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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(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, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-11915
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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
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
SERIES B PREFERRED STOCK, $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 March 29, 1999, was approximately $10,808,367 based on the
closing sale price of the Company's Common Stock, as reported by the Nasdaq
SmallCap Market on March 29, 1999. 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 March 29, 1999, approximately 10,097,720 shares of the Registrant's
Common Stock, $0.0001 par value, were outstanding. The information in this
paragraph assumes the conversion of 2,461,227 shares of Series B Preferred Stock
and the exercise of 492,242 warrants issued or granted in connection with the
Company's September 1998 Series B Preferred Stock financing.
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 1999 Annual Meeting of
Stockholders scheduled to be held on May 27, 1999, are incorporated by
reference into Part III.
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TABLE OF CONTENTS
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PAGE 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............ 19
Item 4A. EXECUTIVE OFFICERS OF THE REGISTRANT........................... 19
PART II................................................................... 19
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS........................................................ 19
Item 6. SELECTED FINANCIAL DATA........................................ 20
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.......................................... 21
Item 7a.QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK....... 27
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................... 27
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE........................................... 27
PART III.................................................................. 27
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............. 27
Item 11. EXECUTIVE COMPENSATION......................................... 28
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT..................................................... 28
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................. 28
PART IV................................................................... 28
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K............................................................ 28
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PART I
ITEM 1. BUSINESS
OVERVIEW
THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K AND IN REPORTS
INCORPORATED BY REFERENCE THAT ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING
STATEMENTS THAT REFLECT CONDUCTUS, INC.'S CURRENT EXPECTATIONS REGARDING ITS
FUTURE RESULTS OF OPERATIONS AND PERFORMANCE AND ACHIEVEMENTS. WE HAVE TRIED,
WHEREVER POSSIBLE, TO IDENTIFY THESE FORWARD-LOOKING STATEMENTS BY USING WORDS
SUCH AS "ANTICIPATE," "BELIEVE," "ESTIMATE," "EXPECT" AND SIMILAR EXPRESSIONS.
THESE STATEMENTS REFLECT OUR CURRENT BELIEFS AND ARE BASED ON INFORMATION
CURRENTLY AVAILABLE TO US. 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 OUR FUTURE RESULTS, PERFORMANCE OR
ACHIEVEMENTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN, OR IMPLIED BY, ANY OF
THESE STATEMENTS. WE UNDERTAKE 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.
BUSINESS
OVERVIEW
We develop, manufacture and market electronic components and subsystems
based on high-temperature superconductor technology. 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.
In 1997, we focused our efforts on applications for the telecommunications
market that take advantage of the superior performance and benefits afforded by
high-temperature superconductor technology. We have developed our line of
ClearSite front-end receiver subsystems for cellular and personal communications
services, or "PCS," base stations. Base stations send and receive wireless
communication signals. ClearSite products can provide significant benefits in
base station performance, reduce the size of the required filter components and
enable network services providers to rapidly deploy new or upgraded systems for
increasingly demanding environments.
In the existing cellular communications infrastructures, network service
providers must overcome problems of limited CAPACITY, insufficient COVERAGE, and
increasing INTERFERENCE. Both cellular PCS network operators face the increasing
need for cost-effective solutions that address these problems. As the wireless
communications infrastructure expands, the incidence of such problems is
increasing, often leading to decreased customer satisfaction and increased
customer turnover. These problems decrease a network operator's ability to
compete effectively and impact the ability to maximize billable minutes.
ClearSite products effectively improve coverage, reduce interference and
increase network capacity, thus improving the network operators' ability to
compete effectively and increase billable airtime. We have begun initial product
shipments to customers, continue to support field test trials and are developing
additional ClearSite products to be introduced soon.
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We began field testing our ClearSite products in wireless base stations in
1996 with four cellular operators. Testing progressed to the beta stage late in
that year with the initiation of an extended field trial with Cellcom, Inc., a
service provider in Wisconsin. This trial, which concluded in April 1997 with
the first commercial order for multiple ClearSite products, successfully
demonstrated a significant reduction in the number of dropped calls and enhanced
voice quality. Commercial product shipments began in December 1997.
From 1987 to 1997, we pursued the development of materials and process
technology for high-temperature superconductor technology as well as
applications research. These efforts were sponsored in part by military and
government agency funding. We initiated commercial product shipments of
high-temperature superconductor technology films in 1990 and of high-temperature
superconductor technology systems in 1992 addressing multiple markets, including
the communications, health care and instrumentation markets. In late 1996, we
made the strategic decision to focus on the rapidly growing telecommunications
market. In the third quarter of 1997, we completed two organizational changes
aimed at focusing on wireless communications. We closed our Instrument and
Systems Division and sold our nuclear magnetic resonance spectroscopy probe
business. Research and development efforts are now focused on developing
applications in the communications market, including superconducting circuits
for high-speed telecommunications switching.
Our target market is both global and growing. According to Federal
Communications Commission and industry reports, there are over 25,000 installed
cellular base stations in the U.S. In addition, industry sources estimate that
more than 70,000 PCS base stations will be installed throughout the U.S. by the
end of 2005. The present cellular communications network, operating at
frequencies near 850 MHz, was established when the typical cellular phone was
capable of transmitting up to 3 watts of radio frequency power and the 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 caused
service providers to use a greater number of channels within their allotted
frequency bands, thereby increasing interference. Moreover, the arrival of PCS
and other competing services has placed new emphasis upon quality of service for
established cellular operators.
Our current customers include such leading wireless service providers as
AllTel, RadioFone, Cellcom and NTT-DoCoMo. In addition, we have completed
initial field tests with Carolina West Wireless, Kansas Cellular and Citizens
Mohave, have ongoing tests with U.S. Cellular and COMMNET, and are scheduling
trials with Cellular One, Ameritech and three regional Bell wireless groups. We
also have established significant strategic alliances and development agreements
with industry leaders such as Lucent Technologies and CTI-Cryogenics, a division
of Helix Technology Corporation. With the continued growth of global
telecommunications networks, network service providers are increasingly
outsourcing critical components in an effort to introduce their products
quicker, reduce production and development costs, and circumvent the increasing
scarcity of skilled specialists in advanced telecommunications technology.
Our current sales and marketing strategy relies primarily on direct sales
for our communications products. We believe that our products have significant
long-term potential as new generations of telecommunications equipment are
installed throughout the world due to the integration of technology advances and
the opening of new markets. We intend to leverage our product line, established
relationships with industry leaders, and use our experienced team of engineers
to provide support and services to network operators worldwide.
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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
reliable 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 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 of what is found in the best
conventional conductors. This property is extremely beneficial in electronic
components. 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, was discovered
having critical temperatures above 77 K (-320 DEG. F), the boiling point of
liquid nitrogen. These high critical temperatures allow some materials to be
cooled to a superconducting state using liquid nitrogen, which is inexpensive
and relatively easy to use. The science and technology of extremely low
temperatures is known as "cryogenics." We believe that this ability to obtain
the benefits of superconducting technology at more easily achieved temperatures
enables much broader commercial applications.
The cooling required for high-temperature superconductors can also be useful
for other materials. Many electronic technologies 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
super-cooling technologies, the result is a hybrid system whose overall
performance can justify the additional expense associated with super-cooling. We
currently employ this hybrid approach in our front-end receiver systems, which
combine superconductive filters with super-cooled low noise amplifiers.
OUR APPROACH
We develop electronic devices and components using thin-film technology
based upon yttrium barium copper oxide. We believe yttrium barium copper oxide
is the high-temperature superconductor best suited for electronic applications.
We combine what we believe to be the world's most advanced yttrium barium copper
oxide thin-film technology with expertise in electronic device and component
design, analog and digital electronic engineering, super-cooling, mechanical
engineering and system integration. We believe that systems containing
superconductive electronic technology will offer superior performance, reduce
the costs of performing desired functions, or do both.
CHOICE OF MATERIAL. Although a number of high-temperature superconductors
have been identified, we have focused upon the development of yttrium barium
copper oxide. Yttrium barium copper oxide is the only high-temperature
superconductor for which there has been both significant development and
successful demonstration of multilayer technology. We believe that multilayer
structures can be used for better film quality and stability and enhanced device
functionality. We have developed several proprietary processes for producing
yttrium barium copper oxide and other thin-film materials as well as for
fabricating superconducting components and devices.
THIN-FILM EXPERTISE. We use a thin-film fabrication approach. The
fabrication of our components and circuits involves specialized processes, which
are the subject of our patents or proprietary
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know-how. We have performed pioneering work in materials, processes and
structures based on thin-film superconductive technology, and have developed
processes we believe are capable of routinely producing a variety of high
quality films for several applications. Compared to "thick-film" approaches and
ceramic fabrication techniques, we believe the thin-film approach is more
versatile, enables more compact components and provides superior superconducting
properties.
FOCUS ON COMPLETE SOLUTIONS. We believe 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 reduced temperatures necessary to sustain
superconductivity. For this reason, in addition to its thin-film expertise, we
have also established significant expertise and know-how in electronic device
and component design, analog and digital electronic engineering, super-cooling,
mechanical engineering and system integration. We seek to make the presence of
superconductive and super-cooling components an entirely integral feature of our
products. By skillful integration of the refrigeration system into its
communications filter subsystems, for example, and by selection of a
refrigeration approach with proven durability, we believe that our products can
be easily accommodated and well accepted by end users. Furthermore, we believe
that providing our technology at the subsystem level to system manufacturers in
specific markets will allow us to rapidly and efficiently expand both our
product line and our customer base.
BUSINESS AND DEVELOPMENT STRATEGY
Our strategy for developing, manufacturing and marketing superconductive
electronics products includes the following key elements:
COMMERCIALIZE PRODUCTS WITH SIGNIFICANT MARKET POTENTIAL. We believe that
the largest potential near-term market for superconductor-based products is the
wireless communications market. We are actively marketing front-end systems as
well as developing additional component-based subsystems for this market.
DEVELOP COMMERCIAL INFRASTRUCTURE. We are building the manufacturing, sales
and marketing infrastructures we believe are necessary to support the
commercialization of our products in our target markets. This includes the
development of thin-film deposition techniques suitable for high-volume
manufacturing, the acquisition and build-out of manufacturing and assembly
areas, the hiring of employees with significant marketing experience in key
product areas and the expansion of our sales team.
MAINTAIN TECHNOLOGICAL LEADERSHIP. We have devoted significant resources to
developing proprietary high-temperature superconductor thin-film manufacturing
and process technologies. Based on publicly available information, we believe
that our technologies are more advanced than those of other companies or
research laboratories. We currently own, alone or with others, 22 U.S. patents
and three related foreign patents. We also have eight patent applications
pending in the U.S. and related patents pending in other countries relating to
various aspects of our technologies.
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 communication stations, or "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.
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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 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
technology will place additional demands on the performance of wireless base
stations and upon the size of base station hardware. We believe that
superconductive filters used in conjunction with super-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 significant 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
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.
An immediate benefit of superconductor technology in base station
applications is the ability to provide superior interference rejection by making
practical filters with a large number of poles. A second benefit of
superconducting filters is the potential ability to fully utilize the available
spectrum without introducing guard bands or blocked channels at the band edge. 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. A fourth
benefit offered by superconductor technology is the potential for reducing the
size and weight of filter subsystems that utilize thin-film superconductor
components.
APPLICATIONS FOR SUPERCONDUCTING FILTERS
Superconducting filters offer performance advantages to analog systems as
well as to digital protocols. Depending upon the application, one or more of the
benefits of the technology noted above may come into play.
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 congested environments. Key issues are interference and capacity.
In contrast, rural base stations see relatively low call volumes but struggle
with problems with the handset to base station transmissions because of the
lower power levels transmitted by hand-held phones. 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.
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The match-up between benefits and applications for superconductors in wireless
systems is summarized in the chart below.
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RURAL URBAN
SUPERCONDUCTOR BENEFIT REASON CELLULAR CELLULAR PCS
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Reduced interference................................. Sharp filters X X
Increased capacity................................... Sharp filters X X
Improved coverage/extended range..................... Reduced system noise X X
Compact form-factor.................................. Thin-film technology X X
</TABLE>
FUTURE APPLICATIONS
We are 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.
STRATEGIC ALLIANCES AND DEVELOPMENT AGREEMENTS
We are party to a number of collaborative arrangements with corporations and
research institutions with respect to the research, development and marketing of
some of our potential products. We evaluate, on an ongoing basis, potential
collaborative relationships and intend to continue to pursue such relationships.
Our future success will depend significantly on our collaborative arrangement
with third parties. We cannot assure you that these arrangements will result in
commercially successful products.
LUCENT TECHNOLOGIES, INC. Conductus and Lucent entered into a joint
development and licensing agreement in April 1996, under which we are 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 high-temperature
superconductor 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.
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 us to design interfaces between CTI
cryocoolers and our subsystems.
HIGH-TEMPERATURE SUPERCONDUCTOR THIN-FILM MANUFACTURING ALLIANCE. Conductus
is a principal member of the High-Temperature Superconductor Thin-Film
Manufacturing Alliance, an association formed in November 1995 to develop
cost-effective manufacturing methods for yttrium barium copper oxide 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. Superconductor Technologies, Inc. is the other principal member of this
association. Other members include Stanford University, the Georgia Research
Corporation, Focused Research, Microelectronic Control and Sensing Incorporated,
IBIS and BDM Federal. Each member of the association will have certain access to
the technology of the other parties that is developed under the program.
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RESEARCH AND DEVELOPMENT
GOVERNMENT CONTRACTS
Our research and development expenses in the fiscal years 1996, 1997 and
1998 were approximately $11,774,000, $10,626,000 and $5,621,000, respectively.
Externally funded research and development programs, primarily under contracts
with the U.S. government, accounted for approximately $13,178,000, $9,814,000
and $5,661,000 of total operating expenses in the fiscal years 1996, 1997, and
1998, respectively. Our revenue from government-related contracts represented
approximately 77% of total revenues for fiscal years 1996 and 1997 and 79% for
fiscal 1998.
We believe that we will continue to be heavily dependent on U.S. government
contracts to fund a significant portion of our research and development
programs. Our strategy is to fund a significant portion of our research and
development, particularly for wireless communications and digital electronics
applications, through contracts with agencies of the U.S. government.
As of December 31, 1998, Conductus had received aggregate awards since its
inception of approximately $50,347,000 from U.S. government agencies, including
approximately $43,970,000, recognized as revenue by us through December 31,
1998.
Our contracts involving the U.S. government are, or may be, subject to
numerous risks. These risks include:
- Termination at the government's convenience;
- Reductions or modifications due to changes in the government's
requirements or budgetary constraints;
- Increased or unexpected costs causing losses or reduced profits under
fixed-price contracts or the occurrence of non-reimbursable costs under
contracts which otherwise allow reimbursements of costs;
- Disclosure of our confidential information to third parties;
- The failure or inability of a general contractor to perform its contract
in circumstances where we are a subcontractor;
- The failure of the government to exercise contractual options;
- The government's right to freely use technology developed under its
contracts with others; and
- The government's ability to require us to license patented technology
developed under contracts funded by the government if we fail to continue
to develop the technology.
In addition, we cannot assure you the government will continue its
commitment to programs to which our development projects are applicable,
particularly in light of recent legislative initiatives to reduce the funding of
various U.S. government agencies and programs. Nor can we assure you that we can
compete successfully to obtain funding pursuant to such programs.
PATENTS, PROPRIETARY TECHNOLOGY AND TRADEMARKS
We have received 28 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. We retain a license to freely use the
technology related to those patents outside the nuclear magnetic resonance field
of use. The remaining 22 patents have unexpired terms ranging from 11 to 17
years. Additionally, we have 8 patent applications pending. 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.
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These patents and patent applications cover processes and products in many
aspects of our business. Certain of the issued patents and patent applications
are jointly owned by us and others. Any party owner has the right to license
rights under such patents and applications, which could result in us not having
exclusive control over some inventions. We will continue to file other U.S. and
key international patent applications as part of our business strategy to
protect technology we consider important to providing a competitive market
advantage for our technologies.
We also rely 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 our
competitive position.
We believe that, since the discovery of high-temperature superconductors 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 and applications may be
overlapping. There are interference proceedings pending regarding rights to
inventions claimed in some of the applications. Accordingly, the patent
positions of companies using high-temperature superconductor technology,
including Conductus, are uncertain and involve both complex legal and factual
questions. Consequently, there is significant risk that others have obtained or
will obtain patents relating to our planned products or technology and that we
will be unable to obtain licenses on commercially reasonable bases or at all.
A patent issue of particular importance to us relates to copper oxides,
including yttrium barium copper oxide. We have neither obtained any issued
patents nor have we filed any patent applications covering the composition of
any copper oxides. However, several U.S. and foreign patent applications are
pending that would, if issued, cover the composition of yttrium barium copper
oxide. We understand that at least several U.S. applications are the subject of
an interference proceeding currently pending. Additionally, E. I. duPont de
Nemours & Co. has notified us that it is the exclusive licensee of patents
issued in Israel, Sweden, Taiwan and the United Kingdom covering the composition
of yttrium barium copper oxide and a method for using yttrium barium copper
oxide in superconducting applications. We anticipate that we will be required to
obtain a license to use yttrium barium copper oxide in order to continue to
develop and sell products based on yttrium barium copper oxide.
We have granted to others non-exclusive, royalty-bearing licenses to some of
our proprietary technologies for the manufacture and distribution of various
equipment, including rotating target holders, substrate heaters and mutual
inductance probes to be used in low temperature cryogenic measurement systems.
Through our strategic relationships, we have received rights to certain
intellectual property developed by our partners, as well as commitments from
those partners to offer licenses to certain background technology. We cannot
assure you that the terms of these licenses will allow us to compete
effectively.
Additionally, successful marketing of a material portion of Conductus'
ClearSite 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.
We own the U.S. registered trademarks "CONDUCTUS-Registered Trademark-," the
Conductus logo and "Mr. SQUID-Registered Trademark-." We claim rights to the
trademarks "ClearSite-TM-" and "pcSQUID-TM-."
MANUFACTURING
We have performed pioneering work in materials, processes and structures
based on thin-film superconducting technology. We have established a pilot
production facility at our headquarters in Sunnyvale, California, to fabricate,
test and assemble thin films and components. We fabricate two-, three-and
four-inch wafers in two cleanroom areas that consist, in the aggregate, of
approximately 2,600 square
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feet. Additionally, we assemble systems in a 3,250 square foot manufacturing
facility which includes cleanrooms of approximately 1,250 square feet. We
combine what we believe to be the world's most advanced yttrium barium copper
oxide thin-film technology with expertise in electronic and device component
design, analog and digital electronic engineering, low temperature packaging,
mechanical engineering and system integration.
The primary materials and equipment used in our ClearSite products include
substrates, yttrium barium copper oxide precursors and processing equipment. We
procure our substrates from several suppliers. We primarily utilize yttrium,
barium and copper to produce yttrium barium copper oxide. These metals are
available from numerous vendors. In limited cases, we use yttrium barium copper
oxide purchased from two sources. Our processing equipment is assembled from
off-the-shelf components which we can obtain from multiple sources.
We believe that most of our products will be in the form of subsystems that
incorporate superconducting and cryoelectronic components with super-cooling
refrigerators and conventional electronic assemblies. Apart from the
superconducting components which are manufactured by us, we anticipate that most
other components of our subsystems will be purchased as standard products from
commercial vendors or specially ordered from various suppliers. These include
super-cooling refrigerators, printed circuit boards, product cases and housings,
vacuum vessels and other components. Certain ClearSite product components,
including cryocoolers, are currently obtained from a single source or a limited
number of suppliers. Although we do not believe that we are ultimately dependent
upon any supplier as a sole source or limited source for any critical
components, our inability to develop alternative sources, a prolonged
interruption in supply or a significant increase in price of one or more
components would harm our business, operating results and financial condition.
We are focusing on the development of our production processes and are
manufacturing limited quantities of superconducting components and products
incorporating those components at our Sunnyvale, California, facility. Apart
from the production of superconducting components, we expect that our
manufacturing activities generally will be limited to cleaning, final assembly,
vacuum bakeout and testing. We are producing these products in limited
commercial quantities and are continuing to expand our capabilities.
COMPETITION
Although the market for superconductive electronics currently is small and
in the early stages of development, we believe 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 we believe could lead to the development
and/or commercialization of superconductive electronic 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.
We also believe 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 Superconductor Corp. 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.
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Several of our existing collaborative arrangements permit, and future
arrangements also may permit, us and our partner to use the technology developed
under these arrangements. Accordingly, we may compete with our partners for
commercial sales of any products developed under these arrangements.
We believe 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 speed, sensitivity, size and power
dissipation;
- price; and
- product quality and reputation.
We believe that we are competitive with regard to these factors. Nonetheless,
because the market for superconductive electronics is at an early stage, our
relative competitive position in the future is difficult to predict.
SALES AND MARKETING
In order to successfully commercialize our products, we are expanding our
sales, marketing and distribution staffing and activities. During 1998, we hired
a new Vice President Sales and Marketing who will be responsible for expanding
the sales organization for the commercial wireless market. Our current sales and
marketing strategy relies primarily on direct sales for our communications
products. We sell our magnetic sensors primarily to one company.
We intend to add personnel to support our sales and marketing efforts. These
employees will be actively engaged in direct marketing to customers, as well as
in sales and marketing support. We actively market our products through direct
mail advertisements and advertisements in trade journals, as well as through
demonstrations at industry trade shows. Our employees have published the results
of their research at Conductus widely in trade and technical journals.
Additionally, our employees have frequently presented our technology as invited
speakers at conferences worldwide.
For the fiscal years 1996, 1997, 1998, commercial sales to one customer of
$1,560,000, $896,000, and $76,000 were 12%, 9% and 2% of total revenues,
respectively. This customer, Niki Glass Ltd., acts primarily as a distributor of
our magnetic sensing products, selling to end-users
ENVIRONMENTAL MATTERS
We use certain hazardous materials in our research and manufacturing
operations. As a result, we are subject to federal, state and local governmental
regulations. We believe that we have complied with all regulations and have all
permits necessary to conduct our business.
EMPLOYEES
As of December 31, 1998, we had a total of 53 full-time equivalent employees
of which 22 hold advanced degrees. Of the total full-time employees, 30 were
engaged in research and product development, 9 in manufacturing, 3 in sales and
marketing, and 11 in administration and finance. None of our employees is
represented by a labor union. We have not experienced any work stoppages and
consider our relations with our employees to be good.
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RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION IN THIS ANNUAL REPORT, PROSPECTIVE
INVESTORS SHOULD CONSIDER THE FOLLOWING RISK FACTORS.
IF OUR COMMON STOCK IS DELISTED FROM THE NASDAQ SMALLCAP MARKET, OUR COMMON
STOCK WILL BECOME LESS EASILY TRADABLE AND STOCKHOLDERS MAY BE UNABLE TO QUICKLY
AND EASILY BUY OR SELL OUR COMMON STOCK
Holders of our common stock currently enjoy the substantial benefit of being
able to easily buy or sell our common stock because our common stock is listed
on the Nasdaq SmallCap Market trading system. In November 1998, Nasdaq informed
us that, on the basis of our Quarterly Report on Form 10-Q for the quarter
ending September 30, 1998, our net tangible assets had fallen below the level
required for continued listing of our common stock on the Nasdaq National Market
trading system. Subsequently, we submitted information to Nasdaq regarding our
anticipated future net tangible assets and certain financing plans. Based on
this submission, we applied to have our common stock listed on the Nasdaq
SmallCap Market. Pending approval of our application, our common stock began
trading on the Nasdaq SmallCap Market. Nasdaq has since informed us that our
application to be listed on the Nasdaq SmallCap Market has been denied. We have
requested an oral hearing on the subject which has not yet been scheduled, and
delisting of our common stock has been stayed pending the results of this
hearing.
Although Conductus satisfied Nasdaq's requirements for listing on the Nasdaq
SmallCap Market as of December 31, 1998, we do not expect to satisfy these
requirements as of March 31, 1999. We are taking actions designed to help us
satisfy the listing requirements by June 30, 1999. These actions include seeking
to raise additional equity capital and seeking to reduce our operating losses.
However, we may not be successful in these efforts. In addition, even if we are
successful, Nasdaq may deny our appeal if they believe we will not satisfy the
criteria over the longer term.
If our common stock is delisted, trading in our common stock, if any, would
then be conducted in the over-the-counter market on an electronic bulletin
board, or in what are commonly referred to as the "pink sheets." Stockholders
would then find it more difficult to sell, or to quickly and accurately obtain
quotations as to the price of, our common stock.
In addition, if we fail to maintain either (a) net tangible assets, as
defined in Rule 3a51-1 of the Securities Exchange Act, of at least $2,000,000 or
(b) average revenue over a three year period of at least $6,000,000, we could
become subject to certain "penny stock" rules. These rules subject brokers and
dealers who sell or make a market in our common stock to additional trading
rules and requirements. For example, these brokers or dealers would be required
to maintain detailed records on Conductus and their own trading activities in
connection with our common stock. Consequently, this could affect the
willingness of brokers and dealers to sell or make a market in our common stock.
This, in turn, could affect stockholder's ability to quickly and easily sell our
common stock.
WE HAVE A HISTORY OF LOSSES AND MAY NEVER BECOME PROFITABLE
We cannot assure you that we will ever be profitable or, if we become
profitable, that we will continue to be profitable thereafter. As of December
31, 1998, we had accumulated net losses of approximately $44.6 million. We
expect to incur substantial additional losses at least through 1999 as we expand
our operations. Continued development of our products may require us to commit
substantial resources to:
- research and development,
- the establishment of additional pilot and commercial-scale fabrication
processes and facilities, and
- enhanced quality control, marketing, sales and administrative
capabilities.
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In order to become profitable, we must successfully develop, manufacture,
introduce and market our potential products. Our failure to become profitable or
maintain our profitability could significantly harm the value of our common
stock.
WE WILL NEED SUBSTANTIAL ADDITIONAL CAPITAL IF WE ARE TO CONTINUE OUR OPERATIONS
Our revenues from product sales have been limited. As of December 31, 1998,
we had cash reserves of approximately $2.9 million. We anticipate that our
existing sources of liquidity and anticipated revenue will satisfy our projected
working capital and other cash requirements through June 1999. However, changes
in our plans or other events affecting us may result in the expenditure of these
resources before then. THE REPORT OF OUR INDEPENDENT ACCOUNTANTS INCLUDED IN
THIS PROSPECTUS INCLUDES AN EXPLANATORY PARAGRAPH RELATED TO THE SUBSTANTIAL
DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN.
If we are to continue our operations, we will need to raise substantial
additional funds, and these funds may not be available on favorable terms or at
all. Our failure to raise enough capital to meet our needs could force us to
reduce or cease some or all of our operations. These events could significantly
harm our results of operations and the value of our common stock.
BECAUSE OUR FUTURE OPERATING RESULTS ARE UNPREDICTABLE AND LIKELY TO FLUCTUATE
SIGNIFICANTLY, THE VALUE OF OUR COMMON STOCK IS DIFFICULT TO EVALUATE
Our operating history is limited, and our operating results are susceptible
to significant fluctuations. Thus, we cannot reliably predict future operating
results, making it difficult for you to assess the value of our common stock. We
believe that period-to-period comparisons of our operating results are not
necessarily meaningful, and you should not rely upon period-to-period
comparisons as indications of future performance.
Our future operating results may vary significantly due to factors
including:
- Demand for our products;
- The size and timing of significant orders, and their fulfillment;
- The size and timing of government funding contracts;
- Inflexible product life cycles which may affect our ability to change and
compete;
- Changes in our pricing policies, or those of our competitors;
- Changes in our operating expenses and our ability to control costs;
- Our customers' budget cycles;
- Product quality problems;
- Our ability, and our subcontractors' ability, to obtain sufficient
supplies of limited or sole-source components for our products;
- Consolidation by competitors and indirect channel partners; and
- Regulatory changes.
In addition, we may experience changes in our mix of domestic and international
revenues, our mix of direct sales and indirect sales, and the channels through
which we sell our products. For these reasons, our gross profit and operating
margins may fluctuate significantly. These factors make it difficult to predict
our future operating results.
Another factor making our future operating results difficult to predict is
the fact that our products are typically shipped shortly after orders are
received. Accordingly, future quarterly revenues are difficult to
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predict since they depend substantially on orders booked and shipped during
those quarters. Product revenues are also difficult to forecast because our
sales cycle, which may increase in the future, varies substantially from
customer to customer and by distribution channel. We base our expense levels and
plans for expansion, including our plan to significantly increase both our sales
& marketing and research & development efforts, in significant part on our
expectations of future revenues. These expenses and expansion plans are
relatively fixed in the short-term. Consequently, our operating results in any
given quarter are likely to be disproportionately harmed if revenues in that
quarter fall below our expectations.
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY IN THE HIGHLY COMPETITIVE
SUPERCONDUCTIVE ELECTRONICS INDUSTRY OR AGAINST ALTERNATIVE TECHNOLOGIES
Although the market for superconductive electronics currently is small and
in the early stages of development, we believe this market is intensely
competitive. A number of large companies with substantially greater financial
resources and capabilities are engaged in programs to develop and commercialize
products which may compete with ours, or they may begin such programs if the
market develops. Smaller companies, including Illinois Superconductor
Corporation and Superconductor Technologies, Inc., are also developing and
commercializing superconductive electronic products. Furthermore, academic
institutions, governmental agencies and other public and private research
organizations are engaged in development programs that may lead to commercial
superconductive electronic products. Our success will depend on our ability to
develop and maintain our technological leadership while managing the various
risks described in this prospectus. Our failure to compete successfully could
significantly harm our business and financial condition and the value of our
common stock.
In addition to the products that our planned products will compete with
directly, a number of competing approaches and technologies are currently being
used to increase the capacity and improve the quality of wireless networks, some
of which may be less expensive or offer better performance. These approaches
include increasing the numbers of cellular transmission stations, increasing
tower heights, locating filters and amplifiers at the top of antennas and using
advanced antenna technology. We may not succeed in competing with these
alternate technologies, and for this reason our business, operating results and
financial condition may suffer.
WE DEPEND HEAVILY UPON GOVERNMENT CONTRACTS FOR A SUBSTANTIAL PORTION OF OUR
REVENUES, AND OUR BUSINESS, FINANCIAL CONDITION OR OPERATING RESULTS WOULD
SUFFER IF, AMONG OTHER THINGS, ANY OF THESE CONTRACTS ARE TERMINATED OR
ADVERSELY MODIFIED
A significant portion of our revenue has been derived from contracts with
the U.S. government. Although we anticipate that government contract revenues
will grow in 1999 compared to 1998, revenues from government contracts may not
grow and may fall. A reduction in, or discontinuance of, the government's
commitment to or our participation in such programs would significantly harm our
business, operating results and financial condition. Our revenue from
government-related contracts represented approximately 77% of total revenue for
fiscal years 1996 and 1997 and 79% of total revenue for fiscal 1998. Our
contracts involving the U.S. government may include various risks, including:
- Termination by the government for their own convenience;
- 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
contracts where our prices are fixed or unallowable costs under contracts
where the government reimburses us for costs and pays an additional
premium;
- Risks of potential disclosure of our confidential information to third
parties;
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- The failure or inability of the main contractor to perform its contract in
circumstances where we are a subcontractor;
- The failure of the government to exercise options provided for in the
contracts;
- The government's right in certain circumstances to freely use technology
developed under contracts with it; and
- Exercise of the U.S. government's right to require us to license to third
parties patented technology developed under government contracts if we
fail to continue to develop the technology.
The programs in which we participate may extend for several years, but are
normally funded on an annual basis. The U.S. government may not continue to fund
programs to which our development projects apply, particularly in light of
recent legislative initiatives to reduce the funding of various U.S. government
agencies and programs. Even if funding is continued, we may fail to compete
successfully to obtain funding pursuant to such programs.
BECAUSE WE DEPEND ON A SMALL NUMBER OF CUSTOMERS, HARM TO, OR THE LOSS OF, ANY
OF THESE RELATIONSHIPS COULD SIGNIFICANTLY HARM OUR BUSINESS, FINANCIAL
CONDITION OR OPERATING RESULTS
To this day, a relatively small number of customers have accounted for a
significant portion of our total revenue, and we expect that this trend will
continue for the foreseeable future. Accordingly, our future operating results
will continue to substantially depend on the success of a few customers and our
relationships with them. Any reduction or delay in sales of our products to one
or more of these key customers could significantly harm our business, financial
condition and results of operations. Our operating results will also depend on
our ability to successfully develop relationships with additional key customers.
We cannot assure you that we will retain our largest customers or that we will
be able to recruit additional key customers.
Most of our customers can cease doing business with us with limited notice
and with little or no penalty. Our customer agreements typically do not require
minimum purchases. Further, many of our customers also have relationships with
our competitors. These relationships may affect the purchasing decisions of such
customers. We cannot assure you that our customers will not choose to direct
their business to our competitors.
BECAUSE THE SUPERCONDUCTIVE ELECTRONICS MARKET IS NEW AND UNCERTAIN, WE CANNOT
PREDICT WHETHER OUR PRODUCTS WILL BE COMMERCIALLY ACCEPTED
The superconductive electronics market is new, with limited product
commercialization to date. Since our inception we have been engaged principally
in research and development activities. Although we have introduced a number of
superconductive electronic products, most of our revenues to date have been
derived from research and development contracts. We may not successfully
develop, introduce and market new products or product enhancements. Any new
products or product enhancements may not be well received in the marketplace or
achieve any significant degree of commercial acceptance.
We cannot assure you that, even if our products meet performance standards
acceptable to the superconductive electronics market, we will be able to
manufacture adequate quantities of any products we introduce at costs low enough
for us to continue to operate on a timely basis, or that any such products will
offer price/performance advantages sufficient to achieve market acceptance. If
we fail to successfully develop, manufacture and commercialize products that
offer sufficient price/performance advantages or to achieve significant market
acceptance on a timely and cost-effective basis, our business, operating results
and financial condition could be harmed.
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WE MAY NOT SUCCESSFULLY ADJUST TO THE RAPIDLY CHANGING SUPERCONDUCTIVE
ELECTRONICS MARKET
The field of superconductivity is characterized by rapidly advancing
technology. Our success depends upon our ability to keep pace with advancing
superconductive technology, including materials, processes and industry
standards. We have focused our development efforts to date principally on
yttrium barium copper oxide, a high-temperature superconductor. However, yttrium
barium copper oxide may not ultimately prove commercially competitive against
other currently known materials or materials that may be discovered in the
future.
We 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 our products. We will also need to continue to develop and
integrate advances in complementary technologies. We cannot assure you that our
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 us will not prove more advantageous for the commercialization
of superconductive electronic products.
OUR SALES CYCLES ARE LONG AND UNPREDICTABLE, MAKING OUR FUTURE PERFORMANCE AND
THE VALUE OF OUR COMMON STOCK UNPREDICTABLE
Because customers who purchase our systems must commit a significant amount
of capital and other resources, sales to our customers are subject to delays
beyond our control. Our customers must consider budgetary constraints, comply
with internal procedures for approving large expenditures and complete whatever
testing is necessary for them to integrate new technologies that will affect
their key operations. While the sales cycle for an initial order of our products
is typically 6 to 12 months, we may experience longer sales cycles in the
future. Such delays or lengthened sales cycles could have a material adverse
effect on our business, operating results and financial condition.
THE YEAR 2000 COULD FORCE US TO SPEND SIGNIFICANT FUNDS TO PREPARE FOR POTENTIAL
PROBLEMS, AND WE COULD EXPERIENCE SIGNIFICANT LOSSES AT THAT TIME
Many computer systems and applications experience problems handling dates
beyond the year 1999, and will need to be modified before the year 2000 in order
to remain functional. Any of our 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 our key operations, including, among other things, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities. Although we are working to avoid any problems, year 2000
problems could harm our operations and cause significant losses.
In addition, as our year 2000 compliance project continues, we may discover
additional problems for which we may not be able to develop, implement, or test
possible solutions. Also, we may find that the costs of these activities
materially exceed our current expectations. Necessary expenses arising from
these additional problems would harm our results of operations.
OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE
The market price of our common stock has been and is likely to continue to
be highly volatile. Our common stock may be significantly affected by the
following factors:
- Actual or anticipated fluctuations in our operating results;
- Announcements of technological innovations;
- New products or new contracts by us or our competitors;
- Conditions and trends in the telecommunications and other technology
industries;
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- Changes in financial estimates of our future results by securities
analysts.
In addition, the stock market has from time to time experienced significant
price and volume fluctuations that have particularly affected the market prices
for the common stocks of technology companies. In the past, securities class
action lawsuits have often been brought against such companies following periods
of stock price volatility. We may be affected by similar litigation in the
future which could result in substantial costs and cause a diversion of
management's attention and resources. These events could significantly harm our
business, operating results and financial condition.
BECAUSE WE DEPEND HEAVILY ON THE SUCCESSFUL DEVELOPMENT AND SALE OF OTHER
COMPLEMENTARY TECHNOLOGIES, WE MAY NOT SUCCEED IF CERTAIN OTHER PRODUCTS AND
TECHNOLOGIES ARE NOT AVAILABLE TO US
Our success depends on the commercial availability of a number of other
technologies, such as specialized mechanical refrigeration systems, super-cooled
semiconductor technology and specialized microchip materials. Some of these
complementary technologies are in the development stage. We do not intend to
devote significant efforts or resources to developing these technologies; we
depend on the development activities of third parties in these areas. We cannot
assure you that these technologies will be successfully developed and
commercialized, or that they will achieve market acceptance.
OUR DEPENDENCE ON A SMALL NUMBER OF SUPPLIERS MAKES US PARTICULARLY VULNERABLE
TO EVENTS WHICH IMPACT OUR SUPPLIERS, MOST OF WHICH EVENTS ARE BEYOND OUR
CONTROL
Certain components of our subsystems, including cryocoolers, are currently
obtained from a single source or a limited number of suppliers. Our business,
operating results and financial condition could be significantly harmed by (a)
an inability to develop alternative sources or to meet customer demand, (b) a
prolonged interruption in supply, or (c) a significant increase in price of one
or more components.
OUR FAILURE TO SUCCESSFULLY DEVELOP COLLABORATIVE RELATIONSHIPS WITH GOVERNMENT
AGENCIES, RESEARCH INSTITUTIONS AND OTHER COMPANIES WOULD HARM OUR BUSINESS,
FINANCIAL CONDITION AND OPERATING RESULTS
We have established and continue to seek collaborative arrangements with
corporate partners, government agencies and public and private research
institutions to develop, manufacture and market superconductive electronic
products. Our success depends on the development and success of these
collaborative arrangements. However, we may not be able to enter into
collaborative arrangements on commercially reasonable terms, and even if
established, these arrangements may not succeed. Even if these programs are
successful, we cannot assure you that our collaborative partners will not seek
to manufacture jointly developed products themselves or obtain them from
alternative sources. Finally, these programs (a) may require us to share control
over our development, manufacturing and marketing programs and relinquish rights
to our technology, (b) may be subject to termination at the discretion of our
collaborative partners and (c) may restrict our ability to engage in certain
areas of product development, manufacturing and marketing.
PROTECTION OF OUR PATENTS AND PROPRIETARY RIGHTS IS UNCERTAIN
Our efforts to protect our proprietary rights may not succeed in preventing
their infringement by others or ensure that these rights will provide us with a
competitive advantage. Pending patent applications may not result in issued
patents and the validity of our issued patents may be subject to challenge.
Third parties may also be able to design around the patented aspects of our
products. Additionally, certain of the issued patents and patent applications
are jointly owned by us and third parties. The fact that any owner or co-owner
of a patent has the right to license rights under their patent or application
which could cause us to lose exclusive control over our inventions.
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INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST US IN CONNECTION WITH OUR USE
OF YTTRIUM BARIUM COPPER OXIDE COULD MATERIALLY HARM OUR RESULTS OF OPERATIONS
The patent positions of companies using high-temperature superconductor
technology, including Conductus, are uncertain and there is significant risk
that others, including our competitors, have obtained or will obtain patents
relating to our planned products or technology.
We cannot assure you that we will obtain licenses to patents covering
yttrium barium copper oxide compositions, if these patents are issued, or to any
other patents applicable to our business, on commercially reasonable terms. We
may be required to expend significant resources to develop alternatives that
would not infringe the yttrium barium copper oxide patents or to obtain licenses
to the technology that we infringe or would infringe. We may not be able to
successfully design around these patents or obtain licenses to them and may have
to defend ourselves at substantial cost against allegations of infringement of
third party patents. An adverse outcome in such a suit could subject us to
significant liabilities or require us to cease using such technology. Even the
cost of defending a patent lawsuit would constitute a major financial burden for
us, one that would significantly harm our business, operating results and
financial condition.
OUR LIMITED COMMERCIAL MANUFACTURING EXPERIENCE AND CAPABILITIES COULD HAMPER
OUR SUCCESS IN THE HIGHLY COMPETITIVE AND COMPLEX SUPERCONDUCTIVE PRODUCTS
MARKET
Our failure to develop an adequate manufacturing capacity would
significantly harm our business, operating results and financial condition. We
have established a limited production facility. To date, we have focused
primarily on developing fabrication processes and producing limited quantities
of superconducting thin films and components. Although our processing technology
derives principally from semiconductor manufacturing technology, the fabrication
of high-temperature superconductor components is especially difficult because of
specific properties unique to high-temperature superconductor materials.
We cannot assure you that we can develop the enhanced processing technology
necessary to develop more advanced superconducting devices and circuits or that
we will be able to attain commercial yields in the future. Even if we can attain
commercial yields, we may suffer recurring yield problems caused by mask
defects, impurities in materials and other factors. While we have established
limited production facilities for our electronics products, we may not be able
to expand our processing, production control, assembly, testing and quality
assurance capabilities to produce existing or planned superconductive electronic
products in adequate commercial quantities.
OUR SUCCESS DEPENDS ON THE ATTRACTION AND RETENTION OF KEY EMPLOYEES
We depend heavily upon the efforts of our senior management and technical
teams. The loss of the services of one or more members of these teams could slow
our product development and commercialization objectives. Due to the specialized
nature of our business, we also depend upon our ability to attract and retain
qualified technical and key management personnel. Moreover, we target our
products towards markets that require substantial industry knowledge and
expertise. We currently have limited expertise in these areas and it is
essential that we attract and retain qualified personnel with expertise in
manufacturing, marketing, sales and support in each of our targeted markets.
Competition for qualified personnel in our market is intense and we may not be
able to continue to attract and retain qualified personnel necessary for the
development of our business.
REGULATORY CHANGES NEGATIVELY EFFECTING WIRELESS COMMUNICATIONS COMPANIES COULD
SUBSTANTIALLY HARM OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS
The operation of cellular and personal communications services communication
stations, or "base stations," is strictly regulated in the United States by the
Federal Communications Commission. Base
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stations and equipment marketed for use in base stations must meet specific
technical standards. Our ability to sell our high-temperature superconductor
filter subsystems will depend upon the rate of deployment of personal
communications services, or "PCS," the ability of base station equipment
manufacturers and of cellular base station operators to obtain and retain the
necessary approvals and licenses, and changes in regulations that may impact the
requirements for our products. Any failure or delay of base station
manufacturers or operators in obtaining necessary approvals could significantly
harm our business, operating results and financial condition.
COMPLIANCE WITH ENVIRONMENTAL REGULATIONS COULD BE ESPECIALLY COSTLY DUE TO THE
HAZARDOUS MATERIALS WE MUST USE AS A MAKER OF SEMICONDUCTORS
We are 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 our business. Any failure to
comply with present or future regulations could result in fines being imposed,
suspension of production or interruption of our operations. In addition, these
regulations could restrict our ability to expand or require us to acquire costly
equipment or incur other significant expenses to comply with environmental
regulations or to clean up prior discharges.
OUR CORPORATE GOVERNANCE STRUCTURE MAY DELAY OR PREVENT OUR ACQUISITION BY
ANOTHER COMPANY
We have adopted a stockholder rights plan which, if triggered, could make it
more difficult for a third party to acquire a majority of our outstanding voting
stock, even if doing so would create an immediate benefit to our stockholders.
Further, provisions of our Restated Certificate of Incorporation and bylaws and
of Delaware corporate law could delay or make more difficult an acquisition of
Conductus by merger, tender offer or proxy contest, even if it would create an
immediate benefit to our stockholders. For example, our Restated Certificate of
Incorporation does not permit stockholders to act by written consent and our
bylaws require advance notice of any matters to be brought before the
stockholders at the annual meeting.
Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock and to determine the terms of this preferred stock, including
voting rights of those shares, without any further vote or action by the
stockholders. The rights of the holders of common stock may be subordinate to,
and adversely affected by, the rights of holders of preferred stock that may be
issued in the future. The issuance of preferred stock could make it more
difficult for a third party to acquire a majority of our outstanding voting
stock.
WE DO NOT INTEND TO PAY DIVIDENDS
We have never paid cash dividends and do not anticipate paying cash
dividends on the common stock in the foreseeable future.
ITEM 2. PROPERTIES
Our principal facility, including our pilot production facility, is located
in two buildings providing approximately 40,000 square feet of available space
in Sunnyvale, California, with leases which will expire in August 2000 and 2001.
During 1997, we subleased our 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
We are not a party to any material litigation and are not aware of any
pending or threatened litigation against us that could have a material adverse
effect upon our business, operating results or financial condition.
18
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
No matters were submitted to our stockholders during our fourth quarter of
1998.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Our executive officers are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Charles E. Shalvoy................................... 50 President, Chief Executive Officer and Director
Ron Wilderink........................................ 40 Vice President of Finance and Chief Financial Officer
Jim Simmons.......................................... 49 Vice President, Sales and Marketing
Randy W. Simon, Ph.D................................. 44 Vice President, Technology Programs
</TABLE>
MR. SHALVOY joined us 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. WILDERINK was appointed Chief Financial Officer in 1998. From 1995 until
1998, he was Vice President, Corporate Controller of Oak Technology, Inc., a
multinational semiconductor manufacturer. His prior experience includes
management positions in the finance organizations of Bell Microproducts, Inc., a
distributor of high technology products, and VMX, Inc., a manufacturer of
integrated voice processing systems. Mr. Wilderink holds a B.S. degree in
Accounting from San Jose State University.
MR. SIMMONS joined us in November 1998 as Vice President Sales and
Marketing. From 1994 to 1998 he was Vice President, Marketing and Sales of
Superconductor Technologies, Inc., a manufacturer of high-temperature
superconducting wireless subsystems. His prior experience includes senior
management positions at Therma-Wave, Inc., Nanometrics, Inc. and KLA Instruments
Corporation and various management positions at Hewlett-Packard. Mr. Simmons
holds a B.S. degree in Applied Physics from California Institute of Technology
and an M.B.A. from Harvard Business School.
DR. SIMON joined us 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
Our common stock began trading on the Nasdaq National Market under the
trading symbol "CDTS" on August 5, 1993, and moved to the Nasdaq SmallCap Market
on November 10, 1998. We have never declared or paid any cash dividends on our
common stock and do not expect to do so in the foreseeable future. We anticipate
that all future earnings generated from operations will be retained to develop
and
19
<PAGE>
expand our business. Our board of directors, at their discretion, will determine
whether we will pay dividends on the common stock in the future. In addition,
our line of credit prohibits us from paying cash dividends without the lender's
consent.
The following table presents quarterly information on the high and low
closing sales prices for shares of our common stock for the periods indicated,
as reported by the Nasdaq National Market.
<TABLE>
<CAPTION>
HIGH LOW
----------- ------
<S> <C> <C>
1996
First Quarter................................................................ $ 15 $ 61/2
Second Quarter............................................................... 161/2 93/4
Third Quarter................................................................ 127/8 75/8
Fourth Quarter............................................................... 91/2 6
1997
First Quarter................................................................ $ 91/4 $ 6
Second Quarter............................................................... 75/8 55/8
Third Quarter................................................................ 65/16 47/8
Fourth Quarter............................................................... 57/8 31/4
1998
First Quarter................................................................ $ 5 $ 231/32
Second Quarter............................................................... 43/8 27/8
Third Quarter................................................................ 41/2 21/16
Fourth Quarter............................................................... 21/4 11/64
</TABLE>
As of March 29, 1999, the closing sale price of our common stock was $1 5/8
per share.
On March 29, 1999, we had 77 holders of record of our common stock.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
both the Financial Statements and accompanying notes and "Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
statement of operations data for the years ended December 31, 1996, 1997 and
1998 and the balance sheet data at December 31, 1997 and 1998 are derived from
and are qualified by reference to, the audited financial statements included
elsewhere in this prospectus. The statement of operations data for the years
ended December 31, 1994 and 1995 and the balance sheet data at December 31,
1994, 1995 and 1996 are derived from audited financial statements not included
in this
20
<PAGE>
prospectus. The results of operations for the year ended December 31, 1998 or
any other period are not necessarily indicative of future results.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
Contract.................................................. $ 7,048 $ 8,148 $ 9,691 $ 7,266 $ 3,698
Product sales............................................. 1,588 2,434 2,852 2,188 991
--------- --------- --------- --------- ---------
Total revenues.......................................... $ 8,636 $ 10,582 $ 12,543 $ 9,454 $ 4,689
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Loss from operations........................................ $ (4,876) $ (4,423) $ (5,109) $ (7,499) $ (7,132)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net loss attributable to common shareholders................ $ (4,544) $ (4,422) $ (5,004) $ (7,543) $ (7,829)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Basic and diluted net loss per common share attributable to
common shareholders....................................... $ (0.85) $ (0.80) $ (0.80) $ (1.09) $ (1.10)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Shares used in per share calculations....................... 5,323 5,543 6,263 6,897 7,088
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital............................................ $ 7,076 $ 4,287 $ 9,135 $ 1,822 $ 2,656
Total assets............................................... 12,541 10,128 16,081 8,762 7,035
Long-term debt, less current portion....................... 533 1,146 1,022 310 1,341
Total stockholders' equity................................. 9,529 5,814 11,183 4,301 3,364
</TABLE>
- ------------------------
The above "basic and diluted loss per common share" and "shares used in per
share calculations" information was computed on the basis described for net loss
per share in Note 2 of Notes to Financial Statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We develop, manufacture and market electronic components and systems based
on superconductors for applications in the worldwide telecommunications markets.
As of December 31, 1998, we had accumulated losses of approximately $44,599,000
and we expect to incur significant additional losses during 1999. We, alone or
with collaborative partners, must successfully develop, manufacture, introduce
and market our potential products in order to achieve profitability. We do not
expect to recognize meaningful product sales until we successfully develop and
commercialize superconductive components, systems and subsystems that address
significant market needs.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Total revenues consist primarily of contract revenue and, to a lesser
extent, product sales. Our total revenues decreased to $4,689,000 in 1998 from
$9,454,000 in 1997 and $12,543,000 in 1996.
Revenue under U.S. government research and development contracts represented
approximately 77% of total revenue in 1996 and 1997 and 79% of revenue in 1998.
Contract revenue decreased to $3,698,000 in 1998 from $7,266,000 in 1997 and
$9,691,000 in 1996. The decreases in contract revenue relate primarily
21
<PAGE>
to the narrowing scope of our business interests in 1997 and 1998. During this
time, we began to focus exclusively on contracts relating to our wireless
telecommunications business and did not continue to seek additional contracts
related to superconducting technologies outside of the wireless
telecommunications market. We have submitted several proposals related to
prospective contracts associated with our core wireless business and we will
continue to submit proposals as additional programs become available. We believe
we will be able to participate in several of the contracts for which proposals
have been submitted and anticipate that government contract revenues will
increase compared to 1998, however we cannot assure you that we will receive the
level of awards we anticipate. Additionally, the recognition of revenue and
receipt of payment pursuant to these contracts and awards are subject to
numerous risks.
Revenue from product sales represented approximately 23% in 1996 and 1997
and 21% in 1998. Product revenue decreased to $991,000 in 1998 from $2,188,000
in 1997 and $2,852,000 in 1996. The decreases in product revenue relate
primarily to a decrease in revenue from products that do not relate to our core
market, including sales of magnetic sensing systems, and other products
partially offset by an increase in revenue from sales of our wireless
telecommunications products. Conductus recognized revenue on its wireless
telecommunications products of $96,000 and $762,000 in 1997 and 1998,
respectively. Future sales of these products are subject to numerous technical
and market risks.
Cost of product sales were $1,824,000, $1,845,000 and $2,685,000 for 1996,
1997 and 1998, respectively. The cost of products in 1996 and 1997 were
primarily composed of costs of superconducting magnetic systems manufactured by
our Instrument and Systems Division, which we disposed of in 1997. The cost of
products in 1998 were primarily composed of costs of the wireless
telecommunications products. Cost of product sales increased slightly from 1996
to 1997 despite lower volume of sales due to inventory write-downs of
approximately $457,000 related to our Instrument and Systems Division products
and to certain related product lines. Cost of product sales increased in 1998
compared to 1997 despite the lower volume of sales primarily as a result of the
increased overhead and start up costs associated with our wireless
communications products.
Gross margins were 36%, 16% and (171%) for 1996, 1997 and 1998,
respectively. The decrease in gross margins from 1996 to 1997 was primarily due
to the inventory write-downs discussed above. The decrease in gross margins from
1997 to 1998 was primarily due to the start up costs of wireless communications
product lines in late 1997. We anticipate gross margins to increase as shipments
of the wireless communication products increase, however we cannot assure you
that margins will improve in the future. Costs of contract revenues are included
in research and development expenses and are discussed below.
Research and development includes both externally and internally funded
projects. Research and development expenses were $11,774,000, $10,626,000 and
$5,621,000 and represented 94%, 112% and 120% of our revenues in 1996, 1997 and
1998, respectively. The decrease in 1997 compared to 1996 is primarily related
to the impact of the $2,425,000 decrease in contract revenues during the
comparison periods and, to a lesser extent, the dispositions of our Instrument
and Systems Division and our nuclear magnetic resonance product line. These
decreases were offset somewhat by increased spending on new wireless
communication and development activities.
The decrease in 1998 compared to 1997 is primarily related to the decrease
in contract revenues. Externally funded research and development programs,
primarily under contracts with agencies of the U.S. government, accounted for
approximately $13,178,000, $9,814,000 and $5,661,000 of total operating costs
and expenses in 1996, 1997, and 1998, respectively. These decreases reflect
reductions in federal research and development funding and the narrower scope of
our business interests in 1997 and 1998. We expect to continue to incur
significant research and development expenses on internally funded programs as
we seek to develop additional commercial products, particularly in the wireless
communications area and, as a result, anticipate moderate increases in research
and development expenses compared to 1998.
22
<PAGE>
Selling, general and administrative expenses include costs associated with
marketing, sales, and various administrative activities. Selling, general and
administrative expenses were $4,054,000, $4,330,000 and $3,514,000 in 1996, 1997
and 1998, respectively. The increase in spending in 1997 compared to 1996 was
primarily due to increased sales and marketing spending related to commercial
wireless communication products, offset somewhat by lower spending due to the
disposition of our Instrument and Systems division. The decrease in spending in
1998 compared to 1997 was related to decreases in spending in administration
compared to the prior year resulting from lower overall headcount levels. We
expect to continue to incur increasing sales and marketing expenses to the
extent we increase sales of commercial products, particularly in the
communications markets.
Interest income was $263,000, $267,000 and $97,000 in 1996, 1997 and 1998,
respectively. The decrease in interest income in 1998 compared to 1997 was
primarily due to lower average cash balances during the comparison periods.
Interest charges related primarily to our loan from a leasing company as
well as our bank term loans. Interest expense was $183,000, $202,000 and
$530,000 in 1996, 1997 and 1998, respectively. The increase in interest expense
during these years was primarily the result of higher average debt levels during
the comparison periods. Interest expense in 1998 includes interest payments on
the bridge loan facility we entered into with our bank, payments related to the
outstanding loan from a leasing company and the amortization of the value of
warrants issued to the bank and leasing companies.
As a result of incurring losses, we have not incurred any income tax
liability. We have established a valuation allowance against our deferred tax
assets and review this allowance on a periodic basis. At such time that we
believe that it is more likely than not that the deferred tax asset will be
realized, the valuation allowance will be reduced.
We do not believe that inflation has had a material effect on our financial
condition or results of operations during the past three fiscal years. However,
we cannot assure you that our business will not be affected by inflation in the
future.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations since inception primarily through:
- $13,251,000 in net proceeds from our initial public offering of common
stock in August 1993,
- $9,892,000 in net proceeds from our follow-on public offering of common
stock in June 1996,
- $20,989,000 raised in private placement financings, including net proceeds
of $6,344,000 raised in September 1998,
- $43,970,000 from U.S. government contracts,
- $2,234,000 in outstanding borrowings under various lease and bank loan
arrangements, and
- $3,784,000 in interest income.
In September 1998, we issued a total of 2,461,227 shares of Series B
preferred stock, and issued warrants to purchase 492,242 shares of common stock,
for a total of $6,344,461.
As of December 31, 1998 our aggregate cash, cash equivalents and short term
investments totaled $2,888,000 compared to $3,168,000 as of December 31, 1997.
Additionally, we have entered into a bank line of credit facility and an
equipment lease line. We may borrow up to a maximum of $2,000,000 under the bank
line of credit based on a limitation of 80% of certain eligible receivables. As
of December 31, 1998, the total amount outstanding under the bank line of credit
facility was $255,180 and no additional amount was available under the line.
Under the equipment lease, we may finance up to a total of $1,000,000 of future
equipment acquisitions. There were no balances outstanding under the equipment
line as of December 31, 1998.
23
<PAGE>
Net cash used in operations was $4,897,000 $4,702,000 and $7,258,000 for
1996, 1997, and 1998, 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 a larger net loss in 1997. The increase
in net cash used in operating activities in 1998 compared to 1997 was primarily
due to a comparatively smaller decrease in accounts receivable compared to the
prior period as well as a decrease in accounts payable and accrued liabilities
partially offset by an increase in inventory during the comparison periods.
Accounts receivable, net of allowance for doubtful accounts, was $2,055,000 and
$1,110,000 as of December 31, 1997 and 1998, respectively. This decrease was
primarily the result of a decrease in related contract and product revenues from
1997 and 1998 and, to a lesser extent, the increase in the allowance for
doubtful accounts from 1997 to 1998. The increase in the allowance for doubtful
accounts during the comparison periods was primarily due to an increase in the
proportion of accounts greater than 90 days old relative to the total
outstanding balance in 1998 compared to 1997. The increase in the level of
inventory from 1997 to 1998 was primarily due to an increase in the level
wireless communications products during the year required to satisfy ongoing and
anticipated trials and shipments of our latest products partially offset by an
increase in the allowance for obsolete inventory related to discontinued
products and early versions of wireless communications products. We anticipate
that we will incur significant additional net losses during 1999 and anticipate
that our accounts receivable and inventories may increase during 1999 as a
result of increased working capital requirements to support wireless
telecommunications products. As a result, we anticipate the use of additional
cash in operating activities during 1999.
Net cash provided by (used in) investing activities was ($4,868,000) in
1996, compared to $5,848,000 in 1997, and ($1,035,000) in 1998. The change in
1997 compared to 1996 is primarily due to the change in proceeds from sales of
short term investments and purchase of short term investments. In 1997 we sold
$5,956,000 more of our short term investments than we purchased to increase
cash, while in 1996 we purchased $3,633,000 more of short term investments than
we sold to invest cash. The change in 1998 compared to 1997 was primarily due to
relatively higher purchases of short term investments than proceeds received on
maturities of short term investments. In 1998, we purchased $784,000 more of
short term investments than we sold to decrease cash. In addition, capital
expenditures decreased by $575,000 in 1997 compared to 1996 and decreased by
$438,000 in 1998 compared to 1997, due to lower spending on laboratory and
manufacturing equipment. We anticipate that our capital expenditures will
increase slightly in 1999 as we continue our transition to manufacture greater
volumes of commercial products.
Net cash provided by financing activities was $7,229,000 in 1998 compared to
$345,000 in 1997 and $10,612,000 in 1996. 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 our
follow-on offering in June of 1996 and borrowings under our equipment loans,
offset by principal payments under capital lease obligations and equipment term
loans. The net cash provided by financing activities in 1998 was primarily due
to the issuance of preferred Series B stock and related warrants as well as
proceeds from borrowings in excess of debt payments during the year. We have
received limited revenues from product sales to date.
All of our credit arrangements contain reporting and financial covenants
which we are required to satisfy. We cannot assure you that we will satisfy all
such covenants in the future. We cannot assure you that if we default on any of
the covenants, we could obtain a waiver of the default from the lender. In the
event of default on any of these covenants, no further amounts would be advanced
to us under any facility, the entire amounts outstanding could become due and
payable immediately upon default, and those assets that are collateral could be
seized, unless such default is waived by the lender.
To date we have received limited revenues from product sales. The continued
development of our products will require a commitment of substantial funds to
conduct further research and development and testing, to establish
commercial-scale manufacturing and to market these products. We expect to use
significant amounts of cash for capital equipment and to support operations
until product revenues
24
<PAGE>
increase. Additional financing may not be available on acceptable terms or at
all. Unless we are able to raise significant additional funds, through debt or
equity issuances, asset sales or otherwise, we will be required to delay, reduce
or eliminate one or more of our research and development programs or obtain
funds from collaborative partners or others that may require us to relinquish
rights to our technologies or potential products that we would not otherwise
relinquish. Our future capital requirements will depend on many factors,
including:
- continued progress in our 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,
- our ability to establish collaborative arrangements, and
- the cost of manufacturing scale-up and the amount and timing of future
revenues.
We anticipate total capital expenditures of approximately $900,000 during
1999, which will be funded primarily from our $1,000,000 lease line of credit
for new equipment purchases. We anticipate that existing sources of liquidity
and anticipated revenue, primarily from government contracts, will satisfy our
projected working capital and other cash requirements through June 1999.
However, there can be no assurance that changes in our plans or other events
affecting Conductus will not result in the expenditure of our resources before
June 1999. Additionally, we can give you no assurance that additional financing
will be available on acceptable terms or at all.
THE YEAR 2000 ISSUE
The potential problem presented by the year 2000 is the result of computer
programs being written using two digits rather than four to define the
applicable year. As a result, many computer systems and applications experience
problems handling dates beyond the year 1999 and will need to be modified before
the year 2000 in order to function properly. Any of our 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 system failures or
miscalculations, causing disruptions of key operations. Important operations
which could be disrupted include, among other things, a temporary inability to
process transactions, send invoices, or engage in similar normal business
activities.
We have expended resources to review our products, services and internal use
software to identify those products, services and systems that may not properly
process the year 2000 date. The costs related to potential year 2000 problems
are expensed as incurred, and represent a reallocation of existing resources.
Our compliance project comprises four phases: (1) identification of risks,
(2) assessment of those risks, (3) development of remedies and contingency
plans, and (4) implementation and testing. The following describes the status of
our year 2000 compliance project, and our estimates regarding future compliance
expenses, in relation to four pertinent aspects of our business:
SALES, MANUFACTURING AND FINANCE INFORMATION SYSTEMS. We are currently in
the fourth phase of our compliance project. Our vendors have confirmed that the
versions of software currently in use are year 2000 compliant. We plan to
complete our tests by the end of June 1999. We do not anticipate incurring any
material expenses to complete our tests on these systems.
25
<PAGE>
NETWORK HARDWARE, SOFTWARE AND DESKTOP WORKSTATIONS. We have completed
phase three and have developed a plan to complete an upgrade of all
non-compliant hardware and software by June 1999. We estimate that we will spend
approximately $250,000 replacing non-compliant equipment.
PRODUCTS WE HAVE SOLD. Our completed assessment indicates that these
products are year 2000 compliant. We do not anticipate incurring any material
expenses related to products we have sold or to any current product designs.
FABRICATION AND MANUFACTURING EQUIPMENT. We are completing phase two and
beginning to develop remedies and contingency plans. We expect to complete phase
two by the end of March 1999, and to complete phase three by the end of June
1999. We are unable to estimate the remaining financial impact, if any, of the
year 2000 because our assessment phase is not completed. However, we currently
anticipate that our $1,000,000 equipment lease line will be sufficient to cover
both the network costs and any costs that may be incurred related to the upgrade
or replacement of fabrication and manufacturing equipment in 1999.
We have begun to formally communicate with our significant suppliers and
large customers to determine the extent to which we are vulnerable to their
failure to fix their own year 2000 problems. We cannot assure you that the
systems of other companies on which our systems rely will be timely converted,
or that a failure to convert by another company, or a conversion that is
incompatible with our systems, would not harm us.
As our year 2000 compliance project continues, we may (a) discover
additional year 2000 problems, (b) may not be able to develop, implement, or
test remedies or contingency plans, or (c) may find that the costs of these
activities exceed current expectations and become material. These contingencies
could force us to spend additional time and money to avoid potential year 2000
problems.
In the event we do not complete our compliance program as scheduled, the
year 2000 could cause significant problems. If all of our key operations cease
to function properly, we could experience an enterprise-wide shutdown for an
unknown period of time. We are unable to assess the magnitude of any losses that
could result from this worst case scenario.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." This standard requires companies to
capitalize qualifying computer software costs which are incurred during the
application development stage and amortize them over the software's estimated
useful life. Statement of Position 98-1 is effective for fiscal years beginning
after December 15, 1998.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5. "Reporting on the Costs of Start-Up Activities."
This standard requires companies to expense the costs of start-up activities and
organization costs as incurred. In general, Statement of Position 98-5 is
effective for fiscal years beginning after December 15, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." Statement No. 133 establishes new standards of
accounting and reporting for derivative instruments and hedging activities.
Statement No. 133 requires that all derivatives be recognized at fair value in
the statement of financial position, and that the corresponding gains or losses
be reported either in the statement of operations or as a component of
comprehensive income, depending on the type of hedging relationship that exists.
Statement No. 133 will be effective for fiscal years beginning after June 15,
1999. We do not currently hold derivative instruments or engage in hedging
activities.
26
<PAGE>
We are currently in the process of assessing the implications of these
statements and have not yet determined the impact of their adoption.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Conductus' general policy is to limit the risk of principal loss and ensure
the safety of invested funds by limiting market and credit risk. Our exposure to
financial market risks relates primarily to our exposure to the impact of
changes in interest rates on our fixed income investment portfolio and long-term
debt obligations.
FIXED INCOME INVESTMENTS
The primary objective of our investment activities is to preserve our
principal while maximizing yields without significantly increasing risk. To
achieve this objective, we maintain a portfolio that consists primarily of
short-term, high-quality commercial paper and foreign debt. All of our fixed
income investments have maturities of less than one year. Hence, our exposure
related to changes in interest rates is somewhat limited due to the short-term
nature of our portfolio. We do not use derivative financial instruments in our
investment portfolio.
DEBT OBLIGATIONS
Conductus' outstanding debt consists of term loan obligations that are
primarily based on fixed rates. Therefore, our exposure to changes in interests
rates is limited because any increase or decrease in interest rates would not
significantly increase or decrease interest expense on our debt obligations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements of the Registrant and auditor's report
are included in pages 33-54:
Report of Independent Accountants
Balance Sheets--as of December 31, 1997 and 1998
Statements of Operations and Comprehensive Loss--years ended December 31,
1996, 1997 and 1998
Statements of Stockholders' Equity--years ended December 31, 1996, 1997 and
1998
Statements of Cash Flows--years ended December 31, 1996, 1997 and 1998
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 our 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 1999 Annual
Meeting of Stockholders to be held on May 27, 1999.
27
<PAGE>
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 our 1999 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 our 1999 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 our 1999 Proxy
Statement.
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:
<TABLE>
<CAPTION>
PAGE NUMBER
-----------
<C> <S> <C>
1. Financial Statements
Report of Independent Accountants.................................................................. 34
Balance Sheets--as of December 31, 1997 and 1998................................................... 35
Statements of Operations and Comprehensive Loss--years ended December 31, 1996, 1997 and 1998...... 36
Statements of Stockholders' Equity--years ended December 31, 1996, 1997 and 1998................... 37
Statements of Cash Flows--years ended December 31, 1996, 1997 and 1998............................. 38
Notes to Financial Statements...................................................................... 39
2. Financial Statement Schedule
Report of Independent Accountants.................................................................. S-1
Schedule II--Valuation and Qualifying Accounts..................................................... S-2
3. See Exhibits
</TABLE>
<TABLE>
<CAPTION>
EXHIBIT NO DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
2.1(1) Stock Exchange Agreement dated as of May 28, 1993, between the Company and Tristan Technologies, Inc.
3.1(2) Restated Certificate of Incorporation.
3.2(3) Restated Bylaws.
3.3(4) Certificate of Designation of Series B Preferred Stock.
4.1(3) Stockholder Rights Plan.
5.1* Opinion of Counsel.
10.1(1) 1987 Stock Option Plan.
10.2(1) Amended 1989 Stock Option Plan.
10.3(5) 1992 Stock Option/Stock Purchase Plan.
10.4(6) 1994 Employee Stock Purchase Plan.
10.5(1) Second Amended and Restated Registration Rights Agreement dated June 3, 1993.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.6(4) Form of Series B Preferred Stock and Warrant Purchase Agreement, dated September, 1998, and September
22, 1998, between the Company and Series B Investors.
10.7(4) Form of Warrant to Purchase Common Stock between the Company and Series B Investors.
10.8(7) Employment Agreement dated May 3, 1994 between Registrant and Mr. Charles E. Shalvoy.
10.9(1) Form of Indemnification Agreement between the Registrant and each of its directors and officers.
10.10(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.
10.11(8) Collaboration Agreement between Registrant and CTI dated September 19, 1995.
10.12(8) 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.
10.13(9)+ Superconducting Filter Technology Joint Development Agreement dated April 25, 1996 between the
Registrant and Lucent Technologies Inc.
10.14(4) Engagement Letter between the Company and Sutro and Co. Inc., dated March 24, 1998.
10.15(4) Amendment to Engagement Letter between the Company and Sutro and Co. Inc., dated September 2, 1998.
10.16(4) Engagement Letter between the Company and Davenport and Co., dated September 2, 1998.
10.17(4) Master Lease Agreement between the Company and Leasing Technologies International, Inc., dated June
15, 1998.
10.18(1) Lease Agreement dated May 3, 1993 between the Registrant and Mozart-McKee Limited Partnership for
Sunnyvale facilities.
10.19(7) Lease Agreement dated December 8, 1994 between Registrant and Mozart-McKee Limited Partnership for
Sunnyvale facilities.
10.20(7) Business Loan Agreement dated August 15, 1994 between Registrant and Silicon Valley Bank for working
capital credit facility and term loan facility.
10.21(10) Loan Modification Agreement dated June 30, 1997, between Registration and Silicon Valley Bank
modifying the Business Loan Agreement dated August 15, 1994.
10.22(10) Loan Modification Agreement dated November 12, 1997, between Registration and Silicon Valley Bank
modifying the Business Loan Agreement dated August 15, 1994.
10.23(10) Loan Modification Agreement dated December 23, 1997, between Registration and Silicon Valley Bank
modifying the Business Loan Agreement dated August 15, 1994.
10.24(11) Business Loan Agreement dated March 8, 1996 between Registrant and Silicon Valley Bank for working
capital credit facility and term loan facility.
10.25(12) Business Loan Agreement dated December 27, 1996 between Registrant and Silicon Valley Bank for
working capital credit facility and term loan facility.
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.26(4) Master Loan and Security Agreement between the Company and Transamerica Business Credit Corporation,
dated June 26, 1998.
10.27(4) Stock Subscription Warrant Agreement between the Company and Transamerica Business Credit
Corporation, dated June 26, 1998.
10.28(13) Silicon Valley Bank Loan Agreement.
10.29(13) Collateral Assignment, Patent Mortgage and Security Agreement between the Company and Silicon Valley
Bank.
10.30(10)+ Asset Purchase Agreement dated July 9, 1997 between Registrant and Bruker Instruments, Inc. for sale
of assets of Registrant's NMR Probe business.
10.31(10) Asset Purchase Agreement dated August 15, 1997 between Registrant and Neocera, Inc. for sale of
Registrant's assets related to its temperature controller business.
10.32(10) 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 31).
27.1* Financial Data Schedule.
</TABLE>
- ------------------------
* Previously filed.
+ Confidential treatment granted or requested as to certain portions of these
exhibits.
(1) Incorporated herein by reference to the Company's Registration Statement on
Form S-1 (Number 33-64020), filed with the SEC on May 15, 1996, as amended.
(2) Incorporated herein by reference to the Company's 1993 Annual Report on
Form 10-K.
(3) Incorporated herein by reference to the Company's Registration Statement on
Form 8-K, filed with the SEC on January 22, 1998.
(4) Incorporated herein by reference to the Company's Form 10-Q, filed with the
SEC on November 16, 1998.
(5) Incorporated herein by reference to the Company's Registration Statement on
Form S-8, filed with the SEC on November 26, 1997.
(6) Incorporated herein by reference to the Company's Registration Statement on
Form S-8, filed with the SEC on August 5, 1994.
(7) Incorporated herein by reference to the Company's 1994 Annual Report on
Form 10-K.
(8) Incorporated herein by reference to Amendment No. 2 to the Company's
Registration Statement on Form S-1 (Number 333-3815), filed with the SEC on
June 17, 1996.
(9) Incorporated herein by reference to the Company's Registration Statement on
Form S-1 (Number 333-3815), filed with the SEC on May 10, 1996, as amended.
(10) Incorporated herein by reference to the Company's 1998 Annual Report on
Form 10-K.
(11) Incorporated herein by reference to the Company's 1995 Annual Report on
Form 10-K.
(12) Incorporated herein by reference to the Company's 1996 Annual Report on
Form 10-K.
(13) Incorporated herein by reference to the Company's Form 10-Q, filed with the
SEC on May 14, 1998
30
<PAGE>
(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.
31
<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 March
31, 1999.
<TABLE>
<S> <C> <C>
CONDUCTUS, INC.
By: /s/ CHARLES E. SHALVOY
-----------------------------------------
Charles E. Shalvoy
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Charles E. Shalvoy and Ronald Wilderink, and each
of them, as his true and lawful attorneys-in-fact and agents, with full power of
substitution and resubstitution, for him and in his 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.
32
<PAGE>
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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------------------ --------------------------------- ----------------------
<C> <S> <C>
/s/ CHARLES E. SHALVOY President, Chief Executive
------------------------------------------- Officer and Director (Principal March 31, 1996
Charles E. Shalvoy Executive Officer)
/s/ RONALD WILDERINK
------------------------------------------- Chief Financial Officer March 31, 1999
Ronald Wilderink (Principal Accounting Officer)
/s/ JOHN F. SHOCH
------------------------------------------- Chairman of the Board of March 31, 1999
John F. Shoch, Ph.D. Directors
/s/ MARTIN COOPER
------------------------------------------- Director March 31, 1999
Martin Cooper
------------------------------------------- Director
Robert Janowiak
------------------------------------------- Director
Marty Kaplan
</TABLE>
33
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
Conductus, Inc.:
In our opinion, the accompanying balance sheets and the related statements
of operations and comprehensive loss, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of Conductus,
Inc., at December 31, 1997 and 1998, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of Conductus' management; our responsibility
is to express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audits 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
The accompanying financial statements have been prepared assuming Conductus
will continue as a going concern. As discussed in Note 1 to the financial
statements, Conductus' liquidity has been adversely affected by continuing
losses from operations. In addition, continuation of operations is dependent
upon the availability of additional capital and Conductus' ability to generate
increased revenues and improved gross margins on sales. These issues raise
substantial doubt about Conductus' ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
PricewaterhouseCoopers LLP
San Jose, California
February 19, 1999
34
<PAGE>
CONDUCTUS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1997 1998
-------------- --------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents....................................................... $ 2,111,560 $ 1,547,169
Restricted cash equivalent...................................................... 500,000 --
Short-term investments.......................................................... 556,633 1,341,014
Accounts receivable (net of allowance for doubtful accounts of $248,232 and
$292,635 for 1997 and 1998)................................................... 2,055,255 1,109,794
Inventories..................................................................... 610,367 842,384
Prepaid expenses and other current assets....................................... 139,479 145,470
-------------- --------------
Total current assets.......................................................... 5,973,294 4,985,831
Property and equipment, net..................................................... 2,700,594 2,020,324
Other assets.................................................................... 87,762 28,800
-------------- --------------
Total assets.................................................................. $ 8,761,650 $ 7,034,955
-------------- --------------
-------------- --------------
LIABILITIES
Current liabilities:
Current portion of long-term debt............................................... $ 1,547,507 $ 892,139
Accounts payable................................................................ 1,539,590 658,982
Other accrued liabilities....................................................... 1,063,721 778,758
-------------- --------------
Total current liabilities..................................................... 4,150,818 2,329,879
Long-term debt, net of current portion.......................................... 309,681 1,341,407
-------------- --------------
Total liabilities............................................................. 4,460,499 3,671,286
-------------- --------------
Commitments (Note 10)
STOCKHOLDERS' EQUITY
Preferred stock, no par value:
Authorized: 5,000,000 shares
Series B, no par value; Designated: 4,500,000; Issued and outstanding: none in
1997, 2,461,227 in 1998 (Liquidation value: $6,762,065 at December 31,
1998)......................................................................... -- 5,683,461
Common stock, $0.0001 par value:
Authorized: 20,000,000 shares;
Issued: 7,013,062 and 7,144,120 in 1997 and 1998 Outstanding: 7,004,095 and
7,144,120 in 1997 and 1998.................................................... 702 714
Additional paid-in capital........................................................ 41,070,636 42,278,423
Accumulated deficit............................................................... (36,770,187) (44,598,929)
-------------- --------------
Total stockholders' equity.................................................... 4,301,151 3,363,669
-------------- --------------
Total liabilities and stockholders' equity.................................... $ 8,761,650 $ 7,034,955
-------------- --------------
-------------- --------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
35
<PAGE>
CONDUCTUS, INC.
STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Revenues:
Contract............................................................ $ 9,690,989 $ 7,266,157 $ 3,698,049
Product sales..................................................... 2,851,682 2,187,383 990,737
------------- ------------- -------------
Total revenues.................................................. 12,542,671 9,453,540 4,688,786
------------- ------------- -------------
Costs and expenses:
Cost of product sales............................................. 1,823,622 1,845,413 2,684,994
Research and development.......................................... 11,773,587 10,626,133 5,621,284
Selling, general and administrative............................... 4,054,303 4,329,739 3,514,295
Write-off of property and equipment............................... -- 100,000 --
Loss on asset sale................................................ -- 51,741 --
------------- ------------- -------------
Total costs and expenses........................................ 17,651,512 16,953,026 11,820,573
------------- ------------- -------------
Loss from operations................................................ (5,108,841) (7,499,486) (7,131,787)
Interest income..................................................... 262,965 267,492 97,149
Other income (expense).............................................. 25,042 (108,992) (36,391)
Interest expense.................................................... (183,138) (202,395) (529,961)
------------- ------------- -------------
Net loss.......................................................... (5,003,972) (7,543,381) (7,600,990)
Preferred dividend.................................................. -- -- (227,752)
------------- ------------- -------------
Net loss attributable to common shareholders........................ $ (5,003,972) $ (7,543,381) $ (7,828,742)
------------- ------------- -------------
------------- ------------- -------------
Net loss............................................................ $ (5,003,972) $ (7,543,381) $ (7,600,990)
Other comprehensive income, net of tax:
Unrealized gains (losses) on investments.......................... 3,182 (3,808) --
------------- ------------- -------------
Comprehensive loss.................................................. $ (5,000,790) $ (7,547,189) $ (7,600,990)
------------- ------------- -------------
------------- ------------- -------------
Basic and diluted net loss per share................................ $ (0.80) $ (1.09) $ (1.10)
------------- ------------- -------------
------------- ------------- -------------
Shares used in per share calculations............................... 6,263,446 6,896,649 7,088,339
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
36
<PAGE>
CONDUCTUS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ACCUMULATED
SERIES B ADDITIONAL OTHER
PREFERRED COMMON PAID-IN COMPREHENSIVE ACCUMULATED
STOCK STOCK CAPITAL INCOME (LOSS) DEFICIT TOTAL
---------- ----------- ----------- --------------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1996........ $ -- $ 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
Issuance of 2,461,227 shares of
preferred stock net of $300,860
issuance costs................. 5,572,461 -- -- -- -- 5,572,461
Issuance of common stock
warrants....................... -- -- 1,040,671 -- -- 1,040,671
Issuance of 111,955 shares of
common stock to employees...... -- 10 65,798 -- -- 65,808
Issuance of 28,070 shares of
common stock to employees under
the employee stock purchase
plan........................... -- 2 65,659 -- -- 65,661
Compensation associated with
stock options granted.......... -- -- 35,659 -- -- 35,659
Dividend accretion on preferred
stock.......................... 111,000 -- -- -- (227,752) (116,752)
Net loss......................... -- -- -- -- (7,600,990) (7,600,990)
---------- ----- ----------- ------- ------------ -----------
Balance, December 31, 1998....... $5,683,461 $ 714 $42,278,423 $ -- $(44,598,929) $ 3,363,669
---------- ----- ----------- ------- ------------ -----------
---------- ----- ----------- ------- ------------ -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
37
<PAGE>
CONDUCTUS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss........................................................... $ (5,003,972) $ (7,543,381) $ (7,600,990)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization...................................... 925,718 827,071 931,215
Compensation associated with stock options granted................. 27,001 36,001 35,659
Amortization of discount on long term debt......................... -- (107,913)
Provision for excess and obsolete inventories...................... -- 249,845 156,908
(Gain) loss on disposal of equipment............................... (22,922) 51,741 --
Provision for allowance for doubtful accounts...................... -- 273,232 53,744
(Increase) decrease in:
Accounts receivable................................................ (505,439) 1,528,099 891,717
Inventories........................................................ (455,449) (269,017) (388,925)
Prepaid expenses and other current assets.......................... (112,152) 258,077 (5,991)
Other assets....................................................... (63,580) 40,001 58,962
Increase, (decrease) in:
Accounts payable and other accrued liabilities..................... 314,024 (153,367) (1,282,323)
------------- ------------- -------------
Net cash used in operating activities........................ (4,896,771) (4,701,698) (7,257,937)
------------- ------------- -------------
Cash flows from investing activities:
Maturities of short-term investments............................... 44,266,602 39,401,345 556,633
Purchases of short-term investments................................ (47,899,357) (33,445,385) (1,341,014)
Acquisition of property and equipment.............................. (1,264,478) (689,286) (250,945)
Net proceeds from sales of assets.................................. 29,196 581,243 --
------------- ------------- -------------
Net cash (used in) provided by investing activities.......... (4,868,037) 5,847,917 (1,035,326)
------------- ------------- -------------
Cash flows from financing activities:
Proceeds from borrowings........................................... 1,229,019 910,132 4,500,000
Net proceeds from issuance of common stock......................... 10,343,135 629,273 131,469
Net proceeds from issuance of preferred stock...................... -- -- 5,572,461
Net proceeds from issuance of common stock warrants................ -- -- 772,000
Principals payments on long-term debt.............................. (959,765) (1,194,055) (3,747,058)
------------- ------------- -------------
Net cash provided by financing activities.................... 10,612,389 345,350 7,228,872
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents............... 847,581 1,491,569 (1,064,391)
Cash and cash equivalents at beginning of period..................... 272,410 1,119,991 2,611,560
------------- ------------- -------------
Cash and cash equivalents at end of period........................... $ 1,119,991 $ 2,611,560 $ 1,547,169
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
38
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS
1. FORMATION AND BUSINESS OF THE COMPANY AND BASIS OF PRESENTATION:
Conductus 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,
Conductus discontinued operation of its Instrument and Systems Division and is
now focused on development, manufacturing and marketing of electronic components
and systems based on superconductors for applications in the worldwide
telecommunications market.
SUBSTANTIAL FUTURE CAPITAL NEEDS:
Conductus has received limited revenues from product sales to date and has
cash reserves of approximately $2,888,000 as of December 31, 1998. Conductus
anticipates that existing sources of liquidity and anticipated revenue,
primarily from government contracts, will satisfy projected working capital and
other cash requirements through June 1999. However, there can be no assurance
that changes in our plans or other events affecting Conductus will not result in
the expenditure of our resources before June 1999.
The development, manufacture and marketing of Conductus' products will
require a commitment of substantial additional funds. Management is evaluating
alternative methods to raise additional funds, through debt or equity issuances,
asset sales or otherwise, including possible arrangements with collaborative
partners or others that may require Conductus to relinquish rights to certain of
its technologies or potential products that would not otherwise be relinquished.
Unless management is able to raise significant additional funds, Conductus will
be required to delay, scale-back or eliminate one or more research and
development programs. Additionally, management can give no assurance that
additional financing will be available on acceptable terms or at all. No
adjustments have been included in the financial statements to reflect this
uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
FISCAL YEAR:
Prior to January 1998, Conductus used 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. In January 1998, it changed to a 52 week fiscal year ending on the last
day of the month.
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:
Conductus' superconducting products are concentrated in the electronic
component industry which is highly competitive and rapidly changing. Revenues
for its products are concentrated with a relatively limited number of customers
and suppliers for certain components are concentrated among a few providers. In
addition, approximately 77%, 77% and 79% of its total revenues for each of the
fiscal years 1996, 1997, and 1998 were from government-related contracts. The
development of new technologies or
39
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
commercialization of superconductive products by any competitor, or the
conclusion of one or more government contracts could affect operating results
adversely.
CASH, CASH EQUIVALENTS AND INVESTMENTS:
Conductus 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, 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 U.S. banks.
Other financial instruments, principally accounts receivable, long term debt
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 five years for equipment and
furniture and fixtures. 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, the cost and related
accumulated depreciation are removed from the accounts and the resulting gains
and losses are included in results of operations.
Conductus periodically assesses the recoverability of assets by determining
whether the amortization of the asset balance over its remaining life can be
recovered through undiscounted future operating cash flows. The amount of
impairment, if any, is measured as the amount by which the net book value
exceeds the fair value of the asset.
REVENUE RECOGNITION:
Product revenues are generally recognized at the time of shipment.
Appropriate allowance is made for product returns and potential warranty claims
at the time of shipment.
RESEARCH AND DEVELOPMENT CONTRACTS:
Conductus 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
40
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
the relationship of costs incurred to total contract costs. Cost of contract
revenues for the years ended December 31, 1996, 1997, and 1998 was $13,178,000,
$9,814,000 and $5,661,000, 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:
Conductus utilizes the liability method of accounting for income taxes, as
set forth in Statement of Financial Accounting Standards 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
"Accounting for Stock-Based Compensation," Conductus accounts for grants of
equity instruments to employees using the intrinsic value method described in
Accounting Principles Board Opinion No. 25. All other grants are accounted for
using the fair value method described in Statement of Financial Accounting
Standards No. 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 "Earnings Per Share," a reconciliation of the
numerator and denominator of the basic and diluted net loss per share is
provided as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Numerator-basic and diluted net loss per share:
Net loss attributable to common shareholders... $ (5,003,972) $ (7,543,381) $ (7,828,742)
Denominator-basic and diluted net loss per share:
Weighted average common shares................. 6,263,446 6,896,649 7,088,339
Basic and diluted net loss per share........... $ (0.80) $ (1.09) $ (1.10)
</TABLE>
In the 1996, 1997, and 1998 computations, common equivalent shares are
excluded from the diluted loss per share as their effect is antidilutive. Common
equivalent shares, including common stock options, warrants and preferred stock,
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 1,400,000, 1,101,000, and 4,074,000 for the
years ended 1996, 1997 and 1998, respectively.
41
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
COMPREHENSIVE LOSS:
Conductus adopted Statement of Financial Accounting Standards No. 130,
"Accounting for Comprehensive Income," during fiscal year ended 1998. This
statement establishes standards for reporting and display of comprehensive
income and its components (including revenues, expenses, gains and losses) in a
full set of financial statements. Conductus' unrealized gains and losses on
investments represent the only component of comprehensive income which is
excluded from net income for 1998 and prior years. Conductus' comprehensive loss
has been presented in the financial statements. There were no tax effects
allocated to the component of other comprehensive loss as Conductus currently
pays no taxes and has not recognized any benefits.
RECLASSIFICATIONS:
Certain 1997 amounts have been reclassified to conform to the 1998
presentation.
RECENT PRONOUNCEMENTS:
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." This standard requires companies to
capitalize qualifying computer software costs which are incurred during the
application development stage and amortize them over the software's estimated
useful life. Statement of Position 98-1 is effective for fiscal years beginning
after December 15, 1998.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities."
This standard requires companies to expense the costs of start-up activities and
organization costs as incurred. In general, Statement of Position 98-5 is
effective for fiscal years beginning after December 15, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement establishes new standards of accounting
and reporting for derivative instruments and hedging activities. This statement
requires that all derivatives be recognized at fair value in the statement of
financial position, and that the corresponding gains or losses be reported
either in the statement of operations or as a component of comprehensive income,
depending on the type of hedging relationship that exists. Statement No. 133
will be effective for fiscal years beginning after June 15, 1999. Conductus does
not currently hold derivative instruments or engage in hedging activities.
Conductus is currently studying the implications of these statements and has
not yet determined the impact of their adoption.
42
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. SUPPLEMENTAL CASH FLOW DISCLOSURE:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest..................................... $ 191,050 $ 173,571 $ 374,713
---------- ---------- ----------
---------- ---------- ----------
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FUNDING ACTIVITIES:
Unrealized gain (loss) on investments, net................................. $ 3,182 $ 3,808 $ --
---------- ---------- ----------
---------- ---------- ----------
OTHER NONCASH EXPENSES:
Compensation associated with stock options granted......................... $ 27,001 $ 36,001 $ 35,639
---------- ---------- ----------
---------- ---------- ----------
Dividend accretion on preferred stock...................................... $ -- $ -- $ 227,752
---------- ---------- ----------
---------- ---------- ----------
Amortization of discount on long term debt................................. $ -- $ -- $ 107,913
---------- ---------- ----------
---------- ---------- ----------
Value of warrants issued in association with long term debt................ $ -- $ -- $ 268,671
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
4. INVESTMENTS:
Investments, all of which are classified as available-for-sale, are
summarized below:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1998
------------------------ --------------------------
COST MARKET VALUE COST MARKET VALUE
---------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Debt securities:
Foreign debt............................................ $ 289,829 $ 289,829 $ 248,126 $ 248,126
Commercial paper........................................ 247,702 247,702 792,215 792,215
Other................................................... 4,587 4,587 298,468 298,468
Accrued interest........................................ 14,515 14,515 2,205 2,205
---------- ------------ ------------ ------------
Total................................................... $ 556,633 $ 556,633 $ 1,341,014 $1,341,014
---------- ------------ ------------ ------------
---------- ------------ ------------ ------------
</TABLE>
At December 31, 1998, all scheduled maturities of investments are within one
year. Investments consisted primarily of foreign debt and commercial paper
bearing interest between 4.5% to 5.2% per annum are due to mature between
January 1999 and August 1999.
For the years ended December 31, 1996, 1997, and 1998 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.
43
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. ACCOUNTS RECEIVABLE:
Accounts receivable, net, consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1997 1998
------------ ------------
<S> <C> <C>
U.S. government contracts:
Unbilled
Recoverable costs and accrued profit on progress
completed--not billed....................................... $ 796,283 $ 726,342
Unrecovered costs and estimated profits subject to future
negotiation--not billed..................................... 350,000 --
Billed.......................................................... 793,382 297,525
Commercial........................................................ 363,822 378,562
Allowance for doubtful accounts................................... (248,232) (292,635)
------------ ------------
$ 2,055,255 $ 1,109,794
------------ ------------
------------ ------------
</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, 1998 will be billed over the next 120 days as incremental increases
to the contract are funded by the contract administrator.
6. INVENTORIES:
Inventories, net, consist of the following:
<TABLE>
<CAPTION>
1997 1998
----------- -----------
<S> <C> <C>
Raw materials....................................................... $ 293,336 $ 441,130
Work in process..................................................... 366,550 198,341
Finished goods...................................................... 231,326 640,666
Allowance for excess and obsolete inventories....................... (280,845) (437,753)
----------- -----------
$ 610,367 $ 842,384
----------- -----------
----------- -----------
</TABLE>
44
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. PROPERTY AND EQUIPMENT:
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1997 1998
------------- -------------
<S> <C> <C>
Equipment....................................................... $ 6,859,265 $ 7,286,069
Leasehold improvements.......................................... 1,590,605 1,715,096
Furniture and fixtures.......................................... 424,824 431,861
Construction in process......................................... 307,386 --
------------- -------------
9,182,080 9,433,026
Accumulated depreciation and amortization....................... (6,481,486) (7,412,702)
------------- -------------
$ 2,700,594 $ 2,020,324
------------- -------------
------------- -------------
</TABLE>
8. OTHER ACCRUED LIABILITIES:
Other accrued liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1998
------------ ----------
<S> <C> <C>
Accrued consulting and professional................................. $ 138,155 $ 111,022
Accrued compensation................................................ 704,676 395,313
Preferred dividend payable.......................................... -- 116,752
Other accrued liabilities........................................... 220,890 155,671
------------ ----------
$ 1,063,721 $ 778,758
------------ ----------
------------ ----------
</TABLE>
9. LONG-TERM DEBT AND OTHER BORROWINGS:
Our credit facilities consist of a loan from a leasing company, a bank
equipment term loan, a bank line of credit and a lease line of credit for new
equipment purchases. Obligations related to our credit facilities as of December
31, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1997 1998
------------ ------------
<S> <C> <C>
Loan payable to leasing company................................... $ -- $ 1,978,366
Bank equipment term loan payable.................................. 1,357,188 255,180
Bank line of credit............................................... 500,000 --
------------ ------------
Total........................................................... 1,857,188 2,233,546
Less: current portion............................................. 1,547,507 892,139
------------ ------------
Long term debt.................................................. $ 309,681 $ 1,341,407
------------ ------------
------------ ------------
</TABLE>
On April 22, 1998, Conductus entered into a $2,500,000 loan agreement with a
leasing company collateralized by substantially all of the assets of the
Company. In connection with the loan agreement, Conductus granted 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, $4.11. The
45
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. LONG-TERM DEBT AND OTHER BORROWINGS: (CONTINUED)
effective interest rate, including the impact of the warrants, is 13.98%. The
warrants were valued using the Noreen-Wolfson valuation model and have a term of
five years. The value of $101,681 assigned to the warrants is being amortized to
interest expense using the effective interest method.
The bank equipment term loan bears interest at the bank's prime rate plus
2%, with principal and interest payments paid monthly. This term loan matures on
December 31, 1999 subject to renewal of the bank line of credit on April 23,
1999. If the bank line of credit is not renewed, the equipment term loan
requires Conductus to collateralize the term loan with restricted cash deposits.
On April 23, 1998, Conductus entered into a bank line of credit agreement,
which provides for borrowings of up to the lesser of $2,000,000 or 80% of
eligible receivables. Borrowings under this facility bear interest at the bank's
prime rate plus 2.0% and are collateralized by accounts receivable, equipment
and other assets of Conductus. In connection with this line of credit, Conductus
granted warrants to purchase 15,000 shares, 10,000 shares and 25,000 shares of
the Company's common stock to the bank on April 13, 1998, May 31, 1998 and June
30, 1998, respectively. Such grants were based on the length of time the
borrowings remained outstanding and are exercisable at a price of $3.625 per
share. The warrants were valued using the Noreen-Wolfson valuation model and
have a term of five years. The value of $132,455 assigned to the warrants was
charged to interest expense using the effective interest method. As of December
31, 1998, there were no amounts outstanding under this facility however,
outstanding balances under the bank equipment term loan reduce the amount
available under the line of credit and, based on 80% of eligible receivables
there were no amounts available under the line of credit at December 31, 1998.
The line of credit is subject to renewal on April 23, 1999.
The lease line of credit for new equipment purchases provides for borrowings
of up to $1,000,000, is collateralized by equipment purchases under the line and
has an effective interest rate of 14.04%. Conductus also granted to the leasing
company warrants to purchase up to 15,060 shares of our stock at a price equal
to $3.32. The fair value of such warrants is approximately $35,000 and will be
amortized over the three-year term of the lease payments. The warrants were
valued using the Noreen-Wolfson valuation model and have a term of five years.
This line of credit prohibits Conductus from paying cash dividends and expires
on September 30, 1999.
All of the credit facilities contain reporting and financial covenants. In
the event of default on any of these covenants, no further amounts would be
advanced to the Company under any facility. Additionally, the entire amounts
outstanding could become due and payable immediately upon default and those
assets that are collateralized could be seized, unless the lender waives such
default. At December 31, 1998, Conductus was in compliance with all financial
covenants.
10. COMMITMENTS:
Conductus leases its administrative, sales, marketing, manufacturing,
research and development facilities under noncancelable operating leases
expiring in August 2000 and 2001. Under the terms of the leases, Conductus is
responsible for certain expenses and taxes.
46
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. COMMITMENTS: (CONTINUED)
Future minimum payments under these noncancelable leases are as follows:
<TABLE>
<CAPTION>
<S> <C>
1999.......................................................... $ 327,114
2000.......................................................... 279,114
2001.......................................................... 122,076
----------
$ 728,304
----------
----------
</TABLE>
Rent expense was $438,531, $385,432 and $316,583 for the years ending
December 31, 1996, 1997, and 1998, respectively.
11. RESEARCH AND DEVELOPMENT ARRANGEMENTS:
Conductus is party to a number of research and development contracts,
generally short-term in nature, which are substantially all with various
agencies of the U.S. government. Credit risk related to accounts receivable
arising from such contracts is considered minimal.
The following describes some of the major programs undertaken by Conductus:
COORDINATED RESEARCH PROGRAM:
In May 1993, Conductus and Hewlett-Packard Company modified a previous
coordinated research program agreement by entering into a new five-year
agreement. In connection with the modifying agreement, Conductus received
$1,000,000 in cash and $230,000 in equipment from Hewlett-Packard 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 Conductus'
initial public offering in August 1993.
This agreement requires Conductus and Hewlett-Packard to exchange reviews
and assessments of Conductus' technical and applications developments,
particularly with respect to their potential application to Hewlett-Packard's
products.
ADVANCED TECHNOLOGY PROGRAM:
In August 1992, Conductus, 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 $1,613,000 and $714,000
was recognized under this contract for 1996 and 1997, respectively. The contract
was completed in 1997.
FOCUSED RESEARCH INITIATIVE:
In September 1995, Conductus entered into a contract with the Naval Research
Laboratory for the development of high-temperature superconductor receiver coils
for pulse magnetic resonance imaging prototype for screening of breast cancer.
Revenue of $1,473,000, $920,000 and $100,000 was recognized under the contract
for 1996, 1997, and 1998, respectively.
47
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
LUCENT JOINT DEVELOPMENT AGREEMENT:
In April 1996, Conductus 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 $428,000, $1,080,000 and
$152,000 was recognized under the agreement for 1996, 1997 and 1998,
respectively.
DARPA CRYOPACKAGING PROGRAM:
In August 1996, Conductus 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 $616,000, $847,000
and $1,491,000 was recognized under this contract for 1996, 1997 and 1998,
respectively.
MULTICHANNEL INTERCEPT SYSTEM PROJECT:
In June 1998, Conductus entered into a subcontract with Communications
Solutions, Inc., for the High Temperature Superconductor RF Multichannel
Intercept System Project. Conductus is responsible for the design and
fabrication of the filter/amplifier which will be integrated with the
receiver/controller being designed and fabricated by Communication Solutions,
Inc. The ultimate customer for the project is the U.S. government. Revenue of
$643,000 was recognized under the contract in 1998.
12. STOCKHOLDERS' EQUITY
CAPITAL STOCK:
Under the terms of Conductus' articles of incorporation, the board of
directors may determine the rights, preferences and terms of its authorized but
unissued preferred stock.
SERIES B PREFERRED STOCK:
On September 11, 1998 and September 22, 1998, Conductus sold and issued an
aggregate of 2,461,227 shares of its Series B preferred stock at a price per
share of $2.70 and issued warrants to purchase 492,242 shares of common stock at
an exercise price of $2.70 per share in a private placement of its equity
securities. The offering was not underwritten and raised net proceeds of
$6,344,461. Certain affiliates of Conductus and other institutional and
accredited individual investors purchased shares of Series B preferred stock and
warrants in such offering, which sales were exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to Rule 506.
The value of the warrants was determined using the Noreen-Wolfson valuation
model. The value of the warrants is $772,000. The warrants have a term of five
years and are immediately exercisable at a price of $2.70 per share. The
allocation of proceeds between preferred stock and warrants results in a
beneficial conversion feature in the amount of $222,000. The value of the
beneficial conversion feature will be accreted as preferred dividends over six
months.
DIVIDENDS. The holders of the Series B preferred stock shall be entitled to
receive cumulative dividends on each March 31, June 30, September 30, and
December 31 following the date of issuance of such Series B preferred stock at
the rate of $0.162 per year. Cumulative dividends shall be paid upon
48
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. STOCKHOLDERS' EQUITY (CONTINUED)
conversion of the Series B preferred stock or upon the liquidation or
dissolution of Conductus including deemed liquidations as set forth below.
LIQUIDATION PREFERENCE. In the event of any liquidation, dissolution or
winding up of Conductus the holders of each share of Series B preferred stock
shall be entitled to receive prior and in preference to the holders of the
common stock, a per share amount equal to $2.70. After the payment of the
liquidation preferences to the holders of the Series B preferred stock, the
remaining assets shall be distributed ratably to the holders of the common stock
pro rata based on the number of shares of common stock held by each. A merger,
acquisition, sale of voting control or sale of substantially all of our assets
in which our stockholders do not own a majority of the outstanding shares of the
surviving corporation shall be deemed a liquidation.
CONVERSION. Holders of Series B preferred stock will have the right
beginning in March 1999 to convert their Series B preferred shares into shares
of common stock, subject to anti-dilution adjustments described more fully
below. Each share of preferred stock shall automatically be converted into
common stock, at the then applicable conversion price at the election of holders
of two-thirds of such Series B preferred stock.
ANTI-DILUTION ADJUSTMENTS. Each share of Series B preferred stock shall
initially be convertible into one share of common stock. The number of shares of
common stock into which shares of a given series of preferred stock is
convertible will be subject to adjustment in the following circumstances:
- any issuance of additional stock for consideration per share less that the
conversion price for such series of preferred stock,
- any subdivision or combination of the outstanding shares of common stock,
- any distribution of (a) a common stock dividend, (b) other distribution
payable in common stock, or (c) a distribution payable in our securities
other than shares of common stock, or
- any adjustment of the common stock issuable upon the conversion of the
preferred stock, whether by recapitalization, reclassification or
otherwise.
VOTING. The Series B preferred stock will vote together with the common
stock and not as a separate class, except as specifically required by law or by
our certificate of incorporation. Each share of Series B preferred stock shall
have the number of votes equal to the number of shares of common stock then
issuable upon conversion of such shares of Series B preferred stock.
PROTECTIVE PROVISIONS. The prior consent or approval of the holders of at
least two-thirds of the preferred stock, voting together as a single class, is
required for us to take specified actions affecting the rights of such holders.
1992 STOCK OPTION/STOCK ISSUANCE PLAN:
Under Conductus' stock option/stock issuance plan, as amended, a total of
2,080,000 shares of common stock are authorized for issuance under the plan as
of December 31, 1998.
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
49
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. STOCKHOLDERS' EQUITY (CONTINUED)
of incentive stock options granted under the plan must be at least equal to the
fair market value of the common stock 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 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 Conductus' 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. Additionally each year the non-employee board members receive a
3,000 share grant that vests over three years. Under the stock issuance program
eligible individuals are allowed to purchase shares of Conductus' 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, Conductus 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,
1998, this entire balance had been amortized to the Statement of Operations.
In 1998, the Company issued options at below fair market value, resulting in
a compensation charge of $20,346, which was charged to operations in 1998.
50
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. STOCKHOLDERS' EQUITY (CONTINUED)
A summary of the status of Conductus' stock option plans as of December 31,
1996, 1997 and 1998 and changes during the periods ending on these dates is
presented below:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------
AVAILABLE WEIGHTED
FOR GRANT AVG.
UNDER OPTION PRICE PER EXERCISE
PLAN SHARES SHARE PRICE
------------ ---------- -------------- -----------
<S> <C> <C> <C> <C>
Balance, January 1, 1996................................. 279,038 1,022,308 $0.16- 7.25 $ 4.04
Additional shares authorized............................. 300,000 -- -- --
Granted.................................................. (528,000) 528,000 $6.50-15.25 9.57
Exercised................................................ -- (57,311) $0.16- 7.25 2.08
Canceled................................................. 107,815 (107,815) $0.45-11.50 6.09
------------ ---------- -------------- -----
Balance, December 31, 1996............................... 158,853 1,385,182 $0.16-15.25 $ 6.07
Additional shares authorized............................. 200,000 -- -- --
Granted.................................................. (644,000) 644,000 $3.44- 8.38 6.31
Exercised................................................ (137,000) $0.16- 6.38 2.79
Canceled................................................. 806,495 (806,495) $0.45-15.25 7.98
------------ ---------- -------------- -----
Balance December 31, 1997................................ 521,348 1,085,687 $0.45-13.00 $ 4.68
Granted.................................................. (919,296) 919,296 $0.00- 4.25 3.26
Exercised................................................ -- (111,955) $0.00- 0.88 0.59
Canceled................................................. 887,938 (887,938) $0.88-13.00 5.53
------------ ---------- -------------- -----
Balance December 31, 1998................................ 489,990 1,005,090 $0.44- 8.00 $ 3.55
------------ ---------- -------------- -----
------------ ---------- -------------- -----
</TABLE>
At December 31, 1996, 1997 and 1998, vested options to purchase 477,522,
797,925 and 221,521, respectively, were unexercised and the weighted average
prices for the vested options were $3.21, $4.68 and $4.23, respectively.
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 price above the closing
price of Conductus' common 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 Conductus' 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.
On April 13, 1998, the plan administrator adopted a plan for repricing of
stock options under which each employee-holder of outstanding options with an
exercise price above the closing price of Conductus' stock on April 13, 1998,
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 Conductus'
common stock on April 13, 1998, and all shares were to be unvested until April
13, 1999, after which they would be subject to the original vesting schedule.
51
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. STOCKHOLDERS' EQUITY (CONTINUED)
EMPLOYEE STOCK PURCHASE PLAN:
In July 1994, the Employee Stock Purchase Plan was adopted by the board of
directors. A total of 350,000 shares of common stock are authorized for issuance
under the plan as of December 31, 1998. The purpose of the plan is to provide
eligible employees of Conductus with a means of acquiring common stock of
Conductus through payroll deductions. The purchase price of such stock under the
plan 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 1996,
1997 and 1998 employees purchased 57,848, 50,686 and 28,070 shares for a total
of approximately $340,603, $247,667 and $65,661, respectively. At December 31,
1998, 111,606 shares were available for future grants under the plan.
STOCKHOLDER RIGHTS PLAN:
On January 22, 1998, the board of directors declared a dividend of one
preferred share purchase right for each outstanding share of common stock, par
value $0.0001 per share outstanding on February 16, 1998 to the stockholders of
record on that date. Each right entitles the registered holder to purchase from
Conductus one one-thousandth of a share of Series A Junior participating
preferred stock, par value $0.0001 per share, at a price of $29.00 per one
one-thousandth of a preferred share, subject to adjustment. The description and
terms of the rights are set forth in a rights agreement.
COMMON STOCK RESERVED:
At December 31, 1998, Conductus had reserved the following shares of common
stock:
<TABLE>
<CAPTION>
<S> <C>
Conversion of Series B preferred................................................. 2,461,227
Employee Stock Purchase Plan..................................................... 111,606
Warrants......................................................................... 608,016
Option Plan...................................................................... 1,510,080
----------
4,690,929
----------
----------
</TABLE>
STOCK BASED COMPENSATION PLANS--VALUATION:
The following table summarizes information with respect to stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------ OPTIONS EXERCISABLE
WEIGHTED AVERAGE ------------------------------
RANGE OF NUMBER REMAINING NUMBER
EXERCISE OUTSTANDING CONTRACTUAL LIFE WEIGHTED AVERAGE EXERCISABLE WEIGHTED AVERAGE
PRICES AT 12/31/98 (YEARS) EXERCISE PRICE AT 12/31/98 EXERCISE PRICE
- -------------- ----------- ----------------- ----------------- ----------- -----------------
<S> <C> <C> <C> <C> <C>
$0.45-$0.88 57,374 $ 3.53 $ 0.60 57,374 $ 0.60
$1.44-$5.25 832,092 7.57 $ 3.35 376,841 $ 3.01
$5.38-$6.50 90,391 6.74 $ 6.19 90,391 $ 6.19
$6.56-$8.00 40,233 8.05 $ 7.05 40,233 $ 7.05
<CAPTION>
- -------------- ----------- ----------------- ----------------- ----------- -----------------
<S> <C> <C> <C> <C> <C>
$0.45-$8.00 1,020,090 7.29 $ 3.59 564,839 $ 3.56
<CAPTION>
- -------------- ----------- ----------------- ----------------- ----------- -----------------
- -------------- ----------- ----------------- ----------------- ----------- -----------------
</TABLE>
52
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
12. STOCKHOLDERS' EQUITY (CONTINUED)
The following information concerning Conductus' stock issuance plans is
provided in accordance with Statement of Financial Accounting Standards No. 123.
Conductus however continues to apply [APBO] 25, "Accounting for Stock Issued to
Employees," and related interpretations in accounting for its plan.
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 1996, 1997, and 1998.
<TABLE>
<CAPTION>
1996 1997 1998
----------------------- ----------------------- -----------------------
GROUP A GROUP B GROUP A GROUP B GROUP A GROUP B
---------- ----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Risk-free interest rates.............. 6.13% 5.50% 6.23% 5.50% 5.36% 5.17%
Expected life......................... 4.9 years 6 months 4.4 years 6 months 3.9 years 6 months
Volatility............................ 0.76 0.76 0.83 0.83 1.05 1.05
Dividend yield........................ -- -- -- -- -- --
</TABLE>
The weighted average expected life was calculated based on the exercise
behavior of each group. Group A represents all grants of options to 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 1996, 1997, and
1998 was $6.19, $4.10, and $3.26. The weighted average fair value of those
purchase rights granted in 1996, 1997, and 1998 was $3.47,and $2.71, and $2.34.
Had compensation cost for these plans been determined based on fair value of
the options at that grant date in 1996, 1997, and 1998 consistent with the
provisions of Statement of Financial Accounting Standards No. 123, Conductus'
net loss and net loss per share would have been as follows:
<TABLE>
<CAPTION>
1996 1997 1998
------------- ------------- -------------
<S> <C> <C> <C>
Net loss attributable to common shareholders--As reported............ $ (5,004,000) $ (7,543,000) $ (7,829,000)
--Proforma.................... $ (6,057,000) $ (8,746,000) $ (9,067,000)
Basic and diluted net loss per share--As reported.................... $ (0.80) $ (1.09) $ (1.10)
--Proforma............................ $ (0.97) $ (1.27) $ (1.28)
</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 Conductus issued warrants to acquire 15,000 shares of
common stock at a price of $11.25 per share.
13. 401(K) PROFIT SHARING PLAN:
Conductus 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 Conductus irrespective of whether it
has net profits. No contributions were made by Conductus during the years 1994
through 1998.
53
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
14. ASSET DISPOSALS:
During the third quarter of 1997, the company disposed of the net assets of
its Systems and Instrumentation Division, and its nuclear magnetic resonance
product line. The following table summarizes the financial impact of the
transactions:
<TABLE>
<CAPTION>
<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)
------------
Loss on asset sale.............................................................. $ (51,741)
------------
------------
</TABLE>
15. INCOME TAXES:
The components of deferred tax assets are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1997 1998
-------------- --------------
<S> <C> <C>
Property and equipment, principally due to differences in depreciation........... $ 198,000 $ 342,000
Accrued liabilities and other.................................................... 248,000 441,000
Tax credit carryforwards......................................................... 1,191,000 1,006,000
Capitalized research and development expense..................................... 76,000 380,000
Net operating loss carryforward.................................................. 13,028,000 15,411,000
Valuation allowance.............................................................. (14,741,000) (17,580,000)
-------------- --------------
Net deferred tax asset........................................................... $ -- $ --
-------------- --------------
-------------- --------------
</TABLE>
Due to the uncertainty surrounding the realization of the deferred tax
assets in future tax years, Conductus has placed a valuation allowance against
its otherwise recognizable net deferred tax assets.
At December 31, 1998, Conductus had approximately $42,865,000 and
$14,354,000 in net operating loss carry forwards for federal and state income
purposes, respectively. These expire in the years 1999 through 2018. The
utilization of Conductus' net operating loss carry forwards may be subject to
certain limitations upon certain changes in ownership, as defined.
16. BUSINESS SEGMENT AND MAJOR CUSTOMERS:
Conductus has adopted the Financial Accounting Standards Board's Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information," effective for fiscal years beginning after
December 31, 1997. This statement supercedes Statement of Financial Accounting
Standards No. 14, "Financial Reporting for Segments of a Business Enterprise."
Statement No. 131 changes current practice under Statement No. 14 by
establishing a new framework on which to base segment reporting and also
requires interim reporting of segment information.
Conductus markets its products primarily to customers in the United States
and Japan in the wireless industry. Management uses one measurement of
profitability and does not disaggregate its business for internal reporting.
54
<PAGE>
CONDUCTUS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
16. BUSINESS SEGMENT AND MAJOR CUSTOMERS: (CONTINUED)
Commercial sales to one customer as a percentage of revenues were 12%
($1,560,000), 9% ($896,000) and 2% ($76,000), in 1996, 1997 and 1998,
respectively. Receivables from this customer totalled $183,000 at December 31,
1997. There were no outstanding receivables from this customer at December 31,
1998.
Conductus' revenues by geographic area are summarized as follows:
<TABLE>
<CAPTION>
1996 1997 1998
------------- ------------ ------------
<S> <C> <C> <C>
USA................................................................... $ 10,550,000 $ 8,318,000 $ 4,485,000
Japan................................................................. 1,560,000 896,000 146,000
Rest of the world..................................................... 433,000 240,000 58,000
------------- ------------ ------------
$ 12,543,000 $ 9,454,000 $ 4,689,000
------------- ------------ ------------
------------- ------------ ------------
</TABLE>
55
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
Conductus, Inc.:
Our audits of the financial statements referred to in our report dated
February 19, 1999 appearing on page 33 also included an audit of the financial
statement schedule listed in Item 14[a]2 of this Form 10-K. In our opinion, the
financial statement schedule presents fairly, in all material respects, the
information set forth therein when read on conjunction with the related
financial statements.
PricewaterhouseCoopers LLP
San Jose, California
February 19, 1999
S-1
<PAGE>
SCHEDULE II
CONDUCTUS, INC. VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN B COLUMN C COLUMN E
------------ ----------------------- ----------
COLUMN A BALANCE AT CHARGED TO COLUMN D 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, 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
Year ended December 31, 1998:
Allowance for doubtful accounts................. $ 248,232 $ 53,744 $ -- $ (9,341) $ 292,635
Allowance for excess and obsolete inventory..... $ 280,845 $ 156,908 $ -- $ -- $ 437,753
</TABLE>
S-2
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
2.1(1) Stock Exchange Agreement dated as of May 28, 1993, between the Company and Tristan Technologies, Inc.
3.1(2) Restated Certificate of Incorporation.
3.2(3) Restated Bylaws.
3.3(4) Certificate of Designation of Series B Preferred Stock.
4.1(3) Stockholder Rights Plan.
5.1* Opinion of Counsel.
10.1(1) 1987 Stock Option Plan.
10.2(1) Amended 1989 Stock Option Plan.
10.3(5) 1992 Stock Option/Stock Purchase Plan.
10.4(6) 1994 Employee Stock Purchase Plan.
10.5(1) Second Amended and Restated Registration Rights Agreement dated June 3, 1993.
10.6(4) Form of Series B Preferred Stock and Warrant Purchase Agreement, dated September, 1998, and September
22, 1998, between the Company and Series B Investors.
10.7(4) Form of Warrant to Purchase Common Stock between the Company and Series B Investors.
10.8(7) Employment Agreement dated May 3, 1994 between Registrant and Mr. Charles E. Shalvoy.
10.9(1) Form of Indemnification Agreement between the Registrant and each of its directors and officers.
10.10(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.
10.11(8) Collaboration Agreement between Registrant and CTI dated September 19, 1995.
10.12(8) 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.
10.13(9)+ Superconducting Filter Technology Joint Development Agreement dated April 25, 1996 between the
Registrant and Lucent Technologies Inc.
10.14(4) Engagement Letter between the Company and Sutro and Co. Inc., dated March 24, 1998.
10.15(4) Amendment to Engagement Letter between the Company and Sutro and Co. Inc., dated September 2, 1998.
10.16(4) Engagement Letter between the Company and Davenport and Co., dated September 2, 1998.
10.17(4) Master Lease Agreement between the Company and Leasing Technologies International, Inc., dated June
15, 1998.
10.18(1) Lease Agreement dated May 3, 1993 between the Registrant and Mozart-McKee Limited Partnership for
Sunnyvale facilities.
10.19(7) Lease Agreement dated December 8, 1994 between Registrant and Mozart-McKee Limited Partnership for
Sunnyvale facilities.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO DESCRIPTION
- ----------- -----------------------------------------------------------------------------------------------------
<C> <S>
10.20(7) Business Loan Agreement dated August 15, 1994 between Registrant and Silicon Valley Bank for working
capital credit facility and term loan facility.
10.21(10) Loan Modification Agreement dated June 30, 1997, between Registration and Silicon Valley Bank
modifying the Business Loan Agreement dated August 15, 1994.
10.22(10) Loan Modification Agreement dated November 12, 1997, between Registration and Silicon Valley Bank
modifying the Business Loan Agreement dated August 15, 1994.
10.23(10) Loan Modification Agreement dated December 23, 1997, between Registration and Silicon Valley Bank
modifying the Business Loan Agreement dated August 15, 1994.
10.24(11) Business Loan Agreement dated March 8, 1996 between Registrant and Silicon Valley Bank for working
capital credit facility and term loan facility.
10.25(12) Business Loan Agreement dated December 27, 1996 between Registrant and Silicon Valley Bank for
working capital credit facility and term loan facility.
10.26(4) Master Loan and Security Agreement between the Company and Transamerica Business Credit Corporation,
dated June 26, 1998.
10.27(4) Stock Subscription Warrant Agreement between the Company and Transamerica Business Credit
Corporation, dated June 26, 1998.
10.28(13) Silicon Valley Bank Loan Agreement.
10.29(13) Collateral Assignment, Patent Mortgage and Security Agreement between the Company and Silicon Valley
Bank.
10.30(10)+ Asset Purchase Agreement dated July 9, 1997 between Registrant and Bruker Instruments, Inc. for sale
of assets of Registrant's NMR Probe business.
10.31(10) Asset Purchase Agreement dated August 15, 1997 between Registrant and Neocera, Inc. for sale of
Registrant's assets related to its temperature controller business.
10.32(10) 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 31).
27.1* Financial Data Schedule.
</TABLE>
- ------------------------
* Previously filed.
+ Confidential treatment granted or requested as to certain portions of these
exhibits.
(1) Incorporated herein by reference to the Company's Registration Statement on
Form S-1 (Number 33-64020), filed with the SEC on May 15, 1996, as amended.
(2) Incorporated herein by reference to the Company's 1993 Annual Report on
Form 10-K.
(3) Incorporated herein by reference to the Company's Registration Statement on
Form 8-K, filed with the SEC on January 22, 1998.
(4) Incorporated herein by reference to the Company's Form 10-Q, filed with the
SEC on November 16, 1998.
(5) Incorporated herein by reference to the Company's Registration Statement on
Form S-8, filed with the SEC on November 26, 1997.
(6) Incorporated herein by reference to the Company's Registration Statement on
Form S-8, filed with the SEC on August 5, 1994.
(7) Incorporated herein by reference to the Company's 1994 Annual Report on
Form 10-K.
<PAGE>
(8) Incorporated herein by reference to Amendment No. 2 to the Company's
Registration Statement on Form S-1 (Number 333-3815), filed with the SEC on
June 17, 1996.
(9) Incorporated herein by reference to the Company's Registration Statement on
Form S-1 (Number 333-3815), filed with the SEC on May 10, 1996, as amended.
(10) Incorporated herein by reference to the Company's 1998 Annual Report on
Form 10-K.
(11) Incorporated herein by reference to the Company's 1995 Annual Report on
Form 10-K.
(12) Incorporated herein by reference to the Company's 1996 Annual Report on
Form 10-K.
(13) Incorporated herein by reference to the Company's Form 10-Q, filed with the
SEC on May 14, 1998
<PAGE>
EXHIBIT 23.1
CONDUCTUS, INC.
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 19, 1999, on our audits of the financial
statements and financial statement schedule of Conductus, Inc. as of December
31, 1997 and 1998, and for the years ended December 31, 1996, 1997 and 1998
which reports are included in this Annual Report on Form 10-K.
PricewaterhouseCoopers LLP
San Jose, California
March 30, 1999
