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| INS > SEC Filings for INS > Form 10-Q on 13-Nov-2009 | All Recent SEC Filings |
13-Nov-2009
Quarterly Report
In addition to historical information, this Form 10-Q may contain
forward-looking statements relating to ISC. All statements, trend analyses and
other information relative to markets for our products and trends in revenue,
gross margins and anticipated expense levels, as well as other statements
including words such as "anticipate", "believe", "plan", "estimate", "expect",
and "intend", and other similar expressions, constitute forward-looking
statements. Prospective investors are cautioned that any such forward-looking
statements are not guarantees of future performance and involve risks and
uncertainties including those factors described below under "Factors That May
Affect Future Operations", and that actual results may differ materially from
those contemplated by such forward-looking statements. ISC undertakes no
obligation to update or revise forward-looking statements to reflect changed
assumptions, the occurrence of unanticipated events or changes in future
operating results.
For purposes of this discussion and analysis, we are assuming and relying upon
the reader's familiarity with the information contained in Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations, in the
Form 10-K for the year ended December 31, 2008 as filed with the Securities and
Exchange Commission.
Overview
Our consolidated subsidiaries operate in two industry segments: Information
Technology Products and Services ("Information Technology") and Industrial
Products. The Industrial Products segment consists of ChemFree Corporation
("ChemFree") (bio-remediating parts washers). The Information Technology sector
consists of CoreCard Software, Inc. ("CoreCard") (software for managing accounts
receivables, credit and prepaid cards). As discussed in Note 4 to the
Consolidated Financial Statements, we sold our VISaer business as of April 16,
2008. Accordingly, the Consolidated Financial Statements reported in this Form
10-Q and the discussion below do not include the results of our VISaer
subsidiary as part of continuing operations.
We derive our product revenue from sales of software licenses in our Information
Technology sector and sales and leases of equipment and supplies in our
Industrial Products sector. Our service revenue consists of fees for
implementation, consulting, training, maintenance and support for software
products in our Information Technology sector. Our consolidated revenue is the
aggregate of the revenue generated at our subsidiary companies. Our revenue
fluctuates from period to period and our results are not necessarily indicative
of the results to be expected in future periods. Period-to-period comparisons
may not be meaningful and it is difficult to predict the level of consolidated
revenue on a quarterly or annual basis for a number of reasons, including the
following:
• A change in revenue level at one of our subsidiaries may impact
consolidated revenue or be offset by an opposing change at another
subsidiary.
• Customers may decide to postpone or cancel a planned implementation of our software for any number of reasons, which may be unrelated to our software features or contract performance, but which may affect the amount, timing and characterization of our deferred and/or recognized revenue.
• In a given period, new license revenue related to our Information Technology sector may consist of a relatively small number of new contracts. Consequently, even small delays in a delivery under a new software contract (which may be out of our control) could have a significant and unpredictable impact on consolidated revenue that we recognize in a given quarterly or annual period.
Frequently we incur consolidated operating losses on a quarterly and annual basis and are likely to do so in the future from time to time. Our operating expenses consist of the aggregate of our subsidiaries' expenses and the corporate office expenses. Our ChemFree subsidiary generates an operating profit on a regular basis but our earlier stage subsidiary, CoreCard, is not consistently profitable, mainly due to significant research and development expense that is invested to complete new product offerings and the deferral of revenue recognition until such products are delivered to and accepted by customers. Depending upon the size and number of software licenses recognized in a particular period and the level of expenses incurred to support development and sales activities, CoreCard may report operating profits on an irregular basis as it builds its customer base. A significant portion of our subsidiaries' expense is related to personnel. For these and other reasons, our operating profits or losses may vary from quarter to quarter and at the present time are generally not predictable with any degree of certainty.
From time to time, we also generate income or incur losses from non-operating
sources and we may do so in the future. We may derive income from sales of
holdings in subsidiary, affiliate and other minority-owned companies, as
exemplified in the VISaer sale, discussed in more detail in Note 4 to the
Consolidated Financial Statements. Occasionally, we record a charge if we
believe the value of a non-consolidated company is impaired. We also recognize
on a quarterly basis our pro rata share of the income or losses of a
minority-owned affiliate company accounted for by the equity method. The timing
and amount of gain or loss recognized as a result of a sale or the amount of
equity in the income or losses of affiliates generally are not under our control
and are not necessarily indicative of future results, either on a quarterly or
annual basis.
Results of Operations
The following discussion should be read in conjunction with the Consolidated
Financial Statements and the notes to Consolidated Financial Statements
presented in this quarterly report.
Revenue - Total revenue from continuing operations in the three month period
ended September 30, 2009 was $3.4 million, equal to the revenue reported in the
third quarter of 2008, but an increase of 23 percent and 9 percent compared to
the first and second quarters of 2009, respectively. For the nine month period
ended September 30, 2009, total revenue was $9.3 million, a decline of 21
percent compared to the same period in 2008.
• Revenue from products, which includes sales and leases of equipment and
supplies in our Industrial Products segment as well as software license
fees related to the Information Technology segment, was $3.1 million in
both three month periods ended September 30, 2009 and 2008. In the
year-to-date period of 2009, product revenue declined by 26 percent
compared to the first nine months of 2008. The 2009 year-to-date decline
is primarily due to the fact that in the first half of 2008, one of
ChemFree's largest customers was in the middle of a national program to
sell ChemFree products resulting in a high initial volume of sales. With
the initial rollout complete, as anticipated the number of new machines
sold to this customer in the first half of 2009 was lower than during the
rollout period last year. During the first two quarters of 2009, there was
also a period-to-period decline in equipment sales in the international
market reflecting the general economic slowdown in certain European
markets. However, in the third quarter of 2009, sales of new SmartWasher®
machines in both the domestic and international markets were stronger than
in the first two quarters of 2009. Worldwide sales of ChemFree's fluid and
filter consumables in the three and nine month periods ended September 30,
2009 increased compared to the same periods in 2008, reflecting an
increasing base of users of its SmartWasher® part washers. However, sales
of fluid to the European market were lower in the year-to-date 2009 period
compared to the nine month period of 2008 due to a transition to a new
fluid blending facility in the UK. In order to reduce shipping costs and
improve supply to its European market, effective in the third quarter of
2009, ChemFree earns a fee based on fluid blended in the UK that is equal
to the gross margin ChemFree historically earned on fluid shipments from
the US to its UK distributor. As a result, gross revenue reported on fluid
for the European markets is lower in 2009 (and will be going forward as
well) but the gross profit to ChemFree is comparable under this new
arrangement to what it would have earned shipping bulky fluid containers
overseas.
• Software license revenue associated with the Information Technology segment increased in both the three and nine month periods ended September 30, 2009 compared to the respective periods in 2008 due to more new license contracts. The company recognizes software license revenue generally upon completion of each contract and acceptance by customers.
• Service revenue associated with the Information Technology segment was $268,000 and $1,112,000 in the three and nine months ended September 30, 2009, representing a decline of 12 percent and an increase of 57 percent compared to the respective periods in 2008. Year-to-date, the growth in service revenue is attributed to increased professional services projects that were completed for CoreCard customers as well as an increase in the installed base of customers that pay for maintenance and technical support. On a quarterly basis, revenue from customer projects will vary depending on customer requirements and timetables, whereas maintenance revenue is fairly consistent.
• Due to general economic conditions and uncertainty about the impact of a slow economy on the automotive repair and supplies industry, ChemFree had anticipated a relatively flat volume of machine sales for 2009 and carefully managed its costs and inventory levels accordingly. Sales of replenishment fluid and filter to the installed base of customers and lease revenue have been relatively unaffected by fluctuations in general economic conditions. Turmoil in the global financial markets could impact CoreCard's revenue and prospects in the foreseeable future if customers or prospects postpone software purchases or implementations. We are carefully monitoring the evolving dynamics in the marketplace and proactively lowered expenses going into 2009. We expect to fully support existing customers and contracts and have added new prospects and customers in 2009. We expect to use the funds received from the successful completion of our stockholder rights offering as described in more detail in Note 13 to the Consolidated Financial Statements to support CoreCard's growth plans, as well as other general corporate purposes.
Cost of Revenue - Total cost of revenue was 53 percent and 54 percent of total
revenue in the three and nine month periods ended September 30, 2009,
respectively, compared to 58 percent and 60 percent of total revenue in the
three and nine month periods ended September 30, 2008, respectively. The
improvement in 2009 is related mainly to favorable changes in ChemFree's product
mix in both the three and nine month periods in 2009.
• Cost of product revenue was 51 percent and 52 percent of product revenue
in the three and nine months ended September 30, 2009, respectively
compared to costs of 58 percent of product revenue in the three and nine
month periods in 2008. Revenue from higher margin fluid and filters and
software licenses was a larger percentage of product revenue in 2009 than
in the comparable periods in 2008, resulting in the improved gross margin.
• Cost of service revenue (which relates to our CoreCard business only) was significantly lower as a percent of service revenue in the nine month period ended September 30, 2009 as compared to the same period last year. The mix of service revenue in a given period, as well as the number of customers and new products being supported, impacts the gross margin on service revenue. The year-to-date improvement in gross margin in 2009 is due in part to a higher volume of professional service revenue which has a relatively lower cost to deliver than does our customer support and maintenance revenue (both of which are included in the category of service revenue). CoreCard is providing a high level of support to its initial customers to ensure it builds a solid base of reference customers and puts in place an infrastructure for future growth. Cost of providing routine maintenance and support services as a percentage of service revenue is expected to decrease as CoreCard's installed base of customers increases, whereas the cost of professional services is expected to have a relatively consistent gross margin percentage from period to period for similar types of projects.
Operating Expenses - In the three and nine month periods ended September 30,
2009, total consolidated operating expenses were lower by 12 percent and
30 percent, respectively, than in the corresponding periods in 2008. At the
beginning of 2009, we implemented company-wide headcount reductions and pay
cuts. These actions and the associated reductions in personnel-related and
travel expenses resulted in substantial cost savings in the three and nine month
periods of 2009 as compared to the respective periods in 2008. Consolidated
marketing expenses declined by 10 percent and 33 percent in the three and nine
month periods in 2009 compared to the same periods in 2008 mainly due to lower
sales commissions paid by ChemFree and a reduction in personnel and travel
related expenses. Consolidated general and administrative expenses were
7 percent higher in the three month period ended September 30, 2009 but
22 percent lower in the nine month period ended September 30, 2009,
respectively, compared to the same periods in 2008. The changes reflect lower
personnel-related expenses in both periods in 2009 and lower legal expenses for
the year-to-date period in 2009 compared to year-to-date in 2008. However, legal
expenses in the third quarter of 2009 were significantly higher than in the
third quarter of 2008, reflecting the trial that took place in July 2009 related
to ChemFree's legal action, as explained in more detail in Note 9 to the
Consolidated Financial Statements. Consolidated research and development
expenses were 31 percent and 38 percent lower in the three and nine month
periods in 2009, respectively, compared to the same periods in 2008, mainly due
to a reduction in consulting fees and personnel-related expenses associated with
our CoreCard business. In August 2009, the company increased the base salary
levels for most of its personnel back to the level that had been in place before
the company-wide pay cuts were implemented at the beginning of the year.
Interest Income (Expense), net - We recorded net interest income of $26,000 and
$57,000 in the three and nine month periods in 2009 compared to net interest
income of $5,000 and interest expense of $4,000 in the three and nine month
periods ended June 30, 2008. The difference between periods reflects primarily
the net effect of periodic fluctuations in our bank borrowings and notes
receivable balances.
Equity in Income of Affiliate Company - On a quarterly basis, we recognize our
pro rata share of the earnings or losses of our affiliate company that we record
on the equity method. We recorded $4,000 and $24,000 in net equity income of our
affiliate company in the three and nine months ended September 30, 2009,
respectively. These amounts are lower as compared to the respective periods in
2008, reflecting a decline in profitability of the affiliate company.
Other Income - We recorded $6,000 and $18,000 of other miscellaneous income
items in the three and nine-month periods ended September 30, 2009.
Income Taxes - We recorded $6,000 and $10,000 in the three and nine month
periods ended September 30, 2009 for state income tax expense. We believe our
net deferred tax assets should be fully reserved at September 30, 2009 given
their character and our historical losses. Accordingly, no deferred tax assets
have been recorded at September 30, 2009.
Discontinued Operations
Income (Loss) from Discontinued Operations - The amounts recorded in 2008
reflect the operations of our VISaer subsidiary which have been classified as a
discontinued operation as a result of the sale of the VISaer business as
explained in Note 4 to the Consolidated Financial Statements.
Liquidity and Capital Resources
On July 17, 2009, we completed a rights offering of common stock to our
shareholders. The company sold 4,479,014 new shares of common stock and received
gross proceeds from the rights offering of $3.1 million, less expenses related
to the transaction of $149,000. Subsequent to the completion of the rights
offering, we paid down our working capital line of credit in full and expect to
use remaining proceeds from the rights offering primarily to support plans for
our CoreCard subsidiary as well as other general working capital purposes.
Our cash balance at September 30, 2009 was $3.3 million compared to a cash
balance of $1.0 million at December 31, 2008. During the nine months ended
September 30, 2009, our principal sources of cash were net proceeds of
$3.0 million from the shareholder rights offering completed on July 19, 2009,
borrowings of $335,000 on our line of credit and $352,000 from payments received
on notes receivable. Other working capital sources of cash include a reduction
in inventory levels of $247,000, an increase in deferred revenue of $513,000 and
an increase of $209,000 in accounts payable. During the nine month period, we
used $645,000 in net cash for operations, principally to support CoreCard and
its international software development and testing operations and our corporate
office, and paid down $660,000 on our bank line of credit. Working capital uses
of cash included an increase in accounts receivable of $435,000, reflecting
increased billings.
As explained in Note 8 to the Consolidated Financial Statements, in June 2009 we
renewed our bank line of credit for an additional one-year term, expiring
June 30, 2010. The line, which we use from time to time to support short-term
cash needs, has a maximum availability of $1.25 million based on qualifying
accounts receivable and inventory levels. We presently project that we will have
sufficient accounts receivable, inventory balances and tangible net worth for
the foreseeable future to support the line of credit borrowing base for any
required draws under our bank line of credit, although we presently anticipate
limited, if any, borrowings in the foreseeable future, given the recent proceeds
from the rights offering. However, if we fail to control costs, if we fail to
meet software delivery commitments, if anticipated customer payments are delayed
for any reason or if we encounter unforeseen delays in product development or
production, we could require more cash than presently planned.
Long-term, we currently expect that liquidity will continue to improve and
consolidated operations will generate sufficient cash to fund their requirements
with use of our credit facility if necessary to accommodate short-term needs.
Other long-term sources of liquidity include potential sales of investments or
subsidiaries although the timing and amount of any such transactions are
uncertain and, to the extent they involve non-consolidated companies, generally
not within our control.
Off-Balance Sheet Arrangements
We do not currently have any off-balance sheet arrangements that are reasonably
likely to have a current or future material effect on our financial condition,
liquidity or results of operations.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations
is based upon our Consolidated Financial Statements which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amount of assets, liabilities, revenues and
expenses. We consider certain accounting policies related to revenue
recognition, valuation of acquired intangibles and impairment of long-lived
assets, and valuation of investments to be critical policies due to the
estimation processes involved in each. Management discusses its estimates and
judgments with the Audit Committee of the Board of Directors. For a detailed
description on the application of these and other accounting policies, see Note
1 to the Consolidated Financial Statements contained in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2008. Reference is also made to
the discussion of the application of these critical accounting policies and
estimates contained in Management's Discussion and Analysis of Financial
Condition and Results of Operations in our Annual Report on Form 10-K for 2008.
Except as explained in Note 3 to the Consolidated Financial Statements, during
the three and nine month periods ended September 30, 2009, there were no
significant or material changes in the application of critical accounting
policies that would require an update to the information provided in the Form
10-K for 2008.
Factors That May Affect Future Operations
Future operations in both the Information Technology and Industrial Products
segments are subject to risks and uncertainties that may negatively impact our
future results of operations or projected cash requirements. It is difficult to
predict future quarterly and annual results with certainty. Any trend or delay
that affects one of our subsidiaries could have a negative impact on the
company's consolidated results of operations or cash requirements on a quarterly
or annual basis. In addition, the carrying value of our investments is impacted
by a number of factors which are generally beyond our control since we are
typically a non-controlling shareholder in a private company with limited
liquidity.
Among the numerous factors that may affect our consolidated results of
operations or financial condition are the following:
• Turmoil in the global financial markets could have a serious negative impact
on CoreCard due to potential customers (most of whom are financial
institutions or services firms) delaying purchase or implementation
decisions.
• Reluctance by financial institutions to act as sponsor banks for prospective customers (such as issuers and processors of credit and prepaid cards) could increase CoreCard's losses and cash requirements.
• It is unclear to what extent the general weakness in the domestic US and European economies will impact the automotive parts and repair industry and reduce future demand for ChemFree's SmartWasher® products.
• Delays in software development projects could cause our customers to delay implementations or delay payments, which would increase our costs and reduce our revenue.
• Our CoreCard subsidiary could fail to deliver software products which meet the business and technology requirements of its target markets within a reasonable time frame and at a price point that supports a profitable, sustainable business model.
• One of ChemFree's customers represented 37 percent of our consolidated revenue in the first nine months of 2009 and any unplanned changes in the volume of orders or timeliness of payments from such customer could have a negative impact on revenue, profits, inventory levels and cash, at least in the near-term.
• Failure by ChemFree to protect its intellectual property assets could increase competition in the marketplace and result in greater price pressure and lower margins, thus potentially impacting sales, profits and projected cash flows.
• Software errors or poor quality control may delay product releases, increase our costs, result in non-acceptance of our software by customers or delay revenue recognition.
• Compliance with the internal control over financial reporting requirements of Section 404 of the Sarbanes-Oxley Act of 2002 will increase expenses and divert management and staff resources.
• Competitive pressures (including pricing, changes in customer requirements and preferences, and competitor product offerings) may cause prospective customers to choose an alternative product solution, resulting in lower revenue and profits (or increased losses).
• CoreCard could fail to expand its base of customers, resulting in lower revenue and profits (or increased losses), increased cash needs and possibly leading to restructuring or cutting back of the subsidiary's operations.
• In certain limited situations, ChemFree lease customers are permitted to terminate the lease covering a SmartWasher® machine, requiring the unamortized balance of the original machine cost to be written off which could reduce profits in that reporting period and result in lower revenue in future periods.
• CoreCard could fail to retain key software developers and managers who have accumulated years of know-how in our target markets and company products, or fail to attract and train a sufficient number of new software developers and testers to support our product development plans and customer requirements at projected cost levels.
• Delays in anticipated customer payments for any reason would increase our cash requirements and possibly our losses.
• Declines in performance, financial condition or valuation of minority-owned companies could cause us to write-down the carrying value of our investment or postpone an anticipated liquidity event, which could negatively impact our earnings and cash flow.
• Failure to regain compliance with the continued listing standards of NYSE Amex could result in delisting of our common stock, with a potentially negative impact on market price and liquidity of our common stock.
• Other general economic and political conditions could cause customers to delay or cancel software purchases.
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