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. Except to the extent
required by law, 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 6. Management's Discussion and Analysis of Financial Condition and Results of Operations, in the Form 10-K for the year ended
We derive our product revenue from sales and leases of equipment and supplies in our Industrial Products sector and from sales of software licenses in our Information Technology Products and Services sector. Our service revenue consists of fees for software customization, processing services, maintenance and support for software products in our Information Technology Products and Services sector. 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.
? Software license revenue in a given period may consist of a relatively small
number of contracts and contract values can vary considerably depending on the
software product and scope of the license sold. Consequently, even minor delays
in delivery under a software contract (which may be out of our control) could
have a significant and unpredictable impact on the consolidated revenue that we
recognize in a given quarterly or annual period.
? Customers may decide to postpone a planned implementation of our software for
any number of reasons, which may be unrelated to our software or contract
performance, but which may affect the amount, timing and characterization of
our deferred and/or recognized revenue.
We have frequently recognized consolidated operating losses on a quarterly and annual basis and are likely to do so in the future from time to time. Our ChemFree subsidiary typically generates a profit and positive cash flow from operations on a quarterly and annual basis. CoreCard may report operating profits on an irregular basis and its results vary in part depending on the size and number of software licenses recognized in a particular period and the level of expenses incurred to support existing customers and development and sales activities. A significant portion of CoreCard's expense is related to personnel, including approximately 200 employees located in
From time to time, we derive income from sales of holdings in affiliate and other minority-owned companies or we may 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 an affiliate company accounted for by the equity method. The timing and amount of the gain or loss recognized as a result of a sale or the amount of equity in the income or losses of the affiliate generally are not under our control and are not necessarily indicative of future results, either on a quarterly or annual basis.
In recent years, most of our cash has been generated by our ChemFree operations and, on an irregular basis, from sales of our investments or subsidiaries. We have used a significant amount of the cash received from these transactions and operations to support the domestic and international operations associated with our CoreCard subsidiary and the corporate office.
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 in the three month period ended
? 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 Products and Services segment, was
$2,879,000, a decline of 9 percent compared to the three month period ended June 30, 2013. Product revenue was $5,556,000in the six month period ended June 30, 2014, a decline of 15 percent compared to the six month period ended June 30, 2013. In both the three and six month periods ended June 30, 2014, the decline is primarily related to the ChemFree subsidiary and reflects the expiration of an equipment lease contract in mid-2013 when one of ChemFree's largest lease customers opted to purchase the leased equipment and not renew the lease. The total number of SmartWasher machines sold in the second quarter and year-to-date periods of 2014 showed improvement compared to the same periods in 2013. ? Service revenue associated with the Information Technology Products and Services segment was $816,000in the three month period ended June 30, 2014compared to $1,007,000in the same period last year. In the six months ended June 30, 2014, service revenue was $1,809,000, a 5 percent increase compared to the same period in 2013. Service revenue includes three components: revenue from annual maintenance and support contracts for our installed customer base, revenue from professional services (such as software customizations or modifications) and revenue from our processing services. In both the three and six month periods of 2014, revenue generated from CoreCard's transaction processing services increased significantly period-to-period due to an increase in the number of customers and accounts on file. However, this increase was offset by lower levels of revenue generated from professional services due to a decrease in the number and value of contracts completed in 2014 as well as lower maintenance revenue from customers that pay for maintenance and technical support. We expect that processing services will continue to grow as CoreCard's customer base increases and that maintenance revenue will increase slightly from the current level. However, it is not possible to predict with any accuracy the number and value of professional services contracts that CoreCard's customers will require in a given period. Customers typically require our professional services to modify or enhance their CoreCard software implementation based on their specific business strategy and operational requirements, which can vary considerably from customer to customer and period to period.
Cost of Revenue - Total cost of revenue was 56 percent and 54 percent of total revenue in the three and six month periods ended
? Cost of product revenue was 56 percent in both the three and six months ended
June 30, 2014respectively, compared to 46 percent and 47 percent of product revenue in the respective periods in 2013. The reduction in cost of revenue is related mainly to revenue mix during the periods. The relatively higher cost of product in 2014 reflects primarily the decline in ChemFree's more profitable lease revenue in both the second quarter and year-to-date periods of 2014, thus reducing the gross margin contribution in those periods. ? Cost of service revenue (which relates to our CoreCard business only) was lower as a percentage of service revenue in both the three and six month periods ended June 30, 2014, as compared to the respective periods last year. Cost of service revenue includes three components: costs to provide annual maintenance and support services to our installed base of licensed customers, costs to provide professional services and costs to provide our card processing services. Costs associated with delivering professional services vary considerably from period to period depending on the project complexity and mix of domestic vs. international employees delivering such services. 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. We have become more efficient and reduced the costs required to deliver maintenance and customer support to our installed base of license customers. In addition, although our actual costs to provide card processing services are higher in the second quarter and year-to-date periods of 2014 than in the comparable period in 2013 (because we continue to devote the resources necessary to support this new service initiative, including additional direct costs for regulatory compliance, infrastructure and customer support), the costs increased at a lower rate than did processing revenue resulting in an improvement in gross margin. However, we expect these costs to continue to outpace processing revenue for the foreseeable future. Page 11
Operating Expenses - Consolidated marketing expenses were lower by 17 percent (
Accrued Legal Settlement Expense - As a result of the settlement of the ChemFree legal matter described under Legal Proceedings below, in the year-to-date period ended
Investment Income - In the second quarter and year-to-date periods of 2014, we recorded investment income of
Equity in Income (Loss) of
Income Taxes - We recorded
Liquidity and Capital Resources
Our cash balance at
During the six months ended
We renewed our line of credit in
Long-term, we currently expect that liquidity will improve and consolidated operations will generate sufficient cash to fund their requirements with use of our credit facility to accommodate short-term needs. Other long-term sources of liquidity include potential sales of investments, subsidiaries or other assets. Furthermore, 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
Factors That May Affect Future Operations
Future operations in both the Information Technology Products and Services 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 even 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-control 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:
Information Technology Products and Services Industry
? As an alternative to licensing its software, CoreCard is now offering
processing services running on the CoreCard software system. There are numerous
risks associated with entering any new line of business and if CoreCard fails
to manage the risks associated with its processing operations, it could have a
negative impact on our business.
? Stricter regulations and reluctance by financial institutions to act as sponsor
banks for prospective customers (such as issuers and processors of credit and
prepaid cards) could negatively impact the processing services business and
increase CoreCard's losses and cash requirements.
? Delays in software development projects could cause our customers to delay
implementations or delay payments, which would increase our costs and reduce
? 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
? CoreCard's processing business is impacted, directly or indirectly, by more
regulations than its licensed software business. If the company fails to
provide services that comply with (or allow its customers to comply with)
applicable regulations or processing standards, it could be subject to
financial or other penalties that could negatively impact its business.
? Software errors or poor quality control may delay product releases, increase
our costs, result in non-acceptance of our software by customers or delay
? 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.
? Increasing and changing government regulations in
countries related to such issues as data privacy, financial and credit
transactions could require changes to our products and services which would
increase our costs and could affect our existing customer relationships or
prevent us from getting new customers.
Industrial Products Industry
? One of ChemFree's customers represented 22 percent and 21 percent of our
consolidated revenue in the three and six-month periods ended
respectively. Changes in the volume of orders or timeliness of payments from
such customer could potentially have a negative impact on revenue, inventory
levels and cash, at least in the near-term. For instance in the third quarter
of 2013, the customer decided to temporarily reduce new machine orders due to
some internal process changes which resulted in postponed shipments and
significantly reduced revenue and profits related to such customer in the
second half of 2013 and to a lesser extent in the first half of 2014.
? Delays in production or shortages of certain sole-sourced parts for our
ChemFree products could impact revenue and orders. For example, one of
ChemFree's suppliers of a sole-sourced component experienced an equipment
malfunction which created a backlog of certain of ChemFree's products in the
second quarter of 2013. Although the shortage and short-term impact of the
shortage was resolved, longer term the company is taking steps to reduce its
dependency on a single supplier where feasible.
? Increases in prices of raw materials and sub-assemblies could reduce ChemFree's
gross profit if it is not able to offset such increased costs with higher
selling prices for its products or other reductions in production costs.
? In certain situations, ChemFree's lease customers are permitted to terminate
the lease covering one or more SmartWasher® machines. Effective
one of ChemFree's lease customers opted to terminate its equipment lease and
purchase the machines instead. This termination significantly reduced equipment
lease revenue beginning in the third quarter of 2013 and lease revenue is
expected to be lower in future periods compared to prior periods, although the
customer continues to purchase fluid and filter supplies.
? Delays in anticipated customer payments for any reason would increase our cash
requirements and possibly our losses.
? 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).
? 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.
? Our future capital needs are uncertain and depend on a number of factors;
additional capital may not be available on acceptable terms, if at all.
? Other general economic and political conditions could cause customers to delay
or cancel purchases.