SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

Isco, Inc.

(Exact name of registrant as specified in its charter)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ý   No o

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of May 31, 2004.

 

 

 

ISCO, INC. AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION
		Item 1.	Financial Statements
			Condensed Consolidated Statements of Operations
			Condensed Consolidated Balance Sheets
			Condensed Consolidated Statements of Cash Flows
			Notes to Condensed Consolidated Financial Statements
		Item 2.	Management’s Discussion and Analysis
		Item 3.	Quantitative and Qualitative Disclosures about Market Risk
		Item 4.	Controls and Procedures
PART II.  OTHER INFORMATION
	Item 6.		Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATIONS

 

2

 

ISCO, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

(Amounts in thousands, except per share data)

 

		Three months ended						Nine months ended
		Apr 23 2004			Apr 25 2003			Apr 23 2004			Apr 25 2003
Net sales		$	18,093		$	15,057		$	52,633		$	44,813
Cost of sales		7,965			7,358			24,358			21,048
		10,128			7,699			28,275			23,765
Operating expenses:
Selling, general and administrative		7,187			5,975			19,154			18,512
Research and engineering		1,661			1,602			5,016			4,837
		8,848			7,577			24,170			23,349
Income from operations		1,280			122			4,105			416
Other income (expense):
Investment income		127			108			447			440
Interest expense		(38		)	(52		)	(118		)	(179		)
Other, net		42			50			143			136
		131			106			472			397
Income before income taxes		1,411			228			4,577			813
Provision for income taxes		470			6			1,494			170
Net income		$	941		$	222		$	3,083		$	643
Basic earnings per share		$	0.16		$	0.04		$	0.54		$	0.11
Diluted earnings per share		$	0.16		$	0.04		$	0.52		$	0.11
Cash dividends per share		$	0.06		$	0.06		$	0.18		$	0.18
Weighted average number of shares outstanding-basic		5,739			5,704			5,733			5,686
Additional shares assuming exercise of common stock equivalents and dilutive stock options		180			139			166			158
Weighted average number of shares outstanding-diluted		5,919			5,843			5,899			5,844

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

3

 

ISCO, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Columnar amounts in thousands)

 

		Apr 23 2004			Jul 25 2003
Assets
Current assets:
Cash and cash equivalents		$	1,895		$	5,383
Short-term investments		2,965			4,629
Accounts receivable - trade, net of allowance for doubtful accounts of $124,000 and $121,000		10,882			10,590
Inventories (Notes 2 and 3)		8,901			9,489
Refundable income taxes		—			303
Deferred income taxes		991			812
Other current assets		611			417
Total current assets		26,245			31,623
Property and equipment, net of accumulated depreciation of $19,228,000 and $17,656,000		12,972			13,768
Long-term investments		14,659			4,717
Other assets (Note 4)		4,367			4,327
Total assets		$	58,243		$	54,435
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable		$	1,698		$	1,222
Accrued expenses		3,700			3,698
Income taxes payable		980			—
Short-term borrowing		2,313			2,113
Current portion of long-term debt		32			503
Total current liabilities		8,723			7,536
Deferred income taxes		606			532
Long-term debt, less current portion		590			584
Commitments and contingencies
Shareholders’ equity
Preferred stock, $.10 par value, authorized 5,000,000 shares; issued none		—			—
Common stock, $.10 par value, authorized 15,000,000 shares; issued and outstanding 5,741,946 and 5,727,838		574			573
Additional paid-in capital		39,305			38,765
Retained earnings		8,559			6,509
Accumulated other comprehensive loss (Note 5)		(114		)	(64		)
Total shareholders’ equity		48,324			45,783
Total liabilities and shareholders’ equity		$	58,243		$	54,435

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

4

 

ISCO, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

(Columnar amounts in thousands)

 

		Nine Months Ended
		Apr 23 2004			Apr 25 2003
Cash flows from operating activities:
Net income		$	3,083		$	643
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation and amortization		1,681			1,875
Stock-based compensation		482			100
Deferred income taxes		(81		)	(210		)
Loss on asset impairment		153			—
Gain on sale of property and equipment		(284		)	(310		)
Provision for doubtful accounts		26			23
Undistributed (income) losses of AFTCO		(3		)	18
Change in operating assets and liabilities:
Accounts receivable-trade		(227		)	302
Inventories		701			(730		)
Refundable income taxes		303			(204		)
Other current assets		(186		)	(165		)
Accounts payable		434			314
Accrued expenses		(25		)	(770		)
Income taxes payable		980			(176		)
Other		(142		)	(392		)
Total adjustments		3,812			(325		)
Cash flows from operating activities		6,895			318
Cash flows from investing activities:
Proceeds from maturities of available-for-sale securities		11,850			7,350
Proceeds from maturity of held-to-maturity securities		—			2,630
Purchase of held-to-maturity securities		—			(497		)
Purchase of available-for-sale securities		(20,196		)	(5,934		)
Proceeds from sale of property and equipment		481			422
Purchase of property and equipment		(1,113		)	(1,504		)
Other		4			(50		)
Cash flows from investing activities		(8,974		)	2,417
Cash flows from financing activities:
Cash dividends paid		(1,032		)	(1,025		)
Net change in short-term borrowings		38			(30		)
Repayment of long-term debt		(475		)	(848		)
Issuance of common stock and exercise of stock options		60			222
Cash flows from financing activities		(1,409		)	(1,681		)
Cash and cash equivalents:
Net increase (decrease)		(3,488		)	1,054
Balance at beginning of year		5,383			633
Balance at end of period		$	1,895		$	1,687

 

See Note 7 for supplemental cash flow information.

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

5

 

ISCO, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

April 23, 2004

 

(Unaudited)

(Columnar amounts in thousands, except per share data)

 

Note 1:  In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all of the adjustments necessary for a fair presentation of the financial position of the Company and the results of operations and cash flows for the interim periods presented herein.  All such adjustments are of a normal recurring nature.  Results of operations and cash flows for the current unaudited interim period are not necessarily indicative of the results that may be expected for the entire fiscal year. Inter-company transactions and accounts have been eliminated.

 

While the Company believes that the disclosures presented are adequate to make the information not misleading, it is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements included in the Annual Report on Form 10-K for the year ended July 25, 2003.

 

Note 2:  Inventories are valued at the lower of cost or market, principally on the last-in, first-out (LIFO) basis.  The composition of inventories was as follows:

 

		Apr 23, 2004			July 25, 2003
Raw Materials		$	3,229		$	3,526
Work-in-process		3,172			2,951
Finished goods		2,500			3,012
		$	8,901		$	9,489

 

Had inventories been valued on the first-in, first-out (FIFO) basis, they would have been approximately $2,357,000 and $2,303,000 higher than reported on the LIFO basis at April 23, 2004 and July 25, 2003, respectively.

 

Note 3:  During the nine month period ended April 23, 2004, the Company established a $605,000 reserve against inventory associated with the supercritical fluid extraction (SFE) product line to reflect a lower of cost or market adjustment.  The reserve was reflected as a charge to cost of sales in the nine month period ended April 23, 2004.  The reserve reflects information obtained which indicates the current value of the inventory will not be recoverable. During the second quarter of fiscal 2004 the Company communicated to its distribution channel its intent to divest this product line within the next fiscal quarter either via a sale of assets or a shutdown of operations.  During the third quarter of fiscal 2004, the Company began implementing the shutdown process.  No additional write-downs of assets were incurred in connection with this shutdown.

 

In addition to the inventory reserve, the Company recognized an impairment of $153,000 related to property and equipment associated with the SFE product line.  This charge was included in selling, general, and administrative expenses for the nine month period ended April 23, 2004.

 

6

 

Note 4:  Other assets were comprised of the following as of April 23, 2004 and July 25, 2003:

 

		Apr 23, 2004			Jul 25, 2003
Acquired intangible assets, net of accumulated amortization of $900,000 and $802,000		$	786		$	884
Investment in AFTCO		432			430
Cash value of life insurance		1,456			1,401
Notes receivable; due March 2008 - related party		1,000			1,000
Other		693			612
		$	4,367		$	4,327

 

Note 5:  Comprehensive income for the three month and nine month periods ended April 23, 2004 and April 25, 2003, was as follows:

 

		Three months ended						Nine months ended
		Apr 23 2004			Apr 25 2003			Apr 23 2004			Apr 25 2003
Net income		$	941		$	222		$	3,083		$	643
Other comprehensive income (loss), net of income tax (tax benefit):
Foreign currency translation adjustment		4			32			(10		)	(2		)
Unrealized holding gains (losses) on available-for-sale securities		(79		)	(9		)	(40		)	(19		)
Comprehensive income		$	866		$	245		$	3,033		$	622

 

7

 

Note 6:  As permitted by SFAS 123, the Company accounts for its stock-based compensation on the intrinsic-value method in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations.  For those options granted to employees as fixed award stock options and non-employee directors’ stock options, no stock-based employee compensation expense related to the Company’s stock option plans is reflected in net income, as all options granted as fixed awards or to non-employee directors had an exercise price equal to market value of the underlying common stock on the date of grant.  Pro forma information regarding net income and earnings per share is required by SFAS No. 148.  This information is presented as if the Company had accounted for all stock-based awards under the fair value method:

 

		Three months ended						Nine months ended
		Apr 23 2004			Apr 25 2003			Apr 23 2004			Apr 25 2003
Net income, as reported		$	941		$	222		$	3,083		$	643
Less: Stock-based compensation determined under the fair value based method, net of income tax (tax benefit):		(99		)	(59		)	(244		)	(188		)
Add: Stock-based employee compensation expense included in reported net income, net of income tax (tax benefit):		337			5			482			100
Pro forma net income		$	1,179		$	168		$	3,321		$	555
Earnings per share:
Basic-As Reported		$	0.16		$	0.04		$	0.54		$	0.11
Basic-Pro forma		$	0.21		$	0.03		$	0.58		$	0.10
Diluted-As Reported		$	0.16		$	0.04		$	0.52		$	0.11
Diluted-Pro forma		$	0.20		$	0.03		$	0.56		$	0.09

 

Note 7:  Supplemental Cash Flow Information

 

The Company made income tax payments of $292,000 and $759,000 during the nine-month periods ended April 23, 2004 and April 25, 2003, respectively.

 

The Company made interest payments of $118,000 and $179,000 during the nine-month periods ended April 23, 2004 and April 25, 2003, respectively.

 

Note 8:  New Accounting Pronouncements

 

In January and December 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (FIN 46) and No. 46, revised (FIN 46R), “Consolidation of Variable Interest Entities”. These statements, which address the accounting for entities commonly known as special-purpose or off-balance-sheet, require consolidation of certain interests or arrangements by virtue of holding a controlling financial interest in such entities. Certain provisions of FIN 46R related to interests in special purpose entities were applicable for the period ended December 31, 2003. The Company must apply FIN 46R to its interests subject to the interpretation as of the first annual period ending after March 15, 2004. Adoption of this new method of accounting for variable interest entities did not and is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

8

 

Note 9:  Pending Merger

 

On April 8, 2004 Isco, Inc. and Teledyne Technologies Incorporated (Teledyne) jointly announced a definitive agreement which provides for the merger of Isco, Inc. with a wholly owned subsidiary of Teledyne. Upon the consummation of the merger, which is subject to the approval of Isco’s shareholders as well as other customary closing conditions, Teledyne will acquire all of the outstanding shares of Isco for $16.00 per share in cash. The aggregate consideration for the outstanding Isco shares will be approximately $96 million (including payments for the settlement of outstanding stock options) or approximately $76 million taking into account Isco’s net cash and investments at April 23, 2004.  A special shareholders’ meeting to vote on the merger will be held June 15, 2004.  If holders of two-thirds of the outstanding Isco common stock approve the merger, it will be completed on June 18, 2004.  Trading in Isco common stock is expected to cease effective the close of business on June 18, 2004.

 

Note 10:  Subsequent Event

 

In May, 2004, the Company received notice that it was entitled to a refund of certain policy premiums of approximately $650,000 on the health insurance plan the Company had in place for the calendar year ended December 31, 2002.  The Company anticipates receiving this refund within the next fiscal quarter.  Based on the terms of the policy refund, this gain contingency will be recognized as a reduction in operating expenses in the fourth quarter of the Company’s fiscal year 2004.

 

9

 

Item 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contain trend analysis and other forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Actual results could differ materially from those projected in the forward-looking statements within this document.

 

Third Quarter 2004 Pending Merger

 

On April 8, 2004 Isco, Inc. and Teledyne Technologies Incorporated (Teledyne) jointly announced a definitive agreement which provides for the merger of Isco, Inc. with a wholly owned subsidiary of Teledyne. Upon the consummation of the merger, which is subject to the approval of our shareholders as well as other customary closing conditions, Teledyne will acquire all of the outstanding shares of Isco for $16.00 per share in cash. The aggregate consideration for the outstanding Isco shares will be approximately $96 million (including payments for the settlement of outstanding stock options) or approximately $76 million taking into account Isco’s net cash and investments at April 23, 2004. A special shareholders’ meeting to vote on the merger will be held June 15, 2004.  If holders of two-thirds of the outstanding Isco common stock approve the merger, it will be completed on June 18, 2004.  Trading in Isco common stock is expected to cease effective the close of business on June 18, 2004.

 

Results of Operations

 

The following table sets forth, for the three-month and nine-month periods indicated, the percentages which certain components of the Condensed Consolidated Statements of Operations bear to net sales and the percentage of change of such components (based on actual dollars) compared with the same periods of the prior year.

 

		Three months ended						Nine months ended
		Apr 23 2004		Apr 25 2003		Change		Apr 23 2004		Apr 25 2003		Change
Net sales		100.0		100.0		20.2		100.0		100.0		17.5
Cost of sales		44.0		48.9		8.2		46.3		47.0		15.7
		56.0		51.1		31.5		53.7		53.0		19.0
Operating expenses:
Selling, general, & administrative		39.7		39.7		20.3		36.4		41.3		3.5
Research & engineering		9.2		10.6		3.7		9.5		10.8		3.7
		48.9		50.3		16.8		45.9		52.1		3.5
Income from operations		7.1		0.8		949.2		7.8		0.9		886.8
Other income (expense):
Investment income		0.7		0.7		17.6		0.8		1.0		1.6
Interest expense		(0.2	)	(0.3	)	(26.9	)	(0.2	)	(0.4	)	(34.1	)
Other, net		0.2		0.3		(16.0	)	0.3		0.3		5.1
		0.7		0.7		23.6		0.9		0.9		18.9
Income before income taxes		7.8		1.5		518.9		8.7		1.8		463.0
Provision for income taxes		2.6		0.0		7,733.3		2.8		0.4		778.8
Net income		5.2		1.5		323.9		5.9		1.4		379.5

 

10

 

Net Sales Analysis and Review

 

Sales for the three-month period were $18.1 million which was $3.0 million or 20 percent higher than the prior year period and sales for the nine-month period were $52.6 million which was $7.8 million or 17 percent higher than the prior year.  The nine-month improvement included the benefit of $1.1 million in shipments from our previous year-end backlog.

 

Core products sales (wastewater samplers, flow meters, and liquid chromatography products) of $14.1 million for the quarter and $41.0 million for the nine-month period, were up 25 and 20 percent, respectively, as compared to the same periods of last year.  The quarterly improvement was driven by increased U.S. sales of all core products, particularly liquid chromatography, while the year-over-year improvement was due to increased global sales of all core products.  We believe a portion of the strong liquid chromatography sales growth is due to spending that was delayed by pharmaceutical companies in the previous fiscal year.

 

Sales of our non-core products (process monitoring, supercritical fluid extraction (SFE) and syringe pumps products) and services of $4.0 million for the quarter and $11.6 million for the nine-month period were up 6 percent and 11 percent, respectively, compared to the same periods of last year.  For the current quarter, sales of process monitoring products drove the majority of the growth, while SFE decreased due to our divestiture of this product line.  For the year, sales of process monitoring products also provided the majority of the increase.  This was the result of both improved economic conditions and the acceptance of newly introduced products.

 

U.S. sales for the three months and nine months were up 23 percent and 11 percent, respectively.  U.S. sales of our core products for the quarter and nine-month periods increased 27 and 13 percent, respectively, over the comparable periods of fiscal 2003.  Sales of liquid chromatography products drove both the three and nine month improvements with samplers and flow meters also contributing positive growth in both periods. U.S. sales of our non-core products and services for the three-month period increased by 3 percent and decreased by 1 percent for the nine-month comparison.  All non-core products and services except SFE showed increased sales to account for the increase in the quarter, while the decrease for the nine-month period was due to lower sales of syringe pumps products.

 

International sales for the three months and nine months increased 15 percent and 34 percent, respectively.  Sales of our core products for the same periods were up 19 percent and 43 percent, respectively, over last year.  Liquid chromatography sales increases drove the performance for the quarter while liquid chromatography and flow meter product sales contributed most to the nine month improvement.  International sales of our non-core products and services for the three months and nine months increased by 9 and 22 percent, respectively, in each period.  For the three-month period process monitoring products drove the increase while for the nine-month period process monitoring and SFE drove the increase.

 

During the three months and nine months, we received net orders of $19.0 million and $51.5 million, respectively. Net orders received were up 28 percent and 17 percent compared to the same periods last year.  The order backlog at April 23, 2004 was $6.6 million, down approximately 15 percent from the beginning of the fiscal year.

 

Net Income Analysis and Review

 

Our net income for the third quarter and nine months of fiscal 2004 was $0.9 million and $3.1 million, respectively, up approximately $0.7 million and $2.4 million, respectively from the prior year.  The improvement for both periods reported was due to increased income from operations. We generated income from operations of $1.3 million and $4.1 million, respectively, for the three months and nine months ended April 23, 2004.  For the same periods last year, we generated operating income of $0.1 million for the quarter and operating income of $0.4 million for the nine-month period.

 

The improvement in income from operations was primarily driven by the additional gross margin dollars generated by increased sales.  Offsetting the margin improvements was the negative gross margin impact of a $0.6 million

 

11

 

write down of inventory associated with the divestiture of our supercritical fluid extraction (SFE) product line which was recorded primarily in the first quarter of fiscal 2004.  Operating expenses declined as a percentage of sales for the quarter and nine-month periods which also contributed to the improvement in operating income.

 

Gross margins, as a percentage of sales, were 56.0 and 53.7 percent for the three and nine-month periods, respectively, compared with 51.1 and 53.0 percent for the same periods last year, and increased in dollars by $2.4 million and $4.5 million, respectively.  Excluding the impact of the inventory write down, our gross margin for the nine month period would have been 54.9%.  Positive shifts in the sales mix in both product and geographic areas and benefits from cost improvements drove the quarter and year-over-year improvements.

 

Operating expenses increased by approximately $1.3 million for the quarter and $0.8 million for the nine-month period. On a percentage basis, operating expenses declined by 1.4% and 6.2% of net sales as compared to the same periods of the previous year.  The increase in operating expenses for the quarter resulted from professional fees associated with our pending merger with Teledyne Technologies, increases in the charges for stock-based compensation and increases in commissions associated with higher sales.  For the nine month period, operating expenses were impacted by the same items mentioned for the quarter, partially offset by higher costs incurred in the prior year in connection with severance costs associated with organizational restructuring in fiscal 2003.

 

Other income increased by $25,000 and $75,000, for the three-month and nine-month periods ended April 23, 2004, respectively, as compared to the same periods of the previous year.  This change resulted principally from lower interest expense due to the reduction in our outstanding debt.

 

Our effective income tax rate for the three months and nine months ended April 23, 2004 was 33.3 percent and 32.6 percent, respectively.  For the same periods last year our effective income tax rates were 2.6 percent and 20.9 percent, respectively.  The low effective rates for the third quarter and nine-month periods of the prior year were due to the minimal absolute dollar amount of pre-tax income and affects of exchange rates on the foreign net operating loss carryforwards.  The low effective tax rates for the current quarterly and year-to-date results were associated with the benefit of reduced tax liabilities associated with foreign sourced income.

 

Financial Condition and Liquidity

 

Our overall cash and investments increased to $19.5 million at April 23, 2004 from $14.7 million at the end of fiscal year 2003, an increase of $4.8 million.  Operating activities generated $6.9 million of cash during the nine month period ended April 23, 2004 compared with generating $0.3 million during the same period last year.  The major factors in the increase were the increase in net income and the change in operating assets and liabilities that resulted in a net increase of approximately $3.7 million in operating cash flow, primarily driven by reductions in inventory and increases in taxes and accounts payable.

 

We invested the cash available at the beginning of the year, provided from operations and generated from maturities of investments of $11.9 million, into long-term and short-term investments of $20.2 million.  We utilized the remaining cash available to purchase a net of $0.6 million in equipment, used cash of $0.4 million for the repayment of long and short term bank obligations and used $1.0 million for dividends.  Our net cash and cash equivalents position decreased by $3.5 million for the nine month period of fiscal 2004 compared to a net increase of $1.1 million in the same period of fiscal 2003 due to the timing of purchases and maturities of investments.

 

At April 23, 2004, we had working capital of $17.5 million and a current ratio of 3.0:1.  At period-end, our total long-term debt was $0.6 million with $32,000 payable within the next year.  In addition, we had lines of credit with various banks totaling $7.0 million of which approximately $4.5 million was available for future business needs.

 

12

 

New Accounting Pronouncements

 

In January and December 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (FIN 46) and No. 46, revised (FIN 46R), “Consolidation of Variable Interest Entities”. These statements, which address the accounting for entities commonly known as special-purpose or off-balance-sheet, require consolidation of certain interests or arrangements by virtue of holding a controlling financial interest in such entities. Certain provisions of FIN 46R related to interests in special purpose entities were applicable for the period ended December 31, 2003. The Company applied FIN 46R to its interests subject to the interpretation in the third quarter of fiscal 2004. Adoption of this new method of accounting for variable interest entities did not and is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

Critical Accounting Policies

 

Accounts Receivable

Accounts receivable consist primarily of amounts due to us from normal business activities.  We maintain an allowance for doubtful accounts to reflect the expected uncollectibility of accounts receivable based on a combination of past collection history, aging of outstanding accounts receivables, and specific risks identified in the portfolio.

 

Inventories

Inventories consist of purchased materials, raw materials, in-process subassemblies, and finished goods.  Inventory obsolescence cost has not historically been material and as a result we do not carry a reserve for obsolescence for the majority of our inventory.  We review our inventory balances to determine if inventories can be sold at amounts equal to or greater than their carrying amounts.  The review includes identification of slow-moving inventories, obsolete inventories, and discontinued products or lines of products.  The identification process includes a review of historical performance of the inventory and current operational plans for the inventory.  If our actual results differ from our expectations with respect to the inventory sales at amounts equal to or greater than their carrying amounts, we would be required to adjust our inventory balances accordingly.    We use the link-chain method for valuing the majority of our inventory on a LIFO basis.

 

Revenue Recognition

Revenues are recorded when products are shipped to customers or, in instances where service is performed to customer requirements, upon the successful completion of such service.  We are generally not contractually obligated to accept returns, except for defective products.  Sales are shown net of returns and discounts.

 

Stock-Based Compensation

We have elected to account for fixed award stock options and non-employee directors’ options under the provisions of APB No. 25 “Accounting for Stock Issued to Employees”.  As such, no compensation cost has been recorded in the financial statements relative to these options.  We utilize the Black-Scholes option pricing model to estimate the fair value of these options for disclosure purposes.

 

We account for performance based awards granted under our employee stock option plans in accordance with the provisions of APB 25.  Options granted under the performance based awards are subject to variable accounting treatment until the number of options that will vest is known.  Options not vested at the end of each performance year are cancelled.  Compensation expense is recorded based on difference between the closing market price at the date the shares vest and the exercise price as determined at the date the shares were granted.

 

Deferred stock units granted to non-employee directors are accounted for in accordance with Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation.”  Accordingly, directors deferred stock units are recorded as compensation expense at estimated fair value on the date the units are earned by the director.

 

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Joint Venture

We account for our investment in the AFTCO joint venture using the equity method of accounting.

 

Factors Affecting Future Results

 

As we stated in our fiscal 2003 Form 10-K, we made the decision to divest the supercritical fluid extraction (SFE) product line and expected to complete the divestiture within fiscal 2004.  During the first and second quarter of fiscal 2004 we continued to actively review various alternatives. Based on the alternatives evaluated, we recorded non-cash charges of approximately $0.8 million associated with inventory and property during the first half of fiscal 2004.  During the second quarter of fiscal 2004 we communicated to our distribution channels our intent to divest this product line within the next fiscal quarter either via a sale of assets or a shutdown of operations.  During the third quarter of fiscal 2004, we took further actions to shutdown the operations of this product line, including the cessation of accepting orders from new and current customers.  We do not anticipate any additional material negative operational charge to impact our future performance as a result of these actions.

 

Related to our operational performance, we are very pleased with our continued improved performance in both sales and operational income on a quarter over quarter basis and for the nine-month period compared to the prior year.  While we expect to report sales and earnings above our fiscal 2003 level we remain cautious about our ability to sustain the growth in operating income performance into the future.  We continue to maintain a degree of caution about our ability to repeat the recent strong quarterly sales performance due to the influence on our sales of the continued pace of the global economic recovery and the short-term impact of activities and expenses associated with the pending merger with Teledyne Technologies, Inc.

 

On a positive note, in May, 2004, we received notice that we were entitled to a refund of certain policy premiums of approximately $650,000 on the health insurance plan we had in place for the calendar year ended December 31, 2002.  We anticipate receiving this refund within the next fiscal quarter.  Based on the terms of the policy refund, this gain contingency will be recognized as a reduction in operating expenses in the fourth quarter of our fiscal year 2004.

 

Market Risk

 

Interest rate risk and currency exchange risks are the primary market risks to which we are exposed.  We do not use derivative financial or commodity instruments.  Our other financial instruments include cash and cash equivalents, investments, accounts and notes receivable, accounts and notes payable and long-term debt.  Our cash and cash equivalents, investments, accounts and notes receivable, and accounts and notes payable balances are generally short-term in nature and do not expose our company to material market risk.  At April 23, 2004, we had approximately $0.6 million of fixed rate debt.  In addition, we had $7.0 million of variable rate credit facilities, of which approximately $2.5 million was outstanding under these credit facilities.  We do not believe that changes in interest rates on the debt and credit facilities would have a material effect on our results of operations, given our current obligations under these debt and credit facilities.  We are exposed to the impact of interest rate and market price changes on our investments portfolio.  Due to the nature of these investments being held in high grade corporate or government bonds, we believe our overall exposure to market risk is low.

 

Related to currency exchange, international sales of our United States based operations are denominated in U.S. dollars and international sales of our German subsidiary are denominated in Euros.  The currency exchange risk at the current level of activity is not material to our operating results or financial position.  Our market risk resulting from the translation of the profit and loss of STIP and from our permanent investment in our foreign subsidiaries is not material.

 

There have been no material changes during the first nine months of fiscal 2004 with respect to the Company’s contractual obligations.  Details of the Company’s contractual obligations can be found in the Management’s Discussion and Analysis of Results of Operations and Financial Condition section of the Company’s fiscal 2003 Annual Report on Form 10-K.

 

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Inflation

 

Inflation has not had, and is not expected to have, a material impact upon the Company’s operations.  The effect of inflation on our costs and our ability to pass on cost increases in the form of increased prices is dependent upon market conditions and the competitive environment.

 

Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The information required by this item is included in the section entitled “Market Risk” in Part I, Item 2, Management’s Discussion and Analysis of Results of Operations and Financial Condition.

 

Item 4.  CONTROLS AND PROCEDURES

 

(a) Evaluation of disclosure controls and procedures.

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), within the 90 days prior to the filing date of this report, the Company carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures.  This evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer along with the Company’s Chief Financial Officer.  Based upon that evaluation, the Chief Executive Officer along with the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported with the time periods specified in Securities and Exchange Commission rules and forms.

 

(b) Changes in Internal Control.

There were no significant changes in the Company’s internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 6.    Exhibits and Reports on Form 8-K

 

(a)                      Exhibits:

 

(10.1)		Employment Security Agreement with Douglas M. Grant, President and Chief Operating Officer of Isco, Inc.
(10.2)		Employment Security Agreement with Vicki L. Benne, Chief Financial Officer and Treasurer of Isco, Inc.
(10.3)		Employment Security Agreement with Dr. Vikas V. Padhye, Director of Sales and Marketing of Isco, Inc.
(31.1)		Certification pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 made by Robert W. Allington, Chief Executive Officer
(31.2)		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 made by Vicki L. Benne, Chief Financial Officer
(32.1)		Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 made by Robert W. Allington, Chief Executive Officer

 

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(32.2)

Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 made by Vicki L. Benne, Chief Financial Officer

 

(b)		Reports on Form 8-K:  The Company furnished a Current Report on Form 8-K dated June 4, 2004 announcing earnings for the quarter ended April 23, 2004 and attaching a press release related thereto.
		Isco, Inc. filed a Current Report on Form 8-K on April 8, 2004, for the purpose of reporting, under Item 5 and Item 9, the acquisition by Teledyne Technologies, Incorporated.

 

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.

 

	ISCO, INC.
Date:  June 3, 2004	BY:	/s/Robert W. Allington
			Robert W. Allington
			Chairman and Chief Executive Officer
Date:  June 3, 2004	BY:	/s/Vicki L. Benne
			Vicki L. Benne
			Chief Financial Officer and Treasurer

 

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