Item 2
: Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Certain
statements in this report, other than purely historical information, including
estimates, projections, statements relating to our business plans, objectives
and expected operating results, and the assumptions upon which those statements
are based, are “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995, Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally
are identified by the words “believe,” “expect,” “intend,” “estimate,” “anticipate,”
“project,” “will,” “plan,” “will continue,” “will likely result” and similar
expressions. Forward-looking statements
are based on current expectations and assumptions that are subject to risks and
uncertainties which may cause actual results to differ materially from the
forward-looking statements. A detailed
discussion of these and other risks and uncertainties that could cause actual
results and events to differ materially from such forward-looking statements is
included in the section entitled “Risk Factors” (refer to Item 1A of Part II). We undertake no obligation to update or
revise publicly any forward-looking statements, whether as a result of new
information, future events or otherwise.
General Discussion
We are focused on
the provision of homeland security services and the manufacture of
300-millimeter (and smaller diameter) silicon wafer reclaim and test products,
wafer thinning and custom wafer products for the semiconductor industry. During the past several years, our operations
have been characterized by working capital and cash flow shortfalls, and the
need for a significant amount of third party investment to enable us to meet
our financial obligations. Although we
have met our core obligations to date, we have frequently been required to allocate
our available cash among various obligations.
During the six months ended October 31, 2007 and subsequently, we
have also refocused our operations and have attempted to reduce significantly
our expenses, including the cash flow necessary to pay our corporate and
divisional overhead.
During the year ended April 30, 2007, and the six months ended October 31,
2007, we generated sales from stable and radioactive isotopes, silicon wafer
reclaim and test products, wafer thinning and custom wafer products for the
semiconductor industry, although sales from stable and radioactive isotopes
were reported as discontinued operations in the accompanying condensed
consolidated statements of operations as described below and during the quarter
ended October 31, 2007 we suspended operations in our homeland security
products segment. During the year ended April 30,
2006 and the six months ended October 31, 2007, we also generated revenues
from providing
security services for
leading businesses and institutions in healthcare, education, retail,
manufacturing, banking and the art world.
For information about segment revenue, refer to Note 4 (Segment
Information) to the condensed consolidated financial statements located in Item
1: Financial Statements.
In June 2007, we sold our life sciences
business (which supplied isotopes for life sciences and health-care
applications) as it no longer fit our long-term strategy for building a
sustainable and profitable homeland security and semiconductor company and
because of deteriorating business conditions in the historical, revenue
producing products in this business.
Accounting rules required us to treat the operations of the life
sciences business as discontinued operations whereby the net financial impact
of the operations of the business (including revenue) is combined into a single
line item and prior periods are reclassified for this presentation. Revenue for the life sciences business,
reported in the single line item of gain on operations of discontinued
operations, net of income taxes, was $101,000 and $1,193,000 for the six months
ended October 31, 2007 and 2006, respectively.
In August 2007, we elected to suspend
the development, manufacture and sale of our IMS-based products. The suspension was due primarily to a lack of
working capital but we have also had difficulty competing in the market
space. We will continue to seek
alternatives towards finding a means of monetizing our IMS-based investment,
including an outright sale of the technology.
It is unclear as to when (if at all) we will resume activity on our
IMS-based products and we
15
can offer no assurance that we will be able
to monetize any portion of our IMS technology investment.
In September 2007, we assigned our
existing exclusive rights regarding silicon-28 patents (secured under the 1997
License Agreement with Yale University) to an independent entity, such
assignment receiving the consent and agreement of Yale University. Silicon-28 is a naturally occurring stable
isotope of silicon which, in a near isotopically-pure form, may have performance
benefits as compared to multi-isotopic materials currently prevalent in the
semiconductor marketplace. In periods
presented, proceeds from the sale of silicon-28 based products have been
immaterial and we have not invested material resources in the program.
In October 2007, Lucent terminated our development project regarding
a next-generation infrared imaging and night vision surveillance technology due
to our inability to make a required development payment which was due in July 2007. As a result, our investment in SenseIt has
become valueless.
We
are in process of winding down the operations of SenseIt.
Consistent with management focus during the six months ended October 31,
2007 and prior, we continue to evaluate our portfolio of operating businesses
and technology with the goal of operating our business more efficiently and
monetizing non-core assets.
Additionally, we have considered and will continue to consider business
expansion through merger, acquisition, joint venture or other means, although
we can offer no assurance as to our ultimate success in increasing the scope of
our business through such means.
On December 6, 2007, we received
notification from the Nasdaq stating that it determined to delist our
securities from Nasdaq. Trading in our
shares on the Nasdaq Capital Market was suspended effective with the open of
business on December 10, 2007.
Nasdaq’s
decision was rendered following a hearing held before a Nasdaq Listing
Qualifications Panel on November 29, 2007.
We are working with our market makers and are hopeful that our common
stock will be enabled for trading on the OTC Bulletin Board.
Liquidity
and Capital Resources
We have had working
capital shortages in the past and, although we raised capital totaling more
than $45,800,000 (net of expenses and $4,100,000 of payments related to our 8%
Debentures) since May 1, 2004, we have generated significant losses, which
have impacted working capital. As of October 31,
2007, our condensed consolidated balance sheet reflects working capital of
$1,166,000. In addition, as a result of
our continued operating losses and projected declining working capital balances
during the year ending April 30, 2008, the auditors report included with
our financial statements for the year ended April 30, 2007, included an
explanatory paragraph indicating substantial doubt about our ability to
continue as a going concern.
Based on the amount
of capital we have remaining and our expected negative cash flow from
operations and investing activities, we anticipate that we will not be able to positively
impact our working capital unless we are able to substantially increase our
revenues or reduce our expenses thereby generating positive cash flow from
operations and (ultimately) operating income.
W
e believe we have sufficient working capital to finance our anticipated
operations and projected negative cash flow only into our quarter ending April 30,
2008, unless we are able to achieve significant additional financing. Because of the potential dilution associated
with the outstanding debentures and the holder’s security interest in
substantially all of our assets, we believe that it is unlikely that we will be
able to obtain additional financing unless we are able to reach an
accommodation with our existing debenture holder.
We have not met certain of the requirements
under the 2006 Debentures and the 2007 Debenture (together referred to as the “13%
Debentures”) and their holder may be able to, in its discretion, declare an
Event of Default. Additionally, an Event
of Default under any one of the 13% Debentures would allow the holder to
declare an Event of Default under all of the 13% Debentures. Remedies for an
16
Event of Default include the option to
accelerate payment of the full principal amount of the 13% Debentures, together
with interest and other amounts due (a cumulative amount of $20,044,000 at October 31,
2007), to the date of acceleration and the holder will have the right to
request such payment in cash or in shares of our common stock. If the holder of the 13% Debentures declares
an Event of Default, it is possible that we will not be able to cure the
default or contest any efforts that the holder may take to foreclose against
its security interest in substantially all of our assets.
See additional
discussion of
liquidity and capital
resources in the Liquidity and Capital Resources section included further below
in this Item 2:
Management’s Discussion and Analysis of Financial
Condition and Results of Operations.
Homeland
Security
Isonics Homeland
Security and Defense Corporation (“HSDC”) focuses the majority of our efforts
in the homeland security sector. These
efforts have included entry into the security services market through our
acquisition of PPSC in May 2005, acquisition and (prior to August 2007)
development of our IMS detection technology and our entry into both an
agreement (currently terminated) with Lucent and a 90% owned joint venture
named SenseIt Corp to develop innovative infrared imaging and night vision surveillance
technology. HSDC’s assets also include
our 30% minority interest in IUT.
Security
Services
— Since the effective date of our acquisition of
PPSC in May 2005, PPSC has delivered significant revenue to our condensed
consolidated financial statements and has provided gross margin of
approximately 23% of revenues for the six months ended October 31, 2007.
During the fourth
quarter of the year ended April 30, 2007, and the six months ended October 31,
2007, we implemented cost cutting initiatives that were expected to positively
impact the results of PPSC’s operations.
Additionally we initiated plans to improve operating margins at PPSC by
focusing on customers that are willing to pay for premium security services, a
market in which we believe that PPSC is able to differentiate itself from its
peers. As a result of the impact of our
ongoing cost cutting initiatives, the segment generated operating income of
$323,000 for the six months ended October 31, 2007, as compared to an
operating loss of $(294,000) for the six months ended October 31,
2006. For the six months ended October 31,
2007 and 2006, the operating loss includes non-cash amortization of
acquisition-related customer intangibles and stock-based compensation expense
in the aggregate amount of $97,000 and $137,000, respectively.
While we believe
that these cost cutting initiatives and focused sales and marketing efforts
will enable PPSC to report positive operating income for the year ending April 30,
2008, the industry is cost competitive and customers switch security service
providers on short notice and, therefore, we can offer no assurance that this
will actually occur.
Detection Technology
— During our year ended April 30, 2007 and through August 2007,
we offered our existing IMS-based products (the panel-mounted IMS and
EnviroSecure
™
), although we did
not engage in any significant marketing efforts for these products subsequent
to late in calendar year 2006. Although
w
e continued to offer EnviroSecure™, a system that can monitor and
identify chemical weapons and toxic substances in the air in a variety of
venues including airports, mass transit facilities, sports venues and public
and private sector office buildings, we did not make any sales of this product
or engage in any significant marketing activities. Our sales of the panel-mounted IMS product
were extremely limited and historically resulted in deferred revenue, although
we substantially recognized the deferred revenue during the three months ended October 31,
2007, as a result of reaching an accord with our sole customer for that
product. We do not intend to recommence
any marketing efforts until (if ever) we are adequately capitalized, have a
commercial product and have identified a market.
17
In August 2007, we elected to suspend
the development, manufacture and sale of our IMS-based products. The suspension was due primarily to a lack of
working capital but we have also had difficulty competing in the market space. We will continue to seek alternatives towards
finding a means of monetizing our IMS-based investment, including an outright
sale of the technology. It is unclear as
to when (if at all) we will resume activity on our IMS-based products and we
can offer no assurance that we will be able to monetize any portion of our
IMS-based investment.
Infrared Imaging Technology
— In December, 2005, we approved a development
plan that resulted in us becoming obligated under the Lucent Agreement we
entered into with Lucent in September 2005 which, in October 2006, we
assigned to our 90% owned subsidiary, SenseIt Corp. Under the Lucent Agreement, we were
attempting to develop a next-generation infrared imaging and night vision
surveillance technology based on Lucent’s micro electro-mechanical systems (“MEMS”)
technology under development at its nanotechnology fabrication facility. Infrared technology, which converts infrared
radiation in the non-visible spectrum, such as body heat, into a visible image,
is commonly found in both commercial and military/homeland security applications
including night vision goggles and cameras, rifle scopes and threat detection
devices used to identify concealed weapons or explosives. The development plan contemplated a
proof-of-concept during calendar year 2007, followed by steps towards commercialization.
We did not make the $1,000,000 payment that was due to Lucent on or
before July 16, 2007. As a result
of not making this payment, effective October 13, 2007, Lucent terminated
the Lucent Agreement. Therefore, our
investment in SenseIt and the Lucent Agreement (in the cumulative amount of
approximately $7,000,000) has become valueless.
We are in process of winding down the operations of SenseIt.
Semiconductor
Products and Services
Our semiconductor
operations, based in Vancouver, Washington, showed continued operational and
financial improvement during the years ended April 30, 2007 and 2006,
although we have experienced a softening of demand for our products and
services during the six months ended October 31, 2007 and subsequently (as
discussed further below). The segment
generated operating income for the year ended April 30, 2007, in the
amount of $326,000 (which includes a non-cash charge of $122,000 for
stock-based compensation expense) as compared to an operating loss for the year
ended April 30, 2006, in the amount of $(5,151,000). The positive operating income resulted
primarily from our ongoing effort to reduce our reliance on low margin small
diameter products and diversify into higher margin 300-millimeter products and
services, wafer thinning and custom wafer products.
The large-diameter
wafer segment has become one of the fastest growing segments of the silicon
wafer market and the revenues and gross margins associated with the services
are greater than those associated with the small diameter market. As a result of our strategic realignment,
revenue from 300-millimeter services comprised approximately 46% of segment
revenue for the six months ended October 31, 2007 ($1,870,000 of revenue)
and 54% of segment revenue for the year ended April 30, 2007 ($7,049,000
of revenue), as compared to approximately 36% of segment revenue for the year
ended April 30, 2006 ($2,053,000 of revenue). At the same time, there has also been a focus
on operational efficiency and effectiveness, which has resulted in increased
productivity and processing yields.
Further, we continue to gain new customers and are also in the process
of attempting to qualify our product at others.
While we reported significant revenue and operating income growth in our
semiconductor operations for the year ended April 30, 2007, many of our
top semiconductor customers experienced weakened business results in recent
quarters. In addition, some customers
reported inventory buildup in reclaim and/or test products. As a result of these two factors, during the
six months ended October 31, 2007, we have seen a slowdown in orders of
reclaim and test materials, which has had a negative impact on our operations.
The slowdown significantly impacted our revenues, results of operations
and cash flows for the six months ended October 31, 2007, in which we
generated an
18
operating loss of $(959,000) as compared to $(48,000) for the six months
ended October 31, 2006. The impact
of the slowdown in orders on our business is magnified when the results are
compared to the three months ended April 30, 2007, whereby we generated
operating income of $286,000.
In order to minimize the effect of the slowdown, we have implemented many
cost cutting measures and are continuing to do so. It is unclear as to when our customers’
demand will rebound but we believe that this is a relatively short-term
condition and are hopeful that we will begin to see a recovery during the next
three to six months. While we continue
to aggressively pursue and add new customers to mitigate the underlying
uncertainties with our existing customer base, we expect to reflect continued
decreased revenue for the three months ended January 31, 2008 (as compared
to the three months ended January 31, 2007) and the reporting of an
operating loss for the segment.
We continue to monitor the situation closely and while we believe that we
will see improving financial results in this operating segment (over the
long-term), we cannot offer any assurance that we will be able to regain or
sustain operating profitability in future periods.
Results of Operations
Our results of operations to date have not
been profitable and, in fact, have resulted in significant losses. Our
consolidated revenues in the future will depend primarily on our success in
selling products and services in the homeland security and semiconductor
markets. Our profitability will be
dependent upon
our ability to manage our costs and to increase our revenues in all of our
business segments. However, we can offer
no assurance that we will be able to increase our revenues or our
profitability.
The following table sets forth, for the
periods indicated, condensed consolidated statements of operations data
expressed as a percentage of revenues.
The table and the discussion below should be read in conjunction with
the condensed consolidated financial statements and the notes thereto appearing
elsewhere in this report. In January 2007,
we elected to discontinue the operation of our life sciences business and to
put the assets and business up for sale (which was sold in June 2007). As a result, we reclassified the operations
of our life sciences business as discontinued operations. Prior year information has been reclassified
to conform to the current year presentation.
|
|
|
Three Months Ended
|
|
Six Months Ended
|
|
|
|
|
October 31,
|
|
October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Revenues
|
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
|
Cost of revenues
|
|
92.0
|
|
75.2
|
|
88.6
|
|
78.5
|
|
|
Gross margin
|
|
8.0
|
|
24.8
|
|
11.4
|
|
21.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
Selling, general
and administrative
|
|
30.8
|
|
56.5
|
|
33.2
|
|
56.0
|
|
|
Impairment loss
on intangible assets
|
|
2.4
|
|
—
|
|
1.2
|
|
—
|
|
|
Research and
development
|
|
2.7
|
|
10.8
|
|
9.9
|
|
15.6
|
|
|
Total operating
expenses
|
|
35.9
|
|
67.3
|
|
44.3
|
|
71.6
|
|
|
Operating loss
|
|
(27.9
|
)
|
(42.5
|
)
|
(32.9
|
)
|
(50.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense), net
|
|
(17.9
|
)
|
(7.0
|
)
|
(20.8
|
)
|
7.4
|
|
|
Loss from continuing operations before income taxes
and elimination of minority interest
|
|
(45.8
|
)
|
(49.5
|
)
|
(53.7
|
)
|
(42.7
|
)
|
|
Income tax expense
|
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Minority interest in operations of consolidated
subsidiary
|
|
0.1
|
|
0.6
|
|
0.9
|
|
0.3
|
|
|
Loss from continuing operations
|
|
(45.7
|
)
|
(48.9
|
)
|
(52.8
|
)
|
(42.4
|
)
|
|
Gain (loss) on discontinued operations, net of
income taxes
|
|
—
|
|
(0.7
|
)
|
4.6
|
|
(0.1
|
)
|
|
NET LOSS
|
|
(45.7
|
)%
|
(49.6
|
)%
|
(48.2
|
)%
|
(42.5
|
)%
|
19
Revenues
Revenues from our
security services and homeland security products segments increased slightly
while revenues from our semiconductor products and services segments decreased
for the three and six months ended October 31, 2007, as compared to the
same periods of our prior fiscal year, as described in the following table:
|
|
|
Three Months Ended
|
|
Six Months Ended
|
|
|
|
|
October 31,
|
|
October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Homeland security products
|
|
195,000
|
|
—
|
|
195,000
|
|
—
|
|
|
Security services
|
|
3,866,000
|
|
3,739,000
|
|
7,622,000
|
|
7,616,000
|
|
|
Semiconductor products and
services
|
|
1,994,000
|
|
3,516,000
|
|
4,107,000
|
|
6,425,000
|
|
|
Total
|
|
$
|
6,055,000
|
|
$
|
7,255,000
|
|
$
|
11,924,000
|
|
$
|
14,041,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The slight
increase in revenue from the security services segment for the three and six
months ended October 31, 2007, is due to the net effect of the loss of
several mainly lower margin security services contracts during the current
period offset by the addition of new customers as well as by increases in work
performed at certain existing customers.
We continue to market our services aggressively by seeking
premium
accounts that prefer higher quality of service. W
hile we are hopeful that in the long-term we will be able to grow revenue
in this segment by securing additional new security contracts in our PPSC
subsidiary and retaining existing customers under contract currently with PPSC,
we cannot provide any assurance that we will be able to do so and we may in the
short-term fail to retain certain of our customers.
While we reported significant revenue and operating income growth in our
semiconductor operations for the year ended April 30, 2007, many of our
top semiconductor customers experienced weakened business results in recent
quarters. In addition, some customers
have reported inventory buildup in reclaim and/or test products. As a result of these two factors, we have
recently seen a slowdown in orders of reclaim and test materials, which has had
a negative impact on our operations.
The slowdown in the semiconductor products and services segment
significantly impacted our revenues, which decreased by approximately 36% to
$4,107,000 for the six months ended October 31, 2007, as compared to
$6,425,000 for the six months ended October 31, 2006. The impact of the slowdown in orders on our
business is magnified when the results are compared to the three months ended April 30,
2007, whereby we recorded revenues of $3,686,000.
In order to minimize the effect of the slowdown, we have implemented many
cost cutting measures and are continuing to do so. It is unclear as to when our customers’
demand will rebound but we believe that this is a relatively short-term condition
and are hopeful that we will begin to see a recovery during the next three to
six months. While we continue to
aggressively pursue and add new customers to mitigate the underlying
uncertainties with our existing customer base, we expect to reflect continued
decreased revenue for the three months ended January 31, 2008 (as compared
to the three months ended January 31, 2007) and the reporting of an
operating loss for the segment.
We continue to monitor the situation closely and while we believe that we
will see improving financial results in this operating segment (over the
long-term), we cannot offer any assurance that we will be able to regain or
sustain operating profitability in future periods.
20
Our homeland
security products segment recorded $195,000 of revenue for the three and six
months ended October 31, 2007, as compared to no revenue during the same
periods of our prior fiscal year . The
revenues relate to the installation of fifteen commercial units of our
panel-mounted IMS-based product in the
AirChx
system manufactured by DualDraw, eight of which were installed during the six
months ended October 31, 2007, and seven of which were installed during
the year ended April 30, 2007. The
proceeds from the sale of the units
had been classified as deferred revenue pending completion of certain
tasks. Based upon an agreement signed
with DualDraw during the three months ended October 31, 2007, our
obligations to DualDraw are materially fulfilled and we have recognized the
revenue related to the sale of the IMS-based products.
In August 2007, we elected to suspend
the development, manufacture and sale of our IMS-based products and, as a
result, we do not anticipate any additional revenues from the sale of homeland
security products during our fiscal year ending April 30, 2008, or
subsequently. The suspension was due
primarily to a lack of working capital but we have also had difficulty
competing in the market space. We will
continue to seek alternatives towards finding a means of monetizing our
IMS-based investment, including the development of a strategic partnership or
an outright sale of the technology. It
is unclear as to when (if at all) we will resume activity on our IMS-based
products.
Although we have diversified our sources of revenue, we continue to have
concentrations of revenue with certain customers. For the six months ended October 31,
2007, two security services customers accounted for 19% and 12% of revenues,
respectively, and one semiconductor products and services customer accounted
for 12% of revenues as compared to the six months ended October 31, 2006,
in which two security services customers accounted for 14% and 11% of revenues,
respectively, and one semiconductor products and services customer accounted
for 25% of revenues. Significant
reductions in sales to any of these large customers have had, and may in the
future have, an adverse effect by reducing our revenues and our gross margins. Present or future customers could terminate
their purchasing patterns with us or significantly change, reduce or delay the
amount of products or services ordered from us.
Gross Margin
Our gross margin
decreased for the three and six months ended October 31, 2007, as compared
to the same periods of our prior fiscal year, both on a dollar amount and on a
percentage of revenues, as reflected in the following table:
|
|
|
Three months ended October 31,
|
|
Six months ended October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Dollar amount
|
|
$
|
483,000
|
|
$
|
1,797,000
|
|
$
|
1,354,000
|
|
$
|
3,016,000
|
|
|
Percent of revenues
|
|
8.0
|
%
|
24.8
|
%
|
11.4
|
%
|
21.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The decrease in
gross margin on a percentage basis is due primarily to the downturn in our
semiconductor products and services segment whereby the downturn has lead to a
significant decrease in revenue which has forced us to allocate our fixed
facility costs over a lower base, correspondingly decreasing gross margins on a
percentage basis. To a lesser extent,
the decrease on a percentage basis is also due to the provision of lower prices
in order to obtain new or keep existing business.
The decrease in
gross margin on a dollar basis is due mainly to the decrease in revenue for our
semiconductor products and services segment.
As a result of the slowdown in orders of reclaim and/or test wafers
during the six months ended October 31, 2007, and into the three months
ending January 31, 2008 (as discussed above) it is currently unclear if we
will be successful in maintaining or increasing quarterly gross margins (on a
dollar basis) in our semiconductor products and services segment for the year
ending April 30, 2008.
21
On a dollar basis,
gross margin is expected to increase correspondingly with increases in revenue,
if any, with dependencies on customer and supplier pricing. Our ability to positively impact consolidated
gross margin will in a large part be dependent upon our ability to grow sales
in our security service segment through increased sales of security services
and in our semiconductor products and services segment through increased sales
of 300-millimeter products and services and wafer thinning services.
On a percentage of
revenue basis, in general we anticipate that the gross margin percentage in our
security services segment (within 1-2 percentage points) will remain relatively
stable. As a result of the current
downturn which has and may lead to more increased competition and lower prices,
our semiconductor products and services segment will most likely experience a
decrease in gross margins as a percentage of revenues during the year ending April 30,
2008, as compared to the year ended April 30, 2007. Due to fixed facility costs included in cost
of revenues in the semiconductor products and services segment, the gross
margin percentage is particularly sensitive to volume and revenue changes.
Selling, General and Administrative Expenses
Our selling,
general and administrative expenses decreased both as a dollar amount and as a
percentage of revenue for the three and six months ended October 31, 2007,
as compared to the same respective periods of our prior fiscal year, as
reflected in the following table:
|
|
|
Three months ended October 31,
|
|
Six months ended October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Dollar amount
|
|
$
|
1,864,000
|
|
$
|
4,097,000
|
|
$
|
3,954,000
|
|
$
|
7,865,000
|
|
|
Percent of revenues
|
|
30.8
|
%
|
56.5
|
%
|
33.2
|
%
|
56.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The $3,911,000 decrease in selling, general and administrative expenses
for the six months ended October 31, 2007, compared to the same period in
the prior year is attributable to a combination of factors, including:
·
approximately
$760,000 due to a decrease in staffing and expenditures at the corporate
office;
·
approximately
$690,000 due to a decrease in staffing and expenditures in the security
services segment;
·
approximately
$1,220,000 due to a decrease in staffing and operations in the homeland
security products segment;
·
approximately
$340,000 due to a decrease in staffing and operations in the semiconductor
products and services segment;
·
inclusion in
the six months ended October 31, 2006, of a noncash charge in the amount
of $357,000 related to the amendment to the number of shares issuable and
exercise price of certain warrants with ratchet provisions;
·
an approximate
$450,000 decrease in noncash stock-based compensation expense.
Although we have reduced and are actively
focused on continuing to reduce selling, general and administrative
expenditures, we anticipate that our reported selling, general and
administrative expenses will increase during fiscal year 2008 or fiscal year
2009 due primarily to stock-based incentive compensation issued as part of a
series of management changes made in February 2007. No expense has been recognized to date
related to the option grants made in February 2007 because the new
underlying stock option plan or the proposed increase to an existing underlying
stock option plan have not been approved by shareholders. There can be no assurance that anticipated
selling, general and administrative expenses will result in increased revenues
from product sales.
22
Impairment Loss on Intangible Assets
Our impairment loss on intangible assets
increased on both a dollar and a percentage of revenues basis for the three and
six months ended October 31, 2007, as compared to the same periods of our
prior fiscal year, as reflected in the following table:
|
|
|
Three months ended October 31,
|
|
Six months ended October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Dollar amount
|
|
$
|
145,000
|
|
—
|
|
$
|
145,000
|
|
—
|
|
|
Percent of revenues
|
|
2.4
|
%
|
—
|
|
1.2
|
%
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The impairment loss relates to a write off of
the unamortized balance of the trace and bulk detection technology intangible
asset. Due to suspension of development,
manufacture and sale of our IMS-based products, we determined that the trace
and bulk detection technology intangible asset was fully impaired.
Research and Development Expenses
Our research and development expenses
decreased on both a dollar and a percentage of revenues basis for the six
months ended October 31, 2007, as compared to the same period of our prior
fiscal year, as reflected in the following table:
|
|
|
Three months ended October 31,
|
|
Six months ended October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Dollar amount
|
|
$
|
165,000
|
|
$
|
784,000
|
|
$
|
1,182,000
|
|
$
|
2,188,000
|
|
|
Percent of revenues
|
|
2.7
|
%
|
10.8
|
%
|
9.9
|
%
|
15.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The majority of research and development
expenses for the six months ended October 31, 2007 and 2006 relate
primarily to (1) the development of next-generation infrared imaging and
night vision surveillance technology through our Lucent relationship and (2) our
IMS technology. However, due the
termination of the Lucent Agreement and the suspension of development of our
IMS technology, we did not incur material research and development expense
during the three months ended October 31, 2007 for these projects and we
do not expect to incur material additional research and development expense
related to these projects throughout the remainder of fiscal year 2008 and
beyond.
Historically a significant amount of the
research and development on the IMS technology was performed by IUT. We funded $80,000 and $721,000 under our
agreement with IUT for the six months ended October 31, 2007 and 2006,
respectively. As a result of the
suspension of the development, manufacture and sale of our IMS-based products as
described above, we expect that future research and development expense with
IUT to be minimal.
Except for work being performed on our
semiconductor products at our facilities in Vancouver, Washington, we operate
no other facilities of our own for research and development. Although we have in the past expended
significant resources on research and development, we cannot offer any
assurance that we will receive future financial benefit from our research and
development efforts made to date.
23
Operating
(Loss) Income
For the six months
ended October 31, 2007 and 2006, our operating segments incurred operating
(loss) income as follows:
|
|
|
Three months ended October 31,
|
|
Six months ended October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Homeland security products
|
|
$
|
(715,000
|
)
|
$
|
(2,124,000
|
)
|
$
|
(2,036,000
|
)
|
$
|
(4,071,000
|
)
|
|
Security services
|
|
253,000
|
|
(20,000
|
)
|
323,000
|
|
(294,000
|
)
|
|
Semiconductor products and services
|
|
(598,000
|
)
|
151,000
|
|
(959,000
|
)
|
(48,000
|
)
|
|
Reconciling amounts (1)
|
|
(631,000
|
)
|
(1,091,000
|
)
|
(1,255,000
|
)
|
(2,624,000
|
)
|
|
Total
|
|
$
|
(1,691,000
|
)
|
$
|
(3,084,000
|
)
|
$
|
(3,927,000
|
)
|
$
|
(7,037,000
|
)
|
(1) Reconciling amounts for the
operating loss information includes corporate expenses consisting primarily of
corporate salaries and benefits, professional and consulting fees, investor
relations costs, insurance and directors’ compensation.
In January 2007, we elected to discontinue the operation of our life
sciences business and put the assets and business up for sale (which was sold
in June 2007). As a result, we
reclassified the operations of our life sciences business as discontinued
operations. Prior year information has
been reclassified to conform to the current year presentation.
Our homeland security products segment
generated significant operating losses as our effort to develop and
commercialize our IMS technology and our effort to develop next generation
infrared imaging and night vision surveillance technology has not been
successful.
As a result of the suspension
of the development, manufacture and sale of our IMS-based products and the
cancellation of the Lucent Agreement (both described above), we expect that
future operating losses will decrease significantly as we
seek alternatives towards finding a means of monetizing our IMS-based
investment, including the development of a strategic partnership or an outright
sale of the technology. It is unclear as
to when (if at all) we will resume activity on our IMS-based products and we
can offer no assurance that we will be able to monetize any portion of our IMS
technology investment.
For the six months
ended October 31, 2007 and 2006, our security services segment delivered
revenue of $7,622,000 and $7,616,000, respectively. The operating income for the six months ended
October 31, 2007, is due primarily to the benefits received from the cost
cutting initiatives we implemented at PPSC during the six months ended October 31,
2007 (see below for additional discussion).
The operating loss for the six months ended October 31, 2006 is
inclusive of a write-off of a single customer’s accounts receivable balance in
the amount of $114,000. Although we
continue to pursue selected domestic government contracts, we have taken steps
to reduce our spending on sales and marketing in this area.
During the fourth quarter of the fiscal year ended April 30, 2007,
and the six months ended October 31, 2007, we implemented significant cost
cutting initiatives that were expected to positively impact the results of PPSC’s
operations. Additionally we initiated
plans to improve operating margins at PPSC by focusing on customers that are
willing to pay for premium security services, where PPSC is able to
differentiate itself from its peers.
While we believe that these cost cutting initiatives and refocused sales
and marketing efforts will enable PPSC to report positive operating income for
the year ending April 30, 2008, the industry is cost competitive and
customers switch security service providers on short notice and, therefore, we
can offer no assurance that this will actually occur.
Our semiconductor
operations, based in Vancouver, Washington, showed continued operational and
financial improvement during the years ended April 30, 2007 and 2006,
although we have experienced a softening of demand for our products and
services during the six months ended October 31, 2007 and subsequently (as
discussed further below). The segment
generated operating income for the year ended April 30, 2007, in the
amount of $326,000 (which includes a non-cash charge of $122,000 for
stock-based compensation expense) as compared to an operating loss for the year
ended April 30, 2006, in the amount of $(5,151,000). The positive operating income results
primarily from our ongoing effort to reduce our reliance on low margin small
diameter products and diversify into higher margin 300-millimeter products and
services, wafer thinning and custom wafer products.
24
The large-diameter
wafer segment has become one of the fastest growing segments of the silicon
wafer market and the revenues and gross margins associated with the services
are greater than those associated with the small diameter market. As a result of our strategic realignment,
revenue from 300-millimeter services comprised approximately 46% of segment
revenue for the six months ended October 31, 2007 ($1,870,000 of revenue)
and 54% of segment revenue for the year ended April 30, 2007 ($7,049,000
of revenue), as compared to approximately 36% of segment revenue for the year
ended April 30, 2006 ($2,053,000 of revenue). At the same time, there has also been a focus
on operational efficiency and effectiveness, which has resulted in increased
productivity and processing yields.
Further, we continue to gain new customers and are also in the process
of attempting to qualify our product at others.
While we reported significant revenue and operating income growth in our
semiconductor operations for the year ended April 30, 2007, many of our
top semiconductor customers experienced weakened business results in recent
quarters. In addition, some customers
have reported inventory buildup in reclaim and/or test products. As a result of these two factors, we have
recently seen a slowdown in orders of reclaim and test materials, which has had
a negative impact on our operations.
The slowdown significantly impacted our results of operations and cash
flows for the six months ended October 31, 2007 in which we generated an
operating loss of $(959,000) as compared to an operating loss of $(48,000) for
the six months ended October 31, 2006.
The impact of the slowdown in orders on our business is magnified when
the results are compared to the three months ended April 30, 2007 whereby
we generated operating income of $286,000.
In order to minimize the effect of the slowdown, we have implemented many
cost cutting measures and are continuing to do so. It is unclear as to when our customers’
demand will rebound but we believe that this is a relatively short-term
condition and are hopeful that we will begin to see a recovery during the next
three to six months. While we continue
to aggressively pursue and add new customers to mitigate the underlying
uncertainties with our existing customer base, we expect to reflect a significant
reduction in revenue for the three months ended January 31, 2008 (as
compared to the three months ended January 31, 2007) and the reporting of
an operating loss for that segment.
We continue to monitor the situation closely and while we believe that we
will see improving financial results in this operating segment (over the
long-term), we cannot offer any assurance that we will be able to regain or
sustain operating profitability in future periods.
Other Income (Expense), net
Other income (expense), net decreased for the
three and six months ended October 31, 2007 and 2006 as both a dollar
amount and as a percentage of revenues, as reflected in the following table:
|
|
|
Three months ended October 31,
|
|
Six months ended October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Dollar amount
|
|
$
|
(1,081,000
|
)
|
$
|
(511,000
|
)
|
$
|
(2,483,000
|
)
|
$
|
1,034,000
|
|
|
Percent of revenues
|
|
(17.9
|
)%
|
(7.0
|
)%
|
(20.8
|
)%
|
7.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the six months
ended October 31, 2007, other income (expense), net consists of interest
expense of $(2,926,000), the amortization of debt issuance costs of $(87,000)
and equity in the net loss of an investee of $(80,000) partially offset by
interest and other income of $99,000 and a gain on derivative instruments of
$504,000. Included in interest expense
for the six months ended October 31, 2007 are non-cash charges of
$2,752,000 related primarily to the amortization of the discount and the
accrual of interest on our outstanding convertible debentures.
For the six months
ended October 31, 2006, other income (expense), net consists of the
recording of a gain on derivative instruments in the amount of $2,320,000
related to the change in fair value of the two derivative liabilities which we
recorded in our condensed consolidated balance sheets, equity in the net
25
income of an
investee of $10,000 and the recording of a gain on extinguishment of debt in
the amount of $227,000, which resulted from the retirement of $3,880,000 in
principal amount of 8% Debentures partially offset by $(1,419,000) of interest
expense and $(159,000) of amortization of debt issuance costs.
We expect that our
other expenses will be volatile based on the future timing of repayment , if
ever, of the remaining convertible debentures (see the Liquidity and Capital
Resources discussion below) and the fluctuations in fair value of and
classification of the instruments underlying our derivative liabilities.
Income Taxes
We currently
operate at a loss and expect to operate at a loss until (if ever) our
operations begin to generate sufficient revenue. The losses incurred in the
current year are not expected to generate an income tax benefit because of the
uncertainty of the realization of the deferred tax asset. As a result, we have
provided a valuation allowance against our net deferred tax asset because,
based on available evidence including our continued operating losses, it is
more likely than not that all of the deferred tax assets will not be realized.
Additionally, due to certain “change in ownership” rules (as defined by
the IRS), utilization of our federal net operating losses may be subject to
certain annual limitations.
Minority Interest in Operations
of Consolidated Subsidiary
Minority interest in operations of
consolidated subsidiary for the three and six months ended October 31,
2007 and 2006 is reflected in the following table:
|
|
|
Three months ended October 31,
|
|
Six months ended October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Dollar amount
|
|
$
|
11,000
|
|
$
|
42,000
|
|
$
|
111,000
|
|
$
|
42,000
|
|
|
Percent of revenues
|
|
0.1
|
%
|
0.6
|
%
|
0.9
|
%
|
0.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amount of minority interest in operations
of consolidated subsidiary recorded for the six months ended October 31,
2007, relates to our purchase of a 90% interest in SenseIt in October 2006
and the subsequent operation of the business.
Due to the cancellation of the Lucent Agreement, we do not expect
minority interest in operations of SenseIt to be material in future periods.
Gain on Discontinued Operations,
net of Income Taxes
Gain on discontinued operations, net of
income taxes increased on both a dollar and a percentage of revenues basis for
the six months ended October 31, 2007, as compared to the same period of
our prior fiscal year as reflected in the following table:
|
|
|
Three months ended October 31,
|
|
Six months ended October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Dollar amount
|
|
—
|
|
$
|
(48,000
|
)
|
$
|
553,000
|
|
$
|
(12,000
|
)
|
|
Percent of revenues
|
|
—
|
|
(0.7
|
)%
|
4.6
|
%
|
(0.1
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In January 2007, we decided to
discontinue the operation of our life sciences business and to put the assets
and business up for sale (which was sold in June 2007). We decided to sell this business as it no
longer fit our long-term strategy and because of deteriorating business
conditions in the historical, revenue producing products in the segment. Accounting rules required us to treat
the operations of the life sciences business as discontinued operations whereby
the net financial impact of the operations of the business is combined into a
single line item and prior periods are reclassified for this presentation. The gain, net of income taxes, resulting from
operations of the life sciences business was $37,000 for the six months ended October 31,
2007 as compared to a loss, net of income taxes, in
26
the amount of $(12,000) for the six months
ended October 31, 2006. The gain on
sale of the life sciences business was recorded in the six months ended October 31,
2007, in the amount of $516,000. Revenue
for the life sciences business, reported in the single line item of gain on
operations of discontinued operations, net of income taxes, was $101,000 and
$1,193,000 for the six months ended October 31, 2007 and 2006,
respectively.
Net Loss
Net loss for the three and six months ended October 31,
2007 and 2006 is reflected in the following table:
|
|
|
Three months ended October 31,
|
|
Six months ended October 31,
|
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
Dollar amount
|
|
$
|
(2,761,000
|
)
|
$
|
(3,601,000
|
)
|
$
|
(5,746,000
|
)
|
$
|
(5,973,000
|
)
|
|
Percent of revenues
|
|
(45.7
|
)%
|
(49.6
|
)%
|
(48.2
|
)%
|
(42.5
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We anticipate that consolidated losses will
continue until (if ever) revenues from our current operations substantially
increase or we increase the scope of our operations through merger, acquisition
or other means. Further, the revenue
increases must increase faster than any increases in operating and research and
development expenses. Additionally, we
expect that our consolidated net loss will continue as we continue to work
through the downturn in the semiconductor market. As noted above, we have suspended development
and marketing of our IMS-based products and we have suspended operations at our
SenseIt subsidiary due to the cancellation of the Lucent Agreement. Therefore, we can offer no assurance that we
will be able to proceed with either of these projects or that the development and
commercialization of these technologies will ever occur.
We anticipate that
our operations during the remainder of fiscal year 2008 will result in a net
loss since we are not likely to increase our revenues from our existing
products or generate additional sales from the new products we may develop in a
sufficient amount (if at all) to offset our operating and research and
development expenses.
Liquidity and Capital Resources
During the past several years, we have at
times had significant liquidity and working capital shortages, although we have
been able to pay our core obligations as they have become due. Included in the following table are condensed
consolidated balance sheet items as of October 31, 2007 and April 30,
2007 and condensed consolidated cash flow items for the six months ended October 31,
2007 and 2006:
|
|
|
As of
|
|
|
(in thousands)
|
|
October 31,
2007
|
|
Change
|
|
April 30,
2007
|
|
|
Cash and cash equivalents
|
|
$
|
753
|
|
$
|
(803
|
)
|
$
|
1,556
|
|
|
|
|
|
|
|
|
|
|
|
Working capital
|
|
$
|
1,166
|
|
(2,144
|
)
|
3,310
|
|
|
|
|
|
|
|
|
|
|
|
Current convertible debentures, net of discount
|
|
$
|
—
|
|
—
|
|
—
|
|
|
Convertible debentures, net of discount and current
portion
|
|
10,206
|
|
1,572
|
|
8,634
|
|
|
Total
convertible debentures, net of discount
|
|
$
|
10,206
|
|
$
|
1,572
|
|
$
|
8,634
|
|
|
|
|
|
|
|
|
|
|
|
Total
convertible debentures, face value outstanding
|
|
$
|
18,000
|
|
$
|
—
|
|
$
|
18,000
|
|
27
|
|
|
Six months ended
|
|
|
|
|
October 31,
2007
|
|
Change
|
|
October 31,
2006
|
|
|
Net cash used in operating activities
|
|
$
|
(815
|
)
|
$
|
4,942
|
|
$
|
(5,757
|
)
|
|
Net cash provided by (used in) investing activities
|
|
786
|
|
2,052
|
|
(1,266
|
)
|
|
Net cash (used in) provided by financing activities
|
|
(774
|
)
|
(7,664
|
)
|
6,890
|
|
|
Net (decrease) increase in cash and cash equivalents
|
|
$
|
(803
|
)
|
$
|
(670
|
)
|
$
|
(133
|
)
|
Working Capital
Our working capital was $1,166,000 as of October 31,
2007, as compared to working capital of $3,310,000 as of April 30, 2007.
This $2,144,000 decrease in working capital for the six months ended October 31,
2007, is due to a combination of factors, of which the significant factors are
set out below:
Factors which increased
working capital
·
net cash of
$805,000 received from the sale of our life sciences business in June 2007;
·
net cash of
$60,000 received from the assignment of our silicon-28 license (see Note 10 to
the accompanying condensed consolidated financial statements).
Factors
which decreased working capital
·
$2,425,000 of
cash consumed directly in operating activities (calculated as $815,000 of cash
used in operating activities, increased by $1,610,000 of the cash impact of net
changes in other current assets or liabilities included therein);
·
$79,000 related
to purchases of fixed assets;
·
$152,000
representing the current portion of capital lease entered into during the six
months ended October 31, 2007;
·
$273,000 in
reclassification of capital leases from long-term to current;
·
$210,000 in
payments on notes payable entered into for insurance during the six months
ended October 31, 2007, in excess of the related unamortized prepaid
insurance balance.
Based on the amount
of capital we have remaining and our expected negative cash flow from
operations and investing activities, we anticipate that we will not be able to
positively impact our working capital unless we are able to substantially
increase our revenues or reduce our expenses thereby generating positive cash
flow from operations and (ultimately) operating income. W
e believe we have sufficient
working capital to finance our anticipated operations and projected negative
cash flow only into our quarter ending April 30, 2008, unless we are able
to achieve significant additional financing.
Because of the potential dilution associated with the outstanding
debentures and the holder’s security interest in substantially all of our
assets, we believe that it is unlikely that we will be able to obtain
additional financing unless we are able to reach an accommodation with our
existing debenture holder.
28
Convertible Debentures
Selected information regarding the 13%
Debentures follows (dollars in thousands):
|
|
|
2006
Debentures
|
|
April 2007
Debenture
|
|
Total
|
|
|
Debenture agreement date(s)
|
|
May, June and
November 2006
|
|
April 2007
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Due date - principal and interest
|
|
May 2009
|
|
May 2009
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate
|
|
13
|
%
|
13
|
%
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding balances as of October 31, 2007:
|
|
|
|
|
|
|
|
|
Face value
|
|
$
|
16,000
|
|
$
|
2,000
|
|
$
|
18,000
|
|
|
Accrued interest
|
|
1,899
|
|
145
|
|
2,044
|
|
|
Total liability
|
|
$
|
17,899
|
|
$
|
2,145
|
|
$
|
20,044
|
|
Subsequent to October 31,
2007, we did not meet certain non-financial requirements
under the 13%
Debentures and their holder may potentially be able to, in its discretion,
declare an Event of Default.
Additionally, an Event of Default under any one of the 13% Debentures
would allow the holder to declare an Event of Default under all of the 13%
Debentures. Remedies for an Event of
Default include the option to accelerate payment of the full principal amount
of the 13% Debentures, together with interest and other amounts due (a
cumulative amount of $20,044,000 at October 31, 2007), to the date of
acceleration and the holder will have the right to request such payment in cash
or in shares of our common stock. If the
holder of the 13% Debentures declares an Event of Default, it is possible that
we will not be able to cure the default or contest any efforts that the holder
may take to foreclose against its security interest in substantially all of our
assets.
Cash Flows
As of October 31, 2007, we had $753,000 of cash and cash
equivalents, a decrease of $803,000 as compared to $1,556,000 at April 30,
2007. Our principal source of funding for the six months ended October 31,
2007 was from the existing working capital as of April 30, 2007, along
with the $805,000 (net of selling costs of $45,000) received for the sale of
our life sciences business in June 2007.
Our principal source of funding for the six months ended October 31,
2006 was from the issuance of the 2006 Debentures (with a face amount of
$13,000,000) for which we received net proceeds of $12,270,000.
Cash used in operating activities of
$(815,000) and $(5,757,000) for the six months ended October 31, 2007 and
2006, respectively, was primarily the result of a net loss of $(5,746,000)
(which included noncash expenses and gains in the net amount of a $2,050,000
expense) and of $(5,973,000) (which included noncash expenses and gains in the
net amount of a $1,106,000 expense), respectively.
Investing activities provided cash of
$786,000 and used cash of $(1,266,000) for the six months ended October 31,
2007 and 2006, respectively. Cash provided by investing activities for the six
months ended October 31, 2007, consisted of $805,000 (net of selling costs
of $45,000) received for the sale of our life sciences business in June 2007
and $60,000 from the assignment of our silicon-28 licenses offset by $79,000
expended on additions of property and equipment. Cash used in investing activities for the six
months ended October 31, 2006, consisted of $1,166,000 expended on
additions of property and equipment and $100,000 expended on a 9% equity
investment in a business (which investment was subsequently written off in its
entirety).
29
Financing activities used cash of $(774,000)
and provided cash of $6,890,000 for the six months ended October 31, 2007
and 2006, respectively. Cash used in financing activities for the six months
ended October 31, 2007, consisted of payments of principal on capital
leases and notes payable in the amounts of $230,000 and $544,000,
respectively. Cash provided by financing
activities for the six months ended October 31, 2006, resulted primarily
from the issuance of the 6% Debentures, which yielded net proceeds of
$12,270,000 offset primarily by principal payments on borrowings of $5,388,000.
Additional Liquidity
Considerations
As of October 31, 2007, we have
1,992,377 common stock warrants exercisable at $5.00 related to the 8%
Debenture transaction. In May 2006,
1,139,250 of these common stock warrants were modified to reduce their
anti-dilution provisions to a price-protection provision only. If we were to
enter into a financing agreement in the future with an effective price less
then $5.00 (or if the holder of our 13% Debentures was to convert a portion of
any outstanding debenture at a conversion rate less than $5.00), the remaining
853,125 common stock warrants that have a full anti-dilution provision, would
ratchet into a greater number of common stock warrants at a lower exercise
price. These warrants expire in February 2008.
As of October 31, 2007, we had no commitments outstanding for
capital expenditures. Further, due to
the cancellation of the Lucent Agreement,
we
have no further commitments under that contract.
On December 6, 2007, we received a
letter from the Nasdaq stating that it had determined to delist our securities
from Nasdaq. Trading in our shares on
the Nasdaq Capital Market was suspended effective with the open of business on December 10,
2007.
Nasdaq’s decision was rendered following a hearing held before a Nasdaq
Listing Qualifications Panel on November 29, 2007. We are working with our market makers and are
hopeful that our common stock will be enabled for trading on the OTC Bulletin
Board.
The assumptions underlying the above
statements include, among other things, that there will be no material adverse
developments in the business or market in general. There can be no assurances
however that those assumed events will occur. If our plans are not achieved,
there may be further negative effects on the results of operations and cash
flows, which could have a material adverse effect on our financial position.
Off-Balance Sheet Arrangements
We have no material changes to the disclosure
on this matter made in our Annual Report on Form 10-K for the year ended April 30,
2007.
Critical Accounting Estimates
We consider an accounting estimate to be
critical if 1) the accounting estimate requires us to make assumptions about
matters that were highly uncertain at the time the accounting estimate was
made, and 2) changes in the estimate that are reasonably likely to occur from
period to period, or use of different estimates that we reasonably could have
used in the current period, would have a material impact on our financial
condition or results of operations.
Management has discussed the development and
selection of these critical accounting estimates with the Audit Committee of
our Board of Directors and the Audit Committee has reviewed the foregoing
disclosure. In addition, there are other
items within our financial statements that require estimation, but are not
deemed critical as defined above.
Changes in estimates used in these and other items could have a material
impact on our financial statements.
30
Goodwill and Intangible Assets
Goodwill is recorded on
our books for acquisitions where the purchase price is in excess of the
cumulative fair values of the identified tangible and intangible assets. The assignment of fair value to the
identified tangible and intangible assets requires significant judgment and may
require independent valuations of certain identified assets. Once goodwill and other intangible assets are
established on our balance sheet, we evaluate the assets for impairment as
described in the following paragraphs.
In accordance with SFAS No. 142
Goodwill and Other Intangible Assets
,
goodwill is not amortized, but instead is tested for impairment on an annual
basis
or more frequently if the presence of certain circumstances indicates that
impairment may have occurred. The
impairment review process, which is subjective and requires significant
judgment at many points during the analysis, compares the fair value of the
reporting unit in which goodwill resides to its carrying value. If the carrying value of a reporting unit
exceeds its fair value, then the amount of the impairment loss must be
measured. The impairment loss is calculated by comparing the implied fair value
of reporting unit goodwill to its carrying amount. In calculating the implied
fair value of reporting unit goodwill, the fair value of the reporting unit is
allocated to all of the other assets and liabilities of that unit based on
their fair values. The excess of the fair value of a reporting unit over the
amount assigned to its other assets and liabilities is the implied fair value
of goodwill. An impairment loss would be recognized when the carrying amount of
goodwill exceeds its implied fair value. We have goodwill in the amount of
$3,631,000 on our condensed consolidated balance sheet as of October 31,
2007, related to the acquisition of PPSC in May 2005. During the three months ended January 31,
2007, we performed our annual impairment review on the aforementioned goodwill
and concluded that the goodwill is not impaired.
For intangible assets
other than goodwill, SFAS No. 144
Accounting
for the Impairment or Disposal of Long-Lived Assets
(“SFAS 144”)
is the authoritative standard on the
accounting for the impairment of such intangible assets. As required, we perform tests for impairment
of intangible assets other than goodwill whenever events or circumstances
suggest that such assets may be impaired.
To evaluate potential impairment, SFAS No. 144 requires us to
assess whether the future cash flows related to these assets will be greater
than their carrying value at the time of the test. Accordingly, while our cash
flow assumptions are consistent with the plans and estimates we are using to
manage the underlying businesses, there is significant judgment in determining
the cash flows attributable to our other intangible assets over their
respective estimated useful lives. We
have remaining other net intangible assets in the amount of $78,000 on our
condensed consolidated balance sheet as of October 31, 2007, comprised of the customer base acquired in our acquisition
of PPSC in May 2005. We are
required to periodically evaluate our other intangible assets balances for
impairments.
Due
to our election to suspend operations regarding our IMS-based products, during
the three months ended October 31, 2007, we reviewed for impairment the
trace and bulk detection technology intangible asset associated with the IMS
technology. We determined that the
carrying amount of the intangible asset was not recoverable and its carrying
amount exceeded its fair value, as determined using the expected present value
of future cash flows. As such, during
the three months ended October 31, 2007, we recognized an impairment loss
in the amount of $145,000, such impairment loss representing the full carrying
value of the intangible asset prior to impairment.
If we were to incur additional impairments to our
other intangible assets, it could have an adverse impact on our future
earnings, if any.
Valuation
of Equity Transactions
We value transactions
associated with common or preferred stock that is convertible into common stock
based on the market value of the underlying common stock on the date of the
signing of the agreement (or, sometimes, at the date of conversion). We value
transactions associated with common stock warrants at the appropriate
measurement date utilizing at a minimum, the Black-Scholes pricing model, with
assumptions as to volatility, risk-free interest rate and estimated life of the
warrants based on historical information related to the life of the underlying
warrant. If the assumptions used, as they relate to volatility, risk-free
interest rate and estimated life of the warrants, were materially different,
the overall valuation of these transactions could change significantly.
31
Valuation
of Convertible Debenture Transactions
We enter into
transactions that include debentures that are convertible into common stock at
rates that may be fixed or variable and also include detachable common stock
warrants. We allocate the proceeds from
the debenture transactions based on the estimated fair values of the debentures
and the warrants. If the assumptions
used, as they relate to volatility, risk-free interest rate and estimated life
of the warrants (including any anti-dilution adjustment provisions) and the
fair value of the debentures (included the specific conversion features) were
materially different, the overall allocation of proceeds for these transactions
could change significantly. Further, at
times we have classified certain embedded conversion features or warrants
issued in convertible debenture transactions as derivative liabilities in
accordance with US GAAP. The estimates
of fair value of these derivative liabilities involve complex assumptions in
the initial recording of the liabilities and in the mark-to-market required for
each reporting period. If the
assumptions used to determine the fair value of these liabilities were materially
different, the valuation of the liabilities could change significantly.
Stock-Based
Compensation Expense
We account for
stock-based compensation in accordance with SFAS 123(R). Under the fair value recognition provisions
of SFAS 123(R), stock-based compensation cost is estimated at the grant date
based on the fair value of the award and is recognized as expense ratably over
the requisite service period of the award.
Determining the appropriate fair value model and calculating the fair
value of stock-based awards, which includes estimates of stock price
volatility, forfeiture rates and expected lives, requires judgment that could
materially impact our operating results.
Item 3
:
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk related to
changes in interest rates, equity security market values, foreign currency
rates and the market price of our common stock.
Interest Rates
Our investment portfolio consists of cash and
cash equivalents (in the amount of $753,000 as of October 31, 2007), all
of which is exposed to interest rate fluctuations. The primary objective of our investments is
to earn a market rate of return while preserving principal and maximizing
liquidity. The interest earned on these
investments (with a blended yield of approximately 0.5% at October 31,
2007) may vary based on fluctuations in the prevailing interest rate.
Equity Securities
We do not hold any investments in marketable
equity securities. However, we hold
interests in various wholly- and partially-owned subsidiaries. These securities are non-marketable. Our investment in these subsidiaries may be
impacted by the underlying economic conditions of the entity, including the
ability to raise additional capital and the likelihood of our being able to
realize our investments through liquidity events such as initial public
offerings, mergers or private sales.
These investments involve a great deal of market risk, and there can be
no assurance that a specific company will grow or become successful. Consequently, we could lose all or part of
our investment. Additionally, because
IUT is located in Germany, our investment in the entity (and our share of their
earnings or losses) may be impacted by changes in foreign currency rates. The carrying amount of this investment is $303,000
as of October 31, 2007.
32
Derivative
Instruments
We do not purchase derivative instruments on
the open market. However, in accordance
with current US GAAP, we have classified certain warrants as derivative
instruments (a $517,000 current liability at October 31, 2007). Classification as derivative liabilities was
required because there is a possibility that the instruments could be required
to be settled on a net cash basis. We
are required to mark these instruments to market as of the end of each
reporting period and to recognize the change in fair value in our condensed
consolidated statements of operations.
Our stock price has been historically volatile and the fair values of
these instruments are sensitive to changes in our underlying stock price. As such, the carrying amount of these
instruments may be volatile from period to period. For the six months ended October 31,
2007, we recorded a gain on derivative instruments in the aggregate amount of
$504,000 such amount representing the change in fair value between April 30,
2007, and October 31, 2007. See
Note 9 to the consolidated financial statements located in Item 8. “Financial
Statements and Supplementary Data” of our Form 10-K for the year ended April 30,
2007, for a more detailed discussion of the derivative instruments.
Item 4
: Controls and Procedures
Our management, with the participation of our
principal executive officer and our principal financial officer have evaluated
the effectiveness of our disclosure controls and procedures as required by
Exchange Act Rule 13a-15(b) as of October 31, 2007 (the end of
the period covered by this report). Based on that evaluation, our principal
executive officer and our principal financial officer have concluded that these
disclosure controls and procedures are effective as of such date.
Disclosure controls and procedures are
controls and other procedures that are designed to ensure that information
required to be disclosed in our reports filed or submitted under the Securities
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission’s rules and
forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed in our reports filed under the
Exchange Act is accumulated and communicated to our management, including our
principal executive officer and our principal financial officer, as
appropriate, to allow timely decisions regarding required disclosure.
There were no
changes in our internal control over financial reporting during the three
months ended October 31, 2007, that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
Part II
: Other Information
Item 1: Legal Proceedings
None.
Item 1A: Risk Factors
In addition
to the other information set forth in this report, you
should carefully consider the following factors, which could materially affect
our business, financial condition or future results. The risks described below are not the only
risks we face. Additional risks and uncertainties
not currently known to us or that we currently deem to be immaterial also may
materially adversely affect our business, financial condition or results of
operations.
33
We have historically had working
capital shortages, even following significant financing transactions and we
received an opinion from our auditors indicating a substantial doubt regarding
our ability to continue as a going concern.
We have had working
capital shortages in the past and, although we raised capital totaling more
than $45,800,000 (net of expenses and $4,100,000 of payments related to our 8%
Debentures) since May 1, 2004, we have generated significant losses, which
have impacted working capital. As of October 31,
2007, our condensed consolidated balance sheet reflects working capital of
$1,166,000. In addition, as a result of
our continued operating losses and projected declining working capital balances
during the year ending April 30, 2008, the auditors report included with
our financial statements for the year ended April 30, 2007 included an
explanatory paragraph indicating substantial doubt about our ability to
continue as a going concern.
Based on the amount
of capital we have remaining and our expected negative cash flow from
operations and investing activities, we anticipate that we will not be able to
positively impact our working capital unless we are able to substantially
increase our revenues or reduce our expenses thereby generating positive cash
flow from operations and (ultimately) operating income. W
e believe we have sufficient
working capital to finance our anticipated operations and projected negative
cash flow only into our quarter ending April 30, 2008, unless we are able
to achieve significant additional financing.
Because of the potential dilution associated with the outstanding
debentures and the holder’s security interest in substantially all of our
assets, we believe that it is unlikely that we will be able to obtain
additional financing unless we are able to reach an accommodation with our
existing debenture holder.
If the holder of our April 2007 Debenture or
2006 Debentures declares an Event of Default we may not be able to cure or
contest such a default
Subsequent to October 31,
2007, we did not meet certain non-financial requirements
under the 13%
Debentures and their holder may potentially be able to, in its discretion,
declare an Event of Default.
Additionally, an Event of Default under any one of the 13% Debentures
would allow the holder to declare an Event of Default under all of the 13%
Debentures. Remedies for an Event of
Default include the option to accelerate payment of the full principal amount
of the 13% Debentures, together with interest and other amounts due (a
cumulative amount of $20,044,000 at October 31, 2007), to the date of
acceleration and the holder will have the right to request such payment in cash
or in shares of our common stock. If the
holder of the 13% Debentures declares an Event of Default, it is possible that
we will not be able to cure the default or contest any efforts that the holder
may take to foreclose against its security interest in substantially all of our
assets.
Our
ability to obtain further necessary financing is limited.
We have
historically financed our operating losses and cash flow deficits through
private placements of our equity and debt securities. Our outstanding 13% Debentures contain
significant restrictions on our ability to raise any additional capital for so
long as the convertible debentures are outstanding. While ultimately our ability to finance our
operations will depend on our ability to generate revenues that exceed our
expenses, we have short-term needs for significant additional financing which
may not be available because of the outstanding debentures, as well as the
significant number of outstanding options and warrants which contain adjustment
provisions should we issue shares of our common stock at prices below the
current exercise prices. We do not
believe that we will be able to obtain additional financing without the
cooperation of our principal debenture holder.
Although we have had numerous discussions with our principal debenture
holder, we cannot offer any assurance that it will take the steps necessary for
us to obtain the financing we need to continue our business operations through
the current fiscal year. Ultimately our
only source of additional capital may be the holder of our outstanding
debentures, and if that holder declines (for any reason) to invest additional
amounts into Isonics, we may not be able to continue as a going concern.
Our
securities were delisted from the Nasdaq Capital Market and such delisting may
adversely impact our ability to raise capital.
34
On December 6, 2007, we received a
letter from the Nasdaq stating that it had determined to delist our securities
from Nasdaq. Trading in our shares on
the Nasdaq Capital Market was suspended effective with the open of business on December 10,
2007.
Nasdaq’s decision was rendered following a hearing held before a Nasdaq
Listing Qualifications Panel on November 29, 2007.
Because our financing
activities are dependent to a large extent on eventual liquidity for the
investors, the delisting will make future financing activities significantly
more difficult and may raise liquidity issues for current investors.
We have three business segments
and, for the six months ended October 31, 2007, two of our three segments
operated at a loss.
For the six months
ended October 31, 2007 and 2006, our operating segments incurred operating
(loss) income as follows:
|
|
|
Six months ended October 31,
|
|
|
|
|
2007
|
|
2006
|
|
|
Homeland security products
|
|
$
|
(2,036,000
|
)
|
$
|
(4,071,000
|
)
|
|
Security services
|
|
323,000
|
|
(294,000
|
)
|
|
Semiconductor products and services
|
|
(959,000
|
)
|
(48,000
|
)
|
|
Reconciling amounts
|
|
(1,255,000
|
)
|
(2,624,000
|
)
|
|
Total
|
|
$
|
(3,927,000
|
)
|
$
|
(7,037,000
|
)
|
(1) Reconciling
amounts for the operating loss information includes corporate expenses
consisting primarily of corporate salaries and benefits, professional and
consulting fees, investor relations costs, insurance and directors’
compensation.
In January 2007, we
elected to discontinue the operation of our life sciences business and put the
assets and business up for sale (which was sold in June 2007). As a result, we reclassified the operations
of our life sciences business as discontinued operations. Prior year information has been reclassified
to conform with the current year presentation.
We expect that
these losses (on a consolidated basis) will continue for the foreseeable
future. As described in the next risk
factor, unless we are able to sell new products and services profitably, we may
be unable to remain competitive and it is likely that our losses and negative
cash flow will continue.
Unless we are able to sell our
products and services profitably, we may be unable to remain competitive,
furthering the likelihood that our losses and negative cash flow will continue.
Our ability to
generate positive cash flow, additional revenues, and ultimately net income, is
dependent upon the success of our homeland security services and semiconductor
operations. We have discontinued
development of our IMS-based products and our agreement with Lucent has been
cancelled.
While we reported significant revenue and operating income growth in our
semiconductor operations for the year ended April 30, 2007, many of our
top semiconductor customers experienced weakened business results in recent
quarters. In addition, some customers
have reported inventory buildup in reclaim and/or test products. As a result of these two factors, we have
recently seen a slowdown in orders of reclaim and test materials, which has had
a negative impact on our operations.
The slowdown significantly impacted our results of operations and cash
flows for the six months ended October 31, 2007, in which we generated an
operating loss of $(959,000) as compared to $(48,000) for the six months ended October 31,
2006. The impact of the slowdown in
orders on our business is magnified when the results are compared to the three
months ended April 30, 2007, whereby we generated operating income of
$286,000.
We
continue to monitor the situation closely and while we believe that we will see
improving financial results in this operating segment
35
(over the
long-term), we cannot offer any assurance that we will be able to regain or
sustain operating profitability in future periods.
We
have had minimal success in marketing our homeland security products, having
sold to date only fifteen units of our panel-mounted IMS-based product. In August 2007, we elected to suspend
the development, manufacture and sale of our IMS-based products. The suspension was due primarily to a lack of
working capital but we have also had difficulty competing in the market
space. We will continue to seek
alternatives towards finding a means of monetizing our IMS-based investment,
including the development of a strategic partnership or an outright sale of the
technology. It is unclear as to when (if
at all) we will resume activity on our IMS-based products and we can offer no
assurance that we will be able to monetize any portion of our IMS-based
investment.
We have issued securities during the years ended April 30, 2007,
2006 and 2005, and subsequently which has resulted (and will in the future when
warrant exercises or conversions occur) in dilution to our existing
shareholders. This was accomplished to
provide necessary working capital or obtain assets and services. We will likely issue more securities to raise
additional capital or to obtain other services or assets, any of which may
result in substantial additional dilution.
During the course of the last three
fiscal years, we have raised in excess of $45,800,000 (net of expenses and
$4,100,000 of payments related to our 8% Debentures) to finance our business
operations and acquisitions. We have also issued a number of shares, options,
and warrants, to acquire services and assets from third parties and pursuant to
our stock option plans. If possible
under terms that we believe to be appropriate given our financial condition and
other circumstances (including our existing capital structure), we hope to
raise additional financing during our year ending April 30, 2008. We also expect to issue additional shares,
options, and warrants where we can to obtain necessary services. Some of the issuances we have made in the
past and are likely to make in the future have been issued at prices below
market and (as is frequently the case with declining market prices) at prices
below our historical market prices.
Consequently, our shareholders have suffered dilution in the value of
their shares and can expect that we will be issuing additional securities on
similar terms. Further dilution can be
expected to occur when our outstanding options and warrants are exercised or
debentures are converted at prices below the market.
Two former holders of a portion
of the then outstanding 8% Debentures have asserted that a default existed.
Two entities who held 8% Debentures (which
were paid in full as of February 1, 2007) have previously asserted that
the issuance of the 13% Debentures constituted a default (due to a potential
variable conversion provision contained within the 13% Debentures which gives
the 13% Debenture holder the right to convert the 13% Debentures into common
stock at the lower of $5.00 or at a discount to market, subject to certain
limitations and as defined) under the 8% Debentures. We have contested that allegation (based on
such clause not surviving the final agreement and a defense of
in pari delicto
), and will defend it in court if
necessary. Although we have not had any
further communication from the former holders regarding this issue other than
the allegation of default, any litigation would be time consuming and expensive
and, although we believe that we have significant grounds to contest the
existence of any default, we cannot be assured of success. If they were to prove a default, we could be
liable for 130% of the principal amount of their 8% Debentures on the closing
date of the 13% Debenture transaction (an amount of approximately $1,225,000,
including accrued interest).
Accounting charges result
ing from our
issuance of the 13% Debentures may lead to significant non-cash charges which
would adversely impact future interest expense, net income and earnings per
share and may also lead to future volatility in our financial statement
components.
As a result of the issuance of the 13%
Debentures, we will be required to record significant non-cash interest charges
over the life of the 13% Debentures
36
(in addition to interest expense relating to
the 13% interest rate borne by the 13% Debentures which will be paid in cash or
shares of our common stock, at our option). This will likely result in a
significant adverse impact to future net income and earnings per share and will
likely introduce additional volatility to our future operating results.
Historically we depended upon few
customers for a significant portion of our revenues and our business could have
been materially and adversely affected if we lost any one of those customers.
We have been dependent on
a few significant customers who have purchased our products or services in
amounts greater than 10% of our consolidated revenues. A decision by any significant customer to
substantially decrease or delay purchases from us or an inability to collect
significant amounts owed to us could have a material adverse effect on our
consolidated financial condition and results of operations.
We realized increased expenses,
reduced revenues and longer than anticipated delays in integrating past
business acquisitions into our operations, and we may face similar difficulties
with future acquisitions as well.
We experienced
increased costs and delays in integrating the operations of the business and
assets we acquired from EnCompass Materials Group, Ltd. (“EMG”) in June 2004,
and we also realized revenues that were significantly reduced from that which
we had anticipated which adversely affected the operations of our semiconductor
division. Regardless of the extent of
our planning, we may recognize increased costs and delays, and reduced
revenues, when integrating future business acquisitions into our business operations
and strategy. While we believe that we
have and will continue to plan for integration of acquired business operations
to the best of our ability, we cannot offer any assurance that any or all such
efforts will proceed as anticipated.
If demand for any of our products
grows suddenly, we may lack the resources to meet demand or we may be required
to increase our capital spending significantly.
If we are able to
develop and market our products successfully, we may experience periods of
rapid growth that place a significant strain on our financial and managerial
resources. Our ability to manage growth
effectively will require us to continue to implement and improve our
management, operational and financial information systems, and will require us
to develop the management skills of our personnel and to train, motivate and
manage our employees. Our failure to
effectively manage growth could increase our costs of operations and reduce our
margins and liquidity, which could have a material adverse effect on our
business, financial condition and results of operations.
Because we are dependent upon our
key personnel for our future success, if we fail to retain or attract key
personnel, our business will be adversely affected.
Our future success will depend in significant
part upon the continued service of our key technical, sales and senior
management personnel and consultants, including Christopher Toffales, our
Chairman of the Board. Currently Mr. Toffales is covered by a two-year
employment agreement that is renewable on an annual basis.
We
believe that our future success will also depend upon our ability to attract
and retain other qualified personnel for our operations. The failure to attract or retain such persons
could materially adversely affect our business, financial condition and results
of operations.
We may not be able to protect our
intellectual property, which would reduce our competitive advantage.
We rely primarily on a
combination of trade secrets, confidentiality procedures, contractual
provisions to protect our technology and patents and patent applications. Despite our efforts to protect our
technology, unauthorized parties may attempt to copy aspects of
37
our products or to
obtain and use information that we regard as proprietary. Policing unauthorized use of our technology
and products is difficult. In addition,
the laws of many countries do not protect our rights to information, materials
and intellectual property that we regard as proprietary and that are protected
under the laws of the United States. We
may not be able to protect our proprietary interests, or our competitors may
independently develop similar technology or intellectual property. If either one of these situations occurs, we
may lose existing customers and our business may suffer.
The validity of any of the patents licensed
to us, or that may in the future be owned by us, may not be upheld if
challenged by others in litigation.
Further, our products or technologies, even if covered by our patents,
may infringe upon patents owned by others.
We could incur substantial costs in defending suits brought against us,
or any of our licensors, for infringement, in suits by us against others for
infringement, or in suits contesting the validity of a patent. Any such proceeding may be protracted. In any suit contesting the validity of a
patent, the patent being contested would be entitled to a presumption of
validity and the contesting party would be required to demonstrate invalidity
of such patent by clear and convincing evidence. If the outcome of any such litigation were
adverse to our interests, our liquidity and business operations would be
materially and adversely affected.
We face technological change and intense
competition both domestically and internationally which may adversely affect
our ability to sell our products profitably.
The markets for our homeland security and
semiconductor products and services are characterized by rapidly evolving
technology and a continuing process of development. Our future success will
depend upon our ability to develop and market products that meet changing
customer and technological needs on a cost effective and timely basis. If we fail to remain competitive by
anticipating the needs of our customers and our customers contract with other
suppliers, our revenues and resulting cash flow could be materially and
adversely affected.
Our semiconductor products and services segment is
dependent on the performance of several key pieces of equipment. If any of these items were not to perform to
their ability or were taken out of service for any significant amount of time,
our ability to produce product would be severely compromised.
The performance of our semiconductor products
and services segment is directly tied to the performance of several key pieces
of equipment, which are typically intricate and expensive. The average time between failures is
typically long and the corresponding time for repair is typically short; as a
result, most of the time the issues are routine and are quickly repaired.
However, this is not always the case and there have been times in the past when
critical tools have been out of service for a period of time, which had a
negative impact on revenues in the short term.
Further, due to our historical working capital shortages and the
significant historical net losses, we are unable to purchase the necessary
equipment redundancy. Any future
equipment issues could have a significant impact on our ability to produce and
ship the products to our customers, thereby potentially impacting both our
revenues and related cash flows.
We could be subject to
environmental regulation by federal, state and local agencies, including laws
that impose liability without fault, which could produce working capital
shortages and lessen stockholders’ equity.
Our IMS-based products
use radioactive sources. As a result, we
are subject to a variety of federal, state, and local environmental regulations
relating to the use, storage, discharge and disposal of hazardous chemicals
used during manufacturing processes.
Regulations that become applicable to our operations in the future could
restrict our ability to expand our facilities or could require us to acquire
costly equipment or to incur other significant expenses to comply with
governmental regulations. Historically,
our costs of compliance with environmental regulations have not been
significant because we use licensed
38
manufacturers in
connection with the manufacture of these products.
We are controlled by our Board of
Directors; individual purchasers of our shares will have little ability to
elect directors or control our management.
Our shares are widely-held, and our management
beneficially owns our securities in an amount less than 10% of the outstanding
votes at any shareholders’ meeting.
Nevertheless, it is likely that the Board of Directors will be able to
influence all matters submitted to stockholders for approval, including the
election and removal of directors and any merger, consolidation or sale of
substantially all of our assets, and to control our management and
affairs. Such control may have the
effect of delaying, deferring or preventing a change in control, impeding a
merger, consolidation or takeover or other business combination involving us or
discouraging a potential acquirer from making a tender offer or otherwise
attempting to obtain control of our business, even if such a transaction would
be beneficial to other stockholders.
We risk exposing ourselves to an
above-policy limit product liability claim, which could adversely affect our
working capital, shareholders’ equity and profitability.
Our prior sale and use of explosive and chemical detection products may
expose us to potential liability risks that are inherent with the operation of
these types of products (including, but not limited to failed detection). We currently have product liability
insurance; however, there is a risk that our insurance would not cover
completely or would fail to cover a claim, in which case we may not have the
financial resources to satisfy such claims, and the payment of claims would
require us to use funds that are otherwise needed to conduct our business and
make our products.
Our common stock is vulnerable to
pricing and purchasing actions that are beyond our control and, therefore,
persons acquiring or holding our shares or warrants may be unable to resell
their shares at a profit as a result of this volatility.
The trading price
of our securities has been subject to wide fluctuations in response to
quarter-to-quarter variations in our operating results, our announcements of
technological innovations or new products by us or our competitors, delays in
our product development and marketing, and other events and factors over which
we have no influence or control. The securities markets themselves have
experienced significant price and volume fluctuations that may be unrelated to
the operating performance of particular companies. Regulatory developments in
the United States and foreign countries, public concern as to the safety of
products containing radioactive compounds, economic and other external factors,
all affect the market price of our securities.
In
addition, the realization of any of the risks described in these “Risk Factors”
could have a significant and adverse impact on such market prices
.
SEC penny
stock regulations may limit the ability to trade our securities.
Because Nasdaq delisted
our securities from the Nasdaq Capital Market, our common stock is subject to
additional disclosure requirements for penny stocks mandated by the Securities
Enforcement Remedies and Penny Stock Reform Act of 1990. The SEC Regulations generally define a penny
stock to be an equity security that is not traded on the Nasdaq Stock Market
and has a market price of less than $5.00 per share. Our stock is included
within the SEC Rule 3a-51 definition of a penny stock and, as such,
trading is covered by Rule 15g-9 promulgated under the Securities Exchange
Act of 1934, adding a significant amount of broker-dealer compliance to
transactions in penny stocks. Many
brokers are unwilling to engage in transactions in penny stocks and, therefore,
the marketability of our securities may weaken significantly.
We
cannot give any assurance that a stable
trading market will develop for our stock. See “
Our
securities were delisted from the Nasdaq Capital Market and such delisting may
adversely impact our ability to raise
39
capital
” for additional risk
factors associated with potential Nasdaq listing deficiencies.
Future sales of our common stock
may cause our stock price to decline.
Our stock price has declined from a price of
approximately $24.00 (adjusted for the reverse split) per share at the
beginning of 2005 to prices of less than $0.25 (adjusted for the reverse split)
at various times since May 2006. Our stock price may decline further as a
result of future sales of our shares, the perception that such sales may occur,
our financial or operational performance, or other reasons. As of December 12, 2007, less than
650,000 shares of common stock held by existing stockholders constitute “restricted
shares” as defined in Rule 144 under the Securities Act. The restricted shares may only be sold if
they are registered under the Securities Act, or sold under Rule 144, or
another exemption from registration under the Securities Act.
Approximately 95% of the restricted shares of
our common stock are either eligible for sale pursuant to Rule 144 or have
been registered under the Securities Act for resale by the holders. We are unable to estimate the amount, timing,
or nature of future sales of outstanding common stock. Sales of substantial amounts of our common
stock in the public market may cause the stock’s market price to decline.
We have never paid any cash dividends on our
common stock and we do not anticipate paying cash dividends on our common stock
in the foreseeable future.
We have never declared or paid a cash
dividend on our common stock. We
presently intend to retain our earnings, if any, to fund development and growth
of our business and, therefore, we do not anticipate paying cash dividends in the
foreseeable future. Additionally, the
terms of the 13% Debentures contain restrictions on our ability to pay
dividends to holders of our common stock.
If we fail to effect and maintain
registration of the common stock issued or issuable pursuant to conversion of
our convertible debentures, or certain of our outstanding common stock
warrants, we may be obligated to pay the investors of those securities
liquidated damages.
We have various obligations to file and
obtain the effectiveness of certain registration statements which include
certain outstanding common stock and common stock underlying outstanding
convertible debentures and common stock warrants. Once effective, the prospectus contained
within a registration statement can only be used for a period of time as
specified by statute without there being a post-effective amendment filed that
has become effective under the Securities Act of 1933. If we are unable to meet these obligations,
we may be obligated to pay liquidated damages of 1% of the principal amount of
the 13% Debentures outstanding per month (up to $180,000 per month). We cannot offer any assurance that we will be
able to maintain the currency of the information contained in a prospectus or
to obtain the effectiveness of any registration statement or post-effective
amendments that we may file.
As a public company, we are subject to a
significant amount of regulation. In the
past we have received requests for information from the Securities and Exchange
Commission and from Nasdaq. Any such
inquiry or investigation that may result may adversely affect the market for
our stock or our Company.
Regulators of public companies such as
Isonics have the authority to commence inquiries and investigations where the
regulators have concerns. The
investigations, while involving the company, may not have anything to do with
actions taken by the company or our failure to act. Furthermore, the regulators may not inform us
when the issues they were addressing are resolved. From October 2004 through February 2005,
both Nasdaq and the SEC requested documents from us with respect to inquiries
they were undertaking (related primarily to questions regarding our press
releases, public relations advisors, certain other disclosures that were made
publicly and the termination of Grant Thornton LLP as our independent
auditor). We also met with
representatives of Nasdaq to
40
discuss issues related to market activity,
press announcements, SEC filings, status of our business and other issues. We provided information, which we believe to
be responsive to all of the questions posed in the Nasdaq inquiry and to the
SEC. We have not received any requests
for additional information from either the SEC or Nasdaq relating to those
earlier inquiries since February 2005 and while we believe these issues
are behind us, if any action resulted from these inquiries in the future, it
may adversely impact us, and our ability to carry on our business.
Provisions
in our charter documents could prevent or delay a change in control,
which could delay or prevent a takeover.
Our Articles of Incorporation authorize the
issuance of “blank check” preferred stock with such designations, rights, and
preferences, as may be determined by our Board of Directors. Accordingly, the Board of Directors may,
without shareholder approval, issue shares of preferred stock with dividend,
liquidation, conversion, voting, or other rights that could adversely affect
the voting power or other rights of the holders of our common stock. Preferred stock could also be issued to
discourage, delay, or prevent a change in our control, although we do not
currently intend to issue any additional series of our preferred stock.
Provisions in our bylaws provide for
indemnification of officers and directors to the full extent permitted by
California law, which could require us to direct funds away from our business
and products.
Our Bylaws provide for indemnification of
officers and directors to the full extent permitted by California law, our
state of incorporation. We may be
required to pay judgments, fines, and expenses incurred by an officer or
director, including reasonable attorneys’ fees, as a result of actions or
proceedings in which such officers and directors are involved by reason of
being or having been an officer or director. Funds paid in satisfaction of
judgments, fines and expenses may be funds we need for the operation of our
business and the development of our products, thereby affecting our ability to
attain profitability. This could cause
our stock price to drop.
We will need to make substantial financial and
man-power investments in order to assess our internal controls over financial
reporting and our internal controls over financial reporting may be found to be
deficient.
Section 404 of the Sarbanes-Oxley Act of
2002 requires management to assess our internal controls over financial
reporting and requires auditors to attest to that assessment. Current
regulations of the Securities and Exchange Commission require us to include management’s
assessment and attestation in our Annual Report on Form 10-K commencing
with the annual report for our fiscal year ending April 30, 2008. We have incurred significant costs in
implementing and responding to these requirements and, to the extent our
working capital permits, we will have to incur additional expenses to complete
the implementation and to maintain those controls. Because of our working capital and liquidity
shortages, we may not be able to complete the implementation of all aspects of Section 404
regarding internal controls over financial reporting. If we fail to complete this implementation,
investors may lose confidence in the reliability of our financial statements.
Item 2: Unregistered Sales
of Equity Securities and Use of Proceeds
No unregistered sales of equity securities were
effected subsequent to the filing of our Form 10-Q for the quarter ended July 31,
2007.
41
Item
4: Submission of
Matters to a Vote of Security Holders
None
Item 5: Other Information
Departure of Directors
On December 12, 2007, Russell W. Weiss
informed us that he has decided to retire from our Board of Directors effective
immediately. Mr. Weiss has served
on our Board of Directors since January 2004 and at the time of his
retirement served as a member of the Audit Committee, the Nominating Committee,
the Compensation Committee, and the Management Development Committee of our
Board of Directors.
Also on December 12, 2007, Richard
Parker informed us that he has decided to retire from our Board of Directors
effective immediately. Mr. Parker
has served on our Board of Directors since August 1998 and at the time of
his retirement served as a member of the Audit Committee, the Nominating
Committee, the Compensation Committee, and the Management Development Committee
of our Board of Directors.
Neither Mr. Weiss nor Mr. Parker
cited any disagreement with management or our practices or policies as their
decision to retire. Instead, both cited
personal reasons and their desire to pursue other interests as the reason for
their retirement. A copy of the disclosure in this Form 10-Q was provided
to Mr. Weiss and Mr. Parker on December 13, 2007. Neither has expressed any disagreement with
the disclosure contained herein.
Our Board of Directors now consists of Messrs. Toffales,
Sakys, Hagman and Verdery. Neither Dr. Hagman
nor Mr. Verdery are officers or directors of Isonics and both are
considered independent as that term is defined by Nasdaq Marketplace Rule 4200(a)(15). The committees of the Board of Directors are
now comprised of the following directors:
|
Audit Committee:
|
Richard H. Hagman and John
Sakys
|
|
|
|
|
Compensation, Nominating
and
Management Development Committees:
|
Richard H. Hagman and C.
Stewart Verdery, Jr.
|
Regulation FD Disclosure
On December 6, 2007, we received a
letter from Nasdaq stating that it determined to delist our securities (which
were suspended from trading on the Nadaq Capital Market effective December 10,
2007). The delisting of our securities
constitutes a failure of one of the conditions precedent to the merger
contemplated by that certain non-binding term sheet executed by Isonics and
Universal Guardian Holdings, Inc. (“UGHO”) dated November 16, 2007,
as amended on November 26, 2007 (the “Term Sheet”). We have since advised UGHO that we will not
proceed with the merger under the terms of the Term Sheet, although we continue
to negotiate a potential transaction. We
can offer no assurance that any transaction with UGHO will be consummated.
Item 6: Exhibits
Exhibits.
3.1
Restated articles of incorporation (incorporated by reference from
our Current
Report on Form 8-K (File No. 001-12531), dated June 13, 2007 and
filed on June 25, 2007, and incorporated herein by reference.
3.2
Restated bylaws
(incorporated by reference from our Current Report on Form 8-K (File No. 001-12531),
dated March 27, 2006, and filed on March 31, 2006, and incorporated
herein by reference.
31.1
Certification
of Chief
Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act
31.2
Certification
of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange
Act
32.1
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350
32.2
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350
42
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, in the City of Golden, County of Jefferson, State of Colorado,
on the 17th day of December 2007.
|
|
Isonics Corporation
|
|
|
|
|
(Registrant)
|
|
|
|
|
|
|
|
|
|
By
|
/s/ John Sakys
|
|
|
|
|
John Sakys
|
|
|
|
|
President, interim Chief Executive Officer
|
|
|
|
|
|
|
|
|
By
|
/s/ Kenneth J. Deane
|
|
|
|
|
Kenneth J. Deane
|
|
|
|
|
Chief Accounting Officer and Chief Financial Officer
|
|
|
|
|
|
|
|
43
Isonics (CE) (USOTC:ISON)
Historical Stock Chart
From Jun 2024 to Jul 2024
Isonics (CE) (USOTC:ISON)
Historical Stock Chart
From Jul 2023 to Jul 2024
