ISCO (ISKO) 10-Q 2002 Q2 Quarterly report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended Januray 25, 2002
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                            to                            

Commission file number 0-14429

Isco, Inc.
(Exact name of registrant as specified in its charter)

Nebraska (State of Incorporation)	47-0461807 (I.R.S. Employer Identification No)
4700 Superior Street, Lincoln, Nebraska (Address of principal executive offices)	68504-1398 (Zip Code)

(402) 464-0231
(Registrant's telephone number, including area code)

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes /x/    No / /

        Indicate the number of shares outstanding of each of the issuer's classes of common stock as of February 22, 2002.

Common Stock, $0.10 par value
Class
5,665,673
Number of Shares

ISCO, INC. AND SUBSIDIARIES
TABLE OF CONTENTS

			Page Number
PART I. FINANCIAL INFORMATION
	Item 1. Financial Statements
		Condensed Consolidated Statements of Operations	3
		Condensed Consolidated Balance Sheets	4
		Condensed Consolidated Statements of Cash Flows	5
		Notes to Condensed Consolidated Financial Statements	6
	Item 2. Management's Discussion and Analysis		7
	Item 3. Quantitative and Qualitative Disclosures about Market Risk		13
PART II. OTHER INFORMATION
	Item 4. Submission of Matters to a Vote of Security Holders		14
	Item 6. Exhibits and Reports on Form 8-K		14
SIGNATURES			15

2

ISCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

		Three months ended						Six months ended
		Jan 25 2002			Jan 26 2001			Jan 25 2002			Jan 26 2001
		(Amounts in thousands, except per share data)
Net sales		$	14,540		$	15,432		$	29,966		$	28,913
Cost of sales			7,220			7,133			14,407			13,416
			7,320			8,299			15,559			15,497
Operating expenses:
	Selling, general, & administrative		5,523			5,184			10,904			10,654
	Research and engineering		1,237			1,261			2,613			2,591
	ERP settlement		—			(425	)		—			(425	)
			6,760			6,020			13,517			12,820
Income from operations			560			2,279			2,042			2,677
Other income (expense):
	Investment income		174			199			353			356
	Interest expense		(72	)		(92	)		(150	)		(186	)
	Other, net		(16	)		2			(79	)		8
			86			109			124			178
Income before income taxes			646			2,388			2,166			2,855
Provision for income taxes			285			759			775			955
Net income		$	361		$	1,629		$	1,391		$	1,900
Basic earnings per share		$	0.06		$	0.29		$	0.25		$	0.34
Diluted earnings per share		$	0.06		$	0.28		$	0.24		$	0.33
Cash dividends per share		$	0.05		$	—		$	0.05		$	—
Weighted average number of shares outstanding-basic			5,664			5,646			5,660			5,645
Additional shares assuming exercise of common stock equivalents and dilutive stock options			240			135			219			83
Weighted average number of shares outstanding-diluted			5,904			5,781			5,879			5,728

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

3

ISCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

				Jan 25 2002		Jul 27 2001
				(Columnar amounts in thousands)
Assets
	Current assets:
		Cash and cash equivalents		$	1,867	$	2,675
		Short-term investments			6,599		2,430
		Accounts receivable—trade, net of allowance for doubtful accounts of $128,000 and $124,000			8,776		9,269
		Inventories (Note 3)			8,705		8,775
		Refundable income taxes			9		460
		Deferred income taxes			1,221		1,515
		Other current assets			483		370
			Total current assets		27,660		25,494
		Property and equipment, net of accumulated depreciation of $15,396,000 and $14,449,000			15,102		15,266
		Long-term investments			6,891		7,358
		Other assets (Note 4)			4,886		5,146
			Total assets	$	54,539	$	53,264
Liabilities and Shareholders' Equity
	Current liabilities:
		Accounts payable		$	1,206	$	950
		Accrued expenses			3,350		3,321
		Short-term borrowing			1,595		1,503
		Current portion of long-term debt			1,093		1,056
			Total current liabilities		7,244		6,830
	Deferred income taxes				803		789
	Long-term debt, less current portion				1,534		2,056
	Commitments and contingencies
	Shareholders' equity
		Preferred stock, $.10 par value, authorized 5,000,000 shares; issued none			—		—
		Common stock, $.10 par value, authorized 15,000,000 shares; issued and outstanding 5,665,673 and 5,651,098			567		565
		Additional paid-in capital			38,214		37,929
		Retained earnings			6,125		5,017
		Accumulated other comprehensive income (loss) (Note 5)			52		78
			Total shareholders' equity		44,958		43,589
			Total liabilities and shareholders' equity	$	54,539	$	53,264

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

4

ISCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

			Six months ended
			Jan 25 2002			Jan 26 2001
			(Columnar amounts in thousands)
Cash flows from operating activities:
	Net income		$	1,391		$	1,900
	Adjustments to reconcile net income to net cash flows from operating activities:
		Depreciation and amortization		1,183			1,112
		Deferred income taxes		290			892
		Stock based compensation		228			6
		Change in operating assets and liabilities		1,166			(680	)
		Other		39			(178	)
	Total adjustments			2,906			1,152
		Cash flows from operating activities		4,297			3,052
Cash flows from investing activities:
	Proceeds from maturity of held-to-maturity securities			6,500			2,000
	Purchase of held-to-maturity securities			(2,411	)		(3,929	)
	Purchase of available-for-sale securities			(7,749	)		—
	Proceeds from sale of property and equipment			143			110
	Purchase of property and equipment			(1,070	)		(455	)
	Other			188			9
		Cash flows from investing activities		(4,399	)		(2,265	)
Cash flows from financing activities:
	Cash dividends paid			(283	)		—
	Net change in short-term borrowings			26			(13	)
	Repayment of long-term debt			(508	)		(472	)
	Issuance of common stock and exercise of stock options			59			12
		Cash flows from financing activities		(706	)		(473	)
Cash and cash equivalents:
	Net increase (decrease)			(808	)		314
	Balance at beginning of year			2,675			1,589
	Balance at end of period		$	1,867		$	1,903
Supplemental disclosures of cash flows:
The Company made income tax payments of $11,000 and (received refunds) of ($1,000) during the six-month periods ended January 25, 2002 and January 26, 2001, respectively.
The Company made interest payments of $150,000 and $186,000 during the six-month periods ended January 25, 2002 and January 26, 2001, respectively.

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

5

ISCO, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

January 25, 2002

(Unaudited)
(Columnar amounts in thousands, except per share data)

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

        While the Company believes that the disclosures presented are adequate to make the information not misleading, it is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements included in the Annual Report on Form 10-K for the year ended July 27, 2001.

        Note 2:    Certain reclassifications have been made to the prior period's financial statements to conform to the current period's presentation.

        Note 3:    Inventories are valued at the lower of cost or market, principally on the last-in, first-out (LIFO) basis. The composition of inventories was as follows:

	Jan 25, 2002		Jul 27, 2001
Raw Materials	$	3,459	$	3,489
Work-in-process		2,874		2,883
Finished goods		2,372		2,403
	$	8,705	$	8,775

        Had inventories been valued on the first-in, first-out (FIFO) basis, they would have been approximately $2,139,000 and $1,967,000 higher than reported on the LIFO basis at January 25, 2002 and July 27, 2001, respectively.

        Note 4:    Other Assets

	Jan 25, 2002		Jul 27, 2001
Intangibles, net of accumulated amortization of $604,000 and $535,000	$	1,082	$	1,151
Investment in AFTCO, net of accumulated amortization of $288,000 and $250,000		515		639
Cash value of life insurance		1,309		1,425
Note receivable—related party		1,000		1,000
Other		980		931
	$	4,886	$	5,146

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        Note 5:    Comprehensive income, for the three and six month periods ended January 25, 2002 and January 26, 2001, was as follows:

		Three months ended						Six months ended
		Jan 25 2002			Jan 26 2001			Jan 25 2002			Jan 26 2001
Net income		$	361		$	1,629		$	1,391		$	1,900
Other comprehensive income (loss), net of income tax (tax benefit):
	Foreign currency translation adjustment		14			(20	)		(16	)		7
	Unrealized holding gains (losses) on available-for-sale securities		(1	)		(17	)		(10	)		(15	)
Comprehensive income		$	374		$	1,592		$	1,365		$	1,892

        Note 6:    New Accounting Pronouncements

        In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142 (SFAS No. 142)Goodwill and Other Intangible Assets. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. The Company is currently assessing but has not yet determined the impact of SFAS No. 142 on its financial position and the results of operations upon adoption in fiscal 2003.

        In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143 (SFAS No. 143),Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations related to the retirement of tangible long-lived assets and the related asset retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The Company does not expect the adoption of this standard in fiscal 2003 to have a significant impact on the consolidated financial statements.

        In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144 (SFAS No. 144),Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of certain long-lived assets. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not expect the adoption of this standard in fiscal 2003 to have a significant impact on the consolidated financial statements.

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

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

RESULTS OF OPERATIONS

        The following table sets forth, for the three-month and six-month periods indicated, the percentages which certain components of the Condensed Consolidated Statements of Operations bear

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to net sales and the percentage of change of such components (based on actual dollars) compared with the same periods of the prior year.

		Three months ended						Six months ended
		Jan 25 2002		Jan 26 2001		Change		Jan 25 2002		Jan 26 2001		Change
Net sales		100.0		100.0		(5.8	)	100.0		100.0		3.6
Cost of sales		49.7		46.2		1.2		48.1		46.4		7.4
		50.3		53.8		(11.8	)	51.9		53.6		0.4
Operating expenses:
	Selling, general, & administrative	38.0		33.6		6.5		36.4		36.8		2.3
	Research & engineering	8.5		8.2		(1.9	)	8.7		9.0		0.9
	ERP settlement	0.0		(2.8	)	(100.0	)	0.0		(1.5	)	(100.0	)
		46.5		39.0		12.3		45.1		44.3		5.4
Income from operations		3.8		14.8		(75.4	)	6.8		9.3		(23.7	)
Other income (expense):
	Investment income	1.2		1.3		(12.4	)	1.2		1.2		(0.9	)
	Interest expense	(0.5	)	(0.6	)	(21.7	)	(0.5	)	(0.6	)	(19.6	)
	Other, net	(0.1	)	0.0		—		(0.2	)	0.0		—
		0.6		0.7		(20.7	)	0.5		0.6		(30.3	)
Income before income taxes		4.4		15.5		(72.9	)	7.3		9.9		(24.1	)
Provision for income taxes		2.0		4.9		(62.4	)	2.6		3.3		(18.8	)
Net income		2.4		10.6		(77.8	)	4.7		6.6		(26.8	)

SALES ANALYSIS AND REVIEW

        Our sales for the three-month and six-month periods ended January 25, 2002 were $14.5 million and $30.0 million, respectively. For the periods under review, our sales were 6 percent lower and 4 percent higher than for the respective periods of last year. Core products sales (wastewater samplers, flow meters, and liquid chromatography products) of $10.7 million for the quarter and $22.3 million for the six-month period, were down 7 percent and up 1 percent for the same periods of last year. In each of the periods, liquid chromatography and flow meter products provided increased sales over the prior year offset by a reduction in sales of samplers. Sales of our non-core products (process monitoring, supercritical fluid extraction (SFE) and syringe pumps) of $3.0 million for the quarter and $5.9 million for the six-month period were down 5 percent and up 10 percent for the same periods of last year. For the current quarter, these results were driven by increased sales of SFE products offset by a decline in sales of process monitoring and syringe pump products. For the six-month period, all non-core products posted sales increases over the prior year.

        U.S. sales for the three months and six months were down 9 percent and up 4 percent, respectively. U.S. sales of our core products for the same periods decreased 8 percent and increased 5 percent, respectively, over the comparable periods of fiscal 2001. Liquid chromatography and flow meter products accounted for the increases in both periods, offset by declines in sampler products for both periods. U.S. sales of our non-core products for the three-month period decreased by 26 percent and decreased by 12 percent for the six-month comparisons. Sales of syringe pumps accounted for the decrease in the three-month period and six-month periods, while the other non-core products posted sales increases.

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        International sales for the three months and six months were up 1 percent and 3 percent, respectively. Sales of our core products for the same periods were down 6 percent and down 12 percent, respectively, over last year. Liquid chromatography products contributed to sales increases in both periods, offset by declines in sampler and flow meters products in both periods. International sales of our non-core products for the three months and six months increased by 9 percent and 25 percent, respectively. Syringe pumps recorded increased sales for each of the periods, while SFE sales were flat for each of the periods and process monitoring products declined in the current quarter but provided a sales increase for the six-month period.

        During the three months and six months we received net orders of $13.6 million and $28.9 million, respectively. Net orders received were down 4 percent and up 1 percent compared to the same periods last year. The order backlog at January 25, 2002 was $4.3 million, down approximately 21 percent from the beginning of the fiscal year.

NET INCOME ANALYSIS AND REVIEW

        We had operating income of $560,000 and $2,042,000, respectively, for the three months and six months ended January 25, 2002. For the same periods last year, operating income was $2,279,000 and $2,677,000, respectively. The decline in operating income for the three-month period of approximately $1,719,000 was due to a combination of factors. The decline in sales of approximately $892,000 for the three month period is primarily the result of the timing of shipments in the prior year. In addition to lower sales, we experienced a decrease in the gross margin as a percentage of sales. These two factors resulted in a decline in gross margin dollars of $979,000. Further, our operating expenses increased by approximately $740,000. This increase is due to the prior year receiving a benefit from the ERP settlement of $425,000 and increased selling, general and administration (SG&A) expenses in the current year.

        The operating income decline in the six-month period of approximately $635,000 was due to the prior year receiving the benefit from the ERP settlement and increased SG&A expenses in the current year. While we experienced an increase in sales of $1.1 million over the prior year, the gross margin as a percentage of sales decreased during the current year, resulting in approximately the same amount of gross margin dollars generated in both periods.

        The gross margin, as a percentage of sales, declined to 50.3 percent and 51.9 percent, respectively, for the three months and six months ended January 25, 2002. This compares with gross margin percentages of 53.8 percent and 53.6 percent for the same periods last year. The decline in the three-month period is due to the combination of increased manufacturing costs for our products and a shift in sales from U.S sales to international. The decline in the six-month period is due to increased manufacturing costs in both material and labor.

        Operating expenses increased by $315,000 and $272,000 for the three-month and six-month periods, excluding the impact to the prior fiscal year for the ERP settlement discussed above. Increased SG&A personnel costs were the primary factor for the increase for both the three-month and six-month periods. The personnel cost increase was due to increased selling and marketing compensation costs as well as a non-cash charge of approximately $190,000 related to stock options under the executive compensation program.

        Other income declined by $23,000 and $54,000, for the three-month and six-month periods ended January 25, 2002, respectively, as compared to the same periods of the previous year. Investment income declined by $25,000 for the quarter and by $3,000 for the six-month period. This resulted from lower investment yield rates in the current quarter and six-month period, even though our average investment balances were higher than last year. Interest expense decreased $20,000 and $36,000, for the three-month and six-month periods ended January 25, 2002, respectively, as compared to the same periods of the previous year resulting from the lower average outstanding debt. The other, net category

9

decreased by $18,000 and $87,000, for the three-month and six-month periods ended January 25, 2002, respectively, as compared to the same periods of the previous year primarily from the financial results of the AFTCO joint venture.

        Our effective income tax rate for the three months and six months ended January 25, 2002 was 44.1 percent and 35.8 percent, respectively. For the same periods last year our effective income tax rates were 31.8 percent and 33.4 percent, respectively. For the second quarter of fiscal 2001, the effective tax rate was increased by the nondeductibility, for tax purposes, of the stock based incentive compensation discussed above and tax credits for research and development activities in the current year. For the six month period, the impact of the stock based incentive compensation resulted in a higher effective tax rate for the current year compared to the prior year.

FINANCIAL CONDITION AND LIQUIDITY

        Our overall cash and investments increased to $15.4 million at January 25, 2002 from $12.5 million at the end of fiscal year 2001, an increase of $2.9 million. Operating activities generated $4.3 million of cash flow during the first six months of fiscal 2002 compared with $3.1 million during the same period of fiscal 2001. The year over year improvement of $1.2 million in cash flows from operating activities was driven by the change in operating assets and liabilities, primarily accounts receivable, inventories and the timing of income tax payments. For the current six month, net earnings, depreciation, and other adjustments provided $3.1 million of cash while changes in operating assets and liabilities generated $1.2 million. This compares to the prior year where net earnings, depreciation, and other adjustments provided $3.8 million of cash while changes in operating assets and liabilities used $0.7 million.

        The cash flow generated for the six months was primarily invested in short-term investments due to current market conditions. We invested net cash of $0.9 million into equipment, used cash of $0.5 million for the repayment of debt, and paid a dividend of $0.3 million to shareholders. Our net cash and cash equivalents position was $1.9 million at January 25, 2002 compared to $2.7 million at year-end and $1.9 million at January 26, 2001. The balance at year-end was higher than our normal target range due to the timing of investment purchases and maturities.

        At January 25, 2002, we had working capital of $20.4 million and a current ratio of 3.8:1. At period-end, our total long-term debt was $2.6 million with $1.1 million payable within the next year. In addition, we had lines of credit with various banks totaling $7.0 million of which $5.2 million was available for future business needs.

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        The following table summarizes our outstanding contractual obligations and commitments as of July 27, 2001. There have been no significant changes to debt or other obligations in the first six months of fiscal 2002.

(Amounts in thousands):

	Payments Due by Period
Contractual Obligations	Total		Less than 1 year		1-3 years		4-5 years		After 5 years
Long-Term Debt	$	3,112	$	1,056	$	1,952	$	44	$	60
Operating Leases		615		266		328		21		—

			Amount of Commitment Expiration Per Period
Other Contractual Commitments	Total Amounts Committed		Less than 1 year		1-3 years		4-5 years		After 5 years
Lines of Credit	$	5,200	$	5,200	$	—	$	—	$	—
Standby Letters of Credit		1,800		1,800		—		—		—
Guarantees		1,000		1,000		—		—		—

        At July 27, 2001, the Company had available $7,000,000 in lines of credit expiring February 28, 2002 and December 31, 2003. The lines of credit are secured by inventory, accounts receivable, equipment, and intangibles. The Company has a standby letter of credit in place as a requirement for obtaining a revolving credit agreement for the Company's German subsidiary, currently DM4,000,000 (US$1,800,000). The Company has a guarantee outstanding related to the AFTCO joint venture.

NEW ACCOUNTING PRONOUNCEMENTS

        In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142 (SFAS No. 142)Goodwill and Other Intangible Assets. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. The Company is currently assessing but has not yet determined the impact of SFAS No. 142 on its financial position and the results of operations upon adoption in fiscal 2003.

        In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143 (SFAS No. 143),Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations related to the retirement of tangible long-lived assets and the related asset retirement costs. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The Company does not expect the adoption of this standard in fiscal 2003 to have a significant impact on the consolidated financial statements.

        In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144 (SFAS No. 144),Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of certain long-lived assets. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company does not expect the adoption of this standard in fiscal 2003 to have a significant impact on the consolidated financial statements.

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CRITICAL ACCOUNTING POLICIES

Accounts Receivable

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

Inventories

        Inventories consist of purchased materials, raw materials, in-process subassemblies and finished goods. An allowance is maintained for the expected obsolescence in inventory. The obsolescence factors include a) changes in expected future demand for repair and warranty parts, b) obsolescence in purchased materials, raw material and subassemblies due to changes in finished goods product offerings, and c) the decision not to incorporate these items into existing or new finished goods. We use the link-chain method for valuing the majority of our inventory on a LIFO basis.

Revenue Recognition

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

Stock-Based Compensation

        We account for our stock option plans in accordance with provisions of Accounting Principles Board Option No. 25 (APB 25), "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation expense is recorded on the date of grant if the current market price of the underlying stock exceeds the exercise price. Stock options expected to vest under the current executive incentive compensation plan are reported using variable accounting thus requiring adjustments in compensation expense based on the movements in market price relative to the exercise price. Stock option grants to non-employees are accounted for at the fair value of the stock option grant in accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." Directors deferred stock units are recorded as compensation expense at fair value on the date the units are earned by the director for service on the Company's board of directors.

FACTORS AFFECTING FUTURE RESULTS

        In our fiscal 2001 10-K report we stated that we expected some short-term downward pressure on our operating performance in fiscal 2002 due to uncertain economic conditions as well as our decision to increase operating expenses to capitalize on selected strategic opportunities. At the mid-point of our fiscal year, we have a better understanding of the economic conditions and our ability to address them relative to our future operating performance. While we are pleased that we have been able to generate sales above the prior year's level, at this point we are concerned with our ability to continue to generate increased sales for the remainder of the fiscal year due to the trends and dynamics in incoming orders during the past six months.

        Orders for our core water quality monitoring products (samplers and flow meters) were down 9 percent from the first half of fiscal 2001 to the first half of fiscal 2002. The largest decline has been in samplers, which is our largest core product group. In addition we experienced a sequential decline in orders of approximately 11 percent from the first quarter to the second quarter. This decrease was driven primarily from our core products of samplers and chromatography. We believe the decline in water quality monitoring products is due to delayed spending by domestic municipal customers and are

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uncertain if this trend will continue. The second quarter decline in chromatography is attributable to a temporary buying slow down by pharmaceutical customers.

        As mentioned in the results of operations section, we have experienced a decline in our gross margin as a percentage of sales. Since increased manufactured costs drove the margin deterioration, it may be difficult to completely regain the margin during the second half of the year. Unfortunately, we have not been able to leverage any significant buying power with many of our vendors due to our size. Our best option to improve margins, outside of net sales growth, is to focus on improved efficiencies to offset the material price increases and increased labor costs. We are actively addressing this area.

        Finally, we remain committed to increased funding for the commercialization of the monolithic column media technology for chromatography. Activities in this area are scheduled to increase in the second half of the current fiscal year, and we anticipate expenses to increase during the remainder of the fiscal year.

        At this time, our best estimate is that we will report lower sales and earnings for the last two quarters of fiscal 2002 compared to the prior year. On an annualized basis, we expect sales to be approximately equal to the prior fiscal year, while we expect earnings per share to be 15 to 25 percent lower.

MARKET RISK

        Interest rate risk and currency exchange risks are the primary market risks to which we are exposed. We do not use derivative financial or commodity instruments. Our other financial instruments include cash and cash equivalents, accounts and notes receivable, accounts and notes payable and long-term debt. Our cash and cash equivalents, accounts and notes receivable, and accounts and notes payable balances are generally short-term in nature and do not expose our company to material market risk. At January 25, 2002, we had approximately $2.6 million of fixed rate debt. In addition, we had $7.0 million of variable rate credit facilities, of which approximately $1.6 million was outstanding under these credit facilities. We do not believe that changes in interest rates on the debt and credit facilities would have a material effect on our results of operations, given our current obligations under these debt and credit facilities.

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

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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PART II—OTHER INFORMATION

Item 4.Submission of Matters to a Vote of Security Holders.

        Our company's annual meeting of shareholders was held on December 13, 2001.

        A. The following persons were elected to serve a two-year term on Isco, Inc.'s Board of Directors

Nominee	Votes
	In Favor	Withheld
Robert W. Allington	5,363,449	12,927
James L. Linderholm	5,367,343	9,033
Dale L. Young	5,367,784	8,592

Item 6.Exhibits and Reports on Form 8-K

(a)

Exhibits: None



(b)

Reports on Form 8-K: No reports on Form 8-K have been filed during the quarter ended January 25, 2002, or during the period from January 26, 2002 to the date of this quarterly report on form 10-Q.

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SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	ISCO, INC.
March 8, 2002	By:	/s/  ROBERT W. ALLINGTON      Robert W. Allington Chairman and Chief Executive Officer
March 8, 2002	By:	/s/  VICKI L. BENNE      Vicki L. Benne Chief Financial Officer and Treasurer

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QuickLinks

FORM 10-Q
ISCO, INC. AND SUBSIDIARIES TABLE OF CONTENTS
ISCO, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
ISCO, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
ISCO, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
ISCO, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS January 25, 2002 (Unaudited) (Columnar amounts in thousands, except per share data)
PART II—OTHER INFORMATION
SIGNATURES