29,
2008, the Company entered into a new financing
agreement (the “2008 Loan Agreement”) with its two largest
stockholders, Manchester Securities Corporation (“Manchester”) and Alexander
Finance, L.P. (“Alexander” and together with Manchester, the
“Lenders”). Under the terms of the 2008 Loan Agreement, the Lenders
are providing to the Company a credit line in the aggregate principal amount of
$2.5 million. A portion of this line was immediately drawn upon by
the Company in order to repay the outstanding $500,000 short term loan between
the Lenders and the Company under a receivables factoring arrangement, as well
as $8,056 in accrued interest on the loan. An additional $692,000 was
drawn for working capital of the Company.
The
indebtedness under the 2008 Loan Agreement is evidenced by the Company’s 9.5%
Secured Grid Notes (the “Grid Notes”). The Company issued a Grid Note
to each of Alexander and Manchester in the aggregate
principal amount of $1,250,000.
To secure
and guarantee payment of the Grid Notes, on May 29, 2008, the Company, the
Lenders, and Clarity entered into a Sixth Amended and Restated Security
Agreement (the “New Security Agreement”) and an Amended and Restated Guaranty of
Clarity (the “New Clarity Guaranty”), in favor of the Lenders. The
New Security Agreement amends and restates the Fifth Amended and Restated
Security Agreement and adds the 2008 Loan Agreement and the Grid Notes to the
list of obligations secured by all of the Company’s assets. The New
Clarity Guaranty amends and restates the guaranty and adds the Grid Notes to the
list of obligations for which Clarity is guaranteeing the full payment and
performance by the Company to the Lenders.
The
material terms of the 2008 Loan Agreement and the Grid Notes include the
following:
·
|
The
advances made pursuant to the 2008 Loan Agreement (the “Loans”) bear
interest at a rate of 9.5%. Interest is calculated on a 360 day
year simple interest basis and paid for the actual number of days
elapsed. All interest due on such Loans is payable on August 1,
2010, the maturity date of the 2008 Loan Agreement. After the
occurrence and during the continuance of an event of default, the interest
rate on the Loans is increased to the lesser of 20% per annum, compounded
annually, or the highest rate permitted by law and is payable on the
demand of the Lenders.
|
·
|
The
repayment of the principal amount of the Grid Notes, as well as the notes
issued in connection with the previous financings (the “Prior ISCO Notes”)
and all accrued and unpaid interest may be accelerated in the event of (i)
a failure to pay any principal amount on the Grid Notes, (ii) a failure to
pay the principal amount or accrued but unpaid interest upon any of the
Prior ISCO Notes as and when such notes become due and payable; (iii) a
failure by the Company for ten (10) days after notice to it, to comply
with any other material provision of any of the Grid Notes, the 2008 Loan
Agreement, or any of the Prior ISCO Notes and related agreements ; (iv) a
default under the New Security Agreement or any of the Grid Notes or Prior
ISCO Notes; (v) a breach by the Company of its representations or
warranties under the 2008 Loan Agreement or under the New Clarity
Guaranty; (vi) defaults under any other indebtedness of the Company in
excess of $500,000; (vii) a final judgment involving, in the aggregate,
liability of the Company in excess of $500,000 that remains unpaid for a
period of 45 days; or (viii) bankruptcy
event.
|
·
|
Any
payments or prepayments by the Company or any guarantor permitted or
required under the 2008 Loan Agreement shall be applied to each Lender,
pro rata in relation to the total amount of the Company’s indebtedness to
the Lenders then outstanding under the Grid Notes, in the following order:
first, to the payment of any fees, costs, expenses, or charges of the
Lenders with respect to the Grid Notes arising under the loan documents;
second, to the payment of interest accrued on the outstanding advances
represented by the Grid Notes; and third, to the
principal balance. Any prepayments, whether optional
or mandatory, permanently reduce the Lenders’ commitments under the Grid
Notes, pro rata, to the extent of such
prepayments.
|
·
|
Upon
30 days prior written notice to the Lenders, the Company may prepay
outstanding amounts under the Loans, provided that the minimum amount of
any prepayment must generally be at least $250,000. Upon
receipt of net cash proceeds from (i) certain sales, leases, transfers or
other dispositions of any assets of the Company, (ii) the incurrence or
issuance of debt to third parties, (iii) the sale or issuance of capital
stock, warrants, rights or options to acquire capital stock, or any other
securities other than upon the exercise of outstanding options and
warrants or the issuance of options pursuant to the Company’s equity
incentive plan, in excess of 5% of the outstanding shares of, Common
Stock: (iv) any judgment, award or settlement or (v) a merger or share
exchange pursuant to which 50% of the Company’s voting power is
transferred, the Company must prepay the lesser of the amount outstanding
on the Grid Notes or the amount of such net cash
proceeds.
|
·
|
The
Company is required to pay all of the reasonable fees and expenses
incurred by the Lenders in connection with the transaction
documents.
|
On March
20, 2008, the Company entered into an agreement with the Lenders to assign, or
factor, certain of its trade receivables (the “Assignment
Agreement”). If the Company requests such a transaction and the
Lenders agree, monies will be advanced to the Company based on the Company’s
trade receivables assigned to the Lenders. Under the Assignment
Agreements, as the assigned accounts are collected by the Company (approximately
30 days from the date of the invoice), the Company will promptly pay the Lenders
the amount of the collected account, plus interest at an implied annual rate of
10%. In connection with the Assignment Agreement, the Company and its Lenders
agreed to a $500,000 advance with funding to occur on March 20, 2008. Future
transactions would be subject to the desire of both the Company and
Lenders. An additional $500,000 was borrowed under this arrangement
on April 2, 2008. The first $500,000 borrowed was repaid, with
approximately $6,000 of accrued interest, on May 1, 2008.
2007
Convertible Debt that replaced the 2002 Credit Line
On June
26, 2007, the Company, and the Lenders, entered into an agreement to restructure
the $11.7 million of credit line debt and accrued interest which was to mature
August 2007.
The
Company issued amended and restated notes (the "Amended and Restated Notes") in
aggregate principal amount, including accrued interest on the maturing notes, of
approximately $10.2 million to replace all of the maturing credit line notes and
reflect the amendments to the Company’s previous loan agreements,
including: (i) the extension of the termination dates and maturity dates for all
the maturing notes that were set to mature August 1, 2007 to a new maturity date
of August 1, 2009; (ii) the reduction of the interest rate on each of the
maturing notes from 9% to 7% per annum; (iii) provision for the conversion of
the aggregate principal amount outstanding on each of the maturing notes at the
election of the Lenders, together with all accrued and unpaid interest thereon
into shares (the "Conversion Shares") of the ("Common Stock, at an initial
conversion price of $0.20 per share. In addition, pursuant to the amendments to
the Company’s previous loan agreements, each of the Lenders
immediately converted $750,000 in principal amount and accrued interest
outstanding under the aforementioned notes held by such
Lender prior to the restructuring into shares (the "Initial
Conversion Shares") of Common Stock at a conversion price of $0.18, the 10 day
volume weighted average closing price of the Company's Common Stock on the
American Stock Exchange ("AMEX") as of June 21, 2007. Assuming the Amended and
Restated Notes are not converted until maturity, approximately 58.5 million
shares of Common Stock would be required to be issued upon conversion, for both
principal and interest.
During
January 2008, and associated with the Clarity acquisition, Alexander purchased
an additional $1.5 million of the Amended and Restated Notes. Before
Alexander may exercise its rights to convert the additional $1.5 million of
Amended and Restated Notes into the Conversion Shares, the Company is required
to obtain approval of its stockholders and AMEX to list the additional
Conversion Shares on AMEX. The Company is required to obtain these approvals
within one year of the issuance date of these notes. In the event that these
required approvals are not obtained by that time, then the interest rate on
these notes will increase to a rate of 15% per annum. If the Conversion Shares
are not registered under the Registration Rights Agreement that the
Company entered into with Alexander in connection with the financing of the $1.5
million by the 15-month anniversary of the issuance date of the Amended and
Restated Notes, then the then-current interest rate will increase by a rate of
1% per annum each month thereafter until these Conversion Shares are registered,
up to the default rate of the lower of 20% per annum or the highest amount
permitted by law.
Assuming
these additional Amended and Restated Notes are not converted until maturity,
approximately 8.4 million shares of Common Stock would be required to be issued
upon conversion, for both principal and interest.
2006
Convertible Debt
During
June 2006, the Company entered into a Securities Purchase Agreement (the
“Agreement”) and convertible notes (the “2006 Notes”) with the Lenders, pursuant
to which the Lenders agreed, to loan an aggregate of $5,000,000 to the Company,
$2,500,000 by each Lender, in convertible debt.
The 2006
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 2006 Notes
are convertible into Common Stock at a rate of $0.33 per share, subject to
certain anti-dilution adjustments. The Lenders have the right to convert the
2006 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
2006 Notes in full in cash at any time beginning two years after the date of the
Agreement (June 2008). The conversion rate of the 2006 Notes is 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 2006 Notes will not exceed 19.99% of the aggregate number
of shares of Common Stock presently issued and outstanding.
The 2006
Notes are secured on a first priority basis by all the Company’s intangible and
tangible property and assets. Payment of the 2006 Notes was guaranteed by our
two inactive subsidiaries, Spectral Solutions, Inc. and Illinois Superconductor
Canada Corporation, and are now guaranteed by all the assets in Clarity The
Company filed a registration statement, which was declared effective by the SEC
in September 2006, covering the resale of the shares of Common Stock issuable
upon conversion of the 2006 Notes with the SEC. Concurrently with the execution
of the Agreement, the Lenders waived their right under the 2002 Credit Line to
receive the financing proceeds from the issuance of the 2006 Notes, allowing the
Company to use the funds for product development or general working capital
purposes.
Assuming
the 2006 Notes are held for the full four-year term, approximately 18.5 million
shares of Common Stock would be required to be issued upon conversion, for both
principal and interest.
Note
10 – Income Taxes
The
Company adopted the provisions of FASB Interpretation 48 (“FIN 48”), Accounting for Uncertainty in Income
Taxes, on January 1, 2007. Previously, the Company had accounted for tax
contingencies in accordance with SFAS No.5, Accounting for Contingencies.
As required by FIN 48, which clarifies FASB Statement 109, Accounting for Income Taxes,
the Company recognizes the financial statement benefit of a tax position only
after determining that the relevant tax authority would more likely than not
sustain the position following an audit. For tax positions meeting the
more-likely-than-not threshold, the amount
recognized in the financial statements is the largest benefit that has a greater
than 50 percent likelihood of being realized upon ultimate settlement with the
relevant tax authority. At the adoption date, the Company applied FIN 48 to all
tax positions for which the statute of limitations remained open. As a result of
the implementation of FIN 48, there was no effect on the Company’s financial
statements as of January 1, 2008 and there have been no material changes in
unrecognized tax benefits since January 1, 2008 through June 30,
2008.
The
Company is subject to income taxes in the U.S. federal jurisdiction and various
states jurisdictions. Tax regulations within each jurisdiction are subject to
the interpretation of the related tax laws and regulations and require
significant judgment to apply. As the Company has sustained losses since
inception, a large number of tax years are open as the losses have not been
utilized by the Company.
The
Company is currently not aware of any current or threatened examination by any
jurisdiction. The Company has elected to classify interest and
penalties related to unrecognized tax benefits as a component of income tax
expense, if applicable. No accrual is required as of January 1, 2008 and June
30, 2008 for interest and penalties.
Note
11 – Business Segments
Starting
January 2008, the Company operates in two business segments: Hardware and
Software. The Company’s chief operating decision maker, its President and Chief
Executive Officer uses the following measures in deciding how to allocate
resources and assess performance among the segments:
The results of operations by segments are as follows:
Three
Months ended June 30, 2008
|
Hardware
|
Software
|
Total
|
Revenue
|
$2,134,516
|
$351,125
|
$2,485,641
|
Gross
Profit
|
$1,084,854
|
$89,117
|
$1,173,971
|
Operating
Expenses
|
|
|
$3,177,562
|
Operating
Income (loss)
|
|
|
($2,003,591)
|
Six
Months ended June 30, 2008
|
Hardware
|
Software
|
Total
|
Revenue
|
$4,520,814
|
$721,992
|
$5,242,806
|
Gross
Profit
|
$2,069,956
|
$315,879
|
$2,385,835
|
Operating
Expenses
|
|
|
$6,952904
|
Operating
Income (loss)
|
|
|
($4,567,069)
|
Segment information is not presented for the three and six months ended June 30,
2007 as the segments were created with the acquisition of Clarity in
2008.
Note
12 – Subsequent Events
On August 18, 2008 the Company entered
into a new credit agreement with the Lenders. The Lenders agreed to
loan an aggregate of $3,000,000 to the Company through the issuance of
convertible notes. The new credit agreement also reduced the amount
of advances that may be made under the 2008 Loan Agreement by $550,000. The
notes bear interest at a rate of 9.5% per annum and mature on August
1, 2010. Any outstanding principal and accrued but unpaid interest may be
converted to Company common stock at $0.20 per share at any time during the term
of the loan at the Lenders' discretion. In connection with the new credit
agreement, the Company entered into a registration rights agreement pursuant to
which the Company is required to file a registration statement covering the
resale of 15,000,000 shares of its common stock, representing the number of
shares of common stock issuable upon conversion of the maximum principal amount
due on the convertible notes at the initial conversion price of $0.20 per
share.
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 our
future results of operations, performance and achievements. We have tried,
wherever possible, to identify these forward-looking statements, as defined in
the Private Securities Litigation Reform Act of 1995, as amended, 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 Item 1A, Risk Factors
of our Annual Report on Form 10-K, as amended, for the year ended
December 31, 2007, which could cause our actual results, performance or
achievements for 2008 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, which speak only as of the date of this
Quarterly Report. 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 Quarterly Report or to reflect
the occurrence of unanticipated events. If one or more of these risks or
uncertainties materialize, or if the underlying assumptions prove incorrect, our
actual results may vary materially from those expected or
projected.
General
We have
employed an outsourced manufacturing model in which we sometimes supply raw
materials to external parties and products are then completed, and in other
cases purchase the material and labor from the outsourced
manufacturer. This system allows us to more completely outsource
procurement in the future if we choose to do so. Manufacturing partners then
produce to specification with Company personnel on hand to assist with quality
control. Our products are designed for efficient production in this manner,
emphasizing solid-state electronics over mechanical devices with moving parts.
The cost benefits associated with these developments, coupled with enhanced
product functionality, have allowed us to realize good margins and efficiently
manage overhead costs. Extensions of developed technology, based on substantial
input from customers, have allowed us to launch the RF² product family and
consider additional solutions while generally controlling total research and
development (also referred as “R&D”) cost. As we move
toward digital hardware and software-based solutions, and with the addition of
Clarity Communication Systems Inc. (“Clarity”), we expect to increase the
relative component of royalty and other non-product sales revenue
streams.
We
acquired Clarity in January 2008 in a merger transaction in which we acquired
all of the outstanding stock of Clarity, and Clarity became a wholly-owned
subsidiary. Clarity provides value added mobile device features
including a push-to-talk platform, location-based services, interoperability
with land mobile radios and management from an administrative
portal. The individual features are combined into a proprietary
solution called Clarity Public Safety. Clarity continues to maintain
customers that resell its push-to-talk platform.
Additionally,
we have defined numerous new applications for our Adaptive Interference
Management (AIM) platform that are compelling in a digital hardware
package. We also believe the underlying software technology and
algorithms constituting the Company’s intellectual property could potentially
reach a far broader audience if it could be delivered solely in
software. Such an adaptation would open additional markets such as
mobile devices, small cell sites and repeaters, WiFi nodes, WiMax, and other
architectures in other markets that employ wireless communications.
Wireless
telecommunications have undergone significant merger activity in recent years, a
trend which we believe will continue. These activities often result in operators
with 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 solutions that address these types of requirements. We
believe that spectrum re-mining in Europe will soon be a very significant event
in the RF conditioning and management space, with operators deploying Universal
Mobile Telecommunications Systems (UMTS) in conjunction with existing Global
System for Mobile Communications (GSM) networks, which we believe will create
challenges for these operators. We believe these operators may find
significant benefit from deploying our AIM solution. We see other
areas as likewise benefiting from our RF management solutions, including active
engagements in Latin America and Asia.
We announced several
significant events during 2008, including the merger with Clarity, the addition
of Gordon Reichard, Jr., as the Chief Executive Officer, the resignation of John
Thode and James Fuentes from our Board of Directors and the addition of Torbjorn
Folkebrant, formerly of LM Ericsson Telephone Company, and Stephen McCarthy
formerly of Tellabs, Inc., to our Board of Directors. Frank Cesario
resigned as the Chief Financial Officer and was replaced by Gary Berger. As we
expand our focus on sales both domestically and internationally we entered
agreements with the magis group, L.L.C, and Sales Force Europe. Late in the
second quarter of 2008, several engineers who were working on development of our
DIF product voluntarily left the business. The departure of these individuals has
caused delays in the availability of this new product. Early in the third
quarter of 2008, we hired Jack Christie as the Vice President of Sales to lead
the sales efforts of the Company. We have seen reports of possible
operator spending reductions in North America, with relatively higher
spending outside North America. Market diversification is one of the
primary reasons why we have been more active in exploring international
opportunities. During the second quarter it was announced that
Verizon Wireless would be acquiring Alltel Corporation. Alltel Corporation is
one of the largest customers of our hardware business. At this point, we have
been unable to determine the impact of this transaction on our sales.
In August 2008, we entered
into a new credit agreement with Manchester Securities Corporation and Alexander
Finance, L.P (together, the “Lenders”). Under the new credit
agreement, the Lenders agreed to loan an aggregate of $3,000,000 to the Company
through the issuance of convertible notes and reduced the amount of advances
that may be made under the 2008 Loan Agreement by $550,000. With this
new funding, we will continue to evaluate our options for our existing lines of
business.
Critical
Accounting Policies
The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amount of assets and liabilities, revenues
and expenses, and related disclosure of contingent assets and liabilities at the
date of our financial statements. Actual results may differ from these estimates
under different assumptions or conditions.
Critical
accounting policies are defined as those that are reflective of significant
judgments and uncertainties, and potentially result in materially different
results under different assumptions and conditions. We believe that our critical
accounting policies are limited to those described below.
Revenue
Recognition
In
accordance with Staff Accounting Bulletin No. 104, we recognize revenue when the
following criteria are met: persuasive evidence of an arrangement exists,
delivery has occurred or services have been rendered, price is fixed and
determinable, and collectability is reasonably assured. Revenues from product
sales are generally recognized at the time of shipment and are recorded net of
estimated returns and allowances. Revenues from services are generally
recognized upon substantial completion of the service and acceptance by the
customer. We have under certain conditions, granted customers the right to
return product during a specified period of time after shipment. In these
situations, we establish a liability for estimated returns and allowances at the
time of shipment and make the appropriate adjustment in revenue recognized for
accounting purposes. During the six months ended on June 30, 2008 and 2007, no
revenue was recognized on products that included a right to return or otherwise
required customer acceptance after June 30, 2008. We have established a program
which, in certain situations, allows customers or prospective customers to field
test our products for a specified period of time. Revenues from field test
arrangements are recognized upon customer acceptance of the
products.
During
2006, we began to sell the dANF product which contains software that is
essential to the functionality of the product and as such is required to be
accounted for in accordance with Statement of Position (“SOP”) 97-2, “Software
Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions.” The revenue
recognized for each separate element of a multiple-element software contract is
based upon vendor-specific objective evidence of fair value, which is based upon
the price the customer is required to pay when the element is sold separately.
The dANF product is recognized as revenue upon shipment while the maintenance is
deferred and recognized on a straight line basis during the applicable
maintenance period, typically 1-3 years.
Certain
of our software agreements encompass multiple
deliverables. Accounting for these agreements is in accordance with
Emerging Issues Task Force (“EITF”) No. 00-21, “Accounting for Revenue Arrangements
with Multiple Deliverables” (“EITF 00-21”). If the
deliverables meet the criteria in EITF 00-21, the deliverables are separated
into separate units of accounting and revenue is allocated to the deliverables
based on their relative fair values. In order for this accounting
treatment to apply the deliverables must have value to the customer on a
stand-alone basis, there must be objective and reliable evidence of the fair
value of the undelivered item, and if the arrangement includes a general right
of return relative to the delivered item, delivery or performance of the
undelivered item is considered probable and substantially in the control of the
Company. If the deliverables do not meet the above criteria they are
treated as a single multiple-element arrangement. The accounting
treatment for single multiple-element arrangements means that any milestone
payments made by the customer are recognized over the remaining term of the
arrangement at each milestone date and the proportional amount of the support
fee is recognized monthly starting at the milestone date through the end of the
agreement. Management applies judgment to ensure appropriate application of EITF
00-21, including value allocation among multiple deliverables, determination of
whether undelivered elements are essential to the functionality of the delivered
elements and timing of revenue recognition among others.
We
warrant our products against defects in materials and workmanship typically for
a 1-2 year period from the date of shipment, though these terms may be
negotiated on a case by case basis. A provision for estimated future costs
related to warranty expenses is recorded when revenues are recognized. We
accrued warranty cost of $34,000 for the first six months of 2008 and 2007. This
warranty reserve is based on the cost to replace a percentage of products in the
field at a given point, adjusted by actual experience. Returns and allowances
were not significant in any period reported, and form a data point in
establishing the reserve. Should this warranty reserve estimate be deemed
insufficient, by new information, experience, or otherwise, an increase to
warranty expense would be required.
Goodwill
and Intangible Assets
During 2007, we completed our annual
process of evaluating goodwill for impairment under SFAS No. 142 “Goodwill and
Other Intangible Assets”. As the fair value of the enterprise, using quoted
market prices for our common stock, exceeded the carrying amount, goodwill was
determined to be not impaired. We assess the potential for impairment of
goodwill annually, or more frequently if events or changes in circumstances
indicate that the asset might be impaired. If we determine that the carrying
value of goodwill is less than its fair value, a write-down may be required. In
accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of
Long-Lived Assets”, we review our identifiable intangible assets for impairment
whenever events or changes in circumstances indicate that the carrying amount
may not be recoverable. Recoverability of the intangible assets is measured by a
comparison of the carrying amount to the fair value. If intangible assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the asset exceeds the fair value.
Management does not believe that
there was an impairment to goodwill and intangible assets as of June
2008.
Allowance
for Doubtful Receivables
An
allowance for doubtful receivables may be maintained for potential credit
losses. Management specifically analyzes accounts receivable, on a client by
client basis, when evaluating the adequacy of our allowance for doubtful
receivables including customer creditworthiness and current economic trends and
records any necessary bad debt expense based on the best estimate of the facts
known to date. Should the facts regarding the collectibility of receivables
change, the resulting change in the allowance would be charged or credited to
income in the period such determination is made. There was no bad debt allowance
recorded as of June 30, 2008 and 2007.
Stock-Based
Compensation
Effective
January 1, 2006, we adopted the provisions of SFAS No. 123R, "Share-Based
Payment," ("FAS 123R") which establishes accounting for equity instruments
exchanged for employee services. Under the provisions of FAS 123R, share-based
compensation cost is measured at the grant date, based on the calculated fair
value of the award, and is recognized as an expense over the employee's
requisite service period (generally the vesting period of the equity grant).
Performance-based grants (grants that vest upon a future event and not due to
the passage of time) are not expensed until we believe it probable that vesting
will occur. We elected to adopt the modified prospective transition method as
provided by FAS 123R and, accordingly, financial statement amounts for the prior
periods have not been retroactively adjusted to reflect the fair value method of
expensing share-based compensation. Under the modified prospective method,
share-based expense recognized after adoption includes: (a) share-based expense
for all awards granted prior to, but not yet vested as of January 1, 2006, based
on the grant date fair value and (b) share-based expense for all awards granted
subsequent to January 1, 2006. We changed our equity compensation practices at
the same time to emphasize grants of restricted stock as opposed to stock
options. As most options were fully vested as of January 1, 2006, only a small
portion of its total equity compensation expense came from stock options, with
the vast majority coming from grants of restricted stock. Grants of restricted
stock are valued at the market price on the date of grant and amortized during
the service period on a straight-line basis or the vesting of such grant,
whichever is higher.
Results
of Operations
Three
months ended June 30, 2008 and 2007
Our net
sales decreased $937,000 or 27% to $2,486,000 for the three months ended June
30, 2008 from $3,423,000 for the same period in 2007, which we attribute largely
to the 2007 backlog of customer orders, partially offset by the addition of
software related revenues from our Clarity unit. Gross margins
declined $546,000 due to lower hardware shipments for the second quarter of 2008
compared to the second quarter of 2007. Gross margin rates declined
to 47% of revenue in the current period from 50% for the same period in
2007. This reduction in gross margin rates was the result of new
software contracts where costs were incurred in advance of revenues earned
thereby lowering the gross margin rate. Hardware gross margin rates were
slightly higher than in the prior year. Cumulative deferred revenue, which
represents revenue that will be recognized in future periods increased to $0.8
million at June 30, 2008 which was up from $0.25 million at June 30,
2007.
Cost of
goods sold, decreased by $391, 000 or 23% to $ $1,312,000 for the quarter ended
June 30, 2008 from $1,703,000 for the same period in 2007. The
decrease in cost of goods sold was fully attributable to the decline in hardware
revenue and is shown net of the cost of sales related to software
revenues.
Our
research and development expenses increased $622,000 totaling $1,284,000 for the
most recent quarter compared to total research and development expenses in the
same period in 2007, which totaled $662,000. The entire net increase
in R&D expenditures is attributed to the addition of Clarity, as these
expenditures in the hardware business declined compared to prior
year. We expect R&D spending to continue at approximately the
same rate for at least the next quarter as efforts continue in new product
development for both hardware and software offerings.
Sales and
marketing expenses remained flat at $698,000 for the June 30, 2008 quarter
compared to $671,000 for the same ninety day period in 2007. The
addition of expenses in this category associated with sales and marketing
efforts of our software products were offset by vacancies in the hardware sales
organization along with a reduction in sales commissions due to lower bookings
in the period. We expect expenses in this category to increase for the remainder
of the year as additional internal and external sales resources are added and as
we realize expected increases in order activity specifically in the fourth
quarter.
General
and administrative expenses increased by $214,000 or 22%, compared to the same
period in 2007. The entire increase in this category is related to
the inclusion of Clarity as there was a slight reduction in
expenses during this quarter associated with the hardware
business. A reduction in compensation-related charges associated with
stock grants was the primary driver of the lower expense associated with the
hardware business. Expenses in this category are expected to continue
at second quarter levels for the remainder of 2008.
Net other
expenses increased $64,000 or 27% to $300,000 for the period ended June 30, 2008
compared to the same period in 2007. Higher interest expense due to
higher outstanding debt; along with lower interest income associated with less
excess cash were the causes of the increase. This trend is expected
to continue for the remainder of 2008.
Six
months ended June 30, 2008 and 2007
Our net
sales totaled $5,243,000 for the six months ended June 30, 2008, which
represented an increase of $867,000 or 20% from the same year-to-date period in
2007. The addition of Clarity accounted for the largest portion of
the increase although hardware sales were also higher due to low hardware
shipments during the first quarter of 2007. Gross margins on hardware
sales were $105,000 higher for the first six months of 2008 compared to the
prior year. Most of the margin increase was due to higher volumes
during the period. Hardware gross margins increased to 46% from 45%
the prior year.
Research
and development spending totaled $2,874,000 for the six months ended June 30,
2008, an increase of $1,591,000 from the same period in the prior year,
primarily due to the inclusion of Clarity. R&D spending for
hardware was flat compared to the prior year.
Sales
and marketing expenses for the first six months of 2008 totaled $1,634,000 which
is $380,000 or 30% higher than the prior year. The total increase was
due to the addition of Clarity and was partially offset by reductions in
spending on hardware sales and marketing efforts due to lower sales and
marketing headcounts and lower professional fees.
General
and administrative expenses totaled $2,444,000 for the first six months of 2008,
which was $263,000 or approximately 12% higher than the prior
year. General and Administrative expenses for the hardware business
were $150,000 lower than the prior year as a result of lower stock compensation
expense.
Other
expenses increased $97,000 or 20% from the first six months in the prior
year. The increase was caused by higher outstanding borrowings along
with lower interest income due to lower excess cash balances available for
investing.
Consolidated net loss for the first six
months of 2008 totaled $5,138,000 which is $1,910,000 or 59% higher than the
same period in previous year. Net loss from the hardware business was $2,874,000
which was $355,000 lower than the prior year. The net loss for the software
business totaled $2,265,000 on year to date revenues of $722,000.
Liquidity
and Capital Resources
At June
30, 2008, cash and cash equivalents were approximately $0.3 million, a decrease
of $1.5million from the December 31, 2007 balance. This
decrease was associated with the costs of the combined business operations
during the period and is in addition to the $1.5 million borrowed to pay off
Clarity’s $1.2 million credit line and $0.4 million of Clarity’s closing costs
as required by the merger agreement the Company entered with
Clarity. During the second quarter, $1.2 million was drawn from the
$2.5 million credit line with Manchester Securities Corporation and Alexander
Finance, L.P. with approximately $0.5 million used to repay the loan associated
with the trade receivable factoring arrangement with the remainder of the draw
used to support operations and new product development efforts.
To date,
the Company has financed its operations primarily through public and private
equity and debt financings. The Clarity acquisition has significantly
increased the cash required to fund new product development and for ongoing
operations of the business. The continued operations of our combined
entity will require an immediate commitment and/or availability of funds, as
will continuing development of our product lines and any required defense of our
intellectual property. The actual amount of our immediate and future
funding requirements depends on many factors, including; the amount and timing
of future sales along with the timing of customer payments, the level of
spending required to develop new hardware and software products, the level of
product marketing and sales efforts to support our commercialization plans, our
ability to maintain and improve product margins, the level of deferred revenue
and the costs involved in protecting our patents and other intellectual
property. While the Company has historically been successful in
raising additional operating funds there can be no guarantees that we will be
successful in raising funds at levels sufficient to support all of our operating
activities. As we continue to evaluate strategic options for the
business, efforts are on-going to obtain additional funding in amounts adequate
to support future operating needs from the current Lenders as well as
alternative sources.
Net cash
used in operating activities increased $1,408,000 for the first six months ended
June 30, 2008 compared to the same period ended June 30, 2007. The
increase in the net loss of $1,909,000 was partially offset by a reduction of
net working capital. Lower accounts receivable balances provided most
of the reduction in working capital and were the results of the timing of
customer invoicing and improved cash collection efforts. Inventory
levels were also lower due to inventory reduction programs along with continued
outsourcing of some production activities.
Investing
activities consisted primarily of the acquisition of the outstanding stock of
Clarity by merger. in January 2008. Financing activities consisted of
the issuance of common stock for option exercises. Loan proceeds
represent borrowing used to fund operating activities during the
period. Loan repayment activities reflect repayment of borrowings
under the accounts receivable factoring arrangement with the
Lenders.
Contractual
Obligations and Commitments
The
following table lists the contractual obligations and commitments that existed
as of June 30, 2008:
Contractual
Obligations
|
Payments
Due by Period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
than 1
|
|
|
|
|
|
|
|
|
More
than
|
|
Year
|
|
Total
|
|
|
Year
|
|
|
1-3
Years
|
|
|
3-5
Years
|
|
|
5
Years
|
|
Long
Term Debt Obligations
|
$
|
19,207,981
|
|
$
|
-
|
|
$
|
19,207,981
|
|
$
|
|
|
|
-
|
|
Operating
Lease Obligations
|
$
|
1,353,000
|
|
$
|
204,000
|
|
$
|
422,000
|
|
$
|
441,000
|
|
$
|
286,000
|
|
Total
|
$
|
20,560,981
|
|
$
|
204,000
|
|
$
|
19,629,981
|
|
$
|
441,000
|
|
$
|
286,000
|
|
Off
Balance Sheet Arrangements
We did
not engage in any off-balance sheet arrangements during the period ended June
30, 2008.
The Company
is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act of
1934, as amended (the “Exchange Act”) and is not required to provide the
information required under this item.
|
(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 Exchange Act as of June 30,
2008. 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.
The
Company’s management, including its CEO and CFO, believes that a controls
system, no matter how well designed and operated, is based in part upon
certain assumptions about the likelihood of future events, and therefore
can only provide reasonable, not absolute assurance that the objectives of
the control system are met, and no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within a company have been detected.
|
|
(b)
|
There
were no significant changes in the Company’s internal control over
financial reporting identified in connection with the evaluation of such
controls 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.
|
None.
The
Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange
Act and is not required to provide the information required under this
item.
None.
None.
None.
None.
Exhibit
Number
|
Description
of Exhibit
|
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 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 19 th day of
August 2008.
|
|
|
ISCO
International, Inc.
|
|
|
By:
|
|
|
|
|
Gordon
Reichard, Jr.
|
|
|
President
and Chief Executive Officer
|
|
|
(Principal
Executive Officer)
|
|
|
By:
|
|
|
|
|
Gary
Berger
|
|
|
Chief
Financial Officer
|
|
|
(Principal
Financial and Accounting Officer)
|
EXHIBIT
INDEX
|
|
|
Exhibit
Number
|
|
Description
of Exhibit
|
|
|
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.
|