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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934.
For the fiscal year ended April 30, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the transition period from _______ to ______
Commission file number: 001-12531
ISONICS CORPORATION
(Name of small business issuer in its charter)
California 77-0338561
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
4010 Moorpark Avenue, Suite 119
San Jose, California 95117
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (408) 260-0155
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
--------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
--- ---
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. Yes X No
--- ---
Registrant's revenues for the fiscal year ended April 30, 1998 were
$6,783,000.
The aggregate market value of the voting stock held by non-affiliates
of the Registrant based on the average bid and asked prices of the Registrant's
Common Stock on July 27, 1998 was $3,734,381. Excludes approximately 3,974,013
shares of common stock held by Directors, Officers and holders of 5% or more of
the Registrant's outstanding Common Stock at July 27, 1998. Exclusion of shares
held by any person should not be construed to indicate that such person
possesses the power, direct or indirect, to direct or cause the direction of the
management or policies of the Registrant, or that such person is controlled by
or under common control with the Registrant. There is no non-voting common
equity of the Registrant.
The number of shares outstanding of each of the Registrant's classes of
common equity, as of the latest practicable date: class outstanding at July 27,
1998: Common Stock, no par value 6,071,980 shares
Class A Redeemable Common Stock Purchase Warrants, 810,000.
Transitional Small Business Disclosure Format (check one): Yes No X
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PART I
ITEM 1. BUSINESS
BECAUSE ISONICS CORPORATION ("ISONICS" OR THE "COMPANY") WANTS TO
PROVIDE INVESTORS WITH MORE MEANINGFUL AND USEFUL INFORMATION, THIS ANNUAL
REPORT ON FORM 10-KSB (THE "FORM 10-KSB") CONTAINS, AND INCORPORATES BY
REFERENCE, CERTAIN "FORWARD-LOOKING STATEMENTS" (AS SUCH TERM IS DEFINED IN
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED), THAT REFLECT
THE COMPANY'S CURRENT EXPECTATIONS REGARDING THE FUTURE RESULTS OF OPERATIONS,
PERFORMANCE AND ACHIEVEMENTS OF THE COMPANY. THESE FORWARD-LOOKING STATEMENTS
ARE MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995. THE COMPANY HAS TRIED, WHEREVER POSSIBLE, TO
IDENTIFY THESE FORWARD-LOOKING STATEMENTS BY USING WORDS SUCH AS "ANTICIPATES,"
"BELIEVES," "ESTIMATES," "EXPECTS," "PLANS," "INTENDS" AND SIMILAR EXPRESSIONS.
THESE STATEMENTS REFLECT THE COMPANY'S CURRENT BELIEFS AND ARE BASED ON
INFORMATION CURRENTLY AVAILABLE TO IT. ACCORDINGLY, THESE STATEMENTS ARE SUBJECT
TO CERTAIN RISKS, UNCERTAINTIES AND CONTINGENCIES, WHICH COULD CAUSE THE
COMPANY'S ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS TO DIFFER MATERIALLY FROM
THOSE EXPRESSED IN, OR IMPLIED BY, SUCH STATEMENTS. THESE RISKS, UNCERTAINTIES
AND CONTINGENCIES INCLUDE, WITHOUT LIMITATION, DEMAND FOR, AND ACCEPTANCE OF,
THE COMPANY'S MATERIALS; CHANGES IN DEVELOPMENT AND DISTRIBUTION RELATIONSHIPS;
THE IMPACT OF COMPETITIVE PRODUCTS AND TECHNOLOGIES; AND THE FACTORS SET FORTH
UNDER "ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION -
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS." THE COMPANY UNDERTAKES NO
OBLIGATION TO UPDATE OR REVISE ANY SUCH FORWARD-LOOKING STATEMENTS THAT MAY BE
MADE TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS FORM10-KSB OR TO
REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS.
Isonics is an advanced materials and technology company which develops
and commercializes products based on enriched stable isotopes. Stable isotopes
can be thought of as ultra-ultra pure materials. This high degree of
purification accomplished on the sub-atomic level provides enhanced performance
properties compared to normal purity materials. Stable isotopes have commercial
uses in several areas, including: energy, medical, research, diagnostics and
drug development; product tagging and stewardship; semiconductors; and optical
materials. Isonics has successfully developed and commercialized two stable
isotope products and intends to promote the emergence and growth of new stable
isotope applications.
The Company's principal product to date is isotopically depleted zinc
("DZ"). DZ, in different chemical forms, is used to prevent corrosion in nuclear
power plants. Corrosion is a cause of high radiation fields in such plants and
can result in radiation exposure to workers. DZ also reduces environmental
cracking in certain kinds of nuclear reactors which, if not controlled, can
require extremely costly repairs or can result in premature shutdown and
de-commissioning of the facility. The Company believes that it has provided
substantially all of the DZ used in nuclear power plants worldwide.
The application of DZ was developed by General Electric Company ("GE"),
where the founders of the Company were previously employed. Before fiscal 1997,
all sales of DZ by the Company were made to GE pursuant to sales orders, which
in turn resold the product to end users. In addition to sales to GE, in fiscal
1997 Isonics commenced direct sales to end users. For the years ended April 30,
1997 and 1998, approximately 38% and 51% of DZ revenues were from sales made
directly to end users, respectively.
New applications for stable isotopes are continually being developed by
the Company and by third parties. The Company believes that many new
applications have the potential to create new markets. One opportunity is to
supply stable isotope labeled compounds for the diagnostic breath test ("DBT")
market. DBTs provide early diagnosis of conditions that could otherwise lead to
expensive procedures such as endoscopies and biopsies. DBTs under development by
third parties which utilize stable isotopes in their application include tests
to diagnose peptic ulcers, gastric emptying, fat malabsorption and liver
function. Two DBTs relating to peptic ulcers have been approved by the U.S. Food
and Drug Administration (the "FDA"), and the Company believes that other
companies have applied to the FDA or comparable agencies in foreign countries
for approval of these and other tests, which
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must be obtained before any products can be sold. Certain DBTs are currently
marketed in the U.S., Europe, and Asia.
The key ingredient for DBTs is the rare stable isotope of carbon,
carbon-13. Isonics is the third largest supplier of carbon-13 in the world and
is the only non-Japanese supplier. To further strengthen this position, Isonics
announced in February 1998 the formation of a joint venture with the Institute
of Stable Isotopes in Tblisi, Georgia. The purpose of the joint venture is to
increase carbon-13 production at the Institute initially and to transfer that
production technology to manufacturing facilities to be established in Europe
and North America.
In fiscal 1998, the Company exercised an option to acquire an exclusive
license to two Yale University patents which cover semiconductor devices made of
isotopically pure silicon, germanium, gallium arsenide and most isotopically
pure compound semiconductors. The patents claim that isotopic purity provides
improved device speed and improved thermal conductivity, two properties which
are of great importance to the semiconductor industry. According to the
Semiconductor Industry Association, sales in 1997 of silicon wafers and other
semiconductor substrates were over $6 billion.
Improved thermal conductivity of a thin film of isotopically pure
silicon-28 was demonstrated by a researcher at Brown University in 1997. The 60%
room temperature improvement was in line with Isonics' expectations. Since 1994
Isonics has been working to produce isotopically pure silicon-28 epitaxial
wafers suitable for semiconductor device fabrication. The company believes that
it has achieved this goal.
The Company is collaborating with academia and industry to evaluate the
benefits of isotopically pure silicon-28. The Company believes that if
evaluations demonstrate the commercial feasibility of one or more products,
demand could emerge in certain segments of the semiconductor market. There can
be no assurance, however, that these evaluations will demonstrate the commercial
feasibility of any products, that the Company will be able to commercialize any
such products or that a market will emerge for any such products.
The Company was formed in March 1992 and incorporated in California in
March 1993 under the name A&R Materials, Inc. In September 1996, the Company
changed its name to Isonics Corporation. The Company's principal executive
offices are located at 4010 Moorpark Avenue, Suite 119, San Jose, California,
95117. Its telephone number is (408) 260-0155.
Recent Business Acquisitions
International Process Research Corporation
Effective April 30, 1998, Isonics purchased International Process
Research Corporation ("Interpro") by acquiring all of the outstanding capital
stock of Interpro from Metallurgy International, Inc. Interpro, which does
business as Colorado Minerals Research Institute, is a contract research and
development and materials processing company which has been performing key steps
in Isonics' depleted zinc manufacturing process and jointly developing new,
lower cost technologies to better meet customer needs. The consolidated balance
sheet of Isonics at April 30, 1998 includes the assets and liabilities of
Interpro. The consolidated statement of operations excludes Interpro as the
acquisition occurred on the last day of fiscal 1998. In connection with the
acquisition, Isonics issued shares of its Common Stock in exchange for all of
the outstanding shares of Interpro. The total number of shares of Isonics Common
Stock issued was 353,982, valued at $708,000. The acquisition was accounted for
as a purchase. No goodwill was recognized upon completing the transaction.
Chemotrade GmbH
On July 21, 1998, the Company acquired all of the outstanding shares of
Chemotrade GmbH, 75 percent of the outstanding shares of Chemotrade Liepzig GmbH
and 6 percent of the outstanding shares of IUT (collectively "Chemotrade"), all
of which were owned by two common shareholders and engaged in the distribution,
development and manufacture of stable and radioactive isotopes. The purchase
price consideration consists of $2.576 million to be paid upon closing and
contingent consideration of up to $1.1 million to be paid through June 2001. The
consideration paid upon closing consists of cash of $758,000, 357,730 restricted
shares of common stock with a fair value of $894,000, two notes, one for
$924,000 bearing interest at 2% per month due September 15, 1998, secured by
certain accounts receivable of Chemotrade, and a second note for $833,000
bearing interest at 10%, due June 1, 1999. The sellers have guaranteed
Chemotrade's defined pre tax earnings will be at least
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$550,000 during the sixteen months ended April 30, 1999 and the twelve months
ended April 30, 2000 and 2001. If the pre tax earnings of Chemotrade are less
than $550,000 for the sixteen month period ended April 30, 1999, the note
payable of $833,000 due June 1, 1999, will be reduced $0.75 for each $1.00
shortfall of earnings. If the pre tax earnings of Chemotrade are less than
$550,000 for the year ended April 30, 2000, the owners will repay $0.75 for each
$1.00 shortfall of earnings. If Chemotrade has pretax earnings of $550,000 for
the year ended April 30, 2001, the sellers will receive additional consideration
of $278,000. If the pre tax earnings are less than $550,000, the consideration
will be reduced $0.50 for each $1.00 shortfall in earnings.
Background
An isotope is one of two or more species of the same chemical element
which differ from one another only in the number of neutrons in the nucleus of
the atom. The different number of neutrons can create significantly different
nuclear physics characteristics. To take advantage of some of these different
characteristics, it is usually necessary to increase ("enrich") or decrease
("deplete") the concentration of a particular isotope. There are over 280
naturally occurring stable isotopes of 83 elements. Some elements have only one
naturally occurring stable isotope, while others have many. Stable isotopes are
not radioactive.
Stable isotopes of an element differ in mass and diameter as well as
several nuclear properties, such as cross-section, spin and magnetic moment.
Differences in these properties can result in substantially different effects,
and some of these differences have the potential for commercial application. For
example, in ultra chemically pure crystals grown for electronics or optical
applications, isotopic impurities are the greatest contributor to crystal
disorder due to mass and diameter variations. Eliminating this disorder by using
a single enriched isotope (i.e. isotopically pure) results in increased thermal
conductivity and optical transparency, and thus in improved product performance.
Similarly, enriching or depleting isotopes based upon their cross-sections
allows materials to be engineered for applications in the nuclear power
industry, for controlled doping of some semiconductors and for use as targets to
produce radioisotopes for medicine and industry.
Stable isotopes of an element do not differ significantly in their
chemical behavior. Tagging of materials can be performed by varying the natural
abundance of isotopes to give a compound its own mass or nuclear magnetic
signature without changing its chemical properties. Though chemically
equivalent, the "tagged" or labeled compound is discernible from its unlabeled
twin through the use of several types of instruments called spectrometers.
Company Strategy
The Company believes that its strength is the ability to bring the
necessary elements together to identify, evaluate, develop, engineer and
successfully commercialize applications for stable isotopes and value-added
products manufactured from stable isotopes. This is evidenced by management's
experience (at the Company and in prior employment) in developing DZ from a cost
prohibitive concept to a commercial product. DZ is now one of the largest
worldwide commercial applications of a stable isotope product.
The Company believes it has created a product development model that can
serve as a basis for current and future expansion of the Company. To capitalize
on the commercial opportunities that have been identified for stable isotopes,
the Company has adopted a business strategy designed to maximize the value of
its technologies, business development and management resources, while
attempting to minimize capital costs. This strategy involves:
o focusing on development of high value-added products which have a
perceived competitive advantage in large or growing markets;
o leveraging research and development expenditures through
collaborations, government programs and corporate partnerships;
o minimizing early capital needs by obtaining stable isotopes through
alliances and supply agreements with existing stable isotope sources,
followed by investment in Company owned isotope production facilities
when markets are more established and the optimum production technology
has been determined;
o obtaining value-added processing technology through sub-contract
manufacturing agreements, joint ventures and acquisitions of
strategically important technologies and companies; and
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o developing a time-balanced product pipeline to provide a continual
supply of new business opportunities.
Products
The Company's revenues are presently dominated by isotopically depleted
zinc (DZ). The remainder of revenues comes from several stable isotope labeled
compounds, including carbon-13. No product or licensing revenue has been derived
from isotopically pure silicon-28; however, Isonics believes that the initiation
of such revenue is likely in fiscal 1999.
Isotopically Depleted Zinc
Maintaining radiation exposure of nuclear power plant workers to levels
as low as reasonably achievable is mandated in the U.S. by the Nuclear
Regulatory Commission. Also of significant concern is cracking of nuclear power
plant structural materials due to the corrosive nature of the water used to cool
the nuclear reactor core. Nuclear power plants are designed with substantial
safety margins against such cracking, and frequent surveillance is performed to
assure that this safety margin is not compromised. If not controlled, cracking
can require extremely costly repairs or, if not reparable, can result in
premature shutdown and de-commissioning of a facility which may have cost
hundreds of millions of dollars or more to construct.
Testing sponsored by the Electric Power Research Institute has shown
that the addition of a soluble form of zinc to the nuclear reactor coolant
reduces plant radiation fields, and in some cases, substantially mitigates
environmentally induced cracking. Zinc acts as a corrosion inhibitor for the
stainless steel and other metal components of the nuclear reactor systems. In
boiling water reactors ("BWRs"), zinc prevents the development and concentration
of corrosion products, the cause of high radiation fields which can result in
radiation exposure to plant workers. In pressurized water reactors ("PWRs"),
zinc not only prevents radiation field build-up, but has been shown in a PWR
test to substantially reduce environmental cracking.
Zinc provides the important benefits outlined above, but one isotope of
natural zinc becomes radioactive in the nuclear reactor, thus offsetting a
substantial portion of the desired benefits. By depleting this zinc isotope, the
desired benefits are still obtained while the detrimental side effect is
essentially eliminated. This product is known as isotopically depleted zinc
("DZ").
DZ is currently used by 31 of the approximately 95 BWRs in the world
including 26 of the 37 U.S. BWRs. Typical current annual DZ requirements for a
BWR utilizing DZ are approximately $250,000 to $350,000, based on current
prices.
Programs to evaluate the effectiveness of utilizing DZ at PWRs are
underway in the United States and certain foreign countries. These programs have
demonstrated the technical effectiveness of DZ for PWRs. Several U.S. PWRs have
indicated their intention to use natural zinc, not DZ, due to an unfavorable
cost-benefits evaluation. The Company believes that a market may develop for DZ
use in European PWRs, due in part to the importance of environmental cracking
mitigation and a higher sensitivity to personnel radiation reduction and lower
cost pressures than in the U.S.
Initial test results suggest that PWRs will probably use a smaller
amount of DZ per plant as compared to BWRs, but there are approximately 200 PWRs
in the world. At present prices, the Company estimates the potential market for
sales to nuclear power plants to be between approximately $50-$70 million
annually. There can be no assurance that a market will develop for DZ sales to
PWRs, that the Company will be able to sell DZ to all such potential customers,
or that selling prices of DZ will not decrease.
Sales of DZ are presently the Company's largest source of revenues,
representing approximately 79% and 83% of net revenues for fiscal 1997 and 1998,
respectively. In March 1995, Isonics acquired the stable isotope business of
Isoserve. The Company believes that it and Isoserve have supplied substantially
all of the DZ used in nuclear power plants in the world to date. Until fiscal
1997, DZ was sold only to GE, which in turn resold it to the end-user nuclear
power utilities. The Company's sales of DZ to GE have been pursuant to sales
orders placed from time to time by GE, and the Company does not have any written
purchase or sales agreements with GE relating to sales of DZ or other products.
In addition to sales to GE, the Company currently is marketing DZ directly to
U.S. and foreign utilities and direct end-users, and for the years ended April
30, 1997 and 1998 approximately 38% and
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51% of net revenues from DZ , respectively, were from end-users. The Company
believes that direct sales to end users may increase in the future, while sales
to GE may decrease. There can be no assurance as to the size of orders, if any,
from direct end users in the future or as to the number of customers that can
purchase DZ from the Company. See "Item 6. Management's Discussion and Analysis
or Plan of Operation - Factors That May Affect Future Operating Results -
Customer Concentration."
The Company believes that the decision to purchase DZ is price
sensitive. The Company is actively working to further reduce costs by utilizing
in-house production of raw materials, developing and implementing low-cost zinc
oxide processing technologies, and providing DZ in innovative forms which lowers
the utilities' overall cost. The acquisition of International Process Resource
Corporation (Interpro), a supplier of such services to Isonics, is expected to
aid in reducing DZ costs and provide additional revenue and operating income in
fiscal 1999.
Cadmium
Sales of cadmium isotopes represented less than 10% in fiscal 1997 and
less than 1% of net revenues in fiscal 1998, respectively. The Company sold
enriched cadmium for use in helium cadmium lasers and for the manufacture of
radioisotopes. The Company does not anticipate future sales of cadmium isotopes
due to increased competition and the fact that a new solid state laser, capable
of higher power and generally improved performance, is already commercially
available.
Stable Isotope Labeled Compounds
Stable isotope labeled compounds ("SILCs") are created by
incorporating carbon, nitrogen, hydrogen and oxygen isotopes into several
thousand relevant chemical compounds. Sales of SILCs represented approximately
16% and 13% of net revenues in fiscal 1998 and 1997. SILCs allow researchers to
probe the metabolism of living systems, determine the structures of important
biological compounds, design new drugs and measure extremely low levels of
environmental toxins. The Company believes that greater availability of stable
isotopes and advances in instrumentation (improvements in sensitivity and
reduced cost) will promote increased demand for SILCs. Examples of existing and
emerging applications include:
Metabolic studies. Increasingly, drug studies are performed with
labeled drugs to facilitate research on metabolism, distribution, mode of action
and elimination. The FDA may eventually mandate the labeling of all new drugs
for investigational use during some or all phases of pre-clinical and clinical
evaluations of these drugs, but there can be no assurance that the FDA will make
this mandate in the near future, if at all.
Rational drug design. Nuclear magnetic resonance ("NMR") spectroscopy
is being developed as a tool to determine the structure of larger and larger
molecules in solution, many of which cannot be analyzed by the more traditional
x-ray crystallography techniques. The Company believes that this new NMR
sensitivity combined with the sophisticated isotopically labeled cell growth
media needed to produce the labeled human proteins will require an increasing
supply of the stable isotopes of carbon, nitrogen and deuterium.
Product tagging and stewardship applications. The source of materials
and explosives may be identified, without changing their chemistry, by tagging
with the stable isotopes of carbon, nitrogen, oxygen and hydrogen. Several other
approaches are currently being implemented, and other technologies have also
been proposed. These other approaches involve the addition of extraneous
materials such as dyes, exotic chemical compounds or radioactive compounds. The
Company believes that adding such extraneous materials can sometimes detract
from the performance of the product. Tagging with small amounts of isotopically
engineered versions of the material itself results in a unique identifier which
behaves chemically in exactly the same way as the host material.
The Company's efforts to date in the production and sales of SILCs have
focused on structurally simple "building block" compounds which are used by its
customers to synthesize more complex and higher value SILCs. The Company
presently markets carbon-13 and nitrogen-15 building block SILCs which it
obtains through its supply alliance with several stable isotope producers. In
the near term, the Company will continue this strategy of supplying "building
block" forms of stable isotopes while at the same time increasing its production
capacity both at its alliance producers and Company facilities.
In addition to providing additional revenue potential and possibly
higher margins, the Company believes that developing or acquiring complex SILC
synthesis capability would be synergistic with any Company efforts to
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develop the breath test diagnostics product area, and would also aid in early
identification of future stable isotope business opportunities.
Diagnostic Breath Tests
Healthcare consumes a large amount of resources in the U.S. and
worldwide. The Company believes that substantial changes are taking place to
control or reduce the high cost of healthcare. A significant trend is a general
shift from therapy to cost-effective prevention. Early diagnosis of conditions
which otherwise could require expensive therapies could help diminish the risks
and expense of such subsequent procedures. The Company has elected to pursue
what it believes is a promising segment of this market: Diagnostic Breath Tests
("DBTs").
Breath tests are all based on the same principle and use a common
instrument to measure the result:
o a small amount of a carbon-13 SILC (referred to as a substrate)
is swallowed by the patient;
o breath samples are collected at regular intervals;
o and breath samples are analyzed for their carbon-13 content.
Most DBTs are intended to replace unpleasant, costly and sometimes
risky procedures such as endoscopies and biopsies of the digestive system. The
Company believes that DBTs may become a widely used and accepted diagnostic
tool. Certain DBTs are currently being sold in the U.S. and in Europe. Their
ease of administration may allow medical internists and general practitioners to
use them, potentially resulting in lower cost, earlier diagnosis and broader
application.
The market for DBTs is defined by the incidence of diseases addressed
and existing alternative diagnostic procedures. The urea breath test is the most
established DBT. As they become more widely available, carbon-13 urea breath
tests ("UBTs") may address a potential population of approximately 8 million
peptic ulcer patients in the U.S., who presently utilize drugs and procedures
with an estimated cost of at least $2 billion each year. The Company believes
that the UBT, coupled with antibiotic treatment, can reduce the cost of peptic
ulcer management. Two companies in the U.S. have received FDA approval for a
carbon-13 UBT. The Company believes that several companies in Europe, including
Sanofi and Inbiomed, are also pursuing regulatory approval.
The Company intends first to enter this market as a carbon-13 and a
pharmaceutical-grade substrate supplier. In February 1998, the Company signed a
joint venture agreement with the Institute of Stable Isotopes located in Tblisi,
Georgia. This institute was the center of development of technology for light
isotope separation in the former Soviet Union. The agreement calls for joint
investment to increase capacity of carbon-13 in Tblisi and providing Isonics the
exclusive right to purchase the product. The agreement also provides for the
transfer of technology to enable the construction of carbon-13 production
facilities possibly in Europe or the U.S.
The Company is investigating the feasibility of building such plants
and is considering various strategic options, such as partnering or acquisition
of complementary technologies or businesses, to leverage its carbon-13
production capability.
<TABLE>
The following table identifies additional breath tests which are at
various stages of clinical research and pre-clinical and clinical trials by
various third parties.
<CAPTION>
BREATH TEST CONDITION DIAGNOSED
- ------------------------------- ---------------------------------------------------------------------
<S> <C>
13C-Urea Helicobacter pylori
13C-Triolein Fat malabsorption
13C-Spirulina Gastric emptying
13C-Galactose Liver function
13C-Xylose Small Bowel Bacterial Overgrowth (the major cause of chronic diarrhea)
13C-Aminopyrine Liver function
13C-Caffeine Liver function
13C-Erythromycin Cyclosporin dosage following transplantation
13C-Valine Genotype of MSUD (Maple Syrup Urine Disease)
13C-Sucrose Sucrose malabsorption (sucrase-isomaltase complex deficiency)
13C-Starch Pancreas amylase function
13C-Cholesteryl Octanoate Pancreas esterase function
</TABLE>
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The DBT business is subject to extensive government regulation. The
products and instruments used, which may be regulated as drugs and devices, are
subject to the scrutiny of FDA review and approval as well as ongoing FDA
inspection of most aspects of the production, marketing, distribution and use of
these tests. The Company believes that the production and marketing of DBTs is
also subject to similar regulatory controls in the foreign countries where the
Company would likely seek to market products. Consequently, such products cannot
be commercially introduced for several years, and there can be no assurance that
the products would ever be approved for use.
Medical Imaging and Therapy Materials
Stable isotopes of thallium, zinc, cadmium, xenon, oxygen, strontium
and many others are routinely used in a variety of medical imaging and therapy
applications. In their enriched form or converted to a specific radioactive
isotope in a cyclotron or nuclear reactor, these materials are incorporated in
chemical compounds which concentrate in specific parts of the human body upon
injection, inhalation or ingestion. Measuring the distribution of the materials
in the patient can assist physicians in diagnosing disease states and developing
appropriate treatment therapies, some of which incorporate radioactive materials
produced from stable isotopes.
Isonics has decided to pursue one particular target isotope, oxygen-18,
used to produce fluorine-18 which is incorporated into the pseudo-sugar, FDG,
and used in Nuclear Medicine to diagnose multiple metabolic abnormalities.
Recent approvals by the FDA, favorable reimbursement levels by Medicare/Medicaid
and third party insurers combined with similar dynamics in Europe and Asia are
expected to result in significant growth in FDG studies which should translate
into increased oxygen-18 demand. Buyers of oxygen-18 range from the single site
users who purchase in gram quantities to the radiopharmacy companies who will
buy in kilogram quantities. Isonics will initially focus its sales efforts on
the smaller buyer until assured supplies permit the Company to aggressively
pursue long term supply agreements with the large radiopharmacy companies, like
PetNet, Syncor, Nycomed-Amersham, etc. who will dominate this market through
their networks of regional radiopharmacies. To supply this anticipated demand,
Isonics is exploring a combination of options which include exclusive
distribution rights for existing production, investment in expansion of existing
production facilities and investment in Isonics' own production facilities.
Most phases of the development and ongoing production of these
materials are controlled by the FDA and similar foreign regulatory agencies.
This fact, combined with the complexities of production and distribution, has
resulted in a market with only a few manufacturers. Tight quality control
requirements and the importance to the health care industry of a ready supply of
these drugs leads these manufacturers to pay close attention to their stable
isotope suppliers. Quality, supply reliability, ultimate source, breadth of
offerings, price and track record are principal factors that a manufacturer
considers in evaluating a potential stable isotope supplier. Much of the
material used to manufacture such products originates in countries of the former
Soviet Union. While the U.S. Department of Energy ("DOE") has facilities that
can manufacture stable isotopes, its costs are usually substantially higher
because of the full cost recovery mandated by legislation governing the DOE's
operations.
The Company is capable of supplying many of the stable isotopes
currently sold in this market. Since the original impetus for new applications
of stable isotopes in health care frequently comes from the drug manufacturers,
the Company has recently begun marketing its products, services and capabilities
to the existing and emerging manufacturers.
Isotopically Pure Semiconductors
Isotopic purification of carbon used to manufacture synthetic diamonds
has resulted in substantially improved physical properties. Published tests
conducted by GE and others have shown that the removal of a small amount of
carbon-13 to produce isotopically pure carbon-12 synthetic diamonds can result
in a 50% improvement in room temperature thermal conductivity of the diamond. At
cryogenic (i.e., extremely cold) temperatures, the heat conductivity is so great
that it cannot be measured using conventional techniques. Additionally the new
diamond was found to be highly transparent, and the transmission of certain
frequencies of laser light was increased by approximately 10 times without the
diamond sustaining damage. GE has stated that isotopically pure carbon-12
diamonds may enable faster, more reliable computers due to their superior heat
removal capability and may result in more efficient cutting tools and more
accurate laser measurement devices, and that the new diamonds may enable
designers to use lasers in semiconductor fabrication techniques.
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Studies conducted at Lawrence Berkeley Laboratory and the Max Planck
Institute on isotopically pure germanium have shown thermal conductivity
improvements similar to those found in isotopically pure carbon-12 diamonds.
The Company believes that these and other improved properties might be
found in other isotopically pure materials and may result in commercial
opportunities, particularly in the area of semiconductors. According to the
Semiconductor Industry Association, the 1995 market for silicon wafers and other
semiconductor substrates was approximately $6 billion. This market is projected
to grow 50% by the year 1999 to over $9 billion. Improvement in the thermal
conductivity of these materials is important since as the feature size
continuously decreases, the power density increases. As power density increases,
more heat is generated per unit volume, causing device operating temperature to
rise. The semiconductor industry is moving toward lower operating voltages and
is using mechanical means to remove bulk heat, but the Company believes that
greater heat dissipation on the micro scale will become even more important to
the industry in the future. Better thermal conductivity directly affects heat
removal capability and indirectly improves device speed. As the industry moves
toward multi-layer devices and true 3-D chips, the ability to remove heat will
be a material consideration for the semiconductor industry.
Natural silicon contains three isotopes, silicon-28 (92%), silicon-29
(5%) and silicon-30 (3%). An otherwise perfect crystal of silicon will contain
imperfections in the form of isotopes of different mass, with the density of
these imperfections amounting to nearly 8%. This far exceeds the doping levels
and density of imperfections ordinarily found in device-quality crystals. The
Company believes that removal of the minor isotopes should result in
substantially improved thermal conductivity.
The Company believes that if commercial opportunities emerge,
isotopically pure silicon-28 deployed as wafers or substrates and as silane for
building epitaxial layers should find a niche in the manufacture of high
performance silicon semiconductors. Even at the premium price required for
isotopically pure silicon, the Company believes that it can compete in high
performance, less cost driven markets.
The Company has produced isotopically pure silicon-28 silane and has
produced silicon-28 epitaxial layers on natural silicon substrates. The Company
believes that these materials meet industry standards for semiconductor
fabrication. Isonics has provided specimens to academic institutions which have
agreed to measure certain physical and electrical properties of silicon-28
compared to natural silicon. The Company is also collaborating with
semiconductor industry companies to verify that its silicon-28 epitaxial wafers
meet customer specific requirements and to evaluate the nature and magnitude of
benefits obtainable due to isotopic purity.
Isonics has exercised its option to acquire an exclusive license
regarding two U.S. patents owned by Yale University, for the duration of such
patents, concerning isotopically pure semiconductor devices. These patents
expire in 2009 and 2012 and cover silicon, germanium, gallium arsenide and most
isotopically pure compound semiconductors. The Company believes that if
evaluations demonstrate the commercial feasibility of one or more products,
demand could emerge in certain segments of the semiconductor market. There can
be no assurance, however, that these evaluations will demonstrate the commercial
feasibility of any products, that the Company will be able to commercialize any
such products or that a market will emerge for any such products. To exercise
the option, the Company delivered to Yale specimens of isotopically pure
silicon-28 meeting certain specifications. The license requires payment by the
Company of a royalty based on a percentage of the Company's or its sublicensees'
net sales of products derived from technology covered by the Yale patents.
In addition to silicon, the Company plans to evaluate a number of
compound semiconductors, such as gallium arsenide, which may particularly
benefit from enhanced heat dissipation capability.
Research and Development
Consistent with the Company's product development strategy, a variety
of new stable isotope products and potential markets are continually being
identified and evaluated for economic and technical feasibility. The Company
funds research and development to improve technologies for isotope separation
and materials processing technologies. During fiscal 1998 and 1997, research and
development expenses were $811,000 and $655,000, none of which were reimbursed
by third parties.
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The Company has focused its efforts on developing lower cost carbon-13
separation methods and the production of high chemical purity silicon-28 silane
and epitaxial wafers made from that silane. To date this work has been performed
for the Company on a sub-contract basis. To the maximum extent possible, the
Company attempts to retain ownership of any intellectual property resulting from
such work.
The Company is seeking to enter into formal joint development
agreements with a number of semiconductor industry participants in the areas of
silicon wafer manufacture and various potential applications for isotopically
engineered silicon.
Patents and Proprietary Rights
The Company relies primarily on a combination of trade secrets,
confidentiality procedures and contractual provisions to protect its technology.
Despite the Company's efforts to protect its rights, unauthorized parties may
attempt to copy aspects of the Company's products or to obtain and use
information that the Company regards as proprietary. Policing unauthorized use
of the Company's technology and products is difficult. In addition, the laws of
many countries do not protect the Company's rights in information, materials and
intellectual property that it regards as proprietary to which it regards as
great an extent as do the laws of the United States. There can be no assurance
that the Company's means of protecting its rights in proprietary information,
materials and technology will be adequate or that the Company's competitors will
not independently develop similar information, technology or intellectual
property.
The Company currently has no patents and has not filed any patent
applications. The Company has rights to several isotopically engineered
innovations regarding electronic and optical materials which it believes may be
patentable. Ongoing work in the area of isotope separation by chemical means may
also lead to patentable inventions.
To date, the Company has not been notified of any claim that the
Company's products infringe the proprietary rights of third parties, but there
can be no assurance that third parties will not claim infringement by the
Company with respect to current or future products. Any such claims, with or
without merit, could be time-consuming, result in costly litigation, cause
product shipment delays or require the Company to enter into royalty or
licensing agreements. Such royalty or licensing agreements, if required, may not
be available on terms acceptable to the Company or at all, which could have a
material adverse effect upon the Company's business, financial condition or
results of operations.
Competition
The markets for the Company's products and proposed products are highly
competitive, and the Company expects that competition will continue and increase
as markets grow and new opportunities are realized. Some of the Company's
current competitors, and many of the Company's potential competitors, are larger
and have significantly greater financial, technical, marketing and other
resources. Some of the Company's competitors may form partnerships or alliances
with large pharmaceutical or electronics companies, with the resulting entity
possessing more market strength than the Company. The Company's competition
varies greatly depending on which product or industry is considered.
DZ. At present, the Company is the leading producer of DZ, but believes
that other entities or persons may begin producing DZ in substantial quantities.
Several such possible producers have adequate technical and financial resources
to become viable competitors of the Company in the near future. In particular,
Siemens has indicated that it has a relationship with Ultracentrifuge
Netherlands ("UCN") and GE has indicated that it may establish a second Russian
source to compete with the Company for GE purchases. UCN also competes with the
Company in the markets for medical target isotopes.
SILCs and DBT materials. The Company has several larger and numerous
smaller competitors in the markets for the SILC products that the Company
currently supplies, and will have additional competitors if it offers breath
test diagnostic products and additional SILCs in the future. Two of these
companies, Cambridge Isotope Laboratories Inc., and Isotec, Inc., have their own
isotope separation capability, while all of the competitors produce some
combination of SILCs and DBT substrates. Two companies in the U.S. have received
FDA approval for a carbon-13 UBT. Several companies in Europe are also pursuing
regulatory approval. The Company's principal current competitors and potential
competitors also include MassTrace, euriso-top, Aldrich Chemicals, Icon
Services,
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Omicron, C/D/N Isotopes and Martek Biosciences. The Company has in the past, and
may in the future, sell products to or purchase products from these companies.
Electronics and Optical Materials. Due to the early stage of the
electronic and optical materials opportunities, the Company has not identified
material competitors in these markets. However, given the potential size and
importance of these new potential markets, the Company anticipates that
substantial competition will emerge if these markets develop.
Many of the areas in which the Company is or intends to compete are
rapidly evolving. There can be no assurance that an existing or potential
competitor has already developed, or may develop, a patentable product or
process which will substantially prevent the Company from competing in its
intended markets.
The Company competes primarily on the basis of product performance,
proprietary position and price. Some of the Company's products may also compete
based on product efficacy, safety, patient convenience and reliability. In many
medical only cases the first company to introduce a product to the market will
obtain at least a temporary competitive advantage over subsequent market
entrants.
Manufacturing and Supply
Consistent with the Company's strategy to minimize capital
expenditures, the Company obtains stable isotopes through a multi-year supply
agreement and, to a lesser extent, from time to time from a variety of other
Russian stable isotope sources and may invest in Company-owned isotope
production facilities in the future upon determining the optimum production
technology. Currently, the Company obtains substantially all its isotopes from
Russia and the Republic of Georgia (which was part of the former Soviet Union).
The production of DZ is an international activity involving several
distinct steps which require up to nine months for the complete production
cycle. First the feed material, high purity diethylzinc, is procured from a
chemical plant in the United States and shipped by freighter to St. Petersburg,
Russia. There it is transported by truck or train to the gas centrifuge plant
where it is depleted of the zinc-64 isotope and converted to depleted zinc
oxide. The oxide form of DZ, which is acceptable for air freight, is then
shipped to Interpro in the United States, where additional chemical and
mechanical operations are performed to prepare the powder for use in nuclear
plants either as pellets or as a very fine grained powder. If the final product
form is pellets, further processing is performed in Ireland, but the Company is
pursuing development of the technology to perform this manufacturing step
in-house in the future.
The Company has entered into the Supply Agreement dated July 1996 with
Techsnabexport and an isotope enrichment plant located in Russia, which is owned
by the Ministry of Atomic Energy of the Russian Federation, which is part of the
cabinet of the government of the Russian Federation. The term of the Supply
Agreement is through 2001. Under the Supply Agreement, the plant will produce DZ
and other stable isotopes for the Company, will allocate its stable isotope
production capacity to the Company and will produce other isotopes to respond to
marketplace demand on the Company for other stable isotopes. Under the Supply
Agreement, the specific terms for each year's production, including pricing
terms, are negotiated between the parties by November 1 of the preceding year.
The agreement provides, among other things, that the plant will not sell DZ to
third parties located in North America or to other parties for resale in North
America, that as long as the plant is able to meet all of the Company's
requirements for DZ at prices competitive with other potential suppliers the
Company will not buy DZ from other third parties located in the Russian
Federation, and that disputes arising thereunder will be resolved by arbitration
conducted in Sweden under the arbitration rules of the Stockholm Chamber of
Commerce. The enforceability of the agreement might be subject to the greater
degree of uncertainty than if the agreement was with a U.S. company and disputes
were resolved in the U.S. The supply of stable isotopes could be directly
affected by political, economic and military conditions in Russia. Accordingly,
the operations of the Company could be materially adversely affected if
hostilities involving Russia should occur, if trade between Russia and the
United States were interrupted or curtailed, or if the Company should fail to
obtain and maintain all necessary governmental approvals. Operations in Russia
entail certain other risks, including, among others, supply disruptions as well
as introduction of tariffs and fluctuations in freight rates. See "Item 6.
Management's Discussion and Analysis or Plan of Operation - Factors That May
Affect Future Operating Results - Operations in Russia." There can be no
assurance that the Company's relationship with its processor in Russia will be
successfully maintained. Disruption or termination of the Company's supply
sources could delay shipments by the Company and could have a material adverse
effect on the
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Company's business, financial condition and results of operations. The Company
does not presently maintain political risk insurance but will evaluate the
desirability and availability of such insurance in the future.
The plant with which the Company has the agreement described above is
one of four similar plants which were designed to address the needs of the
former Soviet Union and certain other countries' needs for low enriched uranium
for commercial nuclear power plant fuel and for highly enriched uranium for
military purposes. Following the nuclear accident at Chernobyl, certain of the
Russian nuclear power plants have been shut down, reducing demand on these
enrichment plants. In addition, in recent years the demand on these plants to
produce products for military purposes has declined. In part in response to
these trends, the plant has converted a portion of its capacity to processing
stable isotopes, and the Company believes that additional capacity could be
converted if the plant decided to do so. The Company believes that the plant has
the potential capacity to meet all of the Company's foreseeable needs for
processing of stable isotopes. The Company believes that one or more of the
other similar enrichment plants may convert part of its capacity to the
production of stable isotopes should market demand grow substantially. Certain
other facilities elsewhere in the world, including the Oak Ridge National
Laboratory in Oak Ridge, Tennessee, and certain private and pseudo-governmental
organizations in Great Britain, Germany, The Netherlands and South Africa, have
the potential to produce stable isotopes and, in certain cases, actually produce
isotopes.
Recognizing the need to have more control over the production of
Isonics' isotopes, the Company announced plans for a joint venture with the
Institute of Stable Isotopes in the Republic of Georgia - the pre-eminent center
for the separation of light isotopes on the FSU. This agreement calls for
investment by both parties to increase carbon-13 production at the Institute and
provides for exclusive sales of all carbon-13 production to Isonics. The
agreement further grants rights to Isonics to employ the Institute's separation
technology at new production facilities anywhere in the world. The two parties
have also agreed to cooperate on the development projects which would include
new isotope production technologies as well as new applications of isotope
products.
To increase capacity and to geographically diversify the Company's
production of certain isotopes, the Company is considering constructing a
facility outside of Russia. The Company believes that owning this facility may
improve its profitability and will improve the security of its supply. The
Company intends to conduct a feasibility study to evaluate the nature and timing
of such a facility. The nature and timing of any such construction will depend
on several factors, including the results of the study. If such a facility is
constructed, it is likely that the facility would be located in Europe or North
America.
The Company depends upon a single processor, located in Russia, for one
process involved in the manufacturing of its products, and upon a single
supplier or a limited number of suppliers and processors for certain other
manufacturing processes. Although the Company does have written agreements with
certain of its suppliers and processors, the Company does not have any written
agreements with other suppliers and processors. The Company seeks to reduce its
dependence on its sole and limited suppliers, but disruption or termination of
any of the sources could occur, and such disruptions could have at least a
temporary material adverse affect on the Company's business, financial condition
and results of operations. Moreover, a prolonged inability to obtain alternative
sources for processing could materially adversely affect the Company's relations
with its customers.
Government Regulation
Regulation by government authorities in the United States and other
countries is a significant consideration in the development, production,
distribution and marketing of the Company's products and in its continuing
research, development, and other activities. In order to clinically test,
manufacture, distribute, market and sell products, especially those intended for
therapeutic or diagnostic use, mandatory procedures and safety and other
standards established by applicable regulatory authorities must be followed. In
many cases, specific approval to clinically test and commercially distribute
such products must be obtained from numerous governmental authorities.
Furthermore, the Company is subject to various laws, regulations and
requirements relating to such matters as the import and export of its products,
ensuring safe working conditions, laboratory and manufacturing practices, the
use and disposal of hazardous or potentially hazardous substances used in
connection with the Company's research, development and manufacturing
activities. Some of the regulations are summarized below.
FDA Regulation
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The Company's testing, manufacture, marketing, distribution, export and
sale of diagnostic products, such as any DBT it might in the future develop and
seek to sell, are subject to extensive and rigorous regulation by United States
and other countries in which the Company may choose to test, manufacture or
market its proposed diagnostic products. As of the date of this 10-KSB, the
Company has not determined those countries, other than the United States, where
it might seek regulatory approvals to market any such products it may develop.
The products the Company intends to develop are subject to rigorous preclinical
and clinical testing and other FDA approval requirements, and similar
requirements in most other countries.
The process for obtaining the required regulatory approvals from the
FDA and other regulatory authorities takes many years and can be expensive. The
Company has limited experience in conducting and managing the preclinical and
clinical testing necessary to obtain regulatory approvals and expects to rely on
experienced outside experts to assist as well as develop its own resources. The
various diagnostic products of which the Company is contemplating development
are subject to different regulations and other requirements. Various components
of the DBT and other products proposed for development are regulated as drugs or
medical devices under the Federal Food, Drug, and Cosmetic Act ("FDCA"). The
applicable FDA requirements for approval may be different for different types or
components of products.
There can be no assurance that any product developed by the Company, or
other entities to which the Company may sell bulk or other materials, will prove
to meet all of the applicable standards to receive marketing approval, or that
any such approvals will be granted on a timely basis, if at all, or that such
products if approved will be commercially successful. Delays and costs in
obtaining these regulatory approvals could adversely affect the Company's
ability to commercialize its products and its ability to receive market
revenues. Even if regulatory approvals for a product are obtained, such
approvals may involve restrictions and limitations on the labeling and clinical
use of the product. Following market approval, the product will continue to be
subject to compliance with applicable federal and state laws and regulations.
The Company or the FDA may suspend clinical trials or commercial
distribution at any time if either determines that the subjects or patients are
being exposed to an unacceptable health risk related to the manufacturing,
testing and use of the Company's investigational or approved products, or if the
FDA determines that the Company has violated applicable laws or regulations. If
clinical studies are suspended, the Company may be unable to continue
development of the investigational products affected. Violation of applicable
laws and regulations, particularly those dealing with medical products, can
result in the imposition of substantial penalties against the Company and its
employees and officers, such as product seizures, recalls, fines, injunctions
and withdrawal or suspensions of approvals to test, manufacture, export or
market products. Delays and costs in obtaining or reinstating these approvals
and the subsequent compliance with applicable federal and state statutes and
regulations, and any penalties imposed for their violation, could adversely
affect the Company's ability to commercialize products.
Diagnostic Medical Device Products
Certain diagnostic products that the Company may pursue, such as the
DBT products, are regulated as medical devices. Diagnostic products may be
subject to one of two marketing approval procedures. One procedure, known as a
"510(k) review," is available when the manufacturer can demonstrate that the
proposed product is "substantially equivalent" to another product that either
was in commercial distribution in the United States before May 28, 1976, or that
has been subsequently classified as a Class I or Class II medical device. When a
510(k) review is used, a sponsor is required to submit a Pre-Market Notification
to the FDA, at least 90 days before it plans to initiate commercial distribution
of the product.
The Company cannot proceed with sales of such products for human
clinical use until it receives notification from the FDA that FDA agrees with
the Company's assertion of substantial equivalence, a process that can take six
to eighteen months, or longer. In the event that the FDA requests additional
information for the Pre-Market Notification, there could be multiple cycles of
submissions, each involving an additional waiting period, until clearance is
obtained. The FDA also has statutory authority to require clinical or other
study data to support a Pre-Market Notification 510(k).
Where there is no existing legally marketed product "substantially
equivalent" to the Company's product, the Company will be required to seek
marketing approval of its product by the second procedure. This second
procedure, a Pre-Market Approval ("PMA") application, involves a lengthier and
more burdensome procedure,
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which would likely require clinical studies. Together with the FDA review of the
PMA, this application process may take 3-5 years before commercial marketing can
occur, if the PMA is approved. There can be no assurance that any future product
the Company develops which is the subject to FDA review will be found to have an
intended use and characteristics that would qualify the new test for commercial
distribution for clinical use under 510(k) Pre-Market Notification. Thus, PMAs
may be required for some or all of the Company's future proposed products.
The FDA invariably requires clinical data before approving either a PMA
or a 510(k). The FDA is empowered to grant a 510(k) clearance without supporting
clinical data. If clinical studies are necessary for either a PMA approval or
510(k) clearance, the FDA may require the Company to obtain an investigational
device exemption ("IDE"). An IDE normally restricts the transfer of an
investigational device to a limited number of institutions, and use to a limited
number of investigators. Before the approval and/or clearance is issued, such
institution or investigators may receive the Company's investigational devices
only for the purpose of performing the clinical studies that are to be submitted
to the FDA in support of a 510(k) or a PMA application.
The Company believes that DBT instruments, if any, that it may develop
in the future will be eligible for marketing under a 510(k) Premarket
Notification, if cleared by FDA, but that the substrate would require approval
of a New Drug Application as described in the following section. The Company
believes that clinical studies would be required to obtain FDA approval of the
510(k)/NDA the DBT instrument/substrate, and would be conducted under IDE
approved by FDA. There can be no assurances that FDA will allow the Company to
conduct such clinical studies or that such studies will provide the data
necessary to obtain the approval of the 510(k)/NDA for any DBT or other product
that the Company may develop, or that FDA will in fact provide the necessary
approval of the 510(k)/NDA in a timely manner, if at all.
In addition, use of the DBT and other diagnostic products developed by
the Company may be subject to regulation under the Comprehensive Laboratory
Improvement Act of 1986 ("CLIA"). Under CLIA, clinical laboratories must be
certified to perform diagnostic tests. Such certification specifies the highest
"complexity level" of tests that the laboratory can perform. The specific
complexity level of a given diagnostic product is determined by governmental
agencies, currently the U.S. Centers for Disease Control. The Company's ability
to successfully market diagnostic products within the U.S. may depend on its
obtaining a complexity level determination that allows the broadest use. There
can be no assurance that such complexity level determination can be obtained in
a timely manner, if at all, and that such failure will not have a material
adverse effect on the Company and its operations.
Drug Products
Certain products that may be developed by the Company may be
classified, depending on their characteristics, as drugs regulated under the
FDCA. Development of a drug product for use in humans is a multistep process.
First, laboratory and animal testing establishes reasonable safety of the
experimental product for testing in humans and suggests potential efficacy with
respect to a given disease. Once the general investigative plan and protocols
for specific human studies are developed, an investigational new drug
application ("IND") is submitted to the FDA. Under FDA regulations, the Agency
does not approve an IND. Rather, assuming compliance with applicable
requirements, the IND becomes effective, thus allowing a clinical investigation
to commence unless FDA notifies the sponsor to the contrary within 30 days of
receipt of the IND. That approval may come within 30 days of IND submission but
may involve substantial delays if the FDA requests additional information before
approving any clinical testing.
The initial phase of clinical testing (Phase 1) is conducted on a
relatively small number of subjects (e.g., 20-50) to evaluate the
pharmacological actions and side effects of the experimental product in humans
and, if possible, to gain early evidence of effectiveness. Phase 1 studies
evaluate various routes, dosages and schedules of product administration. The
demonstration of diagnostic performance is not required in order to complete
such studies successfully. If acceptable product safety is demonstrated, then
Phase 2 studies may be initiated. The Phase 2 studies are designed to evaluate
the effectiveness of the product in the diagnosis of a given disease and,
typically, are well-controlled, closely monitored studies on a relatively
moderate number of patients (e.g., 50-200). The optimal routes, dosages and
schedules of administration, and other matters, are determined in these studies.
If Phase 2 trials are successfully completed, Phase 3 trials will be commenced.
Phase 3 trials are the larger controlled trials and uncontrolled
studies, often involving hundreds of patients (400-500 or more) that are
intended to gather additional information about safety and effectiveness in
order to
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demonstrate the overall risk/benefit relationship of the experimental product
and to provide an adequate basis for labeling and marketing approval. It is not
possible to estimate the time in which Phase 1, 2 and 3 studies will be
completed with respect to a given product, although the time period required is
often four to ten years in duration, depending on the clinical protocol design,
endpoints and FDA requirements.
Following the successful completion of these clinical trials, the
clinical evidence that has been accumulated is submitted to the FDA as part of a
new drug application ("NDA"). Approval of the NDA is necessary before a company
may market the product. The approval process can be very lengthy, frequently
taking one to two years, or more, after submission and depends in part upon the
speed of FDA's review of the application and the time required for the company
to provide satisfactory answers or additional clinical or other data when
requested. With any given product, there is no assurance that an NDA will ever
be approved in a timely manner or at all. Failure to obtain such approvals would
prevent the Company from commercializing its products and would have a material
adverse effect on the Company's business. Furthermore, the process of seeking
and obtaining FDA approval for a new product generally requires substantial
funding, and there can be no assurance such funding will be available.
cGMPs and Other Controls
The FDA also has extensive regulations concerning manufacturing of
regulated products in accordance with current good manufacturing practices
("cGMPs"). The Company's compliance with cGMPs, including compliance of its
third-party manufacturers, and its ability to ensure the potency, purity and
quality of the drugs and medical devices manufactured, must be documented in the
NDAs, 510(k)s and PMAs submitted for the products. Continued compliance with
cGMPs is required to continue to market both drugs and medial devices once they
are approved. Failure to comply with the cGMP regulations or other applicable
legal requirements can lead to federal seizure of violating products, injunctive
relief actions brought by the federal government and potential criminal
investigation and prosecution of the Company and its officers and employees who
are responsible for the activities that lead to the violations.
The Company and the facilities used by it also are required to comply
with environmental and other regulations concerning the operations of and the
materials used by the Company, as well as handling and distribution of products
and waste materials. Failure to ensure compliance with such federal, state or
local laws and regulations could have a material adverse effect on the Company.
In addition, the manufacture, distribution and export of some of the
Company's current or potential products and technology may be subject to
governmental controls pertaining to materials and technology that might have
been used for military, nuclear power, or nuclear weapons purposes. These
controls include, in certain cases, export license requirements or other
restrictions. There can be no assurances that the Company will be able to obtain
or maintain such licenses, or that the failure to obtain or maintain such
licenses, or comply with other restrictions that might be placed on such
manufacturing and exports, will not have a material adverse effect on the
Company and its operations.
Export and Environmental Controls
Certain of the Company's products and technology, particularly those
having potential nuclear energy or military applications, such as DZ and related
technology, are subject to stringent controls over their manufacture, use,
distribution, dissemination and export. In many cases, such activities may
require approvals or licenses from various U.S. and foreign governmental
agencies, and compliance with substantial regulatory controls. Such approvals
can be difficult to obtain and maintain and may not be obtainable from certain
countries. Furthermore, such approvals or licenses may be restricted or
terminated because of changes in laws, regulations, policies governing those
approvals and licenses, or changes in the political or other matters in the
countries granting such approvals or licenses to which the Company's products
and technology would be exported. Likewise, certain current and potential
operations of the Company may necessitate submitting registrations or
notifications to federal and state regulatory authorities responsible for
environmental and related matters, including the U.S. Environmental Protection
Agency ("EPA") and complying with stringent controls pertaining to the handling
and distribution of the Company's products and operations, including under
certain conditions obtaining governmental approvals and licenses, either of
which may be subject to significant restrictions. Violation of any of these
regulatory controls may subject the Company to significant administrative civil
and criminal penalties, including loss of its approvals and licenses, or the
imposition of additional restrictions on the Company's operations. There can be
no assurances that the Company will be able to obtain and maintain the approvals
or licenses necessary to successfully market its
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products and technology, or that it will be able to comply with applicable laws
and regulations. Any such failure to obtain such licenses or approvals, where
required, and comply with such laws and regulations may materially and adversely
affect the business, financial condition and results of operations of the
Company.
Regulation of Non-Medical Chemical Products
The import, export, handling, transportation, sale, storage and other
activities undertaken in connection with the Company's non-medical products are
subject, or potentially subject, to substantial federal, state, local and
foreign government controls pertaining to hazardous chemical and chemical
wastes, import export controls and other matters. These regulations are complex,
pervasive and evolving. The Company's ability to effect and maintain compliance
with these controls is important to its commercial success.
With respect to transportation of its products, the Company relies
predominantly on Russian and U.S. freight carriers to handle and deliver all its
shipments, and utilizes domestic overnight courier services for shipments to its
customers. These carriers must comply with Department of Transportation ("DOT")
regulations in the shipping and packaging of the stable isotope chemicals. The
Company must also comply with DOT regulations when packaging material kept in
inventory for domestic shipment. As required under federal and state law, the
Company has prepared Material Safety Data Sheets ("MSDS"), which are enclosed
with each product shipment. The Company must periodically update its MSDS sheets
based on new literature reports. The Company cannot assure that its MSDS sheets
will continue to be in compliance with applicable requirements.
The shipments received at the Company's Columbia, Maryland facility are
subject to federal and Maryland regulations pertaining to hazardous chemicals
and hazardous waste disposal. These shipments are stored in an area of the
facility designated for such materials. Currently, the Company is considered a
small quantity generator of hazardous waste and will rely on certified haulers
to dispose of its minimal amounts of hazardous waste. The Company believes it is
in compliance in all material respects with applicable federal and state
environmental regulatory requirements. Should the levels of hazardous waste
increase as its inventory and handling operations increase in volume, then it
would have to comply with Environmental Protection Agency ("EPA") requirements
and obtain an EPA ID number, which are costly and require an increased
investment of personnel and money. The Company has no experience in this area of
compliance and would have to rely on outside consultants or hire additional
employees with pertinent experience and training. Potentially, if substantially
larger inventories of hazardous chemicals must be maintained at the Maryland
facility, the Company might have to move to new facilities in order to meet EPA
requirements for the storage of hazardous chemicals.
The shipments from Russian manufacturing sources now enter the U.S.
duty (without tariff) free; however, there can be no assurance that such
duty-free importation will continue. If the shipments are subject to tariff, the
Company cannot assure that it will be able to sell the imported products or that
the products will be commercially viable because of these increased tariff
costs.
The Nuclear Regulatory Commission ("NRC") has authority to regulate
importation and exports of deuterium containing chemicals whose ratio of
deuterium atoms to hydrogen atoms exceed 1:5000. At present, the deuterium
containing compounds which the Company imports do not require any special
licenses or importation authorization. There can be no assurances that the NRC
will continue these policies. The NRC regulates exports of deuterium containing
chemicals under general license. The Company will not be able to ship these
chemicals to certain countries which require a special license for such
shipments; none of these countries represent significant current or expected
future markets for the Company. In addition, certain technology or products that
the Company is or may in the future develop, may be subject to other government
controls pertaining to armaments, including the need to obtain special licenses
for exports. The imposition of such controls may impair the ability to broadly
market such products.
Product Liability and Insurance
The Company's business exposes it to potentially substantial product,
environmental, occupational and other liability risks which are inherent in
product research and development, manufacturing, marketing distribution and use
of its products and operations, including, but not limited to, products used in
nuclear power plants and medical device products. The Company currently does not
have product liability insurance, but may seek such insurance before it begins
commercial distribution of medical or other products that it may develop. There
can be no assurance that adequate or necessary insurance coverage will be
available at an acceptable cost, if at all, or that even
16
<PAGE>
if such insurance were obtained, a product liability or other claim would not
materially and adversely affect the business or financial condition of the
Company.
The terms of the Company's agreements with its customers provide that
liability to nuclear power plant utilities is limited to the Company's standard
warranty to replace non-conforming product, and liability for consequential
damages caused by the improper use of the Company's products is limited by
contractual terms. Nevertheless, one or more third parties could bring an action
against the Company based on product liability, breach of warranty or other
claims, and, there can be no assurance that the foregoing contract clauses would
effectively limit the Company's liability in any such actions.
Employees
As of April 30, 1998, the Company had 38 full-time employees, of whom 9
have Ph.D.s and 7 others have advanced degrees in chemistry, engineering and
related fields. Approximately 7 employees are involved in research and product
development, 23 in manufacturing and sourcing, and 8 in business development and
administration, but such employees' responsibilities may also encompass areas
other than their primary area of responsibility. The Company considers its
relations with its employees to be good. None of the Company's employees are
covered by a collective bargaining agreement.
MANAGEMENT
Directors and Executive Officers
<TABLE>
The members of the Board of Directors ("Board") and the executive
officers of the Company are as follows:
<CAPTION>
Name Age Position
------------------------------ ----- ------------------------------------------------------------
<S> <C> <C> <C>
James E. Alexander 49 President, Chief Executive Officer and Chairman of the Board
Boris Rubizhevsky 47 Senior Vice President, Vice Chairman and Director
Daniel J. Grady 44 Vice President, Medical, Research & Diagnostics
Paul J. Catuna 34 Vice President, Finance, Chief Financial Officer, Secretary
Lindsay A. Gardner (1)(2) 45 Director
Larry J. Wells (1)(2) 52 Director
<FN>
----------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
</FN>
</TABLE>
Each of the director holds office until the next annual meeting of
shareholders and until his or her successor is elected and qualified or until
his or her earlier death, resignation, or removal. Each officer serves at the
discretion of the Board.
Mr. Alexander is a founder of the Company and has served as its
President, Chief Executive Officer and a director since its inception. He has
worked full-time for the Company since January 1994. From June 1972 to December
1993, he worked in a variety of technology positions at GE in the aircraft
engine and nuclear power businesses, where his last position was Manager of
Technology Programs. Mr. Alexander received his bachelors degree in
Metallurgical Engineering from the University of Cincinnati and performed
graduate work in materials science there. He earned a masters degree in Business
Administration from Santa Clara University.
Mr. Rubizhevsky is a founder of the Company and has been a Senior Vice
President and a director of the Company since inception and became Vice Chairman
in March 1997. From November 1986 through December 1994, he owned and operated
SAR Marketing, a consulting firm providing business advice and services to large
multinational corporations. From June 1977 to May 1986, Mr. Rubizhevsky worked
at GE as Business Development Manager in various international locations. He
received his bachelors degree in Engineering from Stevens Institute of
Technology.
Dr. Grady joined the Company as Vice President, Medical, Research &
Diagnostics in 1995. From March 1994 through September 1995, Dr. Grady was Vice
President of Research and Development at Sopha Medical Systems. From April 1991
until March 1994, he served as Marketing Manager, Nuclear Energy for GE. From
May 1998 through March 1991, Dr. Grady served as Software Engineer Manager,
Nuclear Medicine for GE in England. From October 1984 through May 1988, he
served as Clinical Applications Manager for GE Nuclear Medicine. Between June
1981 and October 1984, he served as Engineering Analysis Section Head for TRW.
Dr. Grady received his bachelors and masters degree, and Ph.D. in Nuclear
Engineering from the University of Michigan.
Mr. Catuna joined the Company July 1996 as Chief Financial Officer.
From January 1994 to July 1996, Mr. Catuna was employed at Deloitte & Touche
LLP, an international accounting and consulting firm, where he most recently
served as an audit senior manager. From January 1988 to January 1994, Mr. Catuna
worked for Grant Thornton LLP, an international accounting and consulting firm,
where he most recently served as an audit manager. Mr. Catuna received his
bachelors degree in Business Administration-Accounting from California State
University Fresno, and is a certified public accountant.
Ms. Gardner was elected a director of Isonics in September 1993. She
has served from 1991 through the present as President of LG Associates, a
US-based management consulting firm providing materials management expertise to
foreign company affiliates of US companies in developing countries. During her
tenure at LG Associates, she resided in Moscow, Russia from September 1991 to
January 1994 when she moved to Beijing, China, where she currently resides. From
1977 to 1991, Ms. Gardner worked for GE in a variety of management and
functional positions including international marketing, quality assurance and
materials. Ms. Gardner received a bachelors degree in International Economics
from The George Washington University Elliott School of International Affairs,
and earned a masters in Business Administration from the University of
Louisville.
Mr. Wells was elected a director of the Company in September 1996. He
is the founder of Sundance Venture Partners, L.P. ("Sundance"), a venture
capital fund, and is the chairman of the entity that acts as the manager of
Sundance. From 1983 to 1987, Mr. Wells served as Vice President of Citicorp
Venture Capital and then became Senior Vice President of Inco Venture capital.
From May 1969 to June 1983, Mr. Wells was the founder and President of Creative
Strategies International, a market research consulting firm specializing in
emerging markets. Mr. Wells is a director of Identix, Inc., Atlanta Technology
Group, Cellegy Pharmaceuticals, Gateway Data Sciences and Telegen Corporation as
well as several privately held companies. Mr. Wells received his bachelors
degree in Economics and earned a master's degree in Business Administration from
Stanford University.
ITEM 2. PROPERTIES
The Company's headquarters occupies 3,000 square feet for
administrative and technical purposes in San Jose, California on a
month-to-month basis and in August 1998 will move its headquarters to a 4,000
square foot site located in San Jose, California. The new lease expires in July
2003. The Company leases 650 square feet for an administrative office in
Columbia, Maryland that expires in December 1999.
The Company's subsidiary, Interpro, leases approximately 41,000 square
feet in Golden, Colorado that expires in July 2000. The facility is used for
contract research and development and materials processing as well as
administration.
ITEM 3. LEGAL PROCEEDINGS
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the fiscal year ended April 30, 1998,
there were no matters submitted to a vote of security holders.
17
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On September 22, 1997, the Company's Units (consisting one share of
Common Stock and one Class A Redeemable Warrant) started trading on the Over The
Counter (OTC) Electronic Bulletin Board under the symbol ISONU. In October 1997,
the Company unbundled the Units and the Common Stock and Class A Redeemable
18
<PAGE>
Warrants commenced trading on the OTC Electronic Bulletin Board under the
symbols ISON and ISONW, respectively.
<TABLE>
The following table sets forth the high and low bid prices for each of
the Unit, the Common Stock and the Class A Redeemable Warrant (quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission and
may not represent actual transactions) from September 22, 1997 through April 30,
1998 as reported by OTC Electronic Bulletin Board.
<CAPTION>
Quarter Ended
------------------------------------------------
Oct. 31, 1997 Jan. 31, 1998 Apr. 30, 1998
------------- ------------- -------------
<S> <C> <C> <C>
Units (ISONU)
High 10 - -
Low 6 3/8 - -
Common Stock (ISON)
High 8 3/8 5 5/8 3
Low 5 1/2 1/4 1 13/16
Class A Redeemable Warrants (ISONW)
High 2 3/4 2 1/4 11/16
Low 1 3/8 .01 1/8
</TABLE>
As of July 27, 1998 there were 148 holders of record of the Company's
Common Stock.
The Company has never declared or paid a cash dividend on its common
stock. The Company presently intends to retain its earnings to fund development
and growth of its business and, therefore, does not anticipate paying any cash
dividends in the foreseeable future. Additionally, a financing agreement between
the Company and a lender contains a covenant prohibiting the payment of cash
dividends without prior lender approval.
In July 1997 the Company issued warrants to purchase an aggregate of
450,000 shares of its Common Stock to investors in connection with the amendment
to loans by such investors. Such issuance of warrants was made in reliance on
Section 4(2) of the Securities Act. The purchasers were sophisticated investors
who represented to the Registrant that the warrants were being acquired for
investment.
Between April 30, 1997 and September 22, 1997, the Company granted
options under the Company's stock option plans and warrants to purchase a total
of 141,000 shares of Common Stock at an exercise price of $3.50 per share, to a
limited number of employees and advisory board members. In addition, the Company
granted stock options outside of the Company's stock option plans to purchase a
total of 120,000 shares of Common Stock, at an exercise price of $6.38 per
share, to an employee. No consideration was paid to the Company by any recipient
of any of the foregoing options or warrants for the grant of any such option or
warrant. During such period, no shares of Common Stock were issued pursuant to
the exercise of options or warrants. Such grants were made in reliance on
Section 4(2) of and Rule 701 under the Securities Act.
Between September 23, 1997 and April 30, 1998, the Company granted
options under the Company's stock option plans to purchase a total 177,500
shares of Common Stock at exercise prices ranging from $2.00 to $2.88 per share,
to employees. No consideration was paid to the Company by any recipient of any
of the foregoing options for the grant of any such option. During such period,
no shares of Common Stock were issued pursuant to the exercise of options. Such
grants were made in reliance on Section 4(2) of the Securities Act and/or an
exemption was not necessary in that the options were granted in transactions not
involving a "sale" of securities as such term is used in Section 2(3) of the
Securities Act.
On May 15, 1998, the Company issued 353,982 shares of its Common Stock
to Metallurgy International, Inc., a Nevada corporation, in exchange for all of
the outstanding capital stock of International Process Research Corporation, a
Colorado corporation. For accounting purposes the transaction was recorded on
April 30, 1998, the effective date of the acquisition. One-half of such shares
are being held in the name of an escrow agent pursuant to the terms of the stock
purchase agreement. The shares were issued in reliance upon Section 4(2) of the
Securities Act.
19
<PAGE>
Use of Proceeds
On September 22, 1997, the Company's Registration Statement on Form
SB-2 (File no. 333-13289) was declared effective by the Securities and Exchange
Commission. The managing underwriter for the offering was Monroe Parker
Securities, Inc. The Registration Statement, as amended, covered 800,000 Units
plus an additional 120,000 Units that the underwriter had the option to purchase
solely to cover over-allotments, if any. Each Unit consisted of one share of
Common Stock, no par value per share, and one Redeemable Class A Common Stock
Purchase Warrant. The offering commenced on September 23, 1997 and the sale to
the public of 800,000 Units at $5.90 per Unit was completed on September 25,
1997 for an aggregate price of $4.72 million. On September 25, 1997, the
underwriter partially exercised their over-allotment option and purchased 10,000
additional Units. As a result, a total of 810,000 Units were sold in the
offering at an aggregate price of approximately $4.779 million. All of the Units
sold in the offering were sold by the Company. The offering terminated without
any further Units being sold.
Expenses incurred by the Company in connection with the issuance and
distribution of the Units in the offering included (i) underwriting discounts,
commissions and allowances and (ii) other expenses, of approximately $632,000
and $695,000, respectively. Total offering expenses of approximately $1.327
million resulted in net offering proceeds to the Company of approximately $3.452
million. No expenses were paid directly or indirectly to directors, officers or
affiliates of the Company or 10% owners of any class of equity securities of the
Company. Of the net offering proceeds to the Company of approximately $3.452
million, through April 30, 1998, approximately $1.482 million had been used to
repay debt, approximately $74,000 had been used to fund capital expenditures,
approximately $121,000 had been used to further develop technology associated
with the diagnostic breath test market, $133,000 had been used to develop and
test isotopically pure silicon, $42,000 had been used for enhancement of
internal research and development capabilities and approximately $561,000 had
been used for general corporate purposes. No payments were made directly or
indirectly to directors, officers or affiliates of the Company or 10% owners of
any class of equity securities of the Company. Approximately $1.039 million of
the net offering proceeds remain as working capital.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OR PLAN OF
OPERATION
Overview
Founded in 1992, Isonics Corporation is an advanced materials and
technology company which develops and commercializes products based on enriched
stable isotopes. Stable isotopes are ultra-ultra pure materials. This high
degree of purification accomplished on the sub-atomic level provides enhanced
performance properties compared to normal purity materials. Stable isotopes have
commercial uses in several areas, including energy; medical, research,
diagnostics and drug development; product tagging and stewardship;
semiconductors; and optical materials. Isonics has successfully developed and
commercialized two stable isotope products and intends to promote the emergence
and growth of new stable isotope applications.
Isonics core business is production and supply of depleted zinc (DZ), a
non-radioactive stable isotope, to the energy industry. In fiscal 1996, Isonics
expanded its business scope to include development of isotopically engineered
materials for the medical research, medical diagnostic, and semiconductor
industries. In June 1997 Isonics produced the world's first isotopically pure
silicon epitaxial wafer suitable for semiconductor fabrication. In July 1997
Isonics exercised an option for an exclusive license for two U.S. patents owned
by Yale University concerning isotopically pure silicon and a wide range of
other semiconductor materials. The Company is currently evaluating potential
applications for isotopically pure silicon in collaboration with certain
industrial and university partners and is developing strategies for
commercialization. Isonics is supplying stable isotope labeled compounds
("SILCs"), mainly enriched carbon for pharmaceutical research and medical
diagnostic test development. The Company is developing advanced, lower cost,
production technology for enriched carbon which the Company believes will allow
it to become the cost leader in the potentially large enriched carbon market
supporting a new class of minimally invasive diagnostic tests which are being
developed by others. The Company believes that a substantial portion of its
revenues in the future will depend on its success in developing and selling
products in the semiconductor and SILC markets.
In September 1997, Isonics completed its initial public offering. The
proceeds of this offering will allow the Company to continue its silicon and
carbon development efforts, to selective add key technical personnel and to
20
<PAGE>
perform engineering studies prior to adopting a plan to increase and
geographically diversify manufacturing capacity necessary to support planned
sales growth.
Effective April 30, 1998, the Company acquired International Process
Research Corporation ("Interpro") located in Golden, Colorado. Interpro is a
contract research and development and materials processing company which has
been performing key steps in Isonics' DZ manufacturing process and jointly
developing new, lower-cost technologies to better meet customer needs.
Historically, substantially all of the Company's net revenues in any
particular period have been attributable to a limited number of customers and
sales of DZ. Before the acquisition of Interpro, the Company operated with
little backlog and a significant portion of the Company's total revenues to date
have been derived from a limited number of DZ orders in any particular quarter.
Consistent with the Company's historical experience, the Company's quarterly
results are expected to be materially affected by the size and timing and
quantity of DZ orders, and products shipments received from significant DZ users
during such quarter; however with the acquisition of Interpro such fluctuations
should be reduced. However; a lost or delayed DZ sale could have a significant
impact on the Company's operating results for a particular period, and such
fluctuations could materially and adversely affect the Company's business,
financial condition and results of operations. The Company expects that with the
acquisition of Interpro and the continued increase of depleted zinc sales to end
users and commercialization of electronic material products, concentration of
net revenues from a limited number of customers will be reduced.
Results of Operations
The following table sets forth, for the periods indicated, certain
statement of operations data expressed as a percentage of net revenues. The
table and the discussion below should be read in conjunction with the audited
financial statements and the notes thereto appearing elsewhere in this report.
Year Ended
April 30,
-----------------
1997 1998
------ ------
Net revenues 100.0% 100.0%
Cost of revenues 79.7 68.7
------ ------
Gross margin 20.3 31.3
Operating expenses:
Selling, general and administrative 26.1 19.8
Research and development 14.4 12.0
------ ------
Total operating expenses 40.5 31.8
------ ------
Operating income (loss) (20.2) (0.5)
Other expense, net (8.7) (2.1)
------ ------
Income (loss) before extraordinary item and income taxes (28.9) (2.6)
Income tax (expense) benefit (1.1) 4.6
------ ------
Income (loss) before extraordinary item (30.0) 2.0
Extraordinary item - loss on extinguishment of debt - (3.7)
------ ------
Net income (loss) (30.0)% (1.7)%
====== ======
Net Revenues
Net Revenues. Net revenues increased from $4.54 million in fiscal 1997
to $6.78 million in fiscal 1998, an increase of $2.24 million or 49.4%. The
increase is due primarily due to increased demand for DZ and SILC products. Net
revenues from DZ increased by approximately $2.0 million on increased unit sales
of approximately 37%. Average unit sales prices for DZ also increased in
comparison to the previous year. The increase in net revenues and averages unit
sales prices is due to an increased demand for depleted zinc in the nuclear
industry as well as the Company's continued sales growth to end users. Net
revenues for SILCs were approximately $1.1 million an increase of approximately
$500,000 or 81% during fiscal 1997. The revenue growth reflects the increasing
demand for SILCs, specifically enriched carbon products; however, the Company's
revenue from SILCs is limited by the available supply of enriched carbon
products. The Company has and intends to continue to develop relationships with
potential producers of SILCs, such as the Institute of Stable Isotopes in
Tblisi, Georgia, to meet the growing demand for its SILC products.
International sales represented less than 10% of net revenues for the
years ended April 30, 1997 and 1998.
21
<PAGE>
Gross Margin
Gross margin is affected by the volume of product sales, product mix
and average selling price. The Company's gross margin percentage increased to
31.3% of net revenues in fiscal 1998 from 20.3% in fiscal 1997. The improvement
is due to increased average unit sales price of DZ, increased proportion of net
revenues generated from DZ and to lesser extent increased gross margins from
SILCs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased on a dollar
basis to approximately $1.34 million for fiscal 1998 from $1.18 million for
fiscal 1997, while declining on a percentage basis to 19.8% of net revenues for
fiscal 1998 from 26.1% during fiscal 1997. The dollar increase in selling,
general and administrative expenses is primarily attributable to media relations
and insurance costs associated with being a public company and increased
administrative personnel. The decrease as a percentage of net revenues was due
to growth in DZ and SILC product revenues without the need to add significant
additional personnel. The Company anticipates that selling, general and
administrative expenses will generally continue to increase in absolute dollars,
but may vary as a percentage of net revenues.
Research and Development Expenses
Research and development expenses increased on a dollar basis to
approximately $811,000 for fiscal 1998 from $655,000 in fiscal 1997, while
declining on a percentage basis to 12.0% of net revenues in fiscal 1998 from
14.4% during fiscal 1997. The dollar increase during fiscal 1998 is primarily
due to increased staffing and consulting costs associated with the development
of isotopically pure silicon wafers; costs to develop advanced, lower cost
production technology for enriched carbon; and commencement of a feasibility
study to increase isotope production. The decrease in research and development
expenses as a percentage of net revenues for fiscal 1998 compared to the
previous fiscal year was due to revenue growth. The Company believes that the
development and introduction of new product applications is critical to its
future success and expects that research and development expenses will increase
on a dollar basis, but may vary as a percentage of net revenues.
Interest income (expense), net
Interest expense reflects interest and, prior to the Company's initial
public offering, amortization of issuance costs and discounts on outstanding
debt. Interest expense, net, decreased by $250,000 from $395,000 for fiscal 1997
to $145,000 for fiscal 1998. The decrease is due to the Company's repayment of
approximately $1.85 million of outstanding debt during fiscal 1998 which
resulted in reduced interest expense.
Income Taxes
The provision for income taxes was $53,000 for fiscal 1997 and the
effective rate of 4% was the result of providing a valuation allowance for
deferred tax assets. The benefit of $314,000 for fiscal 1998 and the effective
rate of 177% relates to the realization of deferred tax assets associated with
the purchase of Interpro and the reduction of the related valuation allowance.
Extraordinary Item. In accordance with the terms of certain outstanding
notes the Company was required to repay debt totaling $1,397,000 upon the
closing of the Company's initial public offering in September 1997. Upon
repayment of the notes, unamortized debt issuance costs and discounts totaling
$252,000 were charged to earnings as an extraordinary item.
Liquidity and Capital Resources
Since inception, the Company's principal sources of funding has been
its cash from operations, borrowed funds and sales of common stock. The Company
used cash in operating activities of approximately $539,000 and $1,577,000
during fiscal 1998 and 1997, respectively. Cash used by operating activities
during fiscal 1998 was principally the result of a net loss of $115,000, net of
adjustments for non-cash items, primarily depreciation, amortization, deferred
income taxes, and extraordinary loss on extinguishment of debt, and increases of
accounts receivable, offset in part by decreases in inventory. Cash used by
operating activities during fiscal 1997, was
22
<PAGE>
principally the result of a net loss of $1,363,000, adjusted for non-cash items,
primarily depreciation and amortization, and increases in inventories and
decreases in accounts payable, offset in part by increases in accrued
liabilities.
The Company's investing activities used cash of $72,000 and $10,000
during fiscal 1998 and 1997, respectively. Investing activities were for
purchases of property and equipment.
Financing activities provided cash of $1,621,000 and $1,499,000 during
fiscal 1998 and 1997, respectively. Cash provided by financing activities during
fiscal 1998 resulted primarily from the completion of the Company's initial
public stock offering which were offset in part by the repayment of outstanding
debt. Financing activities during fiscal 1997 consisted of the issuance of notes
and common stock which were offset in part by debt issuance costs, deferred
offering costs, and principal payments on debt.
At April 30, 1998, the Company had $1,044,000 of cash equivalents an
increase of $1,016,000 compared to $28,000 at April 30, 1997. At April 30, 1998,
the Company had $1,811,000 of working capital an increase of $2,252,000 compared
to negative working capital of $441,000 at April 30, 1997. The increases were
primarily the result of the Company's initial public stock offering in September
1997.
On July 24, 1998 the Company obtained a $3.0 million credit facility
with an asset based lender. The proceeds of the new facility will be used to
repay approximately $346,000 debt outstanding at April 30, 1998. The Company
believes that cash equivalents on hand at April 30, 1998 and borrowings
available under its line of credit facility will be sufficient to allow the
Company to continue its expected level of operations for the next twelve months.
There can be no assurance; however, that events in the future will not require
the Company to seek additional capital sooner or, if so required, that it will
be available on terms acceptable to the Company. To the extent that cash from
the line of credit is not sufficient to meet the Company's projected future
working capital needs, the Company's business, financial condition, cash flows
and results of operations may be materially and adversely affected.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Some of the factors that could cause actual results to differ
materially are set forth below.
Relationship With Certain Suppliers and Availability of Raw Materials
The Company depends upon an isotope enrichment plant, located in
Russia, which is owned by the Ministry of Atomic Energy of the Russian
Federation, which is part of the cabinet of the government of the Russian
Federation, for one process involved in the manufacturing of depleted zinc (DZ).
The Company also relies upon a single or limited number of suppliers and
processors for certain other manufacturing processes. The Company signed an
agreement with the commercial department of the Ministry to purchase certain
isotope separation services through 2001. Disruption or termination of services
provided by the Ministry or the Company's single or limited suppliers and
processors could have a material and adverse affect upon the Company's financial
condition and results of operations.
Operations in Russia
Operations in Russia entail certain risks. In recent years the former
republics of the Soviet Union have experienced political, social and economic
change as constituent republics sought independence from the former central
government in Moscow, and certain of the republics including Russia have
attempted to transition from a central controlled economy toward market-based
economics. These changes have involved, in certain cases, armed conflict in
certain republics. There can be no assurance that political or economic
instability in these republics will not continue or worsen. The supply of stable
isotopes could be directly affected by political, economic and military
conditions in Russia. Accordingly the operations of the Company could be
materially adversely affected if hostilities in Russia should occur, if trade
between Russia and the United States were interrupted, if political conditions
in Russia disrupt transportation or processing concerning the Company's goods,
if laws or government policies concerning foreign business operations in Russia
change substantially, or if tariffs are introduced.
23
<PAGE>
Customer Concentration
Historically, substantially all of the Company's net revenues in any
particular period have been attributable to a limited number of customers.
Consistent with the Company's historical experience, the Company's quarterly
results during fiscal 1999 are expected to be affected materially by the level
of orders received from significant DZ and SILC users during such quarter and
product shipments by the Company to DZ and SILC customers during such period.
The Company expects that with the acquisition of Interpro and the continued
increase of depleted zinc sales to end users as well as the increase of SILC
revenues will reduce the concentration of net revenues from a limited number of
customers. Although there can be no assurance that the Company's principal
customers will continue to purchase products, a decrease in or loss of orders
from one or more major customers could have a material and adverse effect on the
Company's financial condition and results of operations.
Factors Affecting Operating Results; Variability of Orders
Before the acquisition of Interpro, the Company operated with little
backlog and a significant portion of the Company's net revenues have been, and
the Company believes will continue to be, derived from a limited number of
orders that are processed and shipped in the same quarter in which the orders
are received. The timing of such orders and their fulfillment has caused, and is
likely to continue to cause, material fluctuations in the Company's operating
results. The Company's expense levels are relatively fixed and are based, in
part, on expectations of future net revenues. As has been the case in prior
quarters, these factors will affect the Company's operating results for future
periods.
Management of Growth
The Company has in the past experienced periods of rapid growth that
have placed a significant strain on the Company's financial resources. The
Company's ability to manage growth effectively, particularly given the
increasing scope of operations, will require it to continue to implement and
improve its management, operational, and financial information systems, as well
as to develop the management skills of its managers and to train, motivate and
manage its employees. The company's failure to effectively manage growth could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Dependence on Key Personnel
The Company's future success will depend in significant part upon the
continued service of its key technical, sales and senior management personnel,
including James E. Alexander, Isonics' President and Chief Executive Officer,
Boris Rubizhevsky, Isonics' Senior Vice President, Isotope Production and
Supply, and Robert Cuttriss, President of Interpro. The Company maintains $1
million of key man life insurance on the lives of Messrs. Alexander,
Rubizhevsky, and Cuttriss and all are covered by employment agreements with the
Company extending through 2001, 2001, and 2003, respectively. The Company
believes that its future success will depend in large part upon its ability to
attract and retain qualified personnel for its operations. The failure to
attract or retain such persons could materially adversely affect the Company's
business, financial condition and results of operations.
Dates following December 31, 1999 and beyond (the "Year 2000 Problem")
Many existing computer systems and applications, and other devices, use
only two digits to identify a year in the date field, without considering the
impact of the upcoming change in the century. Such systems and applications
could fail or create erroneous results unless corrected. The Company relies on
its internal financial systems and external systems of business enterprises such
as customers, suppliers, creditors, and financial organizations both
domestically and globally, directly and indirectly for accurate exchange of
data. The Company has evaluated such systems and believes the cost of addressing
the Year 2000 Problem, will not have a material adverse affect on the result of
operations of financial position of the Company. However, even though the
internal systems of the Company are not materially affected by the Year 2000
issue the Company could be affected through disruption in the operation of the
enterprises with which the Company interacts.
24
<PAGE>
Volatility of Stock Price
The trading price of the Company's securities has been subject to wide
fluctuations in response to quarter to quarter variations in operating results,
announcements of technological innovations or new products by the Company or its
competitors, and other events or factors. In addition, the stock market has
experienced wide price and volume fluctuations, which have at times been
unrelated to the operating performance of the companies whose securities are
traded. These broad market fluctuations may adversely effect the market price of
the Common Stock and Warrants.
Shares Eligible for Future Sale
The officers and directors of the Company and all other stockholders
have agreed, pursuant to lock-up agreements, that without the prior written
consent of Monroe Parker Securities, Inc. (the Representative) and the Company,
that they will not sell or otherwise dispose of common stock beneficially owned
by them. The Company has been advised by officials of the Representative in the
initial public offering, that on December 31, 1997, the Representative ceased
market-making activities; therefore, the Company may, in the future at its sole
discretion, release a portion of securities subject to these lock-up agreements.
ITEM 7. FINANCIAL STATEMENTS
The information required by this item is included on pages F-1 to F-18
of Part III of this Report on Form 10-KSB and is incorporated into this part by
reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS, COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
The information required by this item is incorporated by reference from
the information under the captions "Election of Directors," "Executive Officers"
and "Section 16(a) Beneficial Ownership Compliance" contained in the Company's
Definitive Proxy Statement for Annual Meeting of Stockholders to be filed with
the Securities and Exchange Commission no later than August 28, 1998 (the "Proxy
Statement"), and in "Item 1--Business--Management" of this Form 10-KSB.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from
the information under the caption "Executive Compensation" contained in the
Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference from
the information under the caption "Security Ownership of Certain Beneficial
Owners and Management" contained in the Proxy Statement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference from
the information under the caption "Certain Transactions" contained in the Proxy
Statement.
25
<PAGE>
<TABLE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits Pursuant to Item 601 of Regulation S-B:
<CAPTION>
Exhibit No. Title
- --------------- ---------------------------------------------------------------------------------------------------
<S> <C>
3.01 [Reserved]
3.02 Registrant's Bylaws. (1)
3.03 Registrant's Amended and Restated Articles of Incorporation. (1)
4.01 Specimen Common Stock Certificate. (1)
4.02 Form of Representatives' Warrant Agreement. (1)
4.03 Form of Warrant Agreement between the Registrant and Continental Stock Transfer & Trust Company,
Monroe Parker Securities. (1)
4.04 Specimen Warrant Certificate. (1)
10.01 Registrant's 1996 Stock Option Plan. (1)(2)
10.02 Form of Employment Agreement between the Registrant and certain officers of the Registrant. (1)(2)
10.03 Registrant's 1996 Executives Equity Incentive Plan. (1)(2)
10.04 Registrant's 1996 Equity Incentive Plan. (1)(2)
10.05 Memorandum of Agreement between Electrochemical Plant, AO Techsnabexport, Co., Ltd. and
Registrant. (1)
10.06 Option Agreement between the Registrant and Yale University. (1)
10.07 Office Lease Agreement between Paulsen Properties and the Registrant dated as of January 1, 1996,
as amended. (1)
10.08 Letter from Yale University to Registrant dated February 10, 1996. (1)
10.09 Form of Indemnity Agreement to be entered into by Registrant with each of its directors and
investors. (1)(2)
10.10 Stock Purchase Agreement, dated as of April 30, 1998, among Isonics Corporation, a California
corporation, Metallurgy International, Inc., a Nevada corporation, and International Process
Research Corporation, a Colorado corporation. (3)
10.10.1 Escrow Agreement, dated as of May 15, 1998, among Isonics Corporation, a California corporation,
Metallurgy International, Inc., a Nevada corporation, Robert H. Cuttriss (as Agent), and Colorado
Business Bank, as Escrow Agent. (3)
10.11 Registration Rights Agreement dated as of September 27, 1996 by and among Registrant and certain
investors. (1)
10.12 Employment Agreement between the Registrant and James E. Alexander. (1)(2)
10.13 Employment Agreement between the Registrant and Boris Rubizhevsky. (1)(2)
10.14 Security Agreement dated March 31, 1995 between the Company and Isoserve, Inc. (1)
10.15 Consulting Agreement between the Registrant and Larry Wells Co., Inc. (1)(2)
10.16 February 1997 Agreement between the Registrant, Electrochemical Plant and AO Techsnabexport,
Co., Ltd. (1)
10.17 Letter from Yale University to Registrant dated January 28, 1997. (1)
24.01 Power of Attorney (see page 27).
27.01 Financial Statement Schedule.
(b) Reports on Form 8-K. No Report on Form 8-K was filed by the Company in the
quarter ended April 30, 1998.
<FN>
- -----------------------------
(1) Incorporated herein by reference to exhibit filed with the Company's
Registration Statement on Form SB-2 ("Registration Statement"). File No.
333-13289 in which this exhibit bears the same number.
(2) Items that are management contracts or compensatory plans or arrangements
required to be filed as exhibits pursuant to Item 13(a) of Form 10-KSB.
(3) Filed with Isonics' Current Report on Form 8-K (File No. 001-12531), dated
May 15 and filed May 27, 1998, and incorporated herein by reference.
</FN>
</TABLE>
26
<PAGE>
ISONICS CORPORATION AND SUBSIDIARY
Index to Financial Statements
Page
----
Report of Independent Certified Public Accountants...........................F-2
Consolidated Financial Statements
Consolidated Balance Sheets.............................................F-3
Consolidated Statements of Operations...................................F-4
Consolidated Statement of Stockholders' Equity (Deficit)................F-5
Consolidated Statements of Cash Flows...................................F-6
Notes to Consolidated Financial Statements..............................F-7
F-1
<PAGE>
Report of Independent Certified Public Accountants
Board of Directors
Isonics Corporation and Subsidiary
We have audited the accompanying consolidated balance sheets of Isonics
Corporation and Subsidiary as of April 30, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Isonics
Corporation and Subsidiary as of April 30, 1998 and 1997, and the consolidated
results of its operations and its cash flows for the years then ended, in
conformity with generally accepted accounting principles.
San Jose, California
July 1, 1998
F-2
<PAGE>
<TABLE>
Isonics Corporation and Subsidiary
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
<CAPTION>
April 30,
---------------------
1997 1998
------- -------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 28 $ 1,044
Accounts receivable (net of allowances of $0 and $130, respectively) 4 1,629
Inventories 1,539 456
Prepaid expenses 14 45
Deferred income taxes -- 112
------- -------
Total current assets 1,585 3,286
PROPERTY AND EQUIPMENT, net 70 1,626
GOODWILL (net of accumulated amortization of $157 and $236) 315 236
NOTES RECEIVABLE FROM SHAREHOLDERS 41 170
OTHER ASSETS 11 22
DEFERRED OFFERING COSTS 556 --
DEBT ISSUANCE COSTS (net of accumulated amortization of $61) 106 --
DEFERRED INCOME TAXES -- 315
------- -------
TOTAL $ 2,684 $ 5,655
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Current portion of long-term debt $ 403 $ 80
Accounts payable 1,105 657
Accrued liabilities 518 738
------- -------
Total current liabilities 2,026 1,475
LONG-TERM DEBT 1,268 312
DEFERRED INCOME TAXES -- 427
COMMITMENTS -- --
STOCKHOLDERS' EQUITY (DEFICIT)
Class A Preferred Stock - no par value; 10,000,000 shares authorized;
issued and outstanding: none -- --
Common stock -no par value; 20,000,000 shares authorized; issued and
outstanding: 1997, 4,550,268, 1998, 5,714,250 1,129 5,289
Notes receivable from shareholders (343) (337)
Accumulated deficit (1,396) (1,511)
------- -------
Total stockholders' equity (deficit) (610) 3,441
------- -------
TOTAL $ 2,684 $ 5,655
======= =======
<FN>
See Notes to Financial Statements.
</FN>
</TABLE>
F-3
<PAGE>
<TABLE>
Isonics Corporation and Subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<CAPTION>
Year Ended
April 30,
------------------------
1997 1998
------- -------
<S> <C> <C>
Net revenues $ 4,539 $ 6,783
Cost of revenues 3,616 4,662
------- -------
Gross margin 923 2,121
Operating expenses:
Selling, general and administrative 1,183 1,342
Research and development 655 811
------- -------
Total operating expenses 1,838 2,153
------- -------
Operating loss (915) (32)
Other income (expense)
Interest income 14 74
Interest expense (409) (219)
------- -------
Total other expense, net (395) (145)
------- -------
Loss before extraordinary item and taxes (1,310) (177)
Income tax expense (benefit) 53 (314)
------- -------
Income (loss) before extraordinary item (1,363) 137
Extraordinary item - loss on extinguishment of debt -- (252)
------- -------
NET LOSS $(1,363) $ (115)
======= =======
Net income (loss) per share - basic
Net income (loss) per share before extraordinary item $ (0.35) $ 0.03
Extraordinary item $ -- $ (0.05)
Net loss per share $ (0.35) $ (0.02)
Shares used in computing per share information 3,880 5,039
Net income (loss) per share - diluted
Net income (loss) per share before extraordinary item $ (0.35) $ 0.02
Extraordinary item $ -- $ (0.04)
Net loss per share $ (0.35) $ (0.02)
Shares used in computing per share information 3,880 6,469
Pro forma net income (loss) per share
Net income (loss) per share $ (0.23) $ 0.01
Shares used in computing pro forma per share information 4,486 6,614
<FN>
See Notes to Financial Statements.
</FN>
</TABLE>
F-4
<PAGE>
<TABLE>
Isonics Corporation and Subsidiary
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands, except share amounts)
<CAPTION>
Notes
Preferred Stock Common Stock Additional Receivable
------------------ ----------------- Paid-in from (Accumulated
Shares Amount Shares Amount Capital Shareholders Deficit) Total
------ ------ ------ ------ ------- ------------ -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES, May 1, 1996 6,250 $ 125 3,570,046 $ 1 $ 77 $ -- $ (33) $ 170
Exercise of stock options -- -- 750,898 1 531 (330) -- 202
Interest on notes receivable
from stockholders -- -- -- -- -- (13) -- (13)
Conversion of preferred stock (6,250) (125) 229,324 -- 125 -- -- --
Issuance of warrants with
promissory notes -- -- -- -- 394 -- -- 394
Recapitalization -- -- -- 1,127 (1,127) -- -- --
Net loss -- -- -- -- -- -- (1,363) (1,363)
--------- --------- --------- --------- --------- --------- --------- ---------
BALANCES, April 30, 1997 -- -- 4,550,268 1,129 -- (343) (1,396) (610)
Issuance of common stock (net
of issuance costs of $1,327) -- -- 810,000 3,452 -- -- -- 3,452
Interest on notes receivable
from stockholders -- -- -- -- -- (22) -- (22)
Repayment of interest from
stockholders -- -- -- -- -- 28 -- 28
Issuance of common stock in
connection with Interpro
acquisition -- -- 353,982 708 -- -- -- 708
Net loss -- -- -- -- -- -- (115) (115)
--------- --------- --------- --------- --------- --------- --------- ---------
BALANCES, April 30, 1998 -- $ -- 5,714,250 $ 5,289 $ -- $ 337 $ (1,511) $ 3,441
========= ========= ========= ========= ========= ========= ========= =========
<FN>
See Notes to Financial Statements.
</FN>
</TABLE>
F-5
<PAGE>
<TABLE>
Isonics Corporation and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<CAPTION>
Year Ended
April 30
---------------------
1997 1998
------- -------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,363) $ (115)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 310 200
Interest on notes receivable from shareholders (13) (22)
Deferred income taxes 143 (315)
Extraordinary item - loss on extinguishment of debt -- 252
Changes in assets and liabilities:
Accounts and notes receivable (10) (1,232)
Inventories (533) 1,083
Prepaid expenses (4) 5
Other assets (8) 5
Accounts payable (243) (283)
Accrued liabilities and other 233 (117)
Income taxes payable (89) --
------- -------
Net cash used in operating activities (1,577) (539)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (10) (72)
Cash acquired in purchase of Interpro -- 6
------- -------
Net cash used in investing activities (10) (66)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of debt and warrants 1,751 --
Repayment of notes receivable from shareholders -- 28
Payments of debt (339) (1,852)
Proceeds from issuance of common stock 202 3,452
Payment of debt issuance costs (115) (7)
------- -------
Net cash provided by financing activities 1,499 1,621
------- -------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS (88) 1,016
Cash and cash equivalents at beginning of period 116 28
------- -------
Cash and cash equivalents at end of period $ 28 $ 1,044
======= =======
Supplemental disclosure of noncash financing activities:
Stock issued for note receivable $ 330 $ --
======= =======
Forgiveness of note receivable from shareholder $ -- $ 33
======= =======
Purchase of Interpro
Cash acquired $ 6
Stock issued to seller 708
Liabilities assumed 1,464
-------
Assets acquired $ 2,178
=======
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 135 $ 177
Income taxes 9 1
<FN>
See Notes to Financial Statements.
</FN>
</TABLE>
F-6
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
Isonics Corporation, (the "Company") develops and markets products
worldwide based on enriched stable isotopes for applications in the energy,
medical research, diagnostic, pharmaceutical and semiconductor industries.
Through its wholly owned subsidiary, International Process Research Corporation
("Interpro") dba Colorado Minerals Research Institute, the Company provides
contract research and development services. Isonics acquired Interpro effective
April 30, 1998. The consolidated balance sheet at April 30, 1998 includes the
assets and liabilities of Isonics Corporation and Interpro. The consolidated
statement of operations includes the results of Isonics Corporation and does not
include the operations of Interpro as the acquisition occurred on the last day
of fiscal 1998.
Principals of Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary, Interpro. All significant intercompany accounts
have been eliminated.
Cash Equivalents
Cash equivalents include money market investments with an original maturity
of less than ninety days.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents and trade
accounts receivable. Cash equivalents are maintained with high quality
institutions and are regularly monitored by management. The Company extends
credit to its customers, most of whom are large, established companies. Credit
risk is mitigated by performing ongoing credit evaluations of its customers'
financial condition and generally does not require collateral.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over five to seven years. Leasehold improvements are
amortized over the shorter of their estimated useful lives or the lease term.
Goodwill
Goodwill resulted from the acquisition of Isoserve, Inc., and is being
amortized on a straight-line basis over six years. The Company evaluates the
realizability of goodwill annually to determine potential impairment by
comparing the undiscounted future cash flows of the related assets. The Company
modifies or adjusts goodwill if an impairment is indicated. Based upon its most
recent evaluation, the Company believes that no material impairment of goodwill
exists as of April 30, 1998.
F-7
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (continued)
Income Taxes
The Company accounts for income taxes using an asset and liability approach
for financial accounting and reporting purposes.
Revenue Recognition
Revenue from product sales is recognized upon shipment. Product warranty
costs have not been material in any period.
Use of Estimates in the Financial Statements
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements, as
well as revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Fair Values of Financial Instruments
The fair value of cash and equivalents approximates carrying value due to
the short maturity of such instruments. The fair value of long-term debt
approximates carrying value based on terms available for similar instruments.
Accounting for Stock-Based Compensation
The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees. The Company provides
additional pro forma disclosures as required under Statement of Financial
Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation.
Net Income (Loss) Per Share
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, Earnings Per Share. The Company adopted SFAS No. 128 during fiscal 1998 and
restated earnings per share data for all periods to conform with SFAS No. 128.
SFAS No. 128 requires a dual presentation of basic and diluted earnings per
share ("EPS"). Basic EPS excludes dilution and is computed by dividing net
income (loss) attributable to common stockholders by the weighted average of
common shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. Pro forma net income (loss) per
share has been presented to depict what the net income (loss) per share would
have been had the common shares issuable for debt repayment been outstanding
during that period.
F-8
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (continued)
The following table illustrates the reconciliation of the numerators and
denominators of the basic and diluted earnings (loss) per share computation:
Year Ended April 30,
----------------------
1997 1998
--------- ---------
Pro forma net income (loss)
Net loss $ (1,363) $ (115)
Interest on nonconvertible promissory notes 315 193
--------- ---------
Pro forma net income (loss) $ (1,048) $ 78
========= =========
Pro forma shares
Basic shares 3,880 5,039
Stock options and warrants - 1,430
Pro forma shares issued for repayment of debt 606 145
--------- ---------
Pro forma shares 4,486 6,614
========= =========
Diluted shares
Basic shares 3,880 5,039
Stock options and warrants - 1,430
--------- ---------
Diluted shares 3,880 6,469
========= =========
Recent Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
Reporting Comprehensive Income, which requires that an entity report, by major
components and as a single total, the change in net assets from non-shareholder
sources during the period; and SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, which establishes annual and interim
reporting standards for an entity's business segments and related disclosures
about its products, services, geographic areas and major customers. Adoption of
these statements will not impact the Company's financial position, results of
operations or cash flows. Both statements are effective for fiscal years
beginning after December 15, 1997, with earlier application permitted.
NOTE 2 - INVENTORIES
Inventories consist of the following (in thousands):
April 30,
----------------------
1997 1998
--------- ---------
Finished goods $ 1,387 $ 250
Work in process - -
Raw Materials 152 206
--------- ---------
$ 1,539 $ 456
========= =========
F-9
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
April 30,
----------------------
1997 1998
--------- ---------
Office furniture and equipment $ 93 $ 118
Production equipment - 1,549
Leasehold Improvements 4 4
--------- ---------
97 1,671
Accumulated depreciation and amortization (27) (45)
--------- ---------
$ 70 $ 1,626
========= =========
NOTE 4 - ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
April 30,
----------------------
1997 1998
--------- ---------
Compensation $ 328 $ 419
Customer advances - 76
Other 190 243
--------- ---------
$ 518 $ 738
========= =========
NOTE 5 - INCOME TAXES
<TABLE>
Deferred tax assets (liabilities) are comprised of the following (in thousands):
<CAPTION>
April 30,
----------------------
1997 1998
--------- ---------
<S> <C> <C>
Deferred tax assets
Accruals and reserves deductible in future periods $ 226 $ 297
Net operating loss carryforwards 508 211
--------- ---------
Total deferred tax assets 734 508
Valuation allowance (734) (81)
--------- ---------
- 427
Deferred tax liabilities
Amortization and depreciation - (427)
--------- ---------
$ - $ -
========= =========
</TABLE>
F-10
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 5 - INCOME TAXES (continued)
Income tax expense (benefit) consists of the following (in thousands):
April 30,
----------------------
1997 1998
--------- ---------
Current
Federal $ (78) $ -
State (12) 1
--------- ---------
(90) 1
Deferred
Federal 110 (230)
State 33 (85)
--------- ---------
143 (315)
--------- ---------
$ 53 $ (314)
========= =========
<TABLE>
A reconciliation of the statutory federal income tax rate to the effective
tax rate is as follows:
<CAPTION>
April 30,
--------------------
1997 1998
------ -------
<S> <C> <C>
Statutory federal income tax rate (35.0)% (35.0)%
State income taxes (net of federal income tax benefit) (5.5) (4.1)
Amortization of warrants issued with promissory notes 3.9 47.1
Other .5 (.3)
Change in valuation allowance 40.1 (185.1)
------ -------
Effective tax rate 4.0% (177.4)%
====== =======
</TABLE>
The valuation allowance for deferred tax assets as of April 30, 1997 and
1998 was $734,000 and $81,000, respectively. The Company provided a valuation
allowance for its deferred tax asset to the extent it believes realization of
such asset is uncertain.
The Company has $570,000 and $319,000 of net operating loss carryforwards
for state and federal purposes available through 2003 and 2113, respectively.
Current federal and state tax law includes certain provisions limiting the
annual use of net operating loss carryforwards in the event of certain defined
changes in stock ownership. The annual use of the Company's net operating loss
carryforwards could be limited according to these provisions.
F-11
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
<TABLE>
NOTE 6 - LONG TERM DEBT
Long term debt consists of the following (in thousands):
<CAPTION>
April 30,
----------------------
1997 1998
--------- ---------
<S> <C> <C>
Bank term loan - guaranteed by the SBA $ 43 $ 40
Notes payable - unsecured 291 -
Nonconvertible promissory notes, net of unamortized
discount of $245 1,153 -
Royalty payable to Isoserve, Inc. 135 -
Bank term loan - 147
Revolving line of credit - 159
Capital leases 49 46
--------- ---------
1,671 392
Less current maturities 403 80
--------- ---------
$ 1,268 $ 312
========= =========
</TABLE>
The bank term loan, guaranteed by the SBA, is collateralized by all of
Isonics' assets and bears interest at prime (8.5% at April 30, 1997 and 1998)
plus 2.75%. Principal and interest payments are due in 120 monthly payments of
$700 ending January 2005.
Notes payable, unsecured; were repaid during fiscal 1998. The notes were
due on demand and interest ranged from 8.0% to 24.0%.
Nonconvertible promissory notes were repaid during fiscal 1998. The notes
were collateralized by the Company's assets and interest was due monthly at
12.0% through May 1, 1997 and 15% thereafter. In connection with the issuance of
the promissory notes, the Company issued warrants to the noteholders to purchase
a total of 1,131,936 shares of common stock at a weighted average exercise price
of $2.78, exercisable for a period of five years commencing August 1996. In
conjunction with the financing, the Company issued warrants to purchase 304,098
shares of common stock exercisable for a period of five years commencing August
1996, at $0.5788 per share to an advisor. The aggregate fair value of the
warrants issued in connection with the financing was $394,000 of which $149,000
and $74,000 was amortized to operations as additional interest expense during
fiscal 1997 and 1998, respectively. Debt issuance costs of $167,000 were
incurred in conjunction with notes of which $61,000 and $32,000 was amortized to
operations as additional interest expense during fiscal 1997 and 1998,
respectively. Of the total original promissory notes and original warrants
issued, $620,000 and 303,696 warrants were purchased by related parties. Upon
the closing of the Company's initial public offering in September 1997, the
notes were repaid. See Note 9.
The bank term loan is collateralized by certain equipment and bears
interest at prime (8.5% at April 30, 1998) plus 1.0%. Principal and interest
payments of $3,800 are due in forty eight monthly payments ending February 2002.
F-12
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 6 - LONG TERM DEBT (continued)
The revolving line of credit is collateralized by all of Interpro's assets
and is guaranteed by Isonics. Borrowings under the line of credit bear interest
at prime (8.5% at April 30, 1998) plus 1.0%. Borrowings are limited to 75% of
Interpro's eligible trade accounts receivable as contractually defined. Interest
payments are due monthly. The credit arrangement prohibits the payment of any
cash dividends without prior bank approval and requires Interpro to meet certain
financial covenants, including minimum tangible net worth and maximum leverage
ratio. Subsequent to year end, the line of credit was amended to increase the
defined borrowing base from $160,000 to $350,000 and the maturity date of the
line of credit was extended to July 1999. The entire balance of the line of
credit is included as long-term debt on the balance sheet.
Maturities of long-term debt as of April 30, 1998 are as follows (in
thousands):
1999 $ 80
2000 204
2001 45
2002 42
2003 6
Thereafter 15
---------
$ 392
=========
NOTE 7 - COMMITMENTS
At April 30, 1998, furniture and equipment with a cost and accumulated
amortization of $100,000 and $26,000 has been acquired under capital leases. The
Company also rents office, production facilities and equipment under operating
leases expiring through July 2003.
Future minimum annual operating and capital lease commitments are as
follows (in thousands):
April 30, 1998
---------------------
Operating Capital
--------- --------
1999 $ 163 $ 45
2000 178 3
2001 91 -
2002 77 -
2003 20 -
Thereafter - -
--------- --------
Total minimum lease payments $ 529 48
=========
Amount representing interest (2)
--------
Present value of minimum lease payments 46
Current portion (43)
--------
Long-term portion $ 3
========
F-13
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 7 - COMMITMENTS (continued)
Rent expense for operating leases was approximately $47,000 and $39,000 for
the years ended April 30, 1997 and 1998, respectively.
The Company is required to make royalty payments to Isoserve, Inc. for
depleted zinc metal sold through fiscal 2000. The maximum royalty payments under
the agreement are $1,000,000. At April 30 1997, the Company had a liability for
the present value of the expected minimum royalty payments which was met during
fiscal 1998. The Company paid royalties of $140,000 and $192,000 for the years
ended April 30, 1997 and 1998, respectively, and has paid $523,000 of royalties
since inception.
NOTE 8 - STOCKHOLDERS' EQUITY
On September 30, 1996 and March 26, 1997, the Board of Directors approved a
1 for 6.89 and a 1 for 1.26 reverse stock split of its common shares,
respectively. On August 11, 1997, the Board of Directors approved a 3 for 1
stock split of its common shares. All per share amounts, number of shares, stock
options and warrant data have been restated to reflect the reverse stock splits
and stock split. In December 1996, the shareholders approved an increase in the
authorized shares of Preferred and Common Stock to 10,000,000 and 20,000,000,
respectively.
Convertible Preferred Stock
The Articles of Incorporation authorized the issuance of 100,000 shares of
nonvoting Class A and B convertible preferred stock. In December 1996, all
shares of these outstanding convertible preferred stock were converted to
229,324 shares of common stock in a cashless conversion and the Company
eliminated the designation of rights, preferences and restriction for preferred
stock.
Common Stock
On September 22, 1997, the Company completed an initial public offering of
810,000 units, each unit consisting of one share of common stock and one
redeemable common stock purchase warrant. Each warrant entitles the holder to
purchase one share of common stock at $5.80 per share, commencing September 22,
1998. The Company may redeem the warrants commencing March 21, 1999 at a price
of $.10 per warrant if the closing price of the common stock is at lease $14.50
per share for at lease 20 consecutive trading days.
In connection with the offering, the Company granted the underwriter
warrants to purchase up to 160,000 shares of common stock at a weighted average
exercise price of $7.77. The warrants are exercisable for a four year period
commencing September 22, 1998. In addition, the Company granted an executive
stock options to purchase up to 120,000 shares of common stock at $6.38. The
options are exercisable through September 2002 upon obtaining certain financial
goals.
F-14
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 8 - STOCKHOLDERS' EQUITY (continued)
The Company has reserved shares of common stock for issuance as follows:
April 30,
1998
----------
Exercise of stock options 1,587,309
Exercise of warrants 2,462,034
----------
4,049,343
==========
Stock Option Plan
1996 Stock Option Plan
The Company's 1996 Stock Option Plan authorized the grant of 1,727,832
incentive and nonqualified stock options to key employees, directors or
consultants of the Company. Incentive stock options are granted at a price not
less than fair market value, and nonqualified stock options are granted at a
price not less than 85% of the fair market value, as determined by the Board of
Directors. Options generally become exercisable upon issuance under the 1996
Stock Option Plan and are subject to redemption rights typically over three
years and generally expire ten years after the date of grant. In September 1997,
the Board of Directors terminated the Company's 1996 Stock Option Plan.
Executive and Incentive Stock Option Plans
In November 1996, the Board of Directors adopted the Executive and
Incentive Stock Options Plans authorizing the granting of up to 570,000 and
150,000 incentive and nonqualified stock options to key employees, directors or
consultants of the Company, respectively. Incentive stock options are granted at
a price not less than fair market value, and nonqualified stock options are
granted at a price not less than 85% of the fair market value. Options are
exercisable when vested, typically over five years and expire ten years after
the date of grant.
The exercise price of the options generally approximates the fair market
value per share of the Company's stock on the date of grant. Accordingly, no
compensation cost has been recognized for the plan. Had compensation cost for
the plan been determined based on the fair value of the options at the grant
dates consistent with SFAS No. 123, Accounting for Stock-Based Compensation, the
Company's net loss and net loss per share for the years ended April 30, 1997 and
1998 would have been changed to the pro forma amounts indicated below.
1997 1998
------------ -----------
Net loss
As reported $(1,363,000) $(115,000)
Pro forma (1,465,000) (379,000)
Loss per share (diluted)
As reported $(0.35) $(0.02)
Pro forma (0.25) (0.06)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes options-pricing model with the following weighted average
assumptions used for grants in 1997 and 1998, respectively; no expected
dividends, volatility of 150%; risk-free interest rate of 6.0% and expected
lives of 5 years. A summary of the status of the Company's stock option plans as
of April 30, 1997 and 1998, and changes during the years ending on these dates
is presented below.
F-15
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 8 - STOCKHOLDERS' EQUITY (continued)
Weighted
Average
Number of Exercise
Shares Price
--------- ----------
Outstanding, May 1, 1996 993,503 $0.61
Granted 476,761 $0.94
Exercised (750,898) $0.71
Canceled (34,557) $0.87
---------
Outstanding, April 30, 1997 684,809 $0.72
Granted 382,500 $3.82
Exercised - -
Canceled (12,500) $2.60
---------
Outstanding, April 30, 1998 1,054,809 $1.84
=========
The weighted average fair value of options granted during the years ended
April 30, 1997 and 1998 was $0.44 and $3.25, respectively.
<TABLE>
The following information applies to options outstanding at April 30, 1998:
<CAPTION>
<S> <C> <C> <C> <C>
Range of exercise prices $0.58-$0.87 $1.70-$2.50 $2.88-$3.50 $6.38
Options outstanding 613,380 216,429 105,000 120,000
Weighted average exercise price $0.64 $1.99 $3.35 $6.38
Weighted average remaining contractual
life (years) 8 10 10 10
Options exercisable 613,380 14,286 80,000 --
Weighted average exercise price $0.64 $1.70 $3.50 --
</TABLE>
Options to purchase 399,285 and 934,669 shares of common stock at a
weighted average exercise price of $0.61 and $0.66 per share were not subject to
rights of repurchase at April 30, 1997 and 1998, respectively.
In fiscal 1997, two executive officers of the Company exercised stock
options to each acquire 259,175 shares of common stock at an exercise price of
$0.64 per share. In each case, the Company loaned the executive officer
$165,000, representing the exercise price of the option, and the officer
executed a promissory note reflecting the loan. Each executive officer pledged
the purchased shares as collateral for the loan pursuant to a pledge agreement.
Each loan bears interest at an annual rate equal to the minimum applicable
federal rate, and interest is payable annually; principal and accrued but unpaid
interest is due five years from the date of the note. Until each note has been
paid in full and upon any sale of such option shares by the respective
executive, a portion of the sales proceeds will be used to pay amounts owed
under the note. In addition, during fiscal 1998, the Company loaned to each of
the executive officers, pursuant to a five-year note with interest at the
minimum applicable federal rate, the amount equal to the federal and state tax
liability incurred by him as a result of exercising such option, and to pay
compensation to such officer equal to the amount of interest payable under these
loans and the amount of taxes payable as a result of such compensation. At April
30, 1997, principal and interest due on the loans to acquire the common stock
totaled $330,000 and $13,000, respectively. At April 30, 1998, principal and
interest due on the loans to acquire the common stock totaled $330,000 and
$7,000, respectively. At April 30, 1998, principal and interest on the loans to
pay the federal and state tax liability incurred as a result of exercising such
option totaled $123,000 and $3,000, respectively. During fiscal 1998, the
executives received compensation of $38,000 to repay interest payable to the
Company on the common stock and tax notes.
During fiscal 1998, a note receivable and interest due from an executive
officer totaling $25,000 and $8,000, respectively, was forgiven by the Board of
Directors.
F-16
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 9 - EXTRAORDINARY ITEM
The terms of the Company's non-convertible promissory notes stated that in
the event of an initial public offering of the Company's stock, all principal
and interest would be due within five days of the closing of such initial public
offering. Accordingly, the Company repaid the notes and interest in fiscal 1998.
At the time of repayment, unamortized debt issuance costs and discounts totaling
$252,000 were charged to earnings as an extraordinary item.
NOTE 10 - SIGNIFICANT CUSTOMERS AND SUPPLIERS
One customer accounted for 49% and 47% of net revenues in fiscal 1997 and
1998, respectively. A second customer accounted for 20% and 18% of net revenues
in fiscal 1997 and 1998. A third customer accounted for 13% and 11% of net
revenues in fiscal 1997 and 1998. A fourth customer accounted for 10% of net
revenues in fiscal 1997. A fifth customer accounted for 12% of net revenues in
fiscal 1998. Export sales were less than 10% of net revenues in 1997 and 1998.
Export sales are principally to Asia.
The Company currently uses a single source processor in its manufacturing
process; a disruption of this relationship could have an adverse impact on the
operating results of the Company. The Company has not experienced a disruption;
however, the Company recognizes the risks and is actively pursuing alternative
sources.
NOTE 11 - ACQUISITION OF INTERPRO
On April 30, 1998, the Company acquired all of the outstanding common stock
of Interpro. The purchase price was paid in 353,982 shares of the Company's
common stock with a fair market value of $708,000. Transaction costs were
$70,000 and no goodwill was recognized upon completing the transaction. The
assets and liabilities of Interpro are included in the April 30, 1998 balance
sheet of the Company, while the results of operations of the Company for the
year ended April 30, 1998 excludes Interpro as the acquisition occurred on the
last day of the fiscal year end. Pro forma results of operations as if the
acquisition had occurred at the beginning of fiscal 1998 are as follows:
Year Ended
April 30, 1998
--------------
(Unaudited)
Net revenues $ 9,310
Gross margin 2,795
Net loss (151)
Net loss per share $ (.03)
Number of shares used in computing per share information 5,393
F-17
<PAGE>
Isonics Corporation and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - EMPLOYEE BENEFIT PLAN
The Company has established a profit sharing plan under section 401(k) of
the Internal Revenue Code. The plan is a defined contribution plan, covering
substantially all employees of the Company. Company contributions to the plan
aggregated $3,000 for both 1997 and 1998.
NOTE 13 - SUBSEQUENT EVENTS (unaudited)
Acquisition of Chemotrade GmbH
On July 21, 1998, the Company acquired all of the outstanding shares of
Chemotrade GmbH, 75 percent of the outstanding shares of Chemotrade Liepzig GmbH
and 6 percent of the outstanding shares of IUT (collectively "Chemotrade"), all
of which were owned by two common shareholders and engaged in the distribution,
development and manufacture of stable and radioactive isotopes. The purchase
price consideration consists of $2.576 million to be paid upon closing and
contingent consideration of up to $1.1 million to be paid through June 2001. The
consideration paid upon closing consists of cash of $758,000, 357,730 restricted
shares of common stock with a fair value of $894,000, two notes, one for
$924,000 bearing interest at 2% per month due September 15, 1998, secured by
certain accounts receivable of Chemotrade, and a second note for $833,000
bearing interest at 10%, due June 1, 1999. The sellers have guaranteed
Chemotrade's defined pre tax earnings will be at least $550,000 during the
sixteen months ended April 30, 1999 and the twelve months ended April 30, 2000
and 2001. If the pre tax earnings of Chemotrade are less than $550,000 for the
sixteen month period ended April 30, 1999, the note payable of $833,000 due June
1, 1999, will be reduced $0.75 for each $1.00 shortfall of earnings. If the pre
tax earnings of Chemotrade are less than $550,000 for the year ended April 30,
2000, the owners will repay $0.75 for each $1.00 shortfall of earnings. If
Chemotrade has pretax earnings of $550,000 for the year ended April 30, 2001,
the sellers will receive additional consideration of $278,000. If the pre tax
earnings are less than $550,000, the consideration will be reduced $0.50 for
each $1.00 shortfall in earnings.
Line of Credit
On July 24, 1998, the Company entered into a $3.0 million line of credit
agreement. The credit facility bears interest at the bank's prime rate plus
2.25%. Interest payments are due monthly and all outstanding borrowings are due
July 31, 2000. The credit facility consists of the following:
* $500,000 equipment term loan, payable over forty eight equal monthly
installments of principal and interest;
* $250,000 term loan, with interest only payments due monthly and
principal due October 31, 1998;
* $500,000 revolving line of credit, borrowings are limited to 35% of
eligible inventory;
* $1,250,000 revolving line of credit, borrowings are limited to 80% of
eligible accounts receivable; and
* $500,000 equipment acquisition term loan, borrowings are limited to 80%
of invoice cost of equipment, payable over thirty six monthly
installments of principal and interest. The availability of the loan is
conditioned upon the Company achieving and maintaining minimum debt
service coverage ratios.
In connection with the funding of the loan, debt totaling $346,000 at
April 30, 1998 will be repaid.
F-18
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized, on the 11th day of August 1998.
Isonics Corporation
By: /s/ James E. Alexander
-------------------------------------
James E. Alexander
President and Chief Executive Officer
and Director
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints James E. Alexander and Paul J. Catuna, or
any of them, his attorney-in-fact, each with the power of substitution, for him
in any and all capacities, to sign any amendments to this Report, and to file
the same, with exhibits thereto and other documents in connections wherewith,
with the Securities and Exchange Commission, hereby ratifying and confirming all
that each of said attorney-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue hereof.
<TABLE>
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
<CAPTION>
Signatures Title Date
- --------------------------------------- ---------------------------------------------- --------------------
<S> <C> <C>
Principal Executive Officer:
/s/ James E. Alexander President, Chief Executive Officer and Director August 11, 1998
- ---------------------------------------
James E. Alexander
Principal Financial Officer
and Principal Accounting Officer:
/s/ Paul J. Catuna Vice President, Finance, Chief Financial Officer August 11, 1998
- ---------------------------------------
Paul J. Catuna
Additional Directors:
/s/ Boris Rubizhevsky Senior Vice President and Director August 11, 1998
- ---------------------------------------
Boris Rubizhevsky
/s/ Lindsay A. Gardner Director August 11, 1998
- ---------------------------------------
Lindsay A. Gardner
/s/ Larry J. Wells Director August 11, 1998
- ---------------------------------------
Larry J. Wells
</TABLE>
27
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM BALANCE
SHEETS AND STATEMENTS OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> APR-30-1997 APR-30-1998
<PERIOD-START> MAY-01-1996 MAY-01-1997
<PERIOD-END> APR-30-1997 APR-30-1998
<CASH> 28 1,044
<SECURITIES> 0 0
<RECEIVABLES> 4 1,629
<ALLOWANCES> 0 130
<INVENTORY> 1,539 456
<CURRENT-ASSETS> 1,585 3,286
<PP&E> 70 1,626
<DEPRECIATION> 27 45
<TOTAL-ASSETS> 2,684 5,655
<CURRENT-LIABILITIES> 2,026 1,475
<BONDS> 1,671 392
0 0
0 0
<COMMON> 1,129 5,289
<OTHER-SE> (343) (337)
<TOTAL-LIABILITY-AND-EQUITY> 2,684 5,655
<SALES> 4,539 6,783
<TOTAL-REVENUES> 4,539 6,783
<CGS> 3,616 4,662
<TOTAL-COSTS> 3,616 4,662
<OTHER-EXPENSES> 1,838 2,153
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 395 145
<INCOME-PRETAX> (1,310) (177)
<INCOME-TAX> 53 (314)
<INCOME-CONTINUING> (1,363) 137
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 (252)
<CHANGES> 0 0
<NET-INCOME> (1,363) (115)
<EPS-PRIMARY> (.35) (.02)
<EPS-DILUTED> (.35) (.02)
</TABLE>
