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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 for the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 0-11915
CONDUCTUS, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0162388
(State of incorporation) (I.R.S. Employer Identification No.)
969 W. Maude Avenue
Sunnyvale, California 94086
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (408) 523-9950
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $0.0001 par value
Preferred Share Purchase Right, $0.0001 par value
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 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 by a check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not 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-K or any
amendment to this Form 10-K. /X/
The aggregate market value of voting stock held by non-affiliates of the
Registrant, as of February 27, 1998, was approximately $23,490,000 based on the
closing sale price of the Company's Common Stock, as reported by the Nasdaq
National Market on February 27, 1998. Shares of Common Stock held by each
officer, director and holder of 5% or more of the outstanding Common Stock have
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
On February 27, 1998, approximately 7,004,095 shares of the Registrant's
Common Stock, $0.0001 par value, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents are incorporated by reference in those parts of this
Annual Report on Form 10-K as set forth below, but only to the extent
specifically stated in such parts hereof:
1. Portions of the Registrant's Proxy Statement for the 1998 Annual Meeting
of Stockholders scheduled to be held on May 29, 1998, are incorporated by
reference into Part III.
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TABLE OF CONTENTS
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Number
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PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . . . . . .18
Item 3. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . .18
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS. . . . . .18
EXECUTIVE OFFICERS OF THE REGISTRANT . . . . . . . . . . . . . . . . .18
PART II. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . . . . . . .19
Item 6. SELECTED FINANCIAL DATA. . . . . . . . . . . . . . . . . . . .19
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS. . . . . . . . . . . . . . . . . . .20
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. . . . . . . . . .24
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE . . . . . . . . . . . . . . . . . . .24
PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. . . . . .24
Item 11. EXECUTIVE COMPENSATION. . . . . . . . . . . . . . . . . . . .24
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. . .24
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. . . . . . . .24
PART IV. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K . . . . . . . . . . . . . . . . . . . . .25
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PART I
ITEM 1. BUSINESS
OVERVIEW
THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K (THE "FORM 10-K")
AND IN REPORTS INCORPORATED BY REFERENCE THAT ARE NOT PURELY HISTORICAL ARE
FORWARD-LOOKING STATEMENTS (AS SUCH TERM IS DEFINED IN THE RULES PROMULGATED
PURSUANT TO THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"))
THAT REFLECT CONDUCTUS, INC.'S (THE "COMPANY" OR "CONDUCTUS") CURRENT
EXPECTATIONS REGARDING THE FUTURE RESULTS OF OPERATIONS AND PERFORMANCE AND
ACHIEVEMENTS OF THE COMPANY. SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO
THE SAFE HARBOR CREATED BY 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 "ANTICIPATE," "BELIEVE,"
"ESTIMATE," "EXPECT" 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 ASSUMPTIONS, SUCH AS THOSE SET FORTH UNDER "RISK FACTORS"
AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS, WHICH COULD CAUSE THE COMPANY'S FUTURE RESULTS, PERFORMANCE
OR ACHIEVEMENTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN, OR IMPLIED BY,
ANY OF THESE STATEMENTS. THE COMPANY UNDERTAKES NO OBLIGATION TO RELEASE
PUBLICLY THE RESULTS OF ANY REVISIONS TO ANY SUCH FORWARD-LOOKING STATEMENTS
THAT MAY BE MADE TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS
FORM 10-K OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS.
Conductus develops, manufactures and markets electronic components and
subsystems based on superconductors. The unique properties of superconductors
provide the basis for electronic products with significant potential
performance advantages over products based on competing materials such as
copper and semiconductors. Depending on the application, these advantages
include enhanced sensitivity, efficiency, speed, and operating frequency as
well as reduced power consumption, size, weight, and cost.
Conductus is currently focusing the majority of its efforts on applications
for superconductors in the communications market. Conductus is developing,
manufacturing, and marketing front-end receiver subsystems for cellular and
personal communication services ("PCS") base stations. These superconducting
filter subsystems are intended to provide significant benefits in base
station performance as well as reduce the size of the filter components
required. Conductus has begun shipping initial products for this market and
continues to develop additional products for near-term introduction.
In the third quarter of 1997, the Company completed two organizational
changes aimed at focusing the Company's resources on applications of its
superconductive technology in wireless communications. First, it closed its
Instrument and Systems division, located in San Diego, California, and sold
its product rights to its temperature controller business to Neocera, Inc.
and certain of its magnetic sensing instrumentation rights to Niki Glass Co.
Second, it sold its NMR spectroscopy probe business to Bruker Instruments,
Inc. In order to fund current operations and further product development of
wireless communications applications, the Company intends to raise capital
through the sale of its equity securities. See "Risk Factors-Substantial
Future Capital Needs" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
Continuing research and development efforts are aimed primarily at additional
applications in the communications market, including superconducting circuits
for high-speed telecommunications switching. Additionally, Conductus
continues to manufacture and sell superconducting sensors called
Superconducting Quantum Interference Devices ("SQUIDs"), which can be used to
build electronic instruments that detect and precisely locate extremely weak
magnetic signals.
BACKGROUND
SUPERCONDUCTORS
Superconductors are materials that have the ability to transport electrical
energy with little or no loss when cooled to a "critical" temperature. The
intrinsic properties of superconductors are unique in nature and offer
potential performance benefits to electrical and electronic systems. These
include low-loss signal transmission, extreme magnetic sensitivity and
efficient high-speed switching. When electrical currents flow through
ordinary materials, they encounter resistance which consumes energy by
converting electrical energy into heat energy. Depending on
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whether direct or alternating current is applied, superconductors have the
ability to transport electrical current with no resistance at all or with
only a tiny fraction (typically less than one percent) of what is found in
the best conventional conductors. This property is extremely beneficial in
electronic components whose increased efficiency leads to enhanced signal
strength, improved signal resolution and compact form-factor. Other intrinsic
properties of superconductors enable the fabrication of unique electronic
devices, including high-speed electronic switches and ultra-sensitive
magnetic sensors.
From 1911, when superconductivity was first discovered, until 1986, the critical
temperatures for all known superconductors did not exceed 23 K (-418 DEG. F).
As a result, superconductivity was not widely used in commercial applications
because of the high cost and complexities associated with reaching and
maintaining such low temperatures. In 1986, a new class of superconducting
materials, referred to as high-temperature superconductors ("HTS"), was
discovered having critical temperatures above 77 K (-320 DEG. F), the boiling
point of liquid nitrogen. These high critical temperatures allow HTS materials
to be cooled to a superconducting state using liquid nitrogen, which is
inexpensive and relatively easy to use, or using relatively simple mechanical
refrigerators. Conductus believes that this ability to obtain the benefits of
superconducting technology at more easily achieved temperatures enables much
broader commercial applications.
The cooling required for HTS materials can also be useful for other materials.
Many electronic technologies, including CMOS, GaAs, optoelectronics and even
copper, exhibit enhanced performance at reduced temperatures, but the most
compelling performance improvements are enabled by superconductive electronics.
When the unique advantages of superconductive electronics are complemented by
the advantages of other cryoelectronic technologies, the result is a hybrid
system whose overall performance can justify the additional expense associated
with cryogenic cooling. Conductus is currently employing this hybrid approach in
its front-end receiver systems, which combine superconductive filters with
cryogenically-cooled low noise amplifiers.
CONDUCTUS' APPROACH
Conductus develops, manufactures and markets superconductive electronic devices
and components using thin-film technology based upon the material yttrium barium
copper oxide ("YBCO"), which the Company has judged to be best suited for
electronic applications. Conductus combines what it believes to be the world's
most advanced YBCO thin-film technology with expertise in electronic device and
component design, analog and digital electronic engineering, cryogenic
packaging, mechanical engineering and system integration. Conductus believes
that systems containing superconductive electronic technology will offer
performance that is unavailable from competing technology, will reduce the costs
of performing desired functions, or, in many cases, do both.
CHOICE OF MATERIAL. Although a number of high-temperature superconductors
have been identified, Conductus has focused upon the development of YBCO for
electronic applications. See "Risk Factors Uncertainty of Patents and
Proprietary Rights; Risk of Litigation." YBCO is the only HTS material for
which there has been both significant development and successful
demonstration of multilayer technology, i.e., the use of multiple thin-film
materials deposited one upon another. Conductus believes that such multilayer
structures are important for many electronic components and devices, where
they can be used for better film quality and stability and enhanced device
functionality. Conductus has developed several proprietary processes for
producing YBCO and other thin-film materials as well as for fabricating
superconducting components and devices. These processes include thin-film
growth, photolithography, etching and other procedures similar to those used
in the manufacture of electronic devices.
THIN-FILM EXPERTISE. Conductus produces superconducting components using a
thin-film fabrication approach. The Company's superconductive circuits and
components are fabricated on the surface of wafers using vapor-phase
thin-film growth followed by circuit processing steps similar to those used
to manufacture semiconductor devices. The fabrication of HTS components and
circuits entails certain specialized processes, which are the subject of
Conductus' patents or proprietary know-how, in order for HTS materials such
as YBCO to exhibit desirable superconducting properties. Conductus, in many
instances, has performed pioneering work in materials, processes and
structures based on thin-film superconductive technology, and has developed
processes it believes are capable of routinely producing a variety of high
quality films in quantity for several applications, including multiple layer
thin-film materials suitable for more complex devices and components.
Compared to "thick-film" approaches and ceramic fabrication techniques, the
Company believes that the thin-film approach is more versatile and provides
more compact components and that the superconducting properties of the
materials produced in this way are superior.
FOCUS ON COMPLETE SOLUTIONS. Conductus believes that superconductive
component technology can best be provided to customers in the form of
integrated subsystems that incorporate the superconductive components,
additional electronic circuits and devices, and the self-contained
refrigeration equipment and packaging required to maintain the
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reduced temperatures necessary to sustain superconductivity. For this reason,
in addition to its thin-film expertise, Conductus has also established
significant expertise and know-how in areas that it believes are necessary
for the commercial development of superconductive technology, including
electronic device and component design, analog and digital electronic
engineering, cryogenic packaging (including cryoelectronics, thermal
management, vacuum engineering and cryocoolers), mechanical engineering and
system integration. Conductus seeks to make the presence of superconductive
and cryogenic components an entirely integral feature of its products that
requires no special expertise or skill on the part of the user. By skillful
integration of the refrigeration system into its communications filter
subsystems, for example, and by selection of a refrigeration approach with
proven durability, Conductus believes that its products can be easily
accommodated and well accepted by end users. Furthermore, the Company
believes that providing its technology at the subsystem level to system
manufacturers in specific markets will allow it to rapidly and efficiently
expand both its product line and its customer base.
BUSINESS AND DEVELOPMENT STRATEGY
Conductus' strategy for developing, manufacturing and marketing
superconductive electronics products includes the following key elements:
MAINTAIN TECHNOLOGY LEADERSHIP. Conductus has devoted significant resources
to developing proprietary HTS thin-film manufacturing and process
technologies. Based on publicly available information, the Company believes
that its technologies are more advanced than those of other companies or
research laboratories. The Company has successfully developed and marketed
products including single- and multilayer YBCO films, superconducting NMR
spectroscopy probes and SQUID sensors and systems. Conductus has utilized its
technology skills to develop filters, low-noise amplifiers, radio-frequency
receivers and other devices. Conductus has also established significant
expertise and know-how in areas essential to product commercialization,
including electronic device and component design, analog and digital
electronic engineering, cryogenic packaging, mechanical engineering and
system integration. Conductus currently owns, alone or with others, 21 U.S.
patents and three related foreign patents. Additionally, as part of the sale
of its NMR business to Bruker, Inc., it transfered ownership of an additional
6 patents for which it has retained nonexclusive, royalty-free licenses
outside the NMR field of use. Conductus currently has 8 patent applications
pending in the U.S. and related patents pending in other countries relating
to various aspects of its technologies.
COMMERCIALIZE PRODUCTS WITH SIGNIFICANT MARKET POTENTIAL. Conductus believes
that the largest potential near-term market for superconductor-based products
is the wireless communications market. The Company is actively marketing
front-end systems as well as developing additional HTS component-based
subsystems for this markets. In the cellular market, Conductus completed
field trials of its low-noise receiver filter subsystems for base stations in
mid-1997 and began commercial shipments of ClearSite-TM- front-end receiver
systems in October 1997. In addition, the Company continues to develop
additional subsystems of greater complexity for the cellular market. All
these products contain HTS filters and cryogenically-cooled low-noise
amplifiers in an integrated package that includes a refrigeration system.
DEVELOP COMMERCIAL INFRASTRUCTURE. Conductus is building the manufacturing,
sales and marketing infrastructure it believes is necessary to support the
commercialization of its products in target markets. This includes
development of thin-film deposition techniques suitable for volume
manufacture, acquisition and build-out of manufacturing and assembly areas,
hiring of employees with significant marketing experience in key product
areas and expansion of its sales team. The Company's sales and marketing
strategy is to use a direct sales organization for the initial
commercialization of its subsystem products for the communications market and
later to develop additional sales channels through OEM customers for this
equipment.
WIRELESS COMMUNICATIONS APPLICATIONS
The initial applications for superconductive technology in the communications
market are in the area of infrastructure equipment for wireless base
stations. Commercial wireless communications systems use radio frequency
signals to establish communications between customers using portable or
mobile telephones and base stations operated by service providers. Cellular
telephone networks are divided into specific coverage areas called cells,
each of which has a base station for sending and receiving voice and other
communications within the cell. The base station contains electronic
equipment required to send and receive radio signals. In setting up a base
station, the service provider seeks to install equipment with sufficient
sensitivity within the frequency band assigned to it to handle communications
with the lowest power handsets over its entire geographical area and with
sufficient selectivity to avoid interfering signals from adjacent frequency
bands. Filters within these base stations select frequencies within
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the operator's assigned bands and reject unwanted frequencies. Amplifiers
boost the strength of signals coming in and out of the base station. The
operator's assigned frequency range is then allocated using one of several
schemes to provide telephone service to multiple subscribers. The capacity of
the system depends upon the number of effective channels; that is, channels
whose signal quality is sufficient to satisfy customer demands for clear
communications.
Cellular base stations currently face a number of operating problems. These
include signal interference caused by multiple communications channels, poor
signal quality resulting from lower-power, hand-held telephones and strained
capacity due to the growing demand for cellular service. The advent of PCS
(Personal Communications Services) technology will place additional demands on
the performance of wireless base stations and upon the size of the hardware
therein. Conductus believes that superconductive filters used in conjunction
with cryogenically-cooled amplifiers have the potential to offer solutions to
several operating problems in cellular base stations as well as to provide
solutions to anticipated problems in the growing network of PCS base stations.
BENEFITS OF SUPERCONDUCTIVE TECHNOLOGY FOR WIRELESS COMMUNICATIONS
Superconductive technology can offer signficant benefits in base station
receivers. The unique characteristics of superconducting materials can be
exploited to create filters that simultaneously deliver superior performance
with respect to adjacent-band interference rejection and with respect to
insertion loss (reduction of the desired signal because of the filter.) Because
the superconductor is nearly lossless at microwave frequencies, extremely sharp
filters -- ones with a large number of poles -- can be fabricated without
incurring substantial insertion losses. Because of their low-loss property,
superconductors provide the closest physically-attainable approximation to a
perfect filter, which would allow 100% of the desired signals to pass through
and screen out 100% of the unwanted signals. Given their ability to provide
outstanding performance with respect to multiple parameters, superconducting
filters are well suited for use as preselect filters in cellular or PCS base
stations. High-performance transmit filters made from superconducting materials
may also offer significant benefits in future base station applications as the
power-handling capability of these implementations continue to improve.
An immediate benefit of superconductor technology in base station
applications is the ability to provide superior interference rejection by
virtue of making filters with a large number of poles practical to implement.
Superconducting filters can be made with 12, 16 or even 19 poles to
effectively reject adjacent-band interference which can otherwise saturate
amplifiers in the receiver front end and introduce distortion into voice
channels. Losses of 1 dB or less are typical for superconducting filters
even with these high-order designs (ones with a large number of poles). The
number of adjacent-band interference sources is increasing as additional
wireless services such as specialized mobile radio and 2-way paging are
introduced. In the PCS spectrum, the potential for up to six service
providers to operate in a given area and the inevitability of co-location of
transmitters may drive the need for filters with improved rejection
capabilities.
A second benefit of superior superconducting filters is the potential ability
to fully utilize the available spectrum without introducing guard bands or
blocked channels at the band edge. By using extremely sharp adjacent-band
rejection filters -- often referred to as "brick-wall" filters -- it is
possible to maintain a greater number of voice channels in the band. This
opportunity is particularly attractive in the PCS spectrum in which very
narrow, 5 MHz frequency blocks have been licensed to carriers in addition to
earlier wide-band, 15 MHz blocks. In the narrow-band case, the conventional
configuration for CDMA systems is to utilize three 1.25 MHz carriers within
each block, with the remaining 1.25 MHz not utilized for guard-band purposes.
This provides plenty of separation from adjacent, competing services but is
very wasteful of spectrum. By using a sufficiently sharp superconducting
filter, it may be possible to instead have a fourth channel within a single
narrow-band block. Generally speaking, even in less dramatic broad-band use,
extremely sharp filters can increase the effective capacity of wireless
systems.
A third benefit of superconductor and, more generally, cryoelectronic
technology in base stations is the potential for providing extended coverage
by virtue of reducing the noise floor in the receiver front end of the base
station. This benefit is derived from a combination of highly efficient
superconducting filters that contribute minimal losses along with advanced
ultra-low-noise amplifiers whose own noise levels are reduced by the
cryogenic temperatures already present for the associated superconducting
filters. Superconducting filters contribute very small amounts of noise
because their quality or "Q" factors -- a measure of the ratio between stored
and dissipated energy -- are much higher than can be achieved using other
base station filter technologies. Properly-designed semiconductor low-noise
amplifiers (LNAs) -- for example, certain gallium arsenide HEMTs -- exhibit
enhanced noise performance when operated significantly below room
temperatures. Co-locating these LNAs with superconducting filters to take
advantage of the cryogenics required in the latter case provides an
ultra-low-noise receiver front end. Reducing the noise figure of a base
station's receiver enhances its sensitivity to incoming signals, which
potentially both increases its range and improves coverage within a cell.
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The fourth benefit offered by superconductor technology is the potential for
form-factor reductions in filter subsystems that utilize thin-film
superconductor components. The same basic steps of film deposition,
photolithography and etching that are familiar in the semiconductor industry
are used in fabricating thin-film superconducting devices. The resultant
thin-film superconducting filters are planar devices that utilize microstrip
technology to realize high-performance microwave filters in a very compact
form. Even a 19-pole cellular filter can easily fit on a 3-inch wafer.
Superconducting filters do require the use of a cryogenic refrigerator, which
can occupy perhaps a cubic foot or so of space. However, six or even twelve
filters can be cooled by one such refrigerator, leading to an integrated
filter subsystem package that is smaller and lighter than competing
technology can provide.
APPLICATIONS FOR SUPERCONDUCTING FILTERS
There are applications for superconducting filter technology in existing
wireless systems as well as in forthcoming infrastructures such as PCS.
Superconducting preselect filters offer performance advantages to analog
systems like AMPS cellular as well as to digital protocols such as CDMA, TDMA
and GSM. Depending upon the application, one or more of the benefits of the
technology noted above will come into play. There can be no assurance that
even if the Company's products provide such technological benefits that
Conductus will be able to manufacture adequate quantities of any products it
introduces at commercially acceptable costs or on a timely basis or that any
such products will offer sufficient price/performance advantages to achieve
market acceptance. See "Risk Factors - Early Stage of the Superconductive
Electronics Market; Lack of Market Acceptance."
In current cellular systems, the needs of urban and rural operators are quite
different. Urban base stations are typically high-capacity cells in harsh or
otherwise conjested RF environments. Key issues are interference rejection
and maximizing capacity. In contrast, rural base stations see relatively low
call volumes but struggle with problems with the reverse channel path
(mobile/portable handset to base communications) because of the lower power
levels transmitted by hand-held phones compared to earlier mobile systems
whose maximum transmit power was five times that of the small portables in
use today. In this environment, range extension and coverage improvement are
the key issues.
The growing PCS infrastructure presents a variety of opportunities for
superconducting filter technology. With multiple bands, large numbers of
base stations, new interference sources and tight space constraints, all the
virtues of superconducting filter technology are likely to be needed to solve
problems, some of which cannot be anticipated at this early stage of the
deployment. The match-up between benefits and applications for
superconductors in wireless systems is summarized in the chart below.
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SUPERCONDUCTOR BENEFIT REASON RURAL CELLULAR URBAN CELLULAR PCS
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Reduced Interference Sharp filters X X
Increased Capacity Sharp filters X X
Improved Coverage/ Reduced system noise X X
Extended Range
Compact form-factor Thin-film technology X X
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WIRELESS COMMUNICATIONS MARKET
CELLULAR MARKET. According to Federal Communications Commission and industry
reports, there are more than 25,000 installed cellular base stations in the
United States. The present cellular communications network, operating at
frequencies near 850 MHz, was established at a time when the typical cellular
telephone was a mobile unit capable of transmitting up to 3 watts of radio
frequency power and the total number of subscribers was relatively low. Today,
portable handsets that transmit only 0.6 watts are increasingly replacing
higher-power mobile telephones, thereby decreasing the effective receiving range
of existing base stations. As a result, in rural areas where base stations are
widely separated, current cellular customers can experience dropped calls due to
"dead zones" in coverage. At the same time, the increasing demand for cellular
service in urban areas has led to the utilization by service providers of a
greater number of channels within their allotted frequency bands, thereby
increasing the
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incidence of interference. In addition, the arrival of PCS and other
competing services has placed new emphasis upon quality of service for
established cellular operators.
In rural areas, where the primary problem is base station range, solutions that
increase the strength of the received signal or decrease the system noise level
can provide enhanced reception, and thus reduce the occurrence of dead zones.
One solution, which entails significant costs, is to increase the number of base
stations and thereby reduce the required range for each station. Another
solution, which is potentially more economical, is to enhance the signal
reception and noise filtering capabilities of existing base stations. Extended
field trials of Conductus' ClearSite-TM- brand front-end receiver system in the
rural environment have demonstrated the system's ability to fill in holes in
coverage between specific cell sites. In recent trials conducted by the
Company, ClearSite-TM- systems demonstrated a 20% reduction in dropped calls and
provided notable improvements in voice quality.
In urban areas, the high density of cellular users creates problems of
interference and system capacity. In every area, there are two cellular service
providers, each allotted its own operating band within the frequency spectrum.
Near the edges of each provider's operating frequency range, the performance of
cellular systems can be hampered by interference from the competing carrier and
from a variety of other signal sources. Carriers can attempt to avoid this
interference by not using channels at the edges of their operating bands,
however this diminishes system capacity. An alternative approach is to address
interference by using highly selective filters in the base station receiver.
With superconducting materials, which exhibit extremely low energy loss, filters
can be fabricated with a higher number of poles, thereby increasing filter
selectivity. With increased selectivity, increased capacity and better
performance are simulaneously attainable.
PCS MARKET. PCS is a newer, urban-based communication system designed to
provide wireless telephone service utilizing radio frequency signals in a
frequency band near 2 GHz. This all-digital system is being designed to handle
both voice and data transmissions, including features such as Internet access.
Although it utilizes the same basic building blocks as a cellular system, the
higher operating frequency of PCS compared with the cellular network limits the
range of its signal transmission. Because of this limited range of signal
transmission, industry estimates are that more than 70,000 PCS base stations
will be installed throughout the U.S. by the end of the year 2005.
The projected large number and primarily urban location of PCS base stations
drives the need for equipment cost and size reduction. However, signal losses in
base station components such as filters, antennas and cables are exacerbated by
higher frequency operation. Conventional receiver components limit sensitivity
and therefore base station range. Conventional filters tend to be physically
large and proposed PCS base station architectures call for the use of multiple
filters in each station. Collectively, these issues present a difficult set of
requirements for the designers of both current and forthcoming PCS base station
equipment. Conductus believes that as the PCS build-out proceeds, the incidence
of problems such as adjacent-band interference and gaps in coverage will
steadily increase and the opportunities for applications for superconductive
filter subystems will grow accordingly. Due to slower than expected progress in
the PCS deployment, the Company does not expect to begin volume shipments of
product for that market before 2000.
FUTURE APPLICATIONS.
Conductus is exploring the application of superconductive and cryoelectronic
technologies to a variety of applications in the broader communications market.
Among these are subsystems for communications satellites, antenna components and
various elements of high-speed and/or high-bandwidth communications equipment.
Generally speaking, many electronic technologies, including CMOS, GaAs,
optoelectronics and even copper, exhibit enhanced performance at reduced
temperatures, but the most compelling performance improvements are enabled by
superconductive electronics. When the unique advantages of superconductive
electronics are complemented by the advantages of other cryoelectronic
technologies, the result is a hybrid system whose overall performance may
justify the costs and complexities associated with cryogenic cooling.
In the future, cryoelectronics in communications systems may expand to more
complex digital applications. The reason is that the ever-increasing
bandwidth of digital and wireless communication networks has created a need
for ultra-high-bandwidth cryoelectronics to process and route digital
information. Although fiber-optical transport networks are expected to
transmit 100 Gb/s data, conventional electronic switching technology is not
capable of processing at such high data rates. This situation creates an
electronic bottleneck in telecommunication networks for high-throughput
applications such as Internet backbone switching, satellite communications,
local-area and wide-area graphics networks, and video on demand.
Superconductive digital technology, interfaced to optical fiber via cooled
semiconductor electronics, can increase the capacity and functionality of
future ultra-high-speed networks and enable many real-time communication and
multimedia applications. The high-speed, low-power properties of Josephson
junctions, which are active switching devices made from superconductors,
could be applied to
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communications systems to significantly improve data transmission rates and
reduce system power requirements and costs. These devices can be several
times faster than the fastest semiconductor transistor and consume thousands
of times less power. Josephson junction circuit technology is in the early
stages of development, and significant additional advancements will be
required before superconductive products incorporating this technology could
become available. Nevertheless, the combination of high speed, low power
dissipation and fast synchronization makes superconductive digital technology
increasingly attractive for future communications applications. See "Risk
Factors - Early Stage of the Superconductive Electronics Market; Lack of
Market Acceptance," "-- Dependence On Incorporation of Potential Products in
Third Party Systems," and "-- Intense Competition."
COMMERCIALIZATION STATUS
Conductus began field testing prototypes of the ClearSite front-end receiver
systems for wireless base station applications in 1996, working with a number
of cellular operators in several regions of the United States. The product
progressed to the beta stage late in that year with the initiation of an
extended field trial with Cellcom, Incorporated, a service provider in
Wisconsin. The trial was concluded in the Spring of 1997, resulting in data
on the performance of the system in reducing dropped calls and enhancing
voice quality and leading to the first commercial orders for the product.
Based upon these field trial results and on additional inputs from customers
throughout the industry, additional features were engineered into the
ClearSite front-end receiver system and it was released to the market late in
1997. As finally configured, the ClearSite front-end receiver system
incorporates superconducting filters and cryogenic low-noise amplifiers as
well as built-in rf diagnostics, alarm systems, remote monitoring
capabilities and bypass circuitry in case of system failure. Initial
shipments have been for omnisite systems -- incorporating two filters and two
amplifiers -- designed to be installed inside base stations. These systems
are configured for either of the frequency bands currently allotted to
cellular operators (both "A" and "B" bands.) Scheduled for release during
1998 are three-sector systems (incorporating six filter/amplifier pairs) and
tower-mount versions of the product for both carriers. Therefore, by the end
of 1998, ClearSite front-end receiver systems for cellular are planned to be
a family of products designed to address all types of installations in the
domestic market. There can be no assurance that the Company will be
successful in developing, introducing and marketing new products or
enhancements to existing products or will not experience difficulties that
could delay or prevent the successful development, introduction or marketing
of these products, or that its new products and product enhancements will
adequately meet the requirements of the marketplace and achieve any
significant degree of commercial acceptance. Furthermore, there can be no
assurance that even if the Company's products meet commercial performance
standards that Conductus will be able to manufacture adequate quantities of
any products it introduces at commercially acceptable costs or on a timely
basis or that any such products will offer sufficient price/performance
advantages to achieve market acceptance. See "Risk Factors - Early Stage of
the Superconductive Electronics Market; Lack of Market Acceptance."
STRATEGIC ALLIANCES AND DEVELOPMENT AGREEMENTS
Conductus is party to a number of collaborative arrangements with
corporations and research institutions with respect to the research,
development and marketing of certain of its potential products. Conductus
evaluates, on an ongoing basis, potential collaborative relationships and
intends to continue to pursue such relationships. The Company's future
success will depend significantly on its collaborative arrangement with third
parties. There can be no assurance that these arrangements will result in
commercially successful products. See "Risk Factors - Extensive Reliance on
Collaborative Relationships," and "Limited Outlet for Certain Products."
LUCENT TECHNOLOGIES, INC. Conductus and Lucent entered into a joint
development and licensing agreement in April 1996, under which Conductus is
developing a superconductive transceiver filter subsystem for the PCS market.
Both Conductus and Lucent are to provide technical support to the program.
Initial tests of a prototype of the receiver portion of the subsystem were
conducted in April 1996. A more complex prototype subsystem containing six
HTS receiver channels and three conventional transmit filters was delivered
to Lucent at the end of that year. Each party will retain rights to the
intellectual property it develops under the program, subject to certain
nonexclusive licensing rights of the other party, and jointly developed
intellectual property will be jointly owned.
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CTI-CRYOGENICS. Conductus and CTI-Cryogenics, a division of Helix Technology
Corporation, entered into a collaboration agreement in September 1995, under
which CTI will work with Conductus to design interfaces between CTI
cryocoolers and Conductus subsystems.
HIGH-TEMPERATURE SUPERCONDUCTOR THIN-FILM MANUFACTURING ALLIANCE. Conductus
is a principal member of the HTMA, which was formed in November 1995 to
develop cost-effective manufacturing methods for YBCO thin-films for
radio-frequency applications, establish industry standards and provide
second-sourcing and technology transfer among the companies under a program
currently funded in part by the Department of Defense Advanced Research
Projects Agency ("DARPA"). Superconductor Technologies, Inc. ("STI") is the
other principal member of the HTMA. Other members include Stanford
University, the Georgia Research Corporation, Focused Research,
Microelectronic Control and Sensing Incorporated, IBIS and BDM Federal. Under
the HTMA, each party will have certain access to the technology of the other
parties that is developed under the program.
RESEARCH AND DEVELOPMENT
GOVERNMENT CONTRACTS. The Company's research and development expenses in the
fiscal years 1997, 1996 and 1995 were approximately $10,626,000, $11,774,000,
and $9,819,000, respectively. Externally funded research and development
programs, primarily under contracts with agencies of the U.S. government,
accounted for approximately $9,814,000, $13,178,000, and $9,176,000 of total
operating expenses in the fiscal years 1997, 1996, and 1995, respectively.
The Company's revenue from government-related contracts represented
approximately 77% of total revenues for each of the fiscal years 1997, 1996,
and 1995. Conductus believes that it will continue to be heavily dependent on
U.S. government contracts to fund a significant portion of its research and
development programs. The Company's strategy is to fund a significant portion
of its research and development, particularly for wireless communications and
digital electronics applications, through contracts with agencies of the U.S.
government. As of December 31, 1997, the Company had received aggregate
awards since its inception of approximately $46,821,000 from U.S. government
agencies, including approximately $40,272,000, recognized as revenue by the
Company through December 31, 1997, and approximately $6,373,000, in awards
for which it has not yet entered into research contracts. As of December 31,
1997, Conductus had backlog of approximately $176,000, under existing U.S.
government contracts which provide that most of the research and development
is to be performed in the next 12 months. Revenue under U.S. government
research and development contracts decreased to $7,266,000 in 1997 from
$9,691,000 in 1996 and $8,148,000 in 1995 and represented approximately 77%
of total revenue in each of the fiscal years 1997, 1996, and 1995. The
decrease in contract revenues during 1997 is largely attributable to the
completion of several major contracts during 1997. The Company had backlog of
approximately $176,000 and $4,620,000 in contracts and grants at December 31,
1997 and 1996, respectively. In addition, at December 31, 1997 and 1996
respectively, the company had approximately $6,373,000 and $8,976,000 in
awards from U.S. government agencies which have not been funded by the
government. Conductus anticipates that government contract revenues will
continue to decline somewhat in the future compared to historical rates due
to reductions in federal R & D funding and the narrower scope of the
Company's business interests. The recognition of revenue and receipt of
payment pursuant to these contracts and awards are subject to numerous risks.
See "Business -Research and Development" and Note 11 of Notes to Financial
Statements. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Results of Operations."
The Company's contracts involving the U.S. government are or may be subject
to numerous risks. These risks include: unilateral termination for the
convenience of the government; reduction or modification in the event of
changes in the government's requirements or budgetary constraints; increased
or unexpected costs causing losses or reduced profits under fixed-price
contracts or unallowable costs under cost reimbursement contracts; risks of
potential disclosure of Conductus' confidential information to third parties;
the failure or inability of the prime contractor to perform its prime
contract in circumstances where Conductus is a subcontractor; the failure of
the government to exercise options provided for in the contracts; the
government's nonexclusive, royalty-free license to use technology developed
pursuant to the contracts by or on behalf of the government in certain
circumstances; and exercise of "march-in" rights by the government. March-in
rights refer to the right of the U.S. government or government agency to
require the Company to license patented technology developed under contracts
funded by the government if the contractor fails to continue to develop the
technology. In addition, there can be no assurance that the U.S. government
will continue its commitment to programs to which the Company's development
projects are applicable, particularly in light of recent legislative
initiatives to reduce the funding of various U.S. government agencies and
programs, or that the Company can compete successfully to obtain funding
pursuant to such programs, See "Risk Factors -High Degree of Dependence Upon
Government Contracts."
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PATENTS, PROPRIETARY TECHNOLOGY AND TRADEMARKS
Conductus has received 27 U.S. patents and three related foreign patents. Six
issued patents were assigned to Bruker Instruments, Inc. under an asset
purchase agreement entered into in July 1997. Conductus retains a
nonexclusive, royalty-reee license to those patents outside the NMR field of
use. The remaining 21 patents have unexpired terms ranging from 12 to 17
years. Additionally, the Company has 8 patent applications pending before the
U.S. Patent and Trademark Office. International counterparts of several of
these pending applications or issued patents have been filed under the Patent
Cooperation Treaty with a number of applications currently pending in various
countries worldwide. These patents and patent applications cover Conductus
processes and products in many aspects of its business. The Company will
continue to file other U.S. and key international patent applications as part
of its business strategy to protect technology it considers important to
providing a competitive market advantage for its technologies. There can be
no assurance, however, that its applications will result in issued patents,
that the validity of its issued patents will not be subject to challenge or
that third parties will not be able to design around the patented aspects of
the Company's products. The Company also relies upon trade secrets,
unpatented know-how, continuing technological innovation, employee and third-
party nondisclosure agreements and the pursuit of licensing opportunities in
order to develop and maintain its competitive position. The Company's efforts
to protect its proprietary rights may not be successful, prevent their
misappropriation or ensure that these rights will provide the Company with a
competitive advantage. Additionally, certain of the issued patents and patent
applications are jointly owned by the Company and third parties. Any party
owner has the right to license rights under such patents and applications,
which could result in Conductus not having exclusive control over such
inventions.
The Company believes that, since the discovery of HTS in 1986, several
thousand patent applications have been filed worldwide and over 600 patents
have been granted in the U.S. relating to high temperature superconductivity.
In some cases, these patents may be overlapping, and could require a number
of licenses from different entities. There are interference proceedings
pending regarding rights to inventions claimed in some of the applications.
Accordingly, the patent positions of companies using HTS technology,
including Conductus, are uncertain and involve both complex legal and factual
questions. Consequently, there is significant risk that others, including
competitors of the Company, have obtained or will obtain patents relating to
the Company's planned products or technology and that the Company will be
unable to obtain licenses, or will be unable to obtain licenses on
commercially reasonable bases.
A patent issue of particular importance to the Company relates to copper
oxides or "cuprates," that are used to make HTS products, including YBCO.
Conductus has neither obtained any issued patents nor has it filed any patent
applications covering the composition of any cuprates or other HTS materials.
However, several U.S. and foreign patent applications, including applications
filed by IBM, AT&T, the University of Houston, the Naval Research Laboratory
and others, are pending that cover the composition of YBCO and related HTS.
See "Overview --Conductus' Approach." The Company understands that at least
several of such U.S. applications are the subject of an interference
proceeding currently pending in the U.S. Patent and Trademark Office
(Interference No. 101,981). Additionally, E. I. duPont de Nemours & Co.
("DuPont") has notified Conductus that it is the exclusive licensee of
patents issued in Israel, Sweden, Taiwan and the United Kingdom covering the
composition of YBCO and a method for using YBCO in superconducting
applications. The Company anticipates that it will be required to obtain a
license to use YBCO from one or more of these parties in order to continue to
develop and sell products based on YBCO.
There can be no assurance that the Company would be able to obtain licenses
to patents covering YBCO compositions, when issued, or to any other patents
applicable to the Company's business on commercially reasonable terms. In
such an event, the Company could be required to expend significant resources
to develop non-infringing technology alternatives or to obtain licenses to
the technology that the Company infringes or would infringe. There can be no
assurance that the Company would be able to successfully design around these
third party patents or to obtain licenses to technology that it may require.
Furthermore, there can be no assurance that the Company will not be obligated
to defend itself at substantial cost against allegations of infringement of
third party patents. An adverse outcome in such a suit could subject the
Company to significant liabilities to third parties, or require the Company
to cease using such technology. In addition, aside from the merits of a
claim, the cost of defending any such suit would constitute a major financial
burden for the Company that would have a material adverse effect on its
business, operating results, and financial condition.
Conductus has granted to various entities non-exclusive, royalty-bearing
licenses to certain of its proprietary technology for the manufacture and
distribution of various equipment, including rotating target holders,
substrate heaters and mutual inductance probes to be used in cryogenic
measurement systems. Through its strategic relationships, Conductus has
received rights to certain intellectual property developed by its partners,
as well as
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commitments from those partners to offer licenses to certain background
technology. Conductus cannot, however, be certain that such licenses will be
on terms that allow Conductus to compete effectively in the marketplace.
Additionally, successful marketing of a material portion of Conductus'
products depends in part on nonexclusive licenses obtained from various
licensers. There can be no assurance that such licenses will not be
terminated by licensors or that Conductus will be able to develop alternate
products that do not require these or other licenses.
Conductus owns the United States registered trademarks "CONDUCTUS-Registered
Trademark-,' the Conductus logo, "Mr. SQUID-Registered Trademark-" and claims
the rights to the trademarks "ClearSite-TM-", and "pcSQUID-TM-". See "Risk
Factors - Uncertainty of Patents and Proprietary Rights; Risk of Litigation."
MANUFACTURING
Conductus has performed pioneering work in materials, processes and
structures based on thin-film superconducting technology, and has developed
processes it believes are capable of routinely producing a variety of
high-quality films for several applications, including multilayer thin-film
materials suitable for more complex devices and components. Conductus has
established a pilot production facility at its headquarters in Sunnyvale,
California to fabricate, test and assemble HTS and LTS thin films and
components. The Company fabricates two-, three- and four-inch wafers in two
cleanroom areas that consist, in the aggregate, of approximately 2,600 square
feet and that have ratings of subclass 1,000 and 10,000 (meaning there are
fewer than 1,000 or 10,000 particles larger than 0.5 microns per cubic foot
of air). Additionally, Conductus assembles systems in a 3250 square foot
manufacturing facility which includes class 10,000 cleanrooms of
approximately 1250 square feet. See "Properties." Conductus combines what it
believes to be the world's most advanced YBCO thin-film technology with
expertise in electronic and device component design, analog and digital
electronic engineering, cryogenic packaging, mechanical engineering and
system integration.
The primary materials and equipment used in Conductus' products include
substrates, YBCO precursors and processing equipment. The Company procures
its substrates from several suppliers. The Company primarily utilizes
elemental metals (yttrium, barium and copper) to produce YBCO. These
substances are available from numerous vendors. In limited cases, the Company
uses YBCO targets, which it purchases from two sources. The Company's
processing equipment is assembled from off-the-shelf components which can be
obtained from multiple sources.
Conductus believes that most of its products will be in the form of
subsystems that incorporate superconducting and cryoelectronic components
with cryogenic refrigerators and conventional electronic assemblies. Apart
from the superconducting components which are manufactured by Conductus, the
Company anticipates that most other components of its subsystems will be
purchased as standard products from commercial vendors or specially ordered
from various suppliers. These include cryogenic refrigerators, printed
circuit boards, product cases and housings, vacuum vessels and other
components. Certain components of Conductus' subsystems, including
cryocoolers, are currently obtained from a single source or a limited number
of suppliers, Although the Company does not believe that it is ultimately
dependent upon any supplier as a sole source or limited source for any
critical components, the inability of the Company to develop alternative
sources, if required, an inability to meet demand, a prolonged interruption
in supply or a significant increase in price of one or more components would
have a material adverse effect on the Company's business, operating results
and financial condition. See "Risk Factors - High Degree of Dependence Upon
Other Complementary Technologies" and "-- Reliance on Limited or Sole-Source
Suppliers."
Conductus is focusing on the development of its production processes and is
manufacturing limited quantities of superconducting components and products
incorporating those components at its Sunnyvale, California, facility. Apart
from the production of superconducting components, the Company expects that
its manufacturing activities generally will be limited to cleaning, final
assembly, vacuum bakeout and testing. Conductus is producing these products
in limited commercial quantities and is continuing to expand its
capabilities. See "Risk Factors - Limited Commercial Manufacturing
Capability. In July 1997, Conductus ceased operation of its Instrument and
Systems Division in San Diego, California and consolidated its manufacturing
in Sunnyvale, California.
COMPETITION
Although the market for superconductive electronics currently is small and in
the early stages of development, Conductus believes this market will become
intensely competitive if products with significant market potential are
successfully developed.
A number of large American, Japanese and European companies are engaged in
research and development programs that the Company believes could lead to the
development and/or commercialization of superconductive electronic
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products. These include, among others: DuPont, IBM, TRW, and Northrop-Grumman
Corporation in the U.S.; and Fujitsu Ltd., Hitachi Ltd., NEC Corp. and
Sumitomo Electric Industries, Ltd. in Japan. The Company also believes that a
number of smaller companies are engaged in various aspects of the development
and commercialization of superconductive electronics products. These include,
among others, Hypres, Inc. in digital circuits; and Illinois Superconducting
Corp., Superconducting Core Technologies, Inc. and Superconductor
Technologies Inc. in wireless communications. Furthermore, academic
institutions, governmental agencies and other public and private research
organizations are engaged in development programs which may lead to
competitive arrangements for commercializing superconductive electronics
products. In addition, if the superconductor industry does develop further,
new competitors with significantly greater resources are likely to enter the
field. Conductus' ability to compete successfully will require it to develop
and maintain technologically advanced products, attract and retain highly
qualified personnel, obtain patent or other protection for its technology and
products and manufacture and market its products, either alone or with third
parties. See "Risk Factors - Intense Competition."
Several of the Company's existing collaborative arrangements permit, and
future arrangements also may permit, the Company and each partner to use the
technology developed under these arrangements. Accordingly, the Company may
compete with its partners for commercial sales of any products developed
under these arrangements.
The Company's potential products, if successfully developed, may compete
directly with other existing and subsequently developed products using
competitive, conventional technologies. There can be no assurance that the
Company's products will have sufficient performance advantages over these
other products to attract significant commercial interest. These and related
factors may limit market acceptance of products incorporating superconductive
technology. See "Risk Factors - Competing Technologies." Conductus believes
that the principal competitive factors in the market for superconductive
electronics will be the following: the ability to develop commercial
applications of superconductive technology; product performance, including,
where appropriate, speed, sensitivity, size and power dissipation; price;
product quality and reputation. Conductus believes that it is competitive
with respect to these factors. Nonetheless, because the market for
superconductive electronics is at an early stage, the relative competitive
position of the Company in the future is difficult to predict.
SALES AND MARKETING
Although Conductus has limited experience in sales, marketing and
distribution, it has been expanding its expertise and activities in these
areas in order to successfully commercialize its potential products. During
1997, the Company hired a Vice President Sales and Marketing and added a
Director of Sales. Conductus sells its products through a combination of
direct sales and OEM relationships. The Company's sales and marketing
strategy is to rely primarily on direct sales for its communications
products. Its magnetic sensors are sold primarily to an OEM. See "Risk
Factors - Need to Develop Infrastructure to Support Commercialization.
The Company currently employs a sales and marketing staff of 6 full-time
equivalents. These employees are actively engaged in direct marketing to
customers, as well as in sales and marketing support. The Company actively
markets its products through direct mail advertisements and advertisements in
trade journals, as well as through demonstration of its technology and
products at industry trade shows. The Company's employees have published the
results of their research at Conductus widely in trade and technical
journals. Additionally, Conductus' employees have frequently presented
Conductus' technology as invited speakers at conferences worldwide.
For the fiscal years 1997, 1996, and 1995, commercial sales to one customer
of $896,000, $1,560,000, and $1,172,000 were 9%, 12%, and 11% of total
revenues, respectively. This customer, Niki Glass Ltd., acts primarily as a
distributor of the Company's magnetic sensing products, selling to end-users.
ENVIRONMENTAL MATTERS
The Company uses certain hazardous materials in its research and
manufacturing operations. As a result, Conductus is subject to federal, state
and local governmental regulations. Conductus believes that it has complied
with all regulations and has all permits necessary to conduct its business.
See "Risk Factors - Environmental Regulations."
EMPLOYEES
As of December 31, 1997, the Company had a total of 90 full-time equivalent
employees of which 39 hold advanced degrees. Of the total full-time
employees, 52 were engaged in research and product development, 14 in
manufacturing, 4 in sales and marketing, and 20 in administration. None of
the Company's employees
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is represented by a labor union. The Company has not experienced any work
stoppages and considers its relations with its employees to be good.
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RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION IN THIS FORM 10-K, PROSPECTIVE INVESTORS
SHOULD CONSIDER THE FOLLOWING RISK FACTORS INHERENT IN AND AFFECTING THE
BUSINESS OF THE COMPANY. THE DISCUSSION IN THE FORM 10-K CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS MAY DIFFER
SIGNIFICANTLY FROM THE RESULTS DISCUSSED BELOW AND IN "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
SUBSTANTIAL FUTURE CAPITAL NEEDS. The Company to date has received limited
revenues from product sales and as of March 23, 1998, had cash reserves of
approximately $540,000.
On March 30, 1998, the Company entered into an agreement to expand its
existing bank working capital line of credit from $1,000,000 to $2,000,000,
subject to receivables eligibility requirements and certain other
restrictions. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources" and
Note 17 of Conductus, Inc., Notes to Financial Statements, "Subsequent
Events."
On April 23, 1998, the Company entered into a "bridge" loan credit facility
agreement with its bank. The facility provides for borrowings of up to
$2,000,000, with interest at the bank's prime rate plus 2.00%. The facility
matures in 120 days, but may be paid off sooner at the Company's option. The
agreement grants to the bank a warrant to purchase 15,000 shares at $3.625
per share, the closing price for the Company's shares on April 13, 1998.
The agreement provides for additional warrants to be granted based on the
length of time the loan is outstanding, as follows:
if the loan is outstanding after May 31, 1998, a warrant for an
additional 10,000 shares at the May 31, 1998 closing price will be
granted.
if the loan is outstanding after June 30, 1998, a warrant for an
additional 25,000 shares at the June 30, 1998 closing price will
be granted.
Borrowings under this facility are collateralized by a first priority
security interest in all of the Company's property, including intellectual
property rights. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources" and
Notes 1 and 17 of Conductus, Inc. Notes to Financial Statements.
On April 22, 1998, the Company entered into a lease line of credit commitment
with a leasing company. Under the terms of this commitment, the Company will
sell certain of its assets to the leasing company and lease the assets back
from the leasing company. The amount available under this facility is
$2,000,000 with another $500,000 available contingent upon the Company
achieving certain financial requirements in the future. The facility grants
to the leasing company warrants to purchase up to $125,000 of the Company's
stock at a price equal to the average closing bid price for the five days
immediately preceding and including April 22, 1998. The effective interest
rate would be 13.98%, and there are certain reporting and financial covenants
which the company is required to satisfy.
All the credit facilities contain financial and reporting covenants. In the
event of default on any of these covenants, the entire amount outstanding
could become due and payable immediately upon default and assets
collateralizing the amounts outstanding could be seized and sold by the
lender, unless such default is waived by the lender. There can be no
assurance that the Company will satisfy such covenants or, if the Company
fails to satisfy such covenants, that waivers will be obtained from lenders
in the event of future defaults.
Conductus anticipates that its existing sources of liquidity and anticipated
revenue, primarily from government contracts, will satisfy the Company's
projected working capital and other cash requirements through at least
December 1998. There can be no assurance, however, that changes in the
Company's plans or other events affecting the Company will not result in the
expenditure of such resources before such time.
The Company has adopted a plan consisting of the following additional steps
to conserve cash and improve its liquidity. The Company has implemented a
cost reduction program which will result in immediate headcount reduction of
11 employees and reduced levels of operation expenses, working capital
requirements, and capital expenditures over the next several quarters. The
Company also continues to explore and evaluate equity and debt financing
alternatives. There can be no assurance that any or all of the measures
taken by the Company will provide sufficient liquidity.
The development of the Company's planned products will require a commitment
of substantial additional funds. There can be no assurance that additional
financing will be available on acceptable terms or at all. Unless the
Company is able to raise significant additional funds, through debt or equity
issuances, asset sales or otherwise, the Company will be required to delay,
scale-back or eliminate one or more of its research and development programs
or obtain funds through arrangements with collaborative partners or others
that may require the Company to relinquish rights to certain of its
technologies or potential products that the Company would not otherwise
relinquish. The Company's future capital requirements will depend on many
factors, including continued progress in its research and development
programs, the magnitude of these programs, the time and cost involved in
obtaining any required regulatory approvals, the costs involved in preparing,
filing, prosecuting, maintaining and enforcing patents, successful completion
of technological, manufacturing and market requirements, changes in existing
research relationships, the availability of funding under government
contracts, the ability of the Company to establish collaborative arrangements
and the cost of manufacturing scale-up and the amount and timing of future
revenues. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Liquidity and Capital Resources."
EARLY STAGE OF THE SUPERCONDUCTIVE ELECTRONICS MARKET; LACK OF MARKET
ACCEPTANCE. Conductus was founded in September 1987 and to date has been
engaged principally in research and development activities. Although
Conductus has introduced a number of superconductive electronic products,
most of Conductus' revenues to date have been derived from research and
development contracts. The superconductive electronics market is new, with
limited product commercialization to date. There can be no assurance that the
Company will be successful in developing, introducing and marketing new
products or enhancements to existing products or will not experience
difficulties that could delay or prevent the successful development,
introduction or marketing of these products, or that its new products and
product enhancements will adequately meet the requirements of the marketplace
and achieve any significant degree of commercial acceptance. Furthermore,
there can be no assurance that even if the Company's products meet commercial
performance standards that Conductus will be able to manufacture adequate
quantities of any products it introduces at commercially acceptable costs or
on a timely basis or that any such products will offer sufficient
price/performance advantages to achieve market acceptance. The Company's
failure to
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successfully develop, manufacture and commercialize products that offer
sufficient price/performance advantages to achieve significant market
acceptance on a timely and cost-effective basis would have a material adverse
effect on the Company's business, operating results and financial condition.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
ACCUMULATED DEFICIT AND ANTICIPATED FUTURE LOSSES; UNCERTAINTY OF FINANCIAL
RESULTS. As of December 31, 1997, the Company had accumulated net losses of
approximately $36.8 million. Conductus expects to incur substantial
additional losses at least during 1998 as it expands operations. Continued
development of the Company's products may require the commitment of
substantial resources to research and development, establishment of
additional pilot and commercial-scale fabrication processes and facilities,
and enhanced quality control, marketing, sales and administrative
capabilities. In order to achieve profitability, Conductus, on its own or
with collaborative partners, must successfully develop, manufacture,
introduce and markets its potential products. There can be no assurance that
the Company will ever be able to achieve profitable operations or, if
profitability is achieved, that it can be sustained.
QUARTERLY FLUCTUATIONS. The Company's operating results have varied
substantially on a quarterly basis and such fluctuations are expected to
continue and perhaps increase in future periods as the Company seeks to
commercialize its products. Factors that may affect the Company's operating
results include the timing of government funding awards, the timing and
market acceptance of new products or technological advances by the Company
and its competitors, the timing of significant orders from and shipments to
customers, changes in pricing policies by the Company and its competitors,
the mix of distribution channels through which the Company's products are
sold, the accuracy of resellers' forecasts of end user demand, regulatory
changes, the ability of the Company and its subcontractors to obtain
sufficient supplies of limited or sole-source components for the Company's
products and general economic conditions both domestically and
internationally. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
HIGH DEGREE OF DEPENDENCE UPON OTHER COMPLEMENTARY TECHNOLOGIES. Commercial
uses of superconductive products will depend generally on the commercial
availability of a number of other technologies such as specialized mechanical
refrigeration systems, cryogenically-cooled semiconductor technology and
large-area compatible wafer substrates, some of which are in the development
stage. Conductus currently does not intend to devote significant effort or
resources to developing these technologies, and is dependent on the
development activities of third parties in these areas. There can be no
assurance that these technologies will be successfully developed and
commercialized, or that they will achieve market acceptance.
RELIANCE OF LIMITED OR SOLE-SOURCE SUPPLIERS. Certain components of
Conductus' subsystems, including cryocoolers, are currently obtained from a
single source or a limited number of suppliers. The inability of the Company
to develop alternative sources, if required, an inability to meet demand, a
prolonged interruption in supply or a significant increase in price of one
or more components would have a material adverse effect on the Company's
business, operating results and financial condition.
DEPENDENCE ON INCORPORATION OF POTENTIAL PRODUCTS IN THIRD PARTY SYSTEMS.
Many of Conductus' potential products, if successfully developed, are likely
to be used as components or subsystems in systems manufactured and sold by
third party systems manufacturers. There can be no assurance that these
third parties will elect to incorporate superconductive electronic products
in these systems or, if they do, that related system requirements, such as
data processing software and hardware capabilities, can or will be
successfully developed. Failure of third parties to successfully
commercialize complementary technologies or to incorporate the Company's
products into their systems would have a material adverse effect on
Conductus' business, operating results and financial condition.
RELIANCE ON COLLABORATIVE RELATIONSHIPS. Conductus has established and
continues to seek to establish collaborative arrangements with corporate
partners, government agencies and public and private research institutions to
develop, manufacture and market superconductive electronic products.
Conductus' success will depend in large part on the development of successful
collaborative arrangements with third parties, their strategic interest in
the potential products under development, and their willingness to purchase
any such products. There can be no assurance that Conductus will be able to
enter into collaborative arrangements on commercially reasonable terms, that
these arrangements, if established, will result in successful programs to
develop, manufacture or market superconductive electronic products or, if
these programs are successful, that Conductus' collaborative partners will
not seek to manufacture jointly developed products themselves or obtain them
from alternative sources. In addition, these programs may require Conductus
to share control over its development, manufacturing and marketing programs
and relinquish rights to its technology, may be subject to unilateral
termination by the Company's collaborative partners and may restrict
Conductus' ability to engage in certain areas of product development,
manufacturing and marketing.
-14-
<PAGE>
RAPID TECHNOLOGICAL CHANGE. The field of superconductivity is characterized
by rapidly advancing technology. The future success of the Company will
depend in large part upon its ability to keep pace with advancing
superconductive technology, including superconducting materials and
processes, and industry standards. The Company has focused its development
efforts to date principally on YBCO. There can be no assurance that YBCO
will ultimately prove commercially competitive against other currently known
materials or materials that may be discovered in the future. The Company
will have to continue to develop and integrate advances in technology for the
fabrication of electronic circuits and devices and manufacture of commercial
quantities of its products. The Company will also need to continue to
develop and integrate advances in complementary technologies. There can be
no assurance that the Company's development efforts will not be rendered
obsolete by research efforts and technological advances made by others or
that materials other than those currently used by Conductus will not prove
more advantageous for the commercialization of superconductive electronic
products.
INTENSE COMPETITION. The market for electronic products is intensely
competitive. Although the market for superconductive electronics currently
is small and in the early stages of development, Conductus believes this
market will become intensely competitive if products with significant market
potential are successfully developed. A number of large American, Japanese
and European companies, many of which have substantially greater financial
resources, research and development staffs and manufacturing and marketing
capabilities than the Company, are engaged in programs to develop and
commercialize superconductive electronic technology and products. A number
of smaller companies are also engaged in various aspects of the development
and commercialization of superconductive electronic products. Furthermore,
academic institutions, governmental agencies and other public and private
research organizations are engaged in development programs that may lead to
competitive arrangements for commercializing superconductive electronic
products. In addition, if the superconductor industry develops further, new
competitors with significantly greater resources are likely to enter the
field. Conductus' ability to compete successfully will require it to develop
and maintain technologically advanced products, attract and retain highly
qualified personnel, obtain patent or other protection for its technology and
products and manufacture and market its products, either on its own or with
third parties. The Company's inability to compete successfully would have a
material adverse effect on the Company's business, operating results and
financial condition. See "Business - Competition."
COMPETING TECHNOLOGIES. The Company's planned products, if successfully
developed, will compete directly with other existing and subsequently
developed products which use competing technologies. In wireless
communications applications, there are a number of competing approaches and
technologies to increase the capacity and improve the quality of wireless
networks, some of which may be less expensive and/or offer better
performance. These approaches include increasing the number of base
stations, increasing tower heights, locating filters and amplifiers at the
top of antennas and using advanced antenna technology. Failure of the
Company's potential products to compete successfully with products using
competing technologies would have a material adverse effect on the Company's
business, operating results and financial condition.
UNCERTAINTY OF PATENTS AND PROPRIETARY RIGHTS: RISK OF LITIGATION. The
Company's efforts to protect its proprietary rights may not be successful in
preventing their misappropriation or ensuring that these rights will provide
the Company with a competitive advantage. There can be no assurance that the
Company's pending applications will result in issued patents, that the
validity of the Company's issued patents will not be subject to challenge or
that third parties will not be able to design around the patented aspects of
the Company's products. Additionally, certain of the issued patents and
patent applications are jointly owned by the Company and third parties. Any
party has the right to license rights under such patents and applications,
which could result in Conductus not having exclusive control over such
inventions.
The patent positions of companies using HTS technology, including Conductus,
are uncertain and involve both complex legal and factual questions.
Consequently, there is significant risk that others, including competitors of
the Company, have obtained or will obtain patents relating to the Company's
planned products or technology. Since 1987 over 600 patents have issued in
the United States relating to HTS and HTS technology.
A patent issue of particular importance to the Company relates to copper
oxides or "cuprates," that are used to make HTS products, including the YBCO
compound which is currently the basis for the Company's business and
products. Conductus has neither obtained any issued patents nor has it filed
any patent applications covering the composition of any cuprates or other HTS
materials. However, several U.S. and foreign patent applications filed by
IBM, AT&T, the University of Houston, the Naval Research Laboratory and
others are pending regarding the composition of YBCO and related HTS. The
Company understands that several of such U.S. applications are the subject of
an interference proceeding currently pending in the U.S. Patent and Trademark
Office (Interference No. 101,981). Additionally, E. I. du Pont de Nemours &
Co. ("DuPont") has notified Conductus that it is the
-15-
<PAGE>
exclusive licensee of patents issued in Israel, Sweden, Taiwan and the United
Kingdom covering the composition of YBCO and a method for using YBCO in
superconducting applications. DuPont has stated that it is interested in
sublicensing such patents to Conductus, and would consider sublicensing to
Conductus, as they issue any other foreign and U.S. patent applications
licensed to DuPont by the University of Houston. The Company anticipates
that it will be required to obtain a license to use YBCO from one or more of
these parties in order to continue to develop and sell products based on
YBCO.
There can be no assurance that the Company would be able to obtain licenses
to patents covering YBCO compositions, when issued, or to any other patents
applicable to the Company's business on commercially reasonable terms. In
such an event, the Company could be required to expend significant resources
to develop non-infringing technology alternatives or to obtain licenses to
the technology that the Company infringes or would infringe. There can be no
assurance that the Company would be able to successfully design around these
third party patents or to obtain licenses to technology that it may require.
Furthermore, there can be no assurance that the Company will not be obligated
to defend itself at substantial cost against allegations of infringement of
third party patents. An adverse outcome in such a suit could subject the
Company to significant liabilities to third parties, or require the Company
to cease using such technology. In addition, aside from the merits of a
claim, the cost of defending any such suit would constitute a major financial
burden for the Company that would have a material adverse effect on the
Company's business, operating results and financial condition. See "Business
- -- Patents, Proprietary Technology and Trademarks."
DEPENDENCE ON LICENSED TECHNOLOGY. Successful marketing of a material
portion of Conductus' products depends in part on nonexclusive licenses
obtained from various licensors. There can be no assurance that such
licenses will not be terminated by licensors or that Conductus will be able
to develop alternate products that do not require these or other licenses.
LIMITED COMMERCIAL MANUFACTURING CAPABILITY. Conductus has established a
limited production facility. To date, Conductus has focused primarily on the
development of its fabrication processes and the production of limited
quantities of superconducting thin films and components. Although Conductus'
processing technology is derived principally from semiconductor manufacturing
technology, the fabrication of HTS components entails additional difficulties
because of specific properties unique to HTS materials. There can be no
assurance that Conductus can develop enhanced processing technology necessary
to develop more advanced superconducting devices and circuits, that the
Company will be able to attain commercial yields in the future, or that the
Company will not suffer recurring yield problems caused by mask defects,
impurities in materials and other factors. While the Company has established
limited production facilities for its electronics products, there is no
assurance that the Company can expand its processing, production control,
assembly, testing and quality assurance capabilities to produce existing or
planned superconductive electronic products in adequate commercial
quantities. The Company's failure to develop an adequate manufacturing
capacity would have a material adverse effect on the Company's business,
operating results and financial condition. See "Business - Manufacturing."
NEED TO DEVELOP INFRASTRUCTURE TO SUPPORT COMMERCIALIZATION. Conductus has
limited experience in commercial sales, marketing and distribution. Expanded
sales, marketing and customer service capabilities are also needed. There can
be no assurance that it will be able to establish adequate sales, marketing
and distribution capabilities or be successful in gaining market acceptance
for any of its potential products.
HIGH DEGREE OF DEPENDENCE UPON GOVERNMENT CONTRACTS. A significant portion
of the Company's revenues has been derived from contracts with agencies of
the U.S. government. The Company's revenue from government-related contracts
represented approximately 77% of total revenue for each of the fiscal years
1997, 1996, and 1995. The Company's contracts involving the U.S. government
are or may be subject to various risks, including: unilateral termination for
the convenience of the government; reduction or modification in the event of
changes in the government's requirements or budgetary constraints; increased
or unexpected costs causing losses or reduced profits under fixed-price
contracts or unallowable costs under cost reimbursement contracts; risks of
potential disclosure of Conductus' confidential information to third parties;
the failure or inability of the prime contractor to perform its prime
contract in circumstances where Conductus is a subcontractor; the failure of
the government to exercise options provided for in the contracts; the
government's nonexclusive, royalty-free license to use technology developed
pursuant to the contracts by or on behalf of the government in certain
circumstances; and exercise of "march-in" rights by the government. March-in
rights refer to the right of the U.S. government or government agency to
require the Company to license to third parties patented technology developed
under contracts funded by the government if the contractor fails to continue
to develop the technology. The programs in which Conductus participates in
many cases extend for several years, but are normally funded on an annual
basis. There can be no assurance that the U.S. government will continue its
commitment to programs to which the Company's
-16-
<PAGE>
development projects are applicable, particularly in light of recent
legislative initiatives to reduce the funding of various U.S. government
agencies and programs, or that the Company can compete successfully to obtain
funding pursuant to such programs. Conductus does not anticipate that
government contract revenues will grow and there can be no assurance that
revenues from government contracts will continue at historic levels. A
reduction in, or discontinuance of, such commitment or of the Company's
participation in such programs would have a material adverse effect on the
Company's business, operating results and financial condition. See "Business
- - Research and Development - Government Contracts."
HIGHLY REGULATED POTENTIAL PRODUCT APPLICATIONS. The operation of cellular
and PCS base stations is regulated in the United States by the Federal
Communications Commission ("FCC"). Base stations and equipment marketed for
use therein must meet specific technical standards. The Company's ability to
sell its HTS filter subsystems will depend upon the rate of deployment of
PCS, the ability of base station equipment manufacturers and of cellular base
station operators to obtain and retain the necessary FCC approvals and
licenses, and changes in regulations that may impact the requirements for the
Company's products. Any failure or delay of base station manufacturers or
operators in obtaining necessary approvals could have a material adverse
effect on the Company's business, operating results and financial condition.
ENVIRONMENTAL REGULATIONS. The Company is subject to a number of federal,
state and local governmental regulations related to the use, storage,
discharge and disposal of toxic, volatile or otherwise hazardous chemicals
used in its business. Any failure to comply with present or future
regulations could result in fines being imposed on the Company and the
suspension of production or a cessation of operations. In addition, such
regulations could restrict the Company's ability to expand or could require
the Company to acquire costly equipment or to incur other significant
expenses to comply with environmental regulations or to clean up prior
discharges.
ATTRACTION AND RETENTION OF KEY EMPLOYEES. The Company is highly dependent
upon the efforts of its senior management and technical team. The loss of
the services of one or more members of the senior management and technical
team could impede the achievement of product development and
commercialization objectives. Due to the specialized technical nature of the
Company's business, the Company is also highly dependent upon its ability to
attract and retain qualified technical and key management personnel.
Moreover, the Company is targeting its products towards markets, such as
communications, that require substantial industry knowledge and expertise.
The Company currently has limited expertise in these areas and it is
essential to attract and retain qualified personnel with expertise in
manufacturing, marketing, sales and support in each of its targeted markets.
There is intense competition for qualified personnel in the areas of the
Company's activities and there can be no assurance that the Company will be
able to continue to attract and retain qualified personnel necessary for the
development of its business. See "Business - Employees."
VOLATILITY OF STOCK PRICE. There has been significant volatility in the
market price of securities of technology companies, particularly those that,
like the Company, are still engaged primarily in product development
activities. Factors such as technology and product announcements by the
Company or its competitors, disputes relating to patents and proprietary
rights and variations in quarterly operating results may have a significant
impact on the market price of the Common Stock. In addition, the securities
markets have experienced volatility which is often unrelated to the operating
performance of particular companies. In the past, following periods of
volatility in the market price of a company's securities, securities class
action lawsuits have been instituted against a company. If brought, such
litigation could have a material adverse effect on the Company's business,
results of operations and financial condition.
EFFECT OF CERTAIN CHARTER PROVISIONS; ANTITAKEOVER EFFECTS OF RESTATED
CERTIFICATE OF INCORPORATION AND BYLAW PROVISIONS AND OF DELAWARE LAW. The
Board of Directors has the authority to issue up to 1,000,000 shares of
Preferred Stock and to determine the price, rights, preferences, privileges
and restrictions, including voting rights of those shares without any further
vote or action by the stockholders. The rights of the holders of Common
Stock will be subject to, and may be adversely affected by, the rights of the
holders of any Preferred Stock that may be issued in the future. The
issuance of Preferred Stock could have the effect of making it more difficult
for a third party to acquire a majority of the outstanding voting stock of
the Company. The Company has recently adopted a Shareholders' Rights Plan
which, if triggered, could make it more difficult for a third party to
acquire a majority of the outstanding voting stock of the Company. Further,
certain provisions of the Company's Restated Certificate of Incorporation and
Bylaws and of Delaware corporate law could delay or make more difficult a
merger, tender offer or proxy contest involving the Company. Among other
things, the Company's Restated Certificate of Incorporation does not permit
stockholders to act by written consent and the Bylaws require advance notice
of any matters to be brought before the shareholders at the annual meeting.
See "Description of Capital Stock -Preferred Stock" and "-- Antitakeover
Effects of Provisions of the Restated Certificate of Incorporation and Bylaws
and of Delaware Law."
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<PAGE>
ABSENCE OF DIVIDENDS. The Company has never paid cash dividends and does not
anticipate paying cash dividends on the Common Stock in the foreseeable
future. See "Price Range of Common Stock and Dividend Policy."
ITEM 2. PROPERTIES
The Company's principal facility, including its pilot production facility, is
located in two buildings providing approximately 40,000 square feet of
available space located in two buildings in Sunnyvale, California, with
leases which will expire in August 2000 and 2001. During 1997, the Company
subleased its facility in San Diego, California, to Niki Glass, in connection
with an asset sale of certain of the assets of the Instrument and Systems
Division. That lease expired in February 1998.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material litigation and is not aware of any
pending or threatened litigation against the Company that could have a
material adverse effect upon the Company's business, operating results or
financial condition. See "Risk Factors - Uncertainty of Patents and
Proprietary Rights: Risk of Litigation."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
No matters were submitted to the stockholders of the Company during the
Company's fourth quarter of 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Charles E. Shalvoy 50 President, Chief Executive Officer and Director
James Jay Daley 54 Vice President, Sales and Marketing
William J. Fowler 67 Vice President, Manufacturing
Ainslie Mayberry 46 Chief Financial Officer
Graham Y. Mostyn 44 Vice President, Engineering
Randy W. Simon, Ph.D. 44 Vice President, Technology Programs
</TABLE>
MR. SHALVOY joined the Company in June 1994 as President, Chief Executive
Officer and Director. From 1988 to 1994, he was President and Chief
Operating Officer of Therma-Wave, Inc., a manufacturer of semiconductor
production equipment. Prior to that he was employed by Aehr Test Systems,
Emerson Electric Corp. and Raychem Corporation in a variety of senior
management positions. Mr. Shalvoy holds a B.S. in Mechanical Engineering
from the University of Notre Dame and an M.B.A. from Stanford University.
MR. DALEY joined the Company in September 1997 as Vice President of Sales and
Marketing. From 1996 until 1997, he was Senior Vice President Sales and
Marketing and Engineering Services of Metawave Communications Corporation, a
leading manufacturer of "smart" antenna systems for wireless
telecommunication networks. Prior to Metawave, Mr. Daley had many years of
experience in telecommunications including senior management positions with
AirNet Communications, Northern Telecom and Motorola. Mr. Daley holds a B.S.
in Business Administration and Education from the University of
Massachusetts, Salem and an M.A. in clinical psychology from Assumption
College.
MS. MAYBERRY was appointed interim Chief Financial Officer in January 1998.
She is President of Virtual CFO, Inc. From 1981 until 1997 she was Chief
Financial Officer and later Chief Operating Officer, acting Chief Executive
Officer and President of AssureNet Pathways, Inc. Ms. Mayberry holds a BS in
accounting and an MBA from California State University, San Jose.
MR. FOWLER joined the Company in September 1996 as Vice President of
Manufacturing. From 1994 to 1996, he was Vice President of Operations at
Geometrics, a manufacturer of magnetic sensing equipment used in geophysical
exploration. From 1990 to 1994, Mr. Fowler was Vice President of
Manufacturing and Service at Resonex, a producer of Magnetic Resonance
Imaging (MRI) systems. Earlier in his career he held senior manufacturing and
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<PAGE>
operations positions with other high technology companies, including Daisy
Systems and Qume Corporation. Mr. Fowler holds a B.S.E.E. from San Jose State
University.
MR. MOSTYN joined the Company in November 1996 as Vice President of
Engineering. From 1992 to 1996, he was the Director of RF and Analog
Engineering and later the Director of Engineering, Network Systems Division
of MicroUnity, Inc., a communications products start-up company. Prior to
that, he spent 10 years with Harris Corporation in engineering management
positions. Mr. Mostyn holds a B.A. and M.A. in physics from Cambridge
University, England.
DR. SIMON joined the Company in October 1990 as Senior Scientist and served
as Director of Research and Development from March 1991 to January 1993 and
as Vice President, Marketing and Development from January 1993 to November
1994 and Vice President, Technology Programs and Investor Relations from
November 1994 to November 1995 and Vice President, Technology Programs since
November 1995. From January 1985 to October 1990, he held a variety of
scientific and managerial positions at TRW, where he headed TRW's
Superconductivity Research Department's high-temperature superconductivity
program and managed TRW's internal research and development program on
high-temperature superconductive electronics. Dr. Simon holds a B.S. in
Physics from Pomona College and an M.S. and a Ph.D. in Physics from the
University of California, Los Angeles.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been traded on Nasdaq National Market since
August 5, 1993, the date of the Company's initial public offering (symbol:
CDTS). The Company has paid no dividends on its Common Stock since inception
and anticipates that for the foreseeable future, it will continue to retain
its funds for use in its business. The Company is restricted under its bank
financing agreement from paying any cash dividends but may pay stock
dividends. On February 16, 1998, the Company paid a stock dividend of one
preferred share purchase right for each outstanding share of common stock,
par value $0.0001 per share.
On February 28, 1998, the Company had 88 holders of record of its Common
Stock.
The following table sets forth for the indicated periods the high and low
closing sales prices of the Common Stock as furnished by the Nasdaq National
Market.
<TABLE>
<CAPTION>
Price Range of Common Stock
------------------------------------------
Fiscal 1996 Fiscal 1997
------------------- --------------------
High Low High Low
------- ------ ------ ------
<S> <C> <C> <C> <C>
First Quarter $15 $6 1/2 $9 1/4 $6
Second Quarter 16 1/2 9 3/4 7 5/8 5 5/8
Third Quarter 12 7/8 7 5/8 6 5/16 4 7/8
Fourth Quarter 9 1/2 6 5 7/8 3 1/4
</TABLE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in connection with the
Company's audited financial statements and the related notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Annual Report on Form 10-K. The
statement of operations data for the years ended December 31, 1994 and 1993 and
the balance sheet at December 31, 1995, 1994, and 1993 are derived from audited
financial statements not included herein.
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<PAGE>
STATEMENTS OF OPERATIONS DATA:
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------------
1997 1996 1995 1994 1993(2)
---- ---- ---- ---- ------
<S> <C> <C> <C> <C> <C>
Revenues:
Contract $ 7,266 $ 9,691 $ 8,148 $ 7,048 $ 5,070
Product sales 2,188 2,852 2,434 1,588 1,409
--------- --------- --------- -------- ---------
Total revenues $ 9,454 $ 12,543 $ 10,582 $ 8,636 $ 6,479
--------- --------- --------- -------- ---------
--------- --------- --------- -------- ---------
Loss from operations $ (7,499) $ (5,109) $ (4,423) $ (4,876) $(4,070)
--------- --------- --------- -------- ---------
--------- --------- --------- -------- ---------
Net loss $ (7,543) $ (5,004) $ (4,422) $ (4,544) $(4,122)
--------- --------- --------- -------- ---------
--------- --------- --------- -------- ---------
Net loss per common share (basic and
diluted) (1) $ (1.09) $ (0.80) $ (0.80) $ (0.85) $ (1.40)
--------- --------- --------- -------- ---------
--------- --------- --------- -------- ---------
Shares used in computing
per share amounts (basic and diluted) (1) 6,897 6,263 5,543 5,323 2,940
--------- --------- --------- -------- ---------
--------- --------- --------- -------- ---------
</TABLE>
BALANCE SHEET DATA
<TABLE>
<CAPTION>
December, 31
--------------------------------------------------------
1997 1996 1995 1994 1993(2)
---- ---- ---- ---- ------
<S> <C> <C> <C> <C> <C>
Working capital $ 1,822 $ 9,135 $ 4,287 $ 7,076 $12,438
Total assets 8,762 16,081 10,128 12,541 16,233
Long-term debt, excluding current portion 310 1,022 1,146 533 180
Stockholders' equity 4,301 11,183 5,814 9,529 14,057
</TABLE>
(1) Computed on the basis described for net loss per share in Note 2 of
Notes to Financial Statements of Conductus, Inc. Amounts have been
restated for the adoption of Statement of Financial Accounting Standard
No. 128 "Earnings Per Share".
(2) The results of operations of the Company for the year do not include the
results of operations of Tristan prior to its acquisition by Conductus
on May 28, 1993.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
THE MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SECTION AND OTHER PARTS OF THIS FORM 10-K CONTAIN FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS
AND THE TIMING OF CERTAIN EVENTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS
DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
BELOW AND IN "RISK FACTORS AND "BUSINESS".
Conductus develops, manufactures, and markets electronic components and
systems based on superconductors primarily for applications in the
communications market. In May 1993, Conductus acquired Tristan Technologies,
Inc. ("Tristan"), a San Diego, California based company founded in 1991, that
designed, manufactured and sold large-scale magnetic sensing systems and
instrumentation. In June 1994, Tristan became the Conductus Instruments and
Systems division. In July 1997, Conductus discontinued operations of its
Instruments and Systems division. As of December 31, 1997, Conductus had
accumulated losses of approximately $36,770,000 and expects to incur
additional and increasing losses at least during 1998 due to the Company's
planned expansion of operations and reduced revenue from government contracts
due to reductions in federal R & D funding and the narrower scope of the
Company's business interests. Conductus, alone or with collaborative
partners, must successfully develop, manufacture, introduce and market its
potential products in order to achieve profitability. Conductus does not
expect to recognize meaningful product sales until it successfully develops
and commercializes superconductive components, systems and subsystems that
address significant market needs. See "Risk Factors - Early Stage of the
Superconductive Electronics Market; Lack of Market Acceptance."
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<PAGE>
RESULTS OF OPERATIONS
Total revenues decreased to $9,454,000 in 1997 from $12,543,000 in 1996 and
$10,582,000 in 1995. Total revenues consist primarily of contract revenue
and, to a lesser extent, product sales. Revenue under U.S. government
research and development contracts decreased to $7,266,000 in 1997 from
$9,691,000 in 1996 and $8,148,000 in 1995 and represented approximately 77%,
of total revenue in each of the fiscal years 1997, 1996, and 1995. The
decrease in contract revenues during 1997 is largely attributable to the
completion of several major contracts during 1997. The increase in contract
revenues in 1996 compared to 1995 is largely attributable to a solid base of
contracts from 1995 and the addition of several new multi-year contracts. The
Company had backlog of approximately $176,000 and $4,620,000 in contracts and
grants as of December 31, 1997 and 1996, respectively. In addition, the
Company had $6,373,000 and $8,976,000 in awards from U.S. government agencies
which had not been funded as of December 31, 1997 and 1996, respectively.
Conductus anticipates that government contract revenues will continue to
decline somewhat in the future compared to historical rates due to reductions
in federal R & D funding and the narrower scope of the Company's business
interests. The recognition of revenue and receipt of payment pursuant to
these contracts and awards are subject to numerous risks. See "Business -
Research and Development" and Note 11 of Notes to Financial Statements.
Revenue from sales of large-scale superconductive magnetic sensing systems,
SQUIDs, HTS thin films and other products decreased to $2,188,000 in 1997
from $2,852,000 in 1996 and $2,433,000 in 1995. The decrease in 1997 compared
to 1996 was primarily due to the disposition during 1997 of both the
Instrument and Systems division and the NMR product line. The increase in
1996 compared to 1995 was primarily due to increased sales of superconductive
sensor instruments and systems. During the fourth quarter of 1997, the
Company recognized $96,000 as revenue on the first shipment of its ClearSite
front-end system to a commercial customer. Future sales of this product are
subject to numerous technical and market risks. See "Risk Factors - Competing
Technologies," "-- Early Stage of the Superconductive Electronics Market;
Lack of Market Acceptance," "-- Dependence on Incorporation of Potential
Products into Third Party Systems" and "-- Intense Competition."
Cost of product sales were $1,845,000, $1,824,000, and $1,430,000 for 1997,
1996, and 1995, respectively. The cost of products in 1997, 1996, and 1995
were primarily composed of costs of superconducting magnetic systems
manufactured by the Instrument and Systems division, which the Company
disposed of in 1997. Cost of product sales increased slightly from 1996 to
1997 despite lower volume of sales due to inventory writedowns of
approximately $475,000 related to the Instrument and Systems division
products and to certain SQUID product lines no longer considered part of the
Company's future strategic focus. Cost of product sales increased in 1996
and 1995 due to increased levels of revenues from new products introduced in
1995. Gross margins were 16%, 36%, and 41% for 1997, 1996, and 1995,
respectively. The gross margin decrease in 1997 was primarily related to the
inventory writedowns mentioned previously. Gross margins decreased in 1996
compared to 1995 because of increased sales of large systems which have lower
gross margins and increased costs of start-up in the sensor portion of the
magnetic sensor business. Costs of contract revenues are included in
research and development expenses and are discussed below.
The Company's research and development expenses decreased to $10,626,000 in
1997 from $11,774,000 in 1996 but increased from $9,819,000 in 1995, and
represented 63%, 67%, and 65%, respectively, of total operating expenses in
1997, 1996 and 1995. The decrease in 1997 compared to 1996 reflects lower
levels of contract revenues, the dispositions of the Instrument and Systems
and NMR product lines, offset somewhat by increased spending particularly on
new wireless communications products. The increase in 1996 over 1995
reflects the increase in the Company's overall research and development
activities, and an emphasis of efforts in communications and healthcare.
Research and development includes both externally and internally funded
projects. Externally funded research and development programs, primarily
under contracts with agencies of the U.S. government, accounted for
approximately $9,814,000, of total operating costs and expenses in 1997, down
from $13,178,000 in 1996, reflecting reductions in federal R & D funding and
the narrower scope of the Company's business interests during 1997. The
increase in 1996 to $13,178,000 from $9,170,000 in 1995 was due to the
increase in the Company's overall research and development activities
mentioned above. The Company expects to continue to incur significant
research and development expenses on internally funded programs as it seeks
to develop additional commercial products, particularly in the
communications area.
Selling, general and administrative expenses increased to $4,330,000 in 1997
from $4,054,000 in 1996 and $3,756,000 in 1995 and represented 26%, 23%, and
25%, respectively, of total operating expenses in 1997, 1996, and 1995,
respectively. These costs increased in 1997 compared to 1996 primarily due
to increased sales and marketing spending related to commercial wireless
communication products, offset somewhat by lower spending due to the
disposition of the Instrument and Systems division. These costs increased in
1996 compared to 1995 due to the increasing size of the Company since the
acquisition of Tristan in 1993, significant headcount additions and
increasing sales and marketing activities. Total headcount has decreased to
90 at December 31, 1997 from 133 at December 31, 1996 and 99 at December 31,
1995, respectively due to the discontinuation of operations of the Instrument
and Systems division and the sale of the NMR probe business. The Company
expects to continue to incur increasing sales and marketing expenses to the
extent it increases sales of commercial products, particularly in the
communications markets.
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<PAGE>
The Company's total costs and expenses decreased to $16,953,000 in 1997 from
$17,652,000 in 1996 but increased from $15,005,000 in 1995. The decrease in
1997 compared to 1996 was primarily due to the dispositions of the Instrument
and Systems division and NMR product line in the third quarter of 1997,
offset somewhat by increased emphasis in communications product development,
and sales and marketing. The increase in 1996 compared to 1995 was primarily
due to the company's overall increase in research and development activity
for 1996. The Company expects the increased emphasis on communications
product development and sales and marketing to increase total costs and
expenses in 1998.
Loss from operations was $7,499,000, $5,109,000, and $4,423,000, for 1997, 1996,
and 1995, respectively, due to the reasons enumerated above.
Interest income from cash equivalents and investments were $267,000 in 1997,
$263,000 in 1996, and $249,000 in 1995, reflecting the relative average levels
of cash equivalents and investments for each of the years.
Interest charges were $202,000, $183,000, and $156,000 in 1997, 1996, and
1995, respectively. Interest charges are related primarily to the Company's
equipment term loan facilities, and reflect the relative average balances
outstanding under these facilities.
As a result of incurring losses, the Company has not incurred any income tax
liability. The Company has established a valuation allowance against its
deferred tax assets and reviews this allowance on a periodic basis. At such
time that the Company believes that it is more likely than not that the deferred
tax asset will be realized, the valuation allowance will be reduced.
Conductus does not believe that inflation has had a material effect on its
financial condition or results of operations during the past three fiscal
years. However, there can be no assurance that the company's business will
not be affected by inflation in the future.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1997, the Company's aggregate cash, cash equivalents and
short-term investments totaled $3,169,000 compared to $7,636,000 as of
December 31, 1996. The balance at December 31, 1997 includes $500,000 of
cash restricted under the terms of the Company's working capital line of
credit. The Company has financed its operations since inception primarily
through $13,251,000 in net proceeds from its initial public offering of
Common Stock in August 1993, $9,892,000 in net proceeds from its follow-on
public offering of Common Stock in June 1996, $14,645,000 raised in private
financings, $40,272,000 from U.S. government contracts, $6,056,000 in
aggregate borrowings under three equipment lease lines of credit and
equipment term loans and $3,686,000 in interest income.
Net cash used in operations was $4,702,000, $4,897,000, and $4,625,000, for
1997, 1996, and 1995, respectively. The decrease in net cash used in
operations for 1997 compared to 1996 was due primarily to a decrease in
accounts receivable, higher provision for excess and obsolete inventory, and
the decrease in prepaid expenses, offset somewhat by the larger net loss.
The increase in net cash used in operating activities in 1996 over 1995 was
primarily due to an increase in net loss resulting from expanding the
Company's operations, including headcount and other related costs, and
increases in inventories, offset somewhat by the increase in accounts payable
and accrued liabilities. The Company anticipates that its accounts receivable
from revenues under U.S. government contracts during 1998 will be lower than
1997 levels. Accounts receivable and inventories from product sales are
expected to increase with the anticipated increase in revenues from product
sales in 1998.
Net cash provided by (used in) investing activities was $5,848,000 in 1997,
compared to ($4,868,000) in 1996, and $2,670,000 in 1995. The change in 1997
compared to 1996 is primarily due to the change in proceeds from sales of
short term investments and purchases of short term investments. In 1997 the
Company sold $5,956,000 more of its short term investments than it purchased
to increase cash, while in 1996 the Company purchased $3,633,000 more of
short term investments than it sold to invest cash. In 1995, the Company
sold $4,238,000 more of short term investments than it purchased to increase
cash. In addition, capital expenditures decreased by $575,000 in 1997
compared to 1996, due to lower spending on laboratory and manufacturing
equipment. Capital expenditures decreased by $304,000 in 1996 compared to
1995 due to lower spending on laboratory and manufacturing equipment. The
Company anticipates that its capital expenditures will increase slightly in
1998 as the Company continues its transition to manufacture greater volumes
of commercial products.
Net cash from financing activities was $345,000 in 1997 compared to $10,612,000
in 1996 and $1,722,000 in 1995. The decrease in 1997 compared to 1996 was
primarily due to lower net proceeds from the issuance of common stock . The net
cash provided by financing activities in 1996 was primarily due to the Company's
follow-on offering in June of 1996 and borrowings under the Company's equipment
loans, offset by principal payments under capital lease obligations and
equipment term loans.
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<PAGE>
The Company to date has received limited revenues from product sales. The
development of the Company's potential products will require a commitment of
substantial funds to conduct further research and development and testing of its
potential products, to establish commercial-scale manufacturing and to market
any resulting products. The Company expects to use significant amounts of cash
for capital equipment and to support operations until product revenues increase.
At December 31, 1997, the Company had three equipment credit facilities and a
bank working capital line of credit. Borrowings under these agreements bear
interest at the Bank's prime rate plus 1.00% (a total of 9.50% at December 31,
1997), and are collateralized by a $500,000 certificate of deposit, accounts
receivable, equipment and other assets of the Company. At December 31, 1997
there were no amounts available under these credit facilities.
The three equipment credit facilities and line of credit facility require that
the Company provide financial information to the lender, obtain approval of
the lender for any material disposition of the collateral except in the
ordinary course of business and meet certain financial ratios, minimum
tangible net worth, minimum cash and investments and other covenants.
The Company received a waiver in March 1998 from the institution with respect
to default that occured in the fourth quarter of fiscal 1997 on certain
financial covenants. There can be no assurance that waivers will be obtained
from lenders in the event of future defaults.
As of March 23, 1998, the Company had cash reserves of approximately
$540,000. On March 30, 1998, the Company entered into an agreement to expand
its existing bank working capital line of credit from $1,000,000 to
$2,000,000, subject to receivables eligibility requirements and certain other
restrictions. See "Risk Factors--Substantial Future Capital Needs" and Note
17 of Conductus, Inc., Notes to Financial Statements, "Subsequent Events."
On April 23, 1998, the Company entered into a "bridge" loan credit facility
agreement with its bank. The facility provides for borrowings of up to
$2,000,000, with interest at the bank's prime rate plus 2.00%. The facility
matures in 120 days, but may be paid off sooner at the Company's option. The
agreement grants to the bank a warrant to purchase 15,000 shares at $3.625
per share, the closing price for the Company's shares on April 13, 1998.
The agreement provides for additional warrants to be granted based on the
length of time the loan is outstanding, as follows:
if the loan is outstanding after May 31, 1998, a warrant for an
additional 10,000 shares at the May 31, 1998 closing price will be
granted.
if the loan is outstanding after June 30, 1998, a warrant for an
additional 25,000 shares at the June 30, 1998 closing price will
be granted.
Borrowings under this facility are collateralized by a first priority
security interest in all of the Company's property, including intellectual
property rights.
On April 22, 1998, the Company entered into a lease line of credit commitment
with a leasing company. Under the terms of this commitment, the Company will
sell certain of its assets to the leasing company and lease the assets back
from the leasing company. The amount available under this facility is
$2,000,000 with another $500,000 available contingent upon the Company
achieving certain financial requirements in the future. The facility grants
to the leasing company warrants to purchase up to $125,000 of the Company's
stock at a price equal to the average closing bid price for the five days
immediately preceding and including April 22, 1998. The effective interest
rate would be 13.98%, and there are certain reporting and financial covenants
which the company is required to satisfy.
All the credit facilities contain financial and reporting covenants. In the
event of default on any of these covenants, the entire amount outstanding
could become due and payable immediately upon default and assets
collateralizing the amounts outstanding could be seized and sold by the
lender, unless such default is waived by the lender. There can be no
assurance that the Company will satisfy such covenants or, if the Company
fails to satisfy such covenants, that waivers will be obtained from lenders
in the event of future defaults.
On April 17, 1998, the Company received a commitment letter from a current
shareholder stating that the shareholder is prepared, if necessary, to
participate in future financing efforts in the amount of at least $1,500,000.
This commitment expires March 31, 1999. See "Risk Factors -- Substantial
Future Capital Needs", and Notes 1 and 17 of Conductus, Inc. Notes to
Financial Statements.
Conductus anticipates that its existing sources of liquidity and anticipated
revenue, primarily from government contracts, will satisfy the Company's
projected working capital and other cash requirements through at least
December 1998. There can be no assurance, however, that changes in the
Company's plans or other events affecting the Company will not result in the
expenditure of such resources before such time.
The Company has adopted a plan consisting of the following additional steps
to conserve cash and improve its liquidity. The Company has implemented a
cost reduction program which will result in immediate headcount reduction of
11 employees and reduced levels of operation expenses, working capital
requirements, and capital expenditures over the next several quarters. The
Company also continues to explore and evaluate equity and debt financing
alternatives. There can be no assurance that any or all of the measures
taken by the Company will provide sufficient liquidity.
The development of the Company's planned products will require a commitment
of substantial additional funds. There can be no assurance that additional
financing will be available on acceptable terms or at all. Unless the
Company is able to raise significant additional funds, through debt or equity
issuances, asset sales or otherwise, the Company will be required to delay,
scale-back or eliminate one or more of its research and development programs
or obtain funds through arrangements with collaborative partners or others
that may require the Company to relinquish rights to certain of its
technologies or potential products that the Company would not otherwise
relinquish. The Company's future capital requirements will depend on many
factors, including continued progress in its research and development
programs, the magnitude of these programs, the time and cost involved in
obtaining any required regulatory approvals, the costs involved in preparing,
filing, prosecuting, maintaining and enforcing patents, successful completion
of technological, manufacturing and market requirements, changes in existing
research relationships, the availability of funding under government
contracts, the ability of the Company to establish collaborative arrangements
and the cost of manufacturing scale-up and the amount and timing of future
revenues.
YEAR 2000 ISSUE
The year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
Based on a recent assessment of the Company's sales, manufacturing and finance
systems, the Company determined that it will be required to replace this
software so that these computer systems will properly utilize dates beyond
December 31, 1999. The Company presently believes that with the conversion of
its sales, manufacturing, and finance systems to new software, the Year 2000
Issue can be mitigated as far as its impact on those systems. However, if the
conversion is not completed in a timely manner, the Year 2000 Issue could have a
material impact on the operations of the Company. The Company has not yet
completed the assessment of its remaining internal systems which may be effected
by the Year 2000 Issue.
The Company has not yet begun formal communications with its significant
suppliers and large customers to determine the extent to which the Company is
vulnerable to those third parties' failure to remediate their own Year 2000
Issue. There can be no guarantee that the systems of other companies on which
the Company's systems rely will be timely converted, or that a failure to
convert by another company, or a conversion that is incompatible with the
Company's systems, would not have material adverse effect on the Company. The
Company has not yet determined if it has exposure to contingencies related to
the Year 2000 Issue for the products it has sold.
The Company will utilize both internal and external resources to replace its
sales, manufacturing, and finance systems. The Company plans to complete this
phase in early 1999, and anticipates that the cost of the software and its
implementation will not have a material financial impact. The Company is unable
to estimate the remaining financial impact, if any, of the Year 2000 Issue
until it completes the assessment of the potential impact of the Year 2000 Issue
on its remaining internal systems, on third parties such as its suppliers and
customers, on products it has sold, and on other factors that may come to the
Company's attention.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement No. 130
(SFAS 130) "Reporting Comprehensive Income". SFAS No. 130 establishes standards
for the reporting and display of comprehensive income and its components in a
full set of general purpose financial statements. Comprehensive income is
defined as
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<PAGE>
the change in equity of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources. SFAS
130 will become effective for the Company's 1998 fiscal year.
In June 1997, the Financial Accounting Standards Board issued Statement No.
131 (SFAS 131) "Disclosures about Segments of an Enterprise and Other
Information." SFAS No. 131 requires publicly-held companies to report
financial and other information about key revenue-producing segments of the
entity for which such information is available and is utilized by the chief
operation decision makers. Specific information to be reported for individual
segments includes profit and loss, certain revenue and expense items and
total assets. A reconciliation of segment financial information to amounts
reported in the financial statements would be provided. SFAS 131 will become
effective for the Company's 1998 fiscal year.
The Company is currently studying the implications of these statements and
has not yet determined the impact of their adoption.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements of the Registrant and auditor's report are
included in Item 8:
Report of Independent Accountants
Balance Sheets - as of December 31, 1997 and 1996
Statements of Operations - years ended December 31, 1997, 1996 and 1995
Statements of Stockholders' Equity - years ended December 31, 1997, 1996
and 1995
Statements of Cash Flows - years ended December 31, 1997, 1996 and 1995
Notes to Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference is the information required by this item
relating to the Company's directors and nominees and disclosure relating to
compliance with Section 16(a) of the Securities Exchange Act of 1934 that is
included under the captions "Election of Directors" and "Compliance with
Section 16(a) of the Securities Exchange Act of 1934" in the Proxy Statement
for the 1998 Annual Meeting of Stockholders to be held on May 29, 1998 (the
"Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference is the information required by this item that
is included under the caption "Executive Compensation and Related Information"
in the Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference is the information required by this item that
is included under the caption "Ownership of Securities" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference is the information required by this item that
is included under the caption "Certain Transactions" in the Proxy Statement.
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<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Annual Report on
Form 10-K/A:
<TABLE>
<CAPTION>
Page
Number
------
<S> <C>
1. Financial Statements
Report of Independent Accountants..........................................30
Balance Sheets - as of December 31, 1997 and 1996..........................31
Statements of Operations - years ended December 31, 1997, 1996 and 1995....32
Statements of Stockholders' Equity - years ended December 31, 1997, 1996
and 1995.................................................................33
Statements of Cash Flows - years ended December 31, 1997, 1996 and 1995....34
Notes to Financial Statements..............................................35
2. Financial Statement Schedule
Report of Independent Accountants..........................................45
Schedule II - Valuation and Qualifying Accounts............................46
3. See Exhibits
</TABLE>
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<PAGE>
EXHIBIT
NUMBER DESCRIPTION
- ------------ ------------
2.1(1) Stock Exchange Agreement dated as of May 28, 1993 between the
Registrant and Tristan Technologies, Inc. ("Tristan").
3.3(2) Restated Certificate of Incorporation.
3.5(8) Restated Bylaws of Registrant.
4.8(9) Shareholder Rights Plan.
10.1(1) Second Amended and Restated Registration Rights Agreement dated
June 3, 1993.
10.3(1)+ Coordinated Research Program Agreement dated October 14, 1988 and
Amendment dated May 26, 1991 between the Registrant and
Hewlett-Packard Company ("H-P"), as amended by the Agreement
Between Registrant and Hewlett-Packard Company dated
June 2, 1993.
10.7.3(6)+ Superconducting Filter Technology Joint Development Agreement
dated April 25, 1996 between the Registrant and Lucent
Technologies Inc.
10.7.4(7) Collaboration Agreement between Registrant and CTI dated
September 19, 1995.
10.7.5(7) High Temperature Superconductor Thin-Film Manufacturing Alliance
Agreement among Registrant, Superconductor Technologies, Inc.,
Stanford University, Georgia Research Corporation,
Microelectronic Control and Sensing Incorporated, IBIS, Focused
Research and BDM Federal dated November 17, 1995.
10.17(1) Lease Agreement dated May 3, 1993 between the Registrant and
Mozart-McKee Limited Partnership for part of the Sunnyvale
facilities.
10.19(10) 1992 Stock Option/Stock Purchase Plan.
10.20(1) Amended 1989 Stock Option Plan.
10.21(1) 1987 Stock Option Plan.
10.22(1) Form of Indemnification Agreement between the Registrant and each
of its directors and officers.
10.24(4) Lease Agreement dated December 8, 1994 between Registrant and
Mozart-McKee Limited Partnership for Sunnyvale facilities.
10.25(4) Business Loan Agreement dated August 15, 1994 between Registrant
and Silicon Valley Bank for working capital credit facility and
term loan facility.
10.26(4) Employment Agreement dated May 3, 1994 between Registrant and Mr.
Charles E. Shalvoy.
10.28(3) Conductus, Inc. 1994 Employee Stock Purchase Plan.
10.29(5) Business Loan Agreement dated March 8, 1996 between Registrant
and Silicon Valley Bank for working capital credit facility and
term loan facility.
10.30(11) Business Loan Agreement dated December 27, 1996 between
Registrant and Silicon Valley Bank for working capital credit
facility and term loan facility.
10.31(12) Loan Modification Agreement dated June 30, 1997, between
Registration and Silicon Valley Bank modifying the Business Loan
Agreement dated August 15, 1994.
10.32(12) Loan Modification Agreement dated November 12, 1997, between
Registration and Silicon Valley Bank modifying the Business Loan
Agreement dated August 15, 1994.
10.33(12) Loan Modification Agreement dated December 23, 1997, between
Registration and Silicon Valley Bank modifying the Business Loan
Agreement dated August 15, 1994.
10.35(12)+ Asset Purchase Agreement dated July 9, 1997 between Registrant
and Bruker Instruments, Inc. for sale of assets of Registrant's
NMR Probe business.
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<PAGE>
EXHIBIT
NUMBER DESCRIPTION
- ------------ ------------
10.36(12) Asset Purchase Agreement dated August 15, 1997 between Registrant
and Neocera, Inc. for sale of Registrant's assets related to its
temperature controller business.
10.37(12) Asset Purchase Agreement dated September 3, 1997, between
Registrant and Niki Glass Ltd. for sale of Registrant's assets
related to portions of its instruments business.
23.1 Consent of Independent Accountants
24.1 Power of Attorney (See Page 29).
(1) Incorporated herein by reference from the same numbered exhibits filed with
the Company's Registration Statement on Form S-1 (Number 33-64020), as
amended.
(2) Incorporated herein by reference from the same numbered exhibit filed with
the Company's 1993 Annual Report on Form 10-K.
(3) Incorporated herein by reference from exhibit number 99.1 to the Company's
Registration Statement on a Form S-8 filed with the SEC on August 5, 1994.
(4) Incorporated herein by reference from the same numbered exhibit filed with
the Company's 1994 Annual Report on Form 10-K.
(5) Incorporated herein by reference from the same numbered exhibit filed with
the Company's 1995 Annual Report on Form 10K.
(6) Incorporated herein by reference from the same numbered exhibit filed with
the Company's Registration Statement on Form S-1 (Number 333-3815), as
amended, on May 10, 1996
(7) Incorporated herein by reference from the same numbered exhibit filed with
Amendment No. 2 to the Company's Registration Statement on Form S-1 (Number
333-3815) on June 17, 1996.
(8) Incorporated herein by reference from Exhibit 3.3 to the Company's
Registration Statement on Form 8-K filed with the SEC on January 22,
1998.
(9) Incorporated herein by reference from Exhibit 1 to the Company's
Registration Statement on Form 8-K filed with the SEC on January 22, 1998.
(10) Incorporated herein by reference from Exhibit 99.1 to the Company's
Registration Statement on Form S-8 filed with the SEC on November 26, 1997.
(11) Incorporated herein by reference from the same numbered exhibit filed with
the Company's 1996 Annual Report on Form 10K.
(12) Incorporated herein by reference from the same numbered exhibit filed with
the Company's 1997 Annual Report on Form 10K.
+ Confidential treatment granted or requested as to certain portions of these
exhibits.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of the fiscal
year covered by this Form 10-K Annual Report.
(c) Exhibits
See responses to Item 14(a)(3) above.
(d) Financial Statement Schedules
None required, except as indicated in response to Item 14(a)(2) above.
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<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized, on
April 28, 1998.
CONDUCTUS, INC.
By: /s/ Charles E. Shalvoy
--------------------------------
Charles E. Shalvoy
President and Chief Executive Officer
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<PAGE>
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Charles E. Shalvoy, Donald F. DePascal
and Judith A. DeFranco, and each of them, as his or her true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for him or her and in his or her name, place and stead, in
any and all capacities, to sign any and all amendments (including
post-effective amendments) to this Report on Form 10-K, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with
the Securities and Exchange Commission, granting unto said attorneys-in-fact
and agents, and each of them, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in connection
therewith, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
---------- ----- -----
/s/ Charles E. Shalvoy President, Chief Executive Officer April 28, 1998
- ---------------------- and Director (Principal Executive
Charles E. Shalvoy Officer)
/s/ Ainslie Mayberry Chief Financial Officer April 28, 1998
- ----------------------
Ainslie Mayberry
/s/ Donald F. DePascal Controller
- ---------------------- (Principal Accounting Officer) April 28, 1998
Donald F. DePascal
/s/ John F. Shoch Chairman of the Board of Directors April 28, 1998
- ----------------------
John F. Shoch, Ph.D.
/s/ Martin Cooper Director April 28, 1998
- ----------------------
Martin Cooper
/s/ Robert Janowiak Director April 28, 1998
- ----------------------
Robert Janowiak
/s/ Marty Kaplan Director April 28, 1998
- ----------------------
Marty Kaplan
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<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
Conductus, Inc.:
We have audited the accompanying balance sheets of Conductus, Inc. as of
December 31, 1997 and 1996, and the related statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. 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 financial position of Conductus, Inc.
as of December 31, 1997 and 1996, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1997
in conformity with generally accepted accounting principles.
Our previous report on the accompanying financial statements dated
February 9, 1998 (except for Notes 1 and 17, as to which the date was April
17, 1998) contained a paragraph emphasizing the uncertainty surrounding the
Company's ability to raise additional capital. As discussed in Note 1 to the
financial statements, the company has secured additional financing in the
form of a sales leaseback agreement as well as certain commitments from an
existing shareholder; accordingly, the paragraph emphasizing the uncertainty
has been removed.
COOPERS & LYBRAND L.L.P.
San Jose, California
February 9, 1998 (Except for Notes 1 and 17, as to which
the date is April 27, 1998.)
-30-
<PAGE>
CONDUCTUS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $2,111,560 $ 1,119,991
Restricted cash equivalent 500,000 -
Short-term investments 556,633 6,516,401
Accounts receivable (net of allowance
for doubtful accounts of $248,232 and $50,000
for 1997 and 1996) 2,055,255 3,756,586
Inventories 610,367 1,220,873
Prepaid expenses and other current assets 139,479 397,556
---------- ----------
Total current assets 5,973,294 13,011,407
Property and equipment, net 2,700,594 2,941,685
Other assets 87,762 127,763
---------- ----------
Total assets $8,761,650 $16,080,855
---------- -----------
---------- -----------
LIABILITIES
Current liabilities:
Current portion of long-term debt $1,547,507 $1,119,330
Accounts payable 1,539,590 1,710,762
Other accrued liabilities 1,063,721 1,045,916
---------- -----------
Total current liabilities 4,150,818 3,876,008
Long-term debt, net of current portion 309,681 1,021,781
---------- -----------
Total liabilities 4,460,499 4,897,789
---------- -----------
Commitments (Note 10)
STOCKHOLDERS' EQUITY
Preferred stock, $0.0001 par value:
Authorized: 1,000,000 shares
None issued or outstanding in 1997 or 1996
Common stock, $0.000l par value:
Authorized: 11,000,000 shares;
Issued: 7,013,062 and 6,988,517 in 1997 and 1996
Outstanding: 7,004,095 and 6,816,143 in 1997
and 1996 702 683
Additional paid-in capital 41,070,636 40,405,381
Unrealized gain on investments, net - 3,808
Accumulated deficit (36,770,187) (29,226,806)
---------- -----------
Total stockholders' equity 4,301,151 11,183,066
---------- -----------
Total liabilities and stockholders' equity $8,761,650 $16,080,855
---------- -----------
---------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
-31-
<PAGE>
CONDUCTUS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Revenues:
Contract $7,266,157 $ 9,690,989 $ 8,148,189
Product sales 2,187,383 2,851,682 2,433,496
----------- ----------- -----------
Total revenues 9,453,540 12,542,671 10,581,685
----------- ----------- -----------
Costs and expenses:
Cost of product sales 1,845,413 1,823,622 1,429,516
Research and development 10,626,133 11,773,587 9,819,416
Selling, general and
administrative 4,329,739 4,054,303 3,755,653
Write-off of property, plant,
and equipment 100,000 - -
Loss on asset sale 51,741 - -
----------- ----------- -----------
Total costs and expenses 16,953,026 17,651,512 15,004,585
----------- ----------- -----------
Loss from operations (7,499,486) (5,108,841) (4,422,900)
Interest income 267,492 262,965 249,371
Other income (expense) (108,992) 25,042 (92,608)
Interest expense (202,395) (183,138) (155,515)
----------- ----------- -----------
Net loss $(7,543,381) $(5,003,972) $(4,421,652)
----------- ----------- -----------
----------- ----------- -----------
Basic and diluted loss per share $(1.09) $(0.80) $(0.80)
----------- ----------- -----------
----------- ----------- -----------
Shares used in per share calculation 6,896,649 6,263,446 5,543,073
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
-32-
<PAGE>
CONDUCTUS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
For each of the three years in the period ended December 31, 1997
<TABLE>
<CAPTION>
Unrealized
Common Additional Gain (Loss) on Accumulated
Stock Paid-In Capital Investments Deficit Total
------- --------------- ------------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Balances, January 1, 1995 $ 537 $29,414,318 (84,762) $(19,801,182) $9,528,911
Issuance of 224,762 shares of common stock to employees 23 133,386 133,409
Compensation associated with stock options granted 34,528 34,528
Issuance of 101,790 shares of common stock to
employees under the employee stock purchase plan 10 453,216 453,226
Repurchase of 8,967 shares of common stock (90) (90)
Unrealized gain on investments, net 85,388 85,388
Net loss (4,421,652) (4,421,652)
------- ----------- -------- ------------ ----------
Balances, December 31, 1995 570 30,035,358 626 (24,222,834) 5,813,720
Issuance of 69,037 shares of common stock to employees 7 110,318 110,325
Issuance of 1,000,000 shares of common stock through
secondary offering, net of issuance costs 100 9,892,107 9,892,207
Issuance of 57,848 shares of common stock to employees
under the employee stock purchase plan 6 340,597 340,603
Compensation associated with stock options granted 27,001 27,001
Unrealized gain on investments, net 3,182 3,182
Net loss (5,003,972) (5,003,972)
------- ----------- -------- ------------ ----------
Balances, December 31, 1996 683 40,405,381 3,808 (29,226,806) 11,183,066
Issuance of 137,000 shares of common stock
to employees 14 381,592 381,606
Issuance of 50,686 shares of common stock to
employees under the employee stock purchase plan 5 247,662 247,667
Compensation associated with stock options granted 36,001 36,001
Unrealized loss on investments, net (3,808) (3,808)
Net loss (7,543,381) (7,543,381)
------- ----------- -------- ------------ ----------
Balances, December 31, 1997 $ 702 $41,070,636 $ - $(36,770,187) $4,301,151
------- ----------- -------- ------------ ----------
------- ----------- -------- ------------ ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
-33-
<PAGE>
CONDUCTUS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For The Years Ended December 31,
----------------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(7,543,381) $(5,003,972) $(4,421,652)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and amortization 827,071 925,718 901,340
Compensation associated with stock options granted 36,001 27,001 34,528
Provision for excess and obsolete inventories 199,845 20,000
(Gain)loss on disposal of equipment 51,741 (22,922)
Provision for allowance for doubtful accounts 198,232
(Increase) decrease in:
Accounts receivable 1,603,099 (505,439) (910,573)
Inventories (219,017) (455,449) (290,845)
Prepaid expenses and other current assets 258,077 (112,152) (122,994)
Other assets 40,001 (63,580) (1,099)
Increase, (decrease) in:
Accounts payable and accrued liabilities (153,367) 314,024 166,025
----------- ----------- -----------
Net cash used in operating activities (4,701,698) (4,896,771) (4,625,270)
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sales of short-term investments 39,401,345 44,266,602 40,473,743
Purchases of short-term investments (33,445,385) (47,899,357) (36,235,256)
Acquisition of property and equipment (689,286) (1,264,478) (1,568,033)
Net proceeds from sales of assets 581,243 29,196 -
----------- ----------- -----------
Net cash (used in) provided by investing activities 5,847,917 (4,868,037) 2,670,454
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from borrowings 910,132 1,229,019 1,432,944
Net proceeds from issuance of Common stock 629,273 10,343,135 586,635
Repurchase of common stock (90)
Principal payments under capital lease obligations (37,894) (143,340)
Principals payments on long-term debt (1,194,055) (921,871) (153,686)
----------- ----------- -----------
Net cash provided by financing activities 345,350 10,612,389 1,722,463
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 1,491,569 847,581 (232,353)
Cash and cash equivalents at beginning of period 1,119,991 272,410 504,763
----------- ----------- -----------
Cash and cash equivalents at end of period $2,611,560 $ 1,119,991 $ 272,410
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
-34-
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS
1. FORMATION AND BUSINESS OF THE COMPANY AND BASIS OF PRESENTATION:
The Company was formed to develop, manufacture and market
superconductive electronic devices, circuits and systems for sensor,
communications, test and instrumentation, and digital electronics
applications. On September 30, 1997, the Company discontinued operation
of the Company's Instrument and Systems Division.
SUBSTANTIAL FUTURE CAPITAL NEEDS:
The Company to date has received limited revenues from product sales and
as of March 23, 1998, had cash reserves of approximately $540,000. On
March 30, 1998, the Company entered into an agreement to expand its
existing bank working capital line of credit from $1,000,000 to
$2,000,000, subject to receivables eligibility requirements and certain
other restrictions.
On April 23, 1998, the Company entered into a "bridge" loan credit
facility agreement with its bank. The facility provides for borrowings
of up to $2,000,000, with interest at the bank's prime rate plus 2.00%.
The facility matures in 120 days, but may be paid off sooner at the
Company's option. The agreement grants to the bank a warrant to purchase
15,000 shares at $3.625 per share, the closing price for the Company's
shares on April 13, 1998.
The agreement provides for additional warrants to be granted based on
the length of time the loan is outstanding, as follows:
if the loan is outstanding after May 31, 1998, a warrant for an
additional 10,000 shares at the May 31, 1998 closing price will be
granted.
if the loan is outstanding after June 30, 1998, a warrant for an
additional 25,000 shares at the June 30, 1998 closing price will
be granted.
Borrowings under this facility are collateralized by a first priority
security interest in all of the Company's property, including
intellectual property rights.
On April 22, 1998, the Company entered into a lease line of credit
commitment with a leasing company. Under the terms of this commitment,
the Company will sell certain of its assets to the leasing company and
lease the assets back from the leasing company. The amount available
under this facility is $2,000,000 with another $500,000 available
contingent upon the Company achieving certain financial requirements in
the future. The facility grants to the leasing company warrants to
purchase up to $125,000 of the Company's stock at a price equal to the
average closing bid price for the five days immediately preceding and
including April 22, 1998. The effective interest rate would be 13.98%,
and there are certain reporting and financial covenants which the
company is required to satisfy.
On April 17, 1998, the Company received a commitment letter from a current
shareholder stating that the shareholder is prepared, if necessary, to
participate in future financing efforts in the amount of at least
$1,500,000. This commitment expires March 31, 1999. See
"Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources, Risk
Factors -- Substantial Future Capital Needs", and Note 17 of Conductus,
Inc. Notes to Financial Statements, "Subsequent Events."
The Company anticipates that existing sources of liquidity and
anticipated revenue, primarily from government contracts, will satisfy
the Company's projected working capital and other cash requirements
through at least December 1998. There can be no assurance, however, that
changes in the Company's plans or other events affecting the Company
will not result in the expenditure of such resources before such time.
There can be no assurance that additional financing will be available on
acceptable terms or at all.
The Company has adopted a plan consisting of the following additional
steps to conserve cash and improve its liquidity. The Company has
implemented a cost reduction program which will result in immediate
headcount reductions of 11 employees and reduced levels of operating
expenses, working capital requirements and capital expenditures over
the next several quarters. The Company continues to explore and evaluate
equity and debt financing alternatives. There can be no assurance that
any or all of the measures taken by the Company will provide sufficient
liquidity.
The development of the Company's planned products will require a
commitment of substantial additional funds. There can be no assurance
that additional financing will be available on acceptable terms or at
all. Unless the Company is able to raise significant additional funds,
through debt or equity issuances, asset sales or otherwise, the Company
will be required to delay, scale-back or eliminate one or more of its
research and development programs or obtain funds through arrangements
with collaborative partners or others that may require the Company to
relinquish rights to certain of its technologies or potential products
that the Company would not otherwise relinquish. The Company's future
capital requirements will depend on many factors, including continued
progress in its research and development programs, the magnitude of
these programs, the time and cost involved in obtaining any required
regulatory approvals, the costs involved in preparing, filing,
prosecuting, maintaining and enforcing patents, successful completion of
technological, manufacturing and market requirements, changes in existing
research relationships, the availability of funding under government
contracts, the ability of the Company to establish collaborative
arrangements and the cost of manufacturing scale-up and the amount and
timing of future revenues. See "Risk Factors - Substantial Future
Capital Needs."
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
FISCAL YEAR:
The Company uses a 52-53 week fiscal year ending on the last Friday of
the month. For convenience of presentation, the accompanying financial
statements have been shown as ending on December 31 of each applicable
period.
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
CERTAIN RISKS AND CONCENTRATIONS:
The Company's superconducting products are concentrated in the
electronic component industry which is highly competitive and rapidly
changing. Revenues for the Company's products are concentrated with a
relatively limited number of customers and supplies for certain
components are concentrated among a few providers. In addition,
approximately 77% of the Company's total revenues for each of the fiscal
years 1997, 1996, and 1995 were for government-related contracts. The
development of new technologies or commercialization of superconductive
products by any competitor could affect operating results adversely.
CASH, CASH EQUIVALENTS AND INVESTMENTS:
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
Investments, which consist primarily of foreign debt, corporate and
preferred bonds and commercial paper, are stated at fair market value.
Management believes that the financial institutions in which it
maintains such deposits are financially sound and, accordingly, minimal
credit risk exists with respect to these deposits. Additionally, cash
and cash equivalents are held by two major U.S. banks.
Other financial instruments, principally accounts receivable, leases
payable and other borrowings are considered to approximate fair value
based upon comparable market information available at respective balance
sheet dates.
Investments are deemed by management to be available-for-sale and are
reported at fair market value with net unrealized gains or losses
reported as a separate component of stockholders' equity.
Available-for-sale marketable securities with maturities less than one
year from the balance sheet date are classified as short-term and those
with maturities greater than one year from the balance sheet date are
classified as long term.
INVENTORIES:
Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market. Appropriate consideration is given to
obsolescence, excessive levels, deterioration and other factors in
evaluating net realizable value.
PROPERTY AND EQUIPMENT:
Property and equipment are stated at cost and depreciated on the
straight-line method over estimated useful lives of four to six years.
Amortization of leasehold improvements is computed using the
straight-line method over the shorter of the useful life of the assets
or the related lease term. When assets are disposed of,
-35-
<PAGE>
the cost and related accumulated depreciation are removed from the
accounts and the resulting gains and losses are included in results of
operations.
REVENUE RECOGNITION:
Product revenues are generally recognized at the time of shipment.
Income from other revenue and royalty agreements is recognized at such
time as the earnings process is complete and once collectibility is
considered probable. Appropriate allowance is made for product returns
and potential warranty claims at the time of shipment.
RESEARCH AND DEVELOPMENT CONTRACTS:
The Company has entered into contracts to perform research and
development for the U.S. government. Revenues from these contracts are
recognized utilizing the percentage-of-completion method measured by the
relationship of costs incurred to total contract costs. Cost of contract
revenues for the years ended December 31, 1997, 1996, and 1995 was
$9,814,000, $13,178,000, and $9,176,000, respectively. Costs include
direct engineering and development costs and applicable overhead.
RESEARCH AND DEVELOPMENT:
Internally funded research and development expenditures are charged to
operations as incurred.
INCOME TAXES:
The Company utilizes the liability method of accounting for income
taxes, as set forth in Statement of Financial Accounting Standards
(SFAS) No. 109, "Accounting for Income Taxes." Under the liability
method, deferred taxes are determined based on the difference between
the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect in the years in which the differences are
expected to reverse.
ACCOUNTING FOR STOCK-BASED COMPENSATION:
As permitted by Statement of Financial Accounting Standards No. 123
(SFAS 123) "Accounting for Stock-Based Compensation", the Company
accounts for grants of equity instruments to employees using the
intrinsic value method described in Accounting Principles Board Opinion
No. 25 (APBO 25). All other grants are accounted for using the fair value
method described in SFAS 123 with appropriate compensation expense
recognition in the statement of operations, where significant.
BASIC AND DILUTED LOSS PER SHARE:
In accordance with the disclosure requirements of Statement of Financial
Accounting Standards No. 128 (SFAS 128) "Earnings Per Share", a
reconciliation of the numerator and denominator of the basic and diluted
EPS is provided as follows:
<TABLE>
<CAPTION>
Years ended December 31,
------------------------------------------
1997 1996 1995
----- ---- -----
<S> <C> <C> <C>
Numerator - basic and diluted EPS:
Net income (loss) $(7,543,381) $(5,003,972) $(4,421,652)
Denominator - basic and diluted EPS:
Common Stock outstanding 6,896,649 6,263,446 5,543,073
Basic earnings per share $(1.09) $(0.80) $(0.80)
Diluted earnings per share $(1.09) $(0.80) $(0.80)
</TABLE>
In the 1997, 1996, and 1995 computations, common equivalent shares are
excluded from the basic and diluted loss per share as their effect is
antidilutive. Common equivalent shares that could potentially dilute
basic earnings per share in the future and that were not included in the
computations of diluted loss per share because of antidilution were
approximately 268,000, 591,000 and 505,000 for the years ended 1997,
1996, and 1995.
RECLASSIFICATIONS:
Certain 1996 amounts have been reclassified to conform to the 1997
presentation.
-36-
<PAGE>
RECENT PRONOUNCEMENTS:
In June 1997, the Financial Accounting Standards Board issued Statement
No. 130 (SFAS 130) "Reporting Comprehensive Income." SFAS No. 130
establishes standards for the reporting and display of comprehensive
income and its components in a full set of general purpose financial
statements. Comprehensive income is defined as the change in equity of a
business enterprise during a period from transactions and other events
and circumstances from nonowner sources. SFAS 130 will become effective
for the Company's 1998 fiscal year.
In June 1997, the Financial Accounting Standards Board issued Statement
No. 131 (SFAS 131) "Disclosures about Segments of an Enterprise and
Other Information." SFAS 131 requires publicly-held companies to
report financial and other information about key revenue-producing
segments of the entity for which such information is available and is
utilized by the chief operation decision makers. Specific information
to be reported for individual segments includes profit and loss, certain
revenue and expense items and total assets. A reconciliation of segment
financial information to amounts reported in the financial statements
would be provided. SFAS 131 will become effective for the Company's
1998 fiscal year.
The Company is currently studying the implications of these statements
and has not yet determined the impact of their adoption.
3. SUPPLEMENTAL CASH FLOW DISCLOSURE:
<TABLE>
<CAPTION>
For The Years Ended December 31,
------------------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest $173,571 $ 191,050 $ 147,605
-------- ---------- ----------
-------- ---------- ----------
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FUNDING ACTIVITIES:
Unrealized gain (loss) on investments, net $ 3,808 $ 3,182 $ 85,388
-------- ---------- ----------
-------- ---------- ----------
OTHER NONCASH EXPENSES:
Compensation associated with stock options granted $ 36,001 $ 27,001 $ 34,528
-------- ---------- ----------
-------- ---------- ----------
</TABLE>
4. INVESTMENTS:
Investments, all of which are classified as available-for-sale, are
summarized below:
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
-------------------------- ----------------------------
Cost Market Value Cost Market Value
---- ------------ ---- ------------
<S> <C> <C> <C> <C>
Debt securities:
Corporate bonds $2,356,259 $2,359,453
Preferred bonds 2,000,000 2,000,000
Foreign debt $289,829 $289,829
Commercial paper 247,702 247,702 2,078,596 2,079,210
Other 4,587 4,587 18,545 18,545
Accrued interest 14,515 14,515 59,193 59,193
-------- --------- ---------- ----------
Subtotal 556,633 556,633 6,512,593 6,516,401
Unrealized gain, net - - 3,808
-------- --------- ---------- ----------
Total $556,633 $556,633 $6,516,401 $6,516,401
-------- --------- ---------- ----------
-------- --------- ---------- ----------
</TABLE>
-37-
<PAGE>
At December 31, 1997, all scheduled maturities of investments are within
one year. Investments consisted primarily of foreign debt and
commercial paper bearing interest between 5.00% to 6.16% per annum are
due to mature between January 1998 and April 1998.
For the years ended December 31, 1997, 1996, and 1995 gross realized
gains and losses on sales of available-for-sale securities were not
material, the cost of securities sold is based on the specific
identification method.
5. ACCOUNTS RECEIVABLE:
Accounts receivable, net, consists of the following:
<TABLE>
<CAPTION>
December 31,
-------------------------
1997 1996
---- ----
<S> <C> <C>
U.S. government contracts:
Unbilled
Recoverable costs and accrued profit
on progress completed--not billed $ 796,283 $ 466,509
Unrecovered costs and estimated profits
subject to future negotiation--not billed 350,000 -
Billed 793,382 2,842,285
Commercial 363,822 497,792
Reserves (248,232) (50,000)
---------- ----------
$2,055,255 $3,756,586
---------- ----------
---------- ----------
</TABLE>
Recoverable costs and accrued profit and unrecovered costs and estimated
profits not billed are comprised principally of amounts of revenue
recognized on contracts for which billings had not been presented to the
contract owners because the amounts were not billable at the balance
sheet date. It is anticipated such unbilled amounts receivable from the
U. S. Government at December 31, 1997 will be billed over the next 120
days as incremental increases to the contract are funded by the contract
administrator or as final billing rates related to fiscal years 1994
through 1996 are approved by the DCAA.
6. INVENTORIES:
Inventories, net, consist of the following:
<TABLE>
<CAPTION>
December 31,
----------------------
1997 1996
---- ----
<S> <C> <C>
Raw materials $293,336 $ 604,070
Work in process 366,550 521,997
Finished goods 231,326 175,806
Reserves (280,845) (81,000)
-------- -----------
$610,367 $ 1,220,873
-------- -----------
-------- -----------
</TABLE>
7. PROPERTY AND EQUIPMENT:
Property and equipment, including equipment acquired under capital
leases, consist of the following:
<TABLE>
<CAPTION>
December 31,
-------------------------
1997 1996
---- ----
<S> <C> <C>
Equipment $6,859,265 $6,403,590
Leasehold improvements 1,590,605 1,586,350
Furniture and fixtures 424,824 449,574
Construction in process 307,386 318,003
---------- ----------
9,182,080 8,757,517
Accumulated depreciation
and amortization (6,481,486) (5,815,832)
---------- ----------
$2,700,594 $2,941,685
---------- ----------
---------- ----------
</TABLE>
-38-
<PAGE>
8. OTHER ACCRUED LIABILITIES:
Other accrued liabilities consist of the following:
<TABLE>
<CAPTION>
December 31,
-----------------------------
1997 1996
---- ----
<S> <C> <C>
Accrued consulting and professional $ 138,155 $ 171,300
Accrued compensation 704,675 727,299
Other accrued liabilities 220,891 147,317
---------- ----------
$1,063,721 $1,045,916
---------- ----------
---------- ----------
</TABLE>
9. LONG-TERM DEBT AND OTHER BORROWINGS:
At December 31, 1997, the Company has three term loan obligations and a
bank line of credit with annual maturities as follows:
<TABLE>
<S> <C>
1998 $1,547,507
1999 288,416
2000 21,265
----------
$1,857,188
----------
----------
</TABLE>
In December 1997, the Company modified its bank line of credit facility
which expires February 28, 1998. See Note 17. The agreement provides for
borrowings up to the lesser of $500,000 or 75% of eligible receivables.
Borrowings under the agreement bear interest at the bank's prime rate
plus 1.00% (a total of 9.50% at December 31, 1997) and are collateralized
by a $500,000 certificate of deposit, accounts receivable, equipment and
other assets of the Company. At December 31, 1997, the Company had
borrowed $500,000 under the agreement. In connection with a prior line
of credit modification, on March 8, 1996, the Company issued the lender
warrants to acquire 15,000 shares of the Company's common stock at a
price of $11.25 per share. These warrants may be exercised by the holder
at any time until the expiration date, March 8, 2001.
The three equipment credit facilities and line of credit facility
require that the Company provide financial information to the lender,
obtain approval of the lender for any material disposition of the
collateral except in the ordinary course of business and meet certain
financial ratios, minimum tangible net worth, minimum cash and
investments and other covenants.
All borrowings under these credit facilities are at the bank's prime
rate plus 1.00% (a total of 9.50% at December 31, 1997) with interest
paid monthly, and are collateralized by the related equipment. At
December 31, 1997, there were no amounts available under these credit
facilities.
The Company received a waiver in March 1998 from the institution with
respect to default that occurred in the fourth quarter of fiscal 1997 on
certain financial covenants.
10. COMMITMENTS:
The Company leases its administrative, sales, marketing, manufacturing,
research and development facilities under noncancelable operating leases
expiring in February 1998, August 2000 and August 2001. Under the terms
of the leases, the Company is responsible for certain expenses and taxes.
Future minimum payments under these noncancelable leases are as follows:
<TABLE>
<CAPTION>
Fiscal year:
- ------------
<S> <C>
1998 $ 338,810
1999 327,114
2000 279,114
2001 122,076
----------
$1,067,114
----------
----------
</TABLE>
Rent expense was $385,432, $438,531 and $470,379, for December 31, 1997,
1996, and 1995, respectively.
11. RESEARCH AND DEVELOPMENT ARRANGEMENTS:
The Company is party to a number of research and development contracts,
generally short-term in nature, which are substantially all with various
agencies of the United States government. Credit risk related to
-39-
<PAGE>
accounts receivable arising from such contracts is considered minimal.
The following describes some of the major programs underway:
COORDINATED RESEARCH PROGRAM:
In May 1993, the Company and Hewlett-Packard Company (H-P) modified a
previous Coordinated Research Program (CRP) agreement by entering into a
new five-year agreement. In connection with the modifying agreement,
the Company received $1,000,000 in cash and $230,000 in equipment from
H-P in exchange for issuing 439,286 shares of its Series B preferred
stock, which automatically converted into 137,276 shares of common stock
upon the close of the Company's initial public offering in August 1993.
This agreement requires the Company and H-P to exchange reviews and
assessments of the Company's technical and applications developments,
particularly with respect to their potential application to H-P's products.
ADVANCED TECHNOLOGY PROGRAM:
In August 1992, the Company, acting as administrator for and on behalf
of a joint venture formed to conduct research to develop a prototype
hybrid superconductor/semiconductor computer under the Department of
Commerce Advanced Technology Program, entered into a cost-sharing
cooperative agreement with the U.S. government. Under the terms of the
five year agreement, the U.S. government agreed to share costs of the
joint venture's research effort up to an aggregate of $7,450,000,
including subcontractor costs. Revenue of $714,000, $1,613,000, and
$1,920,000 was recognized under this contract for 1997, 1996, and 1995,
respectively.
FOCUSED RESEARCH INITIATIVE:
In September 1995, the Company entered into a contract with the Naval
Research Laboratory for the development of HTS receiver coils for pulse
magnetic resonance imaging (MRI) prototype for screening of breast
cancer. Revenue of $920,000, $1,473,000, and $185,000 was
recognized under the contract for 1997, 1996, and 1995, respectively.
LUCENT JOINT DEVELOPMENT AGREEMENT:
In April 1996, the Company entered into a joint development and
licensing agreement with Lucent Technologies, Inc., to develop a
superconductive transceiver filter subsystem for the PCS market. Both
Conductus and Lucent provide technical support to the program. Each
party will retain rights to the intellectual property it develops under
the program, subject to certain nonexclusive licensing rights of the
other party, and jointly developed intellectual property will be jointly
owned. Revenue of $1,080,000 and $428,000 was recognized under the
agreement for 1997 and 1996, respectively.
DARPA CRYOPACKAGING PROGRAM:
In August 1996, the Company entered into a contract with the Naval
Research Laboratory to solve technical problems associated with the
support and utilization of cryoelectronic components in advanced
electronic systems with particular emphasis on microwave communications.
Revenue of $847,000 and $616,000 was recognized under this contract for
1997 and 1996, respectively.
12. STOCKHOLDERS' EQUITY
CAPITAL STOCK:
Under the terms of the Company's Articles of Incorporation, the Board of
Directors may determine the rights, preferences and terms of the
Company's authorized but unissued preferred stock. In connection with
obtaining the lease lines of credit, the Company issued to the leasing
companies warrants exercisable for the Company's preferred stock, which
converted to warrants for 32,894 and 9,664 shares of common stock, at a
price per share of $6.08 and $8.96, respectively. As of December 31,
1997, warrants for 16,447 and 2,087 shares of Common Stock remain
exercisable, respectively, The warrants, which are immediately
exercisable, expire August 5, 1998. Also see Note 17, "Subsequent
Events."
1992 STOCK OPTION/STOCK ISSUANCE PLAN:
Under the Company's stock option/stock issuance plan (the Plan), as
amended, a total of 2,080,000 shares of common stock are authorized for
issuance under the Plan as of December 31, 1997.
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<PAGE>
Additionally each year the non-employee Board members receive a 3,000
share grant that vests over three years.
The Plan is divided into three separate components: the discretionary
option grant program, the automatic option plan program and the stock
issuance program. Under the discretionary option grant program, eligible
individuals may be granted incentive options or nonstatutory options.
The exercise price of incentive stock options granted under the Plan
must be at least equal to the fair market value of the common stock of
the Company on date of grant. The exercise price of nonstatutory options
granted under the Plan must be not less than 85% of the fair market
value of the common stock on date of grant. Under the automatic option
grant program, non-employee Board members automatically receive
non-statutory options to purchase shares of the Company's common stock.
Each non-employee Board member who first becomes a non-employee Board
member at any time on or after January 23, 1995 is automatically granted
at the time of such initial election or appointment an option to
purchase 15,000 shares of common stock. The options are immediately
exercisable, subject to the Company's repurchase right which lapses with
respect to twenty percent (20%) of the optioned shares upon completion
of twelve (12) months of Board service from the date of grant, and the
remainder of the optioned shares in forty-eight (48) equal monthly
installments. Under the stock issuance program eligible individuals are
allowed to purchase shares of the Company's common stock at fair market
value or for such consideration as the Compensation Committee deems
advisable.
Options granted under the Plan may be immediately exercisable for all
the option shares, on either a vested or unvested basis, or may become
exercisable for fully vested shares in one or more installments over the
participant's period of service. Shares issued under the stock issuance
program may either be vested upon issuance or subject to a vesting
schedule tied to the participant's period of future service or to the
attainment of designated performance goals.
No option may be granted with a term exceeding ten years. However, each
such option may be subject to earlier termination within a designated
period following the optionee's cessation of service with the Company.
In 1992, the Company issued options at below fair market value,
resulting in a compensation charge of $295,000, which is being amortized
to the statement of operations over the vesting period of the related
options. As of December 31, 1997, $18,160 remains to be amortized.
A summary of the status of the Company's stock option plans as of December
31, 1997, 1996 and 1995 and changes during the years ending on these dates
is presented below:
<TABLE>
<CAPTION>
Options Outstanding
---------------------------------------------------------
Available For Weighted
Grant under Avg. Exercise
Option Plan Shares Price per share Price
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balances, January 1, 1995 133,642 1,150,591 $ .16 - 5.75 $2.76
Additional shares authorized 300,000
Granted (309,163) 309,163 $4.94 - 7.25 5.61
Exercised (224,762) $ .16 - 6.31 .58
Canceled 154,559 (212,684) $ .45 - 6.88 3.08
-------- ---------- -----
Balance, December 31, 1995 279,038 1,022,308 $ .16 - 7.25 $4.04
Additional shares authorized 300,000
Granted (528,000) 528,000 $6.50 - 15.25 9.57
Exercised (57,311) $ .16 - 7.25 2.08
Canceled 107,815 (107,815) $ .45 - 11.50 6.09
-------- ---------- -----
Balance, December 31, 1996 158,853 1,385,182 $ .16 - 15.25 $6.07
Additional shares authorized 200,000
Granted (644,000) 644,000 $3.44 - 8.38 6.31
Exercised (137,000) $ .16 - 6.38 2.79
Canceled 806,495 (806,495) $ .45 - 15.25 7.98
-------- ---------- -----
Balance December 31, 1997 521,348 1,085,687 $ .45 - 13.00 $4.68
-------- ---------- -----
-------- ---------- -----
</TABLE>
At December 31, 1997, and 1996, vested options to purchase 797,925 and
477,522 were unexercised. The weighted average price for the vested
options were $4.68 and $3.21.
REPRICING OF STOCK OPTIONS:
On April 29, 1997, the Plan Administrator of the 1992 Stock Option/Stock
Issuance Plan adopted a plan for repricing of stock options under which
each employee-holder of outstanding options with an exercise
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<PAGE>
price above the closing price of the Company's stock on April 29, 1997,
was permitted to elect to exchange the existing options for new options,
subject to the same terms as the corresponding original stock options
being surrendered, except that the exercise price was equal to the
closing price of the Company's common stock on April 29, 1997, and all
shares were to be unvested until April 29, 1998, after which they would
be subject to the original vesting schedule.
EMPLOYEE STOCK PURCHASE PLAN:
In July 1994, the Employee Stock Purchase Plan (the ESPP) was adopted by
the Company's Board of Directors. A total of 350,000 shares of common
stock are authorized for issuance under the ESPP as of December 31,
1997. The purpose of the ESPP is to provide eligible employees of the
Company with a means of acquiring common stock of the Company through
payroll deductions. The purchase price of such stock under the ESPP
cannot be less than 85% of the lower of the fair market values on the
specified purchase date and the beginning of the offering period.
During 1997 and 1996 employees purchased 50,686 and 57,848 shares for a
total of approximately $381,606 and $340,603, respectively. At
December 31, 1997, 139,676 shares were available for future grants under
the Plan.
SHAREHOLDER RIGHTS PLAN:
On January 22, 1998, the Board of Directors of Conductus, Inc. (the
"Company") declared a dividend of one preferred share purchase right (a
"Right") for each outstanding share of common stock, par value $0.0001
per share (the "Common Shares") outstanding on February 16, 1998 (the
"Record Date") to the stockholders of record on that date. Each Right
entitles the registered holder to purchase from the Company one
one-thousandth of a share of Series A Junior Participating Preferred
Stock, par value $0.0001 per share (the "Preferred Shares"), of the
Company, at a price of $29.00 per one one-thousandth of a Preferred
Share (the "Purchase Price"), subject to adjustment. The description
and terms of the Rights are set forth in a Rights Agreement.
COMMON STOCK RESERVED:
At December 31, 1997, the Company had reserved the following shares of
Common Stock:
<TABLE>
<S> <C>
Employee Stock Purchase Plan 139,676
Warrants 33,534
Option Plan 1,607,035
---------
1,780,245
---------
---------
</TABLE>
STOCK BASED COMPENSATION PLANS - VALUATION:
The following table summarizes information with respect to stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------- -----------------------------
Weighted
Number Weighted Average Average Number Weighted
Range of Exercise Outstanding at Remaining Contractual Exercise Exercisable at Average
Prices 12/31/97 Life (Years) Price 12/31/97 Exercise Price
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 0.45 - $ 0.88 163,091 4.66 $ 0.63 163,091 $ 0.63
$ 3.44 - $ 5.25 104,666 7.79 $ 4.79 104,666 $ 4.79
$ 5.38 - $ 6.50 740,252 7.91 $ 5.96 452,490 $ 5.61
$ 6.56 - $13.00 77,678 8.79 $ 7.66 77,678 $ 7.66
- ------------------ --------- ---- ------- ------- -------
$ 0.45 - $13.00 1,085,687 7.47 $ 5.17 797,925 $ 4.68
- ------------------ --------- ---- ------- ------- -------
- ------------------ --------- ---- ------- ------- -------
</TABLE>
The following information concerning the Company's stock issuance plans
(see Employee Stock Purchase Plan) is provided in accordance with SFAS
123. The Company however continues to apply APBO 25 "Accounting for
Stock Issued to Employees" and related interpretations in accounting for
its plan.
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<PAGE>
The fair value of each option grant and purchase right has been estimated
on the date of grant using the Black-Scholes option pricing and valuation
model with the following weighted average assumptions used for grants and
purchase rights in 1997 and 1996.
<TABLE>
<CAPTION>
1997 1996 1995
Group A Group B Group A Group B Group A Group B
------- ------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Risk-free Interest Rates 6.23% 5.50% 6.13% 5.50% 6.38% 5.60%
Expected Life 4.4 years 6 months 4.9 years 6 months 4.9 years 6 months
Volatility 0.83 0.83 0.76 0.76 0.76 0.76
Dividend Yield -- -- -- -- -- --
</TABLE>
The weighted average expected life was calculated based on the exercise
behavior of each group. Group A represents all employees, Officers, and
Directors. Group B represents the employees with purchase rights under
the Employee Stock Purchase Plan.
The weighted average fair value of those options granted in 1997, 1996,
and 1995 was $4.10, $6.19, and $3.64. The weighted average fair value of
those purchase rights granted in 1997, 1996, and 1995 was $2.71, $3.47,
and $2.21.
Had compensation cost for these plans been determined based on fair value
of the options at that grant date in 1997, 1996, and 1995 consistent with
the provisions of SFAS 123, the Company's net loss and net loss per share
would have been as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net Loss - As reported $(7,543,000) $(5,004,000) $(4,422,000)
- Proforma $(8,746,000) $(6,057,000) $(4,917,000)
Basic and diluted loss per share - As reported $(1.09) $(0.80) $(0.80)
- Proforma $(1.27) $(0.97) $(0.89)
</TABLE>
The above proforma effect may not be representative of the effects on
reported net income for future years as the proforma numbers presented do
not take into account the effect of equity grants made prior to 1995 or
additional future grants.
On March 8, 1996 the Company issued warrants to acquire 15,000 shares
of common stock at a price of $11.25 per share.
13. 401(k) PROFIT SHARING PLAN:
The Company has a 401(k) Profit Sharing Plan which covers substantially
all employees. Under the plan, employees are permitted to contribute up
to 15% of gross compensation not to exceed the annual 402(g) limitation
for any plan year. Discretionary contributions may be made by the
Company irrespective of whether it has net profits. No contributions
were made by the Company during the years 1994 through 1997.
14. ASSET DISPOSALS:
During the third quarter of 1997, the company disposed of the net assets
of its Systems and Instrumentation division, and its NMR product line.
The following table summarizes the financial impact of the transactions:
<TABLE>
<S> <C>
Proceeds from the sale of product lines and related assets. $1,128,093
Net book value of assets sold:
Fixed assets (3,306)
Inventories (629,678)
Costs related to asset disposal. (546,850)
----------
Net loss $ (51,741)
----------
----------
</TABLE>
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<PAGE>
15. INCOME TAXES:
The components of deferred tax assets are as follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------
1997 1996
---- -----
<S> <C> <C>
Property and equipment, principally due to
differences in depreciation $ 198,000 $ 327,000
Accrued liabilities and other 248,000 519,000
Tax credit carryforwards 1,191,000 -
Capitalized research and development expense 76,000 882,000
Net operating loss carry forward 13,028,000 9,190,000
Valuation allowance (14,741,000) (10,918,000)
------------- -------------
Net deferred tax asset $ - $ -
------------- -------------
------------- -------------
</TABLE>
Due to the uncertainty surrounding the realization of the deferred tax
assets in future tax years, the Company has placed a valuation
allowance against its otherwise recognizable net deferred tax assets.
At December 31, 1997, the Company had approximately $36,231,000 and
$12,150,000 in net operating loss carry forwards for federal and state
income purposes, respectively. These expire in the years 1998 through
2012. The utilization of the Company's net operating loss carry forwards
may be subject to certain limitations upon certain changes in ownership,
as defined.
16. BUSINESS SEGMENT AND MAJOR CUSTOMERS:
The Company was formed to operate in a single industry segment
encompassing the development, manufacture, and marketing of electronic
components and systems based on superconductors.
Commercial sales to one customer as a percentage of revenues were 9%
($896,000), 12% ($1,560,000) and 11% ($1,172,000), in 1997, 1996 and
1995, respectively. Amounts receivable from this customer were $183,000
and $381,000 at December 31, 1997 and 1996, respectively.
The Company's export revenues are all denominated in U.S. dollars and
are summarized as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Japan $ 896,000 $1,560,000 $1,172,000
Rest of the world 240,000 433,000 256,000
---------- ---------- ----------
$1,136,000 $1,993,000 $1,428,000
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
17. SUBSEQUENT EVENTS:
RE-NEGOTIATED CREDIT FACILITIES:
On March 30, the Company renegotiated the terms of its bank line of
credit and its three equipment term loan facilities. The bank line of
credit facility provides for borrowings of up to the lesser of
$2,000,000 or 80% of eligible receivables. Borrowings under the
agreement bear interest at the bank's prime rate plus 2.0%, and are
collateralized by the accounts receivable, equipment and the assets of
the Company.
The three equipment term loan facilities will continue to be amortized
using the same amortization periods in effect under the previous
agreement. However, the interest rate on these loans is changed to the
bank's prime rate plus 2.0% and amounts owing under these facilities
will be collateralized by certificates of deposit or other restricted
cash accounts. This requirement will be in effect after July 28, 1998.
The Company is required to provide financial information to the lender,
obtain approval of the lender for any material disposition of the
collateral, except in the ordinary course of business, and meet certain
minimum tangible net worth covenants.
NEW "BRIDGE" LOAN FACILITY
On April 23, 1998, the Company entered into a "bridge" loan credit
facility agreement with its bank. The facility provides for borrowings
of up to $2,000,000, with interest at the bank's prime rate plus 2.00%.
The facility matures in 120 days, but may be paid off sooner at the
Company's option. The agreement grants to the bank a warrant to purchase
15,000 shares at $3.625 per share, the closing price for the Company's
shares on April 13, 1998.
The agreement provides for additional warrants to be granted based on
the length of time the loan is outstanding, as follows:
if the loan is outstanding after May 31, 1998, a warrant for an
additional 10,000 shares at the May 31, 1998 closing price will be
granted.
if the loan is outstanding after June 30, 1998, a warrant for an
additional 25,000 shares at the June 30, 1998 closing price will
be granted.
Borrowings under this facility are collateralized by a first priority
security interest in all of the Company's property, including
intellectual property rights.
LEASING FACILITY COMMITMENT
On April 22, 1998, the Company entered into a lease line of credit
commitment with a leasing company. Under the terms of this commitment,
the Company will sell certain of its assets to the leasing company and
lease the assets back from the leasing company. The amount available
under this facility is $2,000,000 with another $500,000 available
contingent upon the Company achieving certain financial requirements in
the future. The facility grants to the leasing company warrants to
purchase up to $125,000 of the Company's stock at a price equal to the
average closing bid price for the five days immediately preceding and
including April 22, 1998. The effective interest rate would be 13.98%,
and there are certain reporting and financial covenants which the
company is required to satisfy.
SHAREHOLDER FINANCING PARTICIPATION COMMITMENT
On April 17, 1998, the Company received a commitment letter from a
current shareholder stating that the shareholder is prepared, if
necessary, to participate in future financing efforts in the amount of
at least $1,500,000. This commitment expires March 31, 1999.
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<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
Conductus, Inc.:
Our report on the financial statements of Conductus Inc., is included on page 30
of this Form 10-K. In connection with our audits of such financial statements,
we have also audited the related financial statement schedule listed in the
index on page 25 of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P
San Jose, California
February 9, 1997
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<PAGE>
SCHEDULE II
CONDUCTUS, INC
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Column A Column B Column C Column D Column E
Balance at Charged to Balance at
Beginning of Cost and Other End of
Description Period Expenses Accounts Deductions Period
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1995:
Allowance for doubtful accounts $ 50,000 $ -- $ -- $ -- $ 50,000
Allowance for excess and obsolete inventory $ 61,000 $ 20,000 $ -- $ -- $ 81,000
Year ended December 31, 1996:
Allowance for doubtful accounts $ 50,000 $ -- $ -- $ -- $ 50,000
Allowance for excess and obsolete inventory $ 81,000 $ -- $ -- $ -- $ 81,000
Year ended December 31, 1997:
Allowance for doubtful accounts $ 50,000 $273,232 $(75,000) $ 248,232
Allowance for excess and obsolete inventory $ 81,000 $249,845 $(50,000) $ 280,845
</TABLE>
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<PAGE>
[LETTERHEAD]
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
Conductus, Inc. on Form S-8 (File Nos. 33-74478 and 33-79946, and 333-41099)
of our reports dated February 9, 1998 (except for Notes 1 and 17, as to which
the date is April 27, 1998), on our audits of the financial statements and
financial statement schedule of Conductus, Inc. as of December 31, 1997 and
1996, and for the years ended December 31, 1997, 1996 and 1995 which reports
are included in this Annual Report on Form 10-K.
San Jose, California
April 27, 1998
