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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________________
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
FOR THE YEAR ENDED DECEMBER 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-21074
SUPERCONDUCTOR TECHNOLOGIES INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0158076
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(State or other jurisdiction of IRS Employer
incorporation or organization) Identification No.)
460 WARD DRIVE, SUITE F, SANTA BARBARA, CALIFORNIA 93111-2310
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (805) 683-7646
______________________
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.001 PAR VALUE PER SHARE
(Title of Class)
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 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. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant (based on the closing sale price the Common Stock as reported on
the Nasdaq National Market on February 3, 1998) was approximately $24,754,429.
For purposes of this determination, shares of Common Stock held by each officer
and director and by each person who owns 5% or more of the outstanding Common
Stock have been excluded in that such persons may be deemed to be affiliates of
the Registrant. This determination of affiliate status is not necessarily a
conclusive determination for other purposes. The number of outstanding shares
of the Registrant's Common Stock as of the close of business on March 10, 1998
was 7,707,081.
DOCUMENTS INCORPORATED BY REFERENCE
Items 10,11,12 and 13 of Part III incorporate information by reference from
the definitive proxy statement for the Registrant's Annual Meeting of
Stockholders to be held on May 20, 1998.
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PART I
ITEM 1. BUSINESS.
This "Item 1-Business" and other parts of this Report contain
forward-looking statements that involve risks and uncertainties. The Company's
actual results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a difference are
discussed throughout "Item 1-Business," including, but are not limited to,
under the caption entitled "Factors Affecting Future Business
Operations--Disclosure Regarding Forward-Looking Statements" and "Item 7-
Management's Discussion and Analysis of Financial Condition and Results of
Operations," including, but not limited to, under the caption entitled
"Fluctuations in Periodic Results."
INTRODUCTION AND OVERVIEW
Superconductor Technologies Inc. ("STI" or the "Company") develops,
manufactures and markets superconductor materials and related cryogenics.
High-temperature superconductors ("HTS") are materials that have the ability to
conduct electrical energy with little or no resistance when cooled to
"critical" temperatures. STI believes that the growing worldwide wireless
communications market offers the most viable commercialization opportunities
for its superconducting products. To capitalize on these opportunities the
Company has developed its SuperFilter(TM) products, which combine specialized
superconducting filters with a proprietary cryogenic cooler and, in many cases,
a low noise amplifier ("LNA") in a highly compact system. The SuperFilter(TM)
products, when incorporated into wireless base stations, offer significant
advantages over conventional filter products for wireless applications,
including reduced size, increased range and reduced interference.
During 1997, the Company underwent a significant transition from a focus on
research and development to the introduction of its first commercial product
line and the establishment of the manufacturing infrastructure to support the
product. The Company introduced the SuperFilter(TM) system for application in
the AMPS/B segment of the cellular market and has recently completed the
cellular offerings by introducing the AMPS/A product.
As a result of the product introductions, the Company has significantly
expanded its sales and marketing efforts. The Company added three Regional
Sales Executives to cover the United States and has recently added another
Sales Executive to cover the Southwest U.S. and Latin America. In addition, an
Applications Engineering Executive with experience at a major carrier has been
hired. The sales and marketing effort has been directed primarily at rural and
suburban cellular provider as the Company believes they will be the early
deployers of product. The Company's product addresses the critical needs of
these service providers: range coverage and call quality. In addition, the
Company continues to pursue and develop urban applications and its relationship
with the base station OEMs.
The SuperFilter(TM) product and increased sales activities have resulted in
multiple orders for the product, including an order for eight systems from
Carolina West Wireless, a rural service provider. In order to further prove the
economic benefits of the product, the Company is in the process of conducting
numerous demonstrations and field trials.
In order to support the SuperFilter(TM) product introductions, the Company
established a manufacturing infrastructure mid-year which is headed by a Vice
President of Operations, and includes operating units to support the
production of all critical components including the superconducting filters,
cryogenic coolers, cryogenic packaging and final enclosures, and quality and
material control functions. In addition, the Company has expanded its
manufacturing space by over 50% and has procured, or is in the process of
procuring, the necessary equipment and tooling to produce the product in
volume.
A critical component of any superconducting application is cryogenic
cooling. STI has developed a proprietary cryogenic cooler which, in addition to
being integrated into its SuperFilter(TM) systems, has the potential to be used
in other applications. One application is the use of the cooler in a home
medical system. During 1997, STI received an order for 13 coolers from In-X, a
private company developing home medical products. Another application the
Company is pursuing is cold computing to increase the processing speed of
workstations. STI is also considering several research applications for the
cooling technology. STI believes that the successful commercialization of its
cryogenic coolers as stand alone products will assist in its ability to achieve
economies of scale associated with volume production.
Since its formation in 1987, the Company has received over $45 million in
revenue from government research and development contracts, through which it
has developed much of the technology used in its commercial products. STI
continues to secure government contracts, primarily to fund its research and
development efforts, and also to address potential wireless product
opportunities in the government sector. The Company has recently hired a Vice
President of Government Business Development in order to continue to develop
this market.
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STI'S STRATEGY
STI's objective is to leverage the experience and expertise of its
management and employee base, its significant investment in research and
development, and its licenses and intellectual properties into a position of
commercial market leadership for HTS.
Several years ago, the Company identified the wireless filter market as the
most viable path to commercialization of HTS. The primary reason for the
selection of this market was the current and expected rapid growth of the
market and STI's ability to address the most critical needs of the market with
HTS. The wireless market (including the receiver filter market, addressed by
the SuperFilter(TM)) is expected to grow at an annual compounded growth rate of
over 20% during the next five years.
STI's approach to product development has been to harness the power of
superconductivity with a high degree of excellence, resulting in a product that
meets the requirements of the Company's customers effectively and efficiently.
The Company provides the wireless communications industry with a proprietary
and integrated solution incorporating superconducting materials, RF circuitry,
and cryogenic cooling and packaging - the key components of which have been
designed, developed and manufactured in-house. STI has designed and developed
a proprietary computer simulation system to assist in RF circuitry design and
prototype delivery. This results in extremely small, high performance RF
circuits that are then integrated into STI's standard platform. The Company
believes that this approach will allow it to respond quickly to specific
customer requirements. STI believes its standard platform is the smallest and
most energy-efficient superconducting filter system in the industry, which
differentiates the Company's products from other competitive offerings
The Company believes the early market acceptance for its product will come
from wireless service providers as they are faced with resolving critical
issues within the wireless networks. In particular, cellular service providers
who are encountering increasing competition from new Personal Communication
Services (PCS) and digital providers are most likely to test and use this
advanced technology to solve their problems. Cellular service providers are
focused on enhancing service in order to retain their market share of wireless
customers. Service enhancements such as coverage in "dead zones," increased
range of the base station, reduction in the dropped calls and decreased static
are some of the most common user complaints, which give rise to customer churn
among service providers. The Company believes its product provides solutions to
these critical problems effectively and economically..
The Company believes that in order to penetrate the market for
superconducting filters, it must market, promote and demonstrate the products'
capabilities directly to service providers. With over 1,500 service providers
in the U.S. alone, this will require a significant increase in the Company's
marketing efforts and approach. In order to effectively cover this market, the
Company has increased its sales and marketing force from one person to six
people over the past several months.
Due to the proprietary and technological nature of the Company's product,
and, in order to produce a high quality product, the company has decided to
manufacture the key components of its product internally. These key components
include the HTS material, the HTS filters, including the micro-packaging, the
cryogenic cooler, the cryogenic packaging and the final enclosure. The Company
believes that this will enable it to control its manufacturing processes
properly, achieve required cost reductions and to produce a highly reliable and
quality product.
In 1997, the Company established its initial manufacturing for
SuperFilter(TM) systems. An additional 10,000 square feet of space was leased
at its existing facility by STI for expansion of the Company's existing
assembly and clean room areas. The Company's internal structure was reorganized
into engineering and manufacturing organizations, with experienced STI managers
appointed to vice president positions responsible for a seamless transition
from design to manufacturing. Additional capital equipment is being acquired
and the employee base has expanded to increase product output. See "--Limited
Manufacturing Experience".
WIRELESS FILTER PRODUCTS
The Company principally targets the worldwide wireless market for its
commercial superconducting products. STI is initially marketing its
SuperFilter(TM) systems primarily to wireless service providers and OEMs for
inclusion in base stations, which are the basic building blocks of wireless
networks. Base stations house the complex electronic equipment required to
receive and transmit radio waves for multiple real-time voice and data
communications. Base station systems generally include an antenna and a series
of transmitters, receivers, receiver filters and network interface electronics.
Base stations are manufactured by OEMs and are sold to service providers that
deliver wireless services to the public. The Company's product provides the
primary receiver filter after the antenna has captured the transmission from
the wireless hand set. The product is designed to improve the uplink
transmission path, which is a critical part of today's wireless technology.
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THE WIRELESS MARKET
Northern Business Information (NBI), wireless industry analysts, estimates
the worldwide number of wireless subscribers will be 445 million by 2002,
compared to 162 million in 1997. To provide services to these customers NBI
estimates that the number of installed base stations will increase from 151,000
in 1997 to 457,000 in 2002. The Company believes that this rapid growth
represents a significant market opportunity for the Company, as each newly
deployed base station must incorporate a wireless filter system. In addition,
as increasing levels of interference create a demand for higher performance
filters, the Company's products could be used by service providers to retrofit
existing base stations. According to NBI, this increase in wireless
infrastructure will result in a worldwide market for superconducting filters of
more than $550 million per year by 2002.
The reasons for the anticipated rapid expansion of the base station market
are two-fold. First, the overall demand for wireless products is increasing
both in the United States and worldwide. As the cost of providing wireless
communications decreases and the number of service providers increases,
consumer access to wireless service will become more affordable and utilization
will increase. In addition, in areas without fully-implemented communications
systems, the cost of installing a wireless communications system is
significantly lower than the cost of installing a traditional land-line
communications system. Accordingly, the Company believes that many developing
countries are seeking to establish a wireless infrastructure.
Second, a broader range of wireless services, such as e-mail, faxing and
internet access, is now being offered, further burdening the already crowded
wireless frequencies. To accommodate the expanding need for wireless
communications, the FCC has auctioned PCS frequencies (around the 2 Ghz
frequency) domestically to wireless service providers. Auction winners are
under financial, regulatory and competitive pressures to deploy and operate
wireless services quickly in these new frequencies. The Company estimates that
as a result of the PCS frequency auctions, the number of licensed wireless
service providers in any given service area will increase from two to as many
as five over the next several years, thereby increasing competition and
creating pressure for cellular and PCS service providers to provide the highest
quality services possible.
WIRELESS NETWORK CONSTRAINTS
The ability of wireless service providers to increase system utilization is
enhanced by their ability to increase base station coverage range, decrease
existing interference and minimize the physical size of base station
components. A wireless network consists of a number of adjoining cells that
form a service provider's geographic coverage area. Each cell has a base
station, and the user communicates through the closest base station on one of a
limited number of RF bands. The call is switched from base station to base
station as the user moves within the geographic area. Transmissions that pass
through a base station are filtered for unwanted signals to improve call
clarity. The filtering process improves the quality of the signals received
and the range that the base station can cover. Range is the distance at which
a base station can continue to pick up a wireless phone signal as the user
travels away from the physical base station site. Most base stations within
the present cellular network were deployed at a time when the typical cellular
telephone unit was designed to transmit up to three watts of RF power. Today,
smaller portable telephones that transmit only 0.6 watts of power are
increasingly replacing higher-power mobile units, thereby decreasing the
effective range of existing cellular base stations. This is particularly a
problem in rural and suburban networks. In the PCS arena, wireless systems
operate at a higher frequency than traditional cellular systems, which reduces
the range of signal transmission due to the larger path losses. In urban
settings, site location, site acquisition and special environmental
requirements can drive total base station implementation costs up to $1 million
per site. In addition, each site may be subject to additional or unique
regional and local regulatory processes and citizen demands that can burden the
deployment process. As a result, decreasing the number of base stations that
must be deployed can significantly reduce the service provider's infrastructure
costs.
The physical size of the base station can also be a significant issue for
service providers. Because a conventional filter system can account for
approximately 30% of the total base station size (excluding the antenna) and a
smaller base station requires less real estate per site, reducing the size of
the filter system can provide significant cost savings to service providers.
In addition, when new sites are not available, base station utilization must be
increased by retrofitting electronics for additional channels in the same
physical space. In such cases, reducing component size is a viable
alternative.
Finally, interference due to the imperfect RF channel selectivity of
filtering components is also a significant issue. Interference, which occurs
when two radio waves of the same or similar frequency interact with one another
to produce "in-band" distortion, can cause dropped calls and cross talk. This
problem can also prevent a service provider from fully utilizing the available
RF spectrum, as some spectrum must be reserved to protect against interference
from another service provider's RF spectrum, which in turn decreases the number
of users a base station can process. Problems caused by interference can be
especially acute in urban areas, where caller density is high. Because these
symptoms of interference can
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dramatically degrade service quality, a wireless filter system that reduces
interference can provide a meaningful advantage in this increasingly
competitive market. See "--Competition."
STI'S WIRELESS PRODUCT SOLUTION
The Company believes that its SuperFilter(TM) systems offer solutions to
some of the most pressing constraints facing the wireless industry: range, size
and interference. Each SuperFilter(TM) system is a self-contained unit that
can be retrofitted into existing base stations or incorporated into new base
stations regardless of the protocol used (including Advanced Mobile Phone
Service ("AMPS"), Code Division Multiple Access ("CDMA"), Time Division
Multiple Access ("TDMA") and Global Systems for Mobile communications ("GSM"),
among others) with little or no modification to conventional design. The
benefits offered by the Company's SuperFilter(TM) products include the
following:
- - Range Extension. The Company's SuperFilter(TM) systems incorporate an LNA
with a superconducting filter, both of which are then cryogenically cooled.
The filters and LNAs expand the receiving range of the base station by
reducing the electrical noise of the system, enabling each base station
site to cover a larger area. The Company believes that extending base
station range reduces the number of base stations that must be deployed in
a given service area, which can result in lower capital costs, more calls
completed per base station and higher revenue per base station.
- - Decrease in System Size. Advanced thin-film superconductor materials and
designs allow STI to provide superconducting filters that are one
one-thousandth the size of the conventional filters most commonly used in
base stations. A complete SuperFilter(TM) system is approximately 70% to
90% smaller than a high-performance cellular conventional filter and can be
incorporated easily into a standard 19- inch component rack mount. This
significant reduction in physical size makes valuable space available for
other required electronic components, enabling service providers to enhance
the utilization of existing base stations instead of deploying additional
base stations. In addition, reduced size can decrease deployment costs for
new base stations, as less real estate is required to support a base
station. STI believes its SuperFilter(TM) systems are the smallest filters
currently available in the industry.
- - Reduction in Interference. STI has demonstrated that superconducting
thin-film materials are attractive for wireless communications base station
applications because the near-perfect conductivity of the superconductor
filters allows for greater control of RF signals. The Company believes
that its superconducting filter systems can insulate a desired frequency
against interference from unwanted frequency transmissions more selectively
than conventional copper filters, thereby reducing the number of dropped
calls and the amount of cross talk. While the exact number of dropped
calls will vary among base stations due to differences in call volume and
geographic location, a reduction in the number of dropped calls can
increase revenues to the service provider. STI believes that a decrease in
interference also can result in an increase in utilization of the service
provider's allocated frequency spectrum, which in turn can result in an
increase in the volume of calls processed.
- - Low Power Consumption and Tower Mounting. The Company believes that an
additional benefit to its superconducting filter systems is that these
systems consume less energy than competing superconducting systems, because
the power budget for some base stations can be as low as 1500 watts. A
higher power budget requires high capacity back-up units, resulting in
undesirable increases in base station size. Currently, the most
energy-efficient competing superconducting system consumes more than 500
watts or more of power, while the Company's SuperFilter(TM) system consumes
only approximately 150 watts of power, comparable to that of a household
light bulb. The Company believes that as PCS and cellular base stations are
deployed, service providers and base station manufacturers will want to
install filtering and LNA capabilities at the top of the station's antenna
tower, because such mounting substantially reduces the significant signal
losses associated with tower-to-ground cabling. The Company believes tower
mounting can be a key component of extending the range of base stations and
received orders for four tower mount systems in 1997.
ACCESSING THE WIRELESS MARKET
The Company markets its products to service providers and OEMs worldwide
with particular focus on domestic rural and suburban service providers. The
Company has found rural service providers to have the most immediate need for
the SuperFilter(TM) system's benefits, particularly for range extension. By
targeting this segment of the market STI expects to create a "pull through"
interest from industry OEMs by creating market demand for the Company's
products. The Company has been successful at receiving orders for small
quantities of systems (under 10) for use in laboratory testing, field trials
and small commercial deployments. Product accelerated life testing provides
proof of the reliability and durability of the Company's product, while field
trials verify the system's capabilities when implemented into a live system in
the field. This
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approach allows the Company to build customer confidence in its technology, to
provide product reliability data and to build a foundation for volume orders.
The Company believes it has been successful with this approach and has
established relationships with major service providers and OEMs from which STI
expects to eventually seek volume orders. See "Factors Affecting Future
Business Operations--Dependence on Sales to Service Providers and OEMs."
At a major industry trade show in March 1997, the Company introduced the
SuperFilter(TM) system for use in AMPS/B cellular networks. The AMPS/B product
offers range extension, with a notch filter for reduced interference. In
February 1998, the Company introduced the SuperFilter(TM) system for use in
AMPS/A cellular networks. The AMPS/A product offers the same advantages as the
AMPS/B, with filters designed for the AMPS/A frequency. With the introduction
of both systems, STI has positioned itself to provide products to both major
segments of the cellular industry. STI has chosen to offer these two cellular
products initially as the Company believes cellular service providers utilizing
AMPS networks are the most immediately receptive customer base for the
Company's products. The Company believes that cellular service providers will
be receptive to its product due to the increasing competition from PCS
providers, which will cause cellular providers to enhance service in order to
retain customers. The Company has demonstrated in prototypes the ability to
design products for use in PCS networks, as well as a variety of digital
protocols. STI expects to offer additional product offerings in these areas as
the Company's position in the wireless market increases. See "Factors
Affecting Future Business Operations--Early Stage of the Commercial
Superconductor Products Market: Market Acceptance and Reliability."
During 1997, the Company received several orders from both service
providers and OEMs. STI received an order for one PCS prototype system from a
major Asian base station manufacturer, which was delivered in September 1997.
In July 1997, the Company received an order from Carolina West Wireless, a
rural service provider, for eight SuperFilter(TM) systems for use in an AMPS/B
network. Carolina West Wireless is deploying the SuperFilter(TM) systems
throughout the company's cellular network for commercial use. Following the
successful completion of an acceptance trial conducted with the first unit, the
second system was delivered in early 1998. The remaining six units, including
two tower mount configurations, are scheduled for delivery during the early
portion of 1998. The Company received an order for two AMPS/A tower mount
systems from a second major Asian base station manufacturer in September 1997
and delivered the units in January 1998. In December 1997, STI delivered one
SuperFilter(TM) system to Motorola's Cellular Infrastructure Group for
environmental testing and field trials.
CRYOGENIC COOLER PRODUCTS
Superconducting materials require cooling to temperatures as low as 77
Kelvin (-196 degrees C) to operate. In order to incorporate a compact, efficient
and reliable cooling system into its superconducting products, STI developed a
proprietary Stirling closed-cycle cryogenic cooler. About the size of a wine
bottle, the cooler utilizes helium gas as both the lubricant and coolant. This
eliminates the use of oils and grease, often used in other cryogenic cooling
systems and requiring scheduled maintenance. STI's cryogenic technology
requires approximately 150 watts of power, much less than other commonly-used
cryogenic systems. The resulting product is energy-efficient and extremely
compact with the ability to generate very cold temperatures reliably.
The Company expects to market its cryogenic cooling technology as a
stand-alone product in addition to utilizing the product in its SuperFilter(TM)
systems, although there can be no assurances in this regard. The Company has
focused on opportunities for cryogenic cooling products in the high-speed
computing and home medical markets, as well as potential opportunities in the
research and development industry. The Company believes that the successful
commercialization of its cryogenic coolers as stand-alone products will assist
in its ability to achieve economies of scale through higher volumes, which will
result in lower manufacturing costs.
COOLING APPLICATIONS
In 1997 STI received an order from In-X, a private company developing
products with medical applications, for 13 cryogenic coolers. The coolers will
be incorporated as a component into prototype products being developed by In-X
for use in home medical applications. Although the Company believes the
potential for this market is significant, there can be no assurance that this
market will develop. The Company has also investigated the cold computing
market. The Company has demonstrated that it can improve the performance of the
central processing unit (CPU) by more than 50% when cooled to -55 degrees C. The
Company believes that additional improvements can be achieved as much as 200%
with minor modifications to the CPU. Although the Company believes that the
market potential for this application is significant, there can be no
assurances that the Company will be able to identify an appropriate partner to
package and market a product. In addition, the Company is pursuing
opportunities for cooler sales to research and development organizations,
universities and other institutions conducting high technology research. The
extremely cold temperatures provided by STI's cooling technology are attractive
to the development of this market.
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GOVERNMENT CONTRACTS
The Company's strategy has been to pursue government research and
development contract awards to supplement its funding of superconducting
wireless and cryogenic product development. Since inception, 95% of the
Company's net revenues have been from research and development contracts, sales
directly with the government or resellers to the government. Nearly all of
such revenues were paid under contracts between the Company and the Department
of Defense ("DoD"). STI extensively markets to various government agencies to
identify opportunities and actively solicits partners for product development
proposals. Since 1988, the Company has successfully obtained a number of
non-classified government contracts for superconductor research, including one
of the largest non-classified high temperature superconducting (HTS) awards
from the DoD Advanced Research Projects Agency ("DARPA") through the Office of
Naval Research, under DARPA's original superconductivity program. In addition
to actively soliciting government contracts, the Company participates in the
Small Business Innovative Research ("SBIR") program. Since its inception, the
Company has been awarded 32 Phase I SBIR contracts, each of which typically
generates from $70,000 to $100,000 of revenues for the Company. The Company
has been successful in converting eight of these Phase I contracts into Phase
II programs, each of which typically generates $500,000 to $1 million of
revenues for the Company. Since the Company's inception, government contracts
have provided over $45 million of revenue to the Company. The Company believes
that it has successfully leveraged its technology developed under government
funded projects into commercial applications.
PRODUCTS DEVELOPED UNDER GOVERNMENT CONTRACTS
STI pursues government research contracts that augment the Company's
internal development programs, particularly in the areas of HTS materials
production, RF filter design, and cryogenics. STI believes it has successfully
leveraged its government research in the development of commercial products for
the wireless industry. In addition, the Company believes it has developed
products that can be marketed to the government communications industry, with
potential for volume sales.
The Company is working with military communications equipment contractors
on a government wireless program. The focus of this program is to improve the
integrity of a digital communications link through the use of a superconducting
filter system. The Company has also developed a proprietary switched filter
bank ("SFB") system in conjunction with Wright Laboratory at Wright-Patterson
Air Force Base ("WP-AFB") with funding from DARPA. The SFB has demonstrated an
ability to mitigate the problem of signal interference, which DARPA believes
resolving can increase aircraft and pilot survival rates. The Company believes
that its filter bank system can also be adapted to mitigate similar problems on
ships, helicopters and tanks.
CURRENT GOVERNMENT R&D CONTRACTS
At December 31, 1997, the Company was working with the government under 9
separate research and development contracts with a total award value of $26
million. $18.2 million has been funded under these contracts and $1.2 million
remains unspent under the funded amount. Because all of the Company's
government contracts are terminable by the contracting agency at its option,
award amounts should not be used as a measure of future revenues. See "Factors
Affecting Future Business Operations--High Degree of Dependence on Government
Contracts" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
STI'S TECHNOLOGY
SUPERCONDUCTING TECHNOLOGY
Superconductors are materials that have the ability to conduct electrical
energy with little or no resistance when cooled to "critical" temperatures. In
contrast, electric currents that flow through ordinary materials encounter
resistance that consumes energy when electrical energy is converted into heat.
Substantial improvements in the performance characteristics of electrical
systems can be made with superconductors, including reduced power loss, lower
heat generation and decreased electrical noise. As these properties have been
applied to radio and microwave frequency applications, new products, such as
wireless filters, have been developed that can be extremely small, highly
sensitive and highly frequency selective.
The discovery of superconductors was made in 1911. However, a
fundamental understanding of the phenomenon of superconductivity eluded
physicists until J. Robert Schrieffer (a director of the Company and Chairman
of its Technical Advisory Board), John Bardeen (co-inventor of the transistor)
and Leon Cooper proposed a theory explaining superconductivity, for which they
were awarded the Nobel Prize in Physics in 1972. Until 1986, all
superconductor utilization was done at extremely low temperatures below 23K
(-250 degrees C). Superconductors were not widely used in commercial
applications because of the high cost and complexities associated with reaching
and maintaining such low temperatures. In 1986, high temperature
superconductors with critical temperatures greater than 30K (-243 degrees C)
were
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discovered. In early 1987 yttrium barium copper oxide ("YBCO") was
discovered, which has a critical temperature of 93K (-180 degrees C). Shortly
thereafter, thallium barium calcium copper oxide ("TBCCO") was discovered,
which has a critical temperature of 125K (-148 degrees C). These discoveries
were important because these high temperature superconductors allowed for
operating temperatures higher than 77K (-196 degrees C), or the point at which
nitrogen liquefies. These high critical temperatures allow superconductors to
be cooled using less expensive and more conventional refrigeration processes.
STI was formed following this discovery to develop and commercialize high
temperature superconductors.
STI'S TECHNOLOGY APPROACH
The Company has internally-developed its key technologies from a standard
set of technology platforms. The Company utilizes a proprietary manufacturing
process for HTS thin-film production, the base material for the Company's
filtering products. An in-house design team develops the filters, which are
packaged into a vacuum-sealed container for thermal insulation. The filter
package is incorporated with the Company's cryogenic cooler, and then
integrated with the necessary control electronics into a complete system for
simple adaptation into new or existing wireless communications base stations.
The Company believes that its filter systems provide its targeted markets with
the smallest and most cost-effective products and that it is the only
superconducting company that develops and manufactures all of these key
components.
HTS Materials. A number of HTS materials have been discovered with
superconducting properties, but only a few have characteristics capable of
commercialization. The Company primarily utilizes TBCCO, which has one of the
highest known critical temperatures, allowing for reduced cooling needs in
order to achieve superconducting properties. The Company holds a worldwide
exclusive license, in all fields of use, to TBCCO formulations covered by
patents held by the University of Arkansas through a license agreement. The
Company also utilizes YBCO for some of its applications, including some
manufacturing processes for its RF components. Thin-film superconductors are
the base materials used by STI to produce RF components, such as wireless
communications filters. The Company has obtained nine patents for technologies
related to thin film production. The Company believes that the process
technology it has developed produces state-of-the-art HTS thin films of the
highest quality.
RF Circuitry. The Company has devoted a significant portion of its
engineering resources to design and model the complex RF circuitry that is
basic to the Company's products. The Company's RF engineering team is led by
Vice President of Engineering Neal O. Fenzi, and includes Drs. Gregory
Hey-Shipton and George Matthaei, recognized leaders in RF filter design. In
addition, Dr. J. Robert Schrieffer, a Nobel laureate, is head of the Company's
Technical Advisory Board. The expertise of this highly qualified team has
allowed the Company to design and fabricate very precise individual components,
such as RF signal filters. STI has implemented computer simulation systems to
design its products, and this RF circuitry design has allowed the Company to
produce extremely small, high-performance circuits. Some of the Company's
design and engineering innovations have been patented; others are the subject
of pending patent applications. The Company believes that its RF engineering
expertise provides the Company with a competitive advantage.
Cryogenic Cooling Technology. The availability of a low-cost, highly
reliable, compact cooling technology is critical to the successful
commercialization of the Company's superconducting products. Although such
technology had been used successfully in military applications in the past, no
such cryogenic cooler was commercially available. As a result, the Company
developed a low-cost, low-power cooler designed to cool to 77K (-196 degrees C)
with sufficient heat dissipation for its superconducting applications, and has
a target life of over 40,000 hours. Its development was based in part on
patents licensed by the Company from Sunpower, Inc. under a cross-licensing
arrangement. STI believes that its internally-developed cryogenics allow it to
offer a cooler that is both compact and reliable enough to meet wireless
industry standards and provides the Company with a significant competitive
advantage. In addition, the Company believes its cryogenic cooler can be
marketed as a stand-alone product to other industries. In high volume
production, the Company believes that unit costs for this cooler will be
significantly less than currently available cryogenic coolers. See
"--Cryogenic Cooler Products".
Cryogenic Packaging. Cooling to cryogenic temperatures requires proper
insulation and packaging. Any superconducting or other cryogenically-cooled
device must be maintained at its optimal operating temperature, and its
interaction with higher temperature components must be controlled. The Company
has developed several thermal insulation technologies to satisfy this
requirement.
MANUFACTURING
As the Company has commercialized its SuperFilter(TM) systems and
cryogenic products, it has developed prototypes and established its
manufacturing infrastructure. During 1997, STI began the process of expanding
its pilot scale production capabilities into a volume manufacturing line. A
formal manufacturing organization was established mid-year and includes a Vice
President of Operations and operating units to support the production of all
critical components including superconducting filters, cryogenic coolers,
cryogenic packaging and final enclosures, as well as quality and material
control functions. The expansion process has included the leasing of an
additional 10,000 square feet at the Company's existing
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facility. A portion of STI's manufacturing processes, including thin-film
production, are performed in "clean rooms." Other manufacturing stages,
including system assembly, are conducted in a standard manufacturing
environment.
Due to the proprietary and technical nature of the Company's product and
the requirement to produce high quality products, the Company has decided to
produce substantially the entire product in-house. The Company believes this
will enable it to control its manufacturing process and achieve required cost
reductions. The Company has demonstrated a proprietary manufacturing process
for thin-film TBCCO materials that the Company believes is scaleable for high
volume production. The Company has established a production operation, which
the Company uses to produce TBCCO thin films on wafers for wireless electronics
applications. The Company currently purchases wafers for growth of HTS thin
films from two primary outside suppliers because of the quality of their
products. The RF circuitry utilized by STI is designed and modeled by internal
engineering resources. The Company has in-house capabilities to pattern the
superconducting material and all other aspects of RF component production,
including packaging the filters. STI has in-house capabilities to manufacture
its cryogenic coolers at a pace consistent with current quantity requirements.
The Company with its expansion has adequate capabilities in order to perform
the final system integration and test of the SuperFilter(TM) product to order
to meet current and projected demand. See "--STI's Technology--STI's
Technology Approach", "Factors Affecting Future Business Operations--Limited
Manufacturing Experience".
MARKETING AND SALES
The Company pursues a marketing strategy aimed at service providers, OEMs
and government agencies with the goal of building long-term business
relationships that will lead to future volume orders for STI's filter products.
The Company also pursues customer relationships with potential customers for
STI's cryogenic cooler products. In addition, the Company demonstrates STI
products at trade shows, participates in industry conferences, utilizes
advertising and direct mailings, and provides technical and application reports
to recognized trade journals. Product information in the form of brochures,
data sheets, application notes, trade journal reports, product photos and press
releases are updated as necessary. The Company has a six-person in-house sales
staff with experience in wireless marketing and sales, in addition to eleven
sales representatives located domestically and internationally. The Company's
officers and directors are also involved in STI's marketing efforts. There can
be no assurance that the Company's efforts in developing its marketing and
sales capabilities could have a material adverse effect on the acceptance of
the Company's products in the commercial markets and, as a result, on the
Company's business, results of operations and financial condition. See "Factors
Affecting Business Operations--Dependence on Sales to Service Providers and
OEMs."
INTELLECTUAL PROPERTY
The Company regards elements of its manufacturing processes, product design
and fabrication equipment as proprietary and seeks to protect its rights in
them through a combination of patent, trademark, trade secret and copyright law
and internal procedures and non-disclosure agreements. The Company also seeks
licenses from third parties for HTS materials and processes used by the Company
which have been patented by other parties. The Company believes that its
success will depend, in part, on the protection of its proprietary information,
patents and the licensing of key technologies from third parties.
The Company has focused its development efforts on TBCCO and, to a lesser
extent, on YBCO materials. Several U.S. patents have been issued to the
University of Arkansas covering TBCCO, and the Company has an exclusive
worldwide license (including the right to sublicense) under these patents,
subject to the University of Arkansas' right to conduct research related to the
patents. The consideration for the license included $250,000 in cash, prepaid
royalties of $750,000 through April 1995 and an aggregate of 200,000 shares of
Common Stock. Commencing April 1995, the Company has been obligated to pay
royalties of 4% on sales of TBCCO-based products, subject to a $100,000 annual
minimum from and after April 1997, and royalties of 35% of sublicense revenues
received by the Company. In the event that the Company fails to pay minimum
annual royalties, the license automatically becomes non-exclusive. The license
terminates upon expiration of the right to claim damages for infringement of
all the patents covered. Under the terms of its exclusive license, the Company
has agreed to assume litigation expenses for infringement actions, subject to a
right of setoff against future royalty obligations.
In January 1993, as part of its strategy to stimulate the development and
use of TBCCO and to create potential second sourcing foundry service to STI,
the Company granted DuPont a non-exclusive worldwide sublicense to develop
processes and market TBCCO thin films. DuPont paid the Company $388,000 as
partial consideration for the sublicense, a portion of which represents prepaid
royalties. Commencing in 1998, DuPont will pay royalties on sales of TBCCO
thin films or devices containing TBCCO thin films, subject to annual minimums.
In the event that the Company grants another sublicense to a third party on
more favorable terms, it will be obligated to extend those terms to DuPont.
The term of the sub-license is the same as the Company's license from the
University of Arkansas, but the sublicense is terminable by DuPont upon 30
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days' notice to the Company. During 1997, the Company entered into a supply
agreement with DuPont. As part of the supply agreement a cross- licensing
agreement was entered into thereby reducing the royalty payments under the
original agreement. In 1994, the Company granted a nonexclusive license for
TBCCO to Superconducting Core Technologies, Inc., and in 1996, to Midwest
Superconductivity, Inc. on terms substantially similar to those of the 1993
DuPont agreement. DuPont, Superconducting Core Technologies, Inc., Midwest
Superconductivity, Inc., and their customers are current or potential
competitors of the Company, and there can be no assurance that these
sublicenses will not adversely affect the Company's business, results of
operations and financial conditions.
The Company is also focusing development efforts on YBCO, although to a
lesser extent than TBCCO. YBCO is the other significant material that the
Company has used in the development of its products. The Company believes that
a number of patent applications are pending that cover the composition of YBCO,
including applications filed by IBM, AT&T and other large potential competitors
of the Company. STI believes that such applications are the subject of
interference proceedings currently pending in the U.S. Patent and Trademark
Office. The Company is not involved in any such proceedings. Therefore, there
is a substantial risk that one or more third parties will be granted patents
covering YBCO and that the Company's use of these materials may require a
license. The Company has received access to some of the patents through its
cross-licensing agreement with DuPont. In addition, international patents have
been issued for specific YBCO compounds. As with other patents, the Company has
no assurance that it will be able to obtain licenses to any such patents for
YBCO or that such licenses would be available on commercially reasonable terms.
The Company's efforts to develop products based on YBCO would be substantially
impaired by its failure to obtain any such license for YBCO, and such failure
could have a material adverse effect on the Company's business, results of
operations and financial condition.
As of December 31, 1997, the Company holds 16 U.S. patents. Nine of the
Company's patents are for technologies directed toward producing thin-film
materials, including its proprietary thin-film process for TBCCO production. In
addition, the Company currently holds six patents for circuit designs and one
patent covering cryogenics and packaging. As of December 31, 1997, the Company
has fifteen patents pending, including six related to materials, two related to
cryogenics and seven covering STI designs. As the Company has developed
prototype products, it has increased the number of design patents applied for
in an effort to protect all phases of product development. See "Factors
Affecting Future Business Operations-Uncertainty of Patents and Proprietary
Rights."
RESEARCH AND DEVELOPMENT
As part of STI's strategy to maintain its technological leadership, the
Company has focused its research and development activities on materials, RF
circuitry, cryogenics design and product application. At December 31, 1997,
the Company's research and development department consisted of 44 individuals.
The Company's contract research and development expenses consist primarily of
labor, engineering, material and overhead costs incurred in connection with
research and development activities. For the fiscal years ended 1995, 1996 and
1997 contract research and development expenses were approximately $5.4
million, $5.7 million and $6.2 million, respectively. The Company's revenues
from government-related contracts provided for approximately $7.3 million, $7.1
million and $8.1 million, respectively, during these same periods. This
accounted for 96%, 96% and 97% of the Company's total revenues in the fiscal
years ended 1995, 1996 and 1997, respectively.
Since the Company's inception, it has received approximately $45.1 million
of revenues from government contracts. The Company believes that it will
continue to rely largely on government research and development awards to fund
a significant portion of its research and development activities. See "Factors
Affecting Future Business Operations--High Degree of Dependence on Government
Contracts" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
COMPETITION
The Company faces competition in various aspects of its technology and
product development and in each of the markets targeted by the Company. The
Company's current and potential competitors include conventional RF filter
manufacturers and both established and newly-emerging companies developing
similar or competing technologies. In addition, the Company currently supplies
components and licenses technology to large companies and industry leaders that
may decide to manufacture or design their own superconducting components
instead of purchasing them, or licensing the technology, from the Company. The
Company expects increased competition both from existing competitors and a
number of companies that may enter the wireless communications markets.
In the wireless communications market, the Company competes primarily with
Conductus, Inc. and Illinois Superconductor Corporation, with respect to its
superconducting filter systems. In the government sector, the Company competes
with universities, national laboratories and both large and small companies for
research and development contracts.
The Company believes that it competes on the basis of technological
sophistication, product performance, reliability,
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quality, cost-effectiveness and product availability. Many of the Company's
current and potential competitors have significantly greater financial,
technical, manufacturing and marketing resources than the Company. There can
be no assurance that the Company will be able to compete successfully in the
future. See "Factors Affecting Future Business Operations--Intense
Competition."
ENVIRONMENTAL ISSUES
The Company uses certain hazardous materials in its research, development
and manufacturing operations. As a result, the Company is subject to stringent
federal, state and local regulations governing the storage, use and disposal of
such materials. It is possible that current or future laws and regulations
could require the Company to make substantial expenditures for preventative or
remedial action, reduction of chemical exposure, or waste treatment or
disposal. In addition, although the Company believes that its safety procedures
for handling and disposing of such materials comply with the standards
prescribed by state and federal regulations, nevertheless there is the risk of
accidental contamination or injury from these materials. To date, the Company
has not incurred substantial expenditures for preventive action with respect to
hazardous materials or for remedial action with respect to any hazardous
materials accident, but the use and disposal of hazardous materials involves
the risk that the Company could incur substantial expenditures for such
preventive or remedial actions. If such an accident occurred, the Company
could be held liable for resulting damages. The liability in the event of an
accident or the costs of such remedial actions could exceed the Company's
resources or otherwise have a material adverse effect on the Company's
financial condition and results of operations. See "Factors Affecting Future
Business Operations--Hazardous Materials; Environmental Regulations."
EMPLOYEES
As of December 31, 1997, the Company employed a total of 94 persons, 30 of
whom were employed in manufacturing and 44 in research and development. Eight
of the Company's employees have Ph.D.s and 21 others hold advanced degrees in
physics, materials science, electrical engineering and related fields. The
Company's employees are not represented by a labor union, and the Company
believes that its employee relations are good.
The Company is highly dependent upon the efforts of its senior management.
Due to the specialized technical nature of the Company's business, the Company
is also highly dependent upon its ability to attract and retain qualified
technical personnel, primarily in the areas of wireless communications. The
loss of the services of one or more members of the senior management or
technical teams could impede STI's ability to achieve its product development
and commercialization objectives. There is intense competition for qualified
personnel in the areas of the Company's activities and there can be no
assurance that the Company will be able to continue to attract and retain
qualified personnel necessary for the development of its business.
FACTORS AFFECTING FUTURE BUSINESS OPERATIONS
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-K includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. All statements other than statements of historical fact
included in this Form 10-K, including, without limitation, the statements under
"Factors Affecting Future Business Operations," "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources" and "Business" regarding: the Company's ability to design,
develop, manufacture and market products, including, without limitation, its
SuperFilter(TM) systems and cryogenic coolers; the ability of the Company's
products to achieve anticipated benefits; the Company's ability to achieve
product commercialization; the anticipated growth of its target markets; its
ability to achieve profitability; and other matters regarding the Company's
expectations, beliefs, intentions or strategies regarding the future are
forward-looking statements. All forward-looking statements included herein are
based on information available to the Company on the date hereof, and the
Company assumes no obligation to update any such statements. Although the
Company believes that the expectations reflected in such forward-looking
statements are reasonable at this time, it can give no assurance that such
expectations will prove to have been correct. Important factors that could
cause actual results to differ materially from the Company's expectations
("Cautionary Statements") are set forth in these "Factors Affecting Future
Business Operations," as well as elsewhere in this Form 10-K.
EARLY STAGE OF THE COMMERCIAL SUPERCONDUCTOR PRODUCTS MARKET: MARKET ACCEPTANCE
AND RELIABILITY
The commercial superconductor products market has experienced limited
product commercialization to date. Moreover, since inception, the Company has
been principally engaged in research and development activities and has only
limited experience in the commercialization of its products. The Company's
ability to grow will depend on its ability to successfully
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transition its expertise in superconducting filter and cryogenics technologies
and applications to commercial markets, including the wireless communications
market. The Company's success in this regard will depend upon a number of
factors, including successful product testing by its potential customers, the
success of the Company's sales and marketing efforts into the wireless
communications market, the ability of the Company's products to achieve its
anticipated benefits, its ability to attract and retain qualified personnel,
successful and rapid scale-up of the Company's manufacturing capacity, the
establishment of satisfactory vendor relationships to ensure continual supply
of key components which are sourced outside the company, reduction of
manufacturing expenses in order to price products competitively and continued
product development to meet customer demands. Moreover, the Company's
commercial customers establish demanding specifications for performance and
reliability. While the Company's products and components have passed certain
product performance and reliability testing by its customers to date, there can
be no assurance that its products will continue to pass customer reliability
testing and performance requirements in the future. If such problems occur,
the Company could experience increased costs, delays, reductions or
cancellations of orders and shipments, and product returns and discounts.
There can be no assurance that the Company will be able to produce its products
in volume or that any of the Company's products will achieve market acceptance.
If the Company is unable to manufacture and market its products for its target
markets successfully, its business, results of operations and financial
condition will be materially and adversely affected. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
DEPENDENCE ON SALES TO SERVICE PROVIDERS AND OEMS
Most of the Company's products, including those developed for wireless
communications base stations and government applications, are intended for use
as components or subsystems in base station systems. Therefore, to gain market
acceptance, the Company must demonstrate that its products will provide
advantages to the service providers who utilize base station systems and the
OEMs that manufacture base station systems. These benefits include a decrease
in system size, an increase in range extension and a reduction in interference.
There can be no assurance that upon acceptance, the Company's products will be
able to achieve any of these advantages. Moreover, even if the Company is able
to demonstrate such advantages, there can be no assurance that service
providers and OEMs will elect to incorporate the Company's products into their
systems or, if they do, that related system and manufacturing requirements can
or will be met. Failure of service providers or OEMs to incorporate the
Company's products into their systems or failure of such systems including the
SuperFilter(TM) product to achieve market acceptance would have a material
adverse effect on the Company's business, results of operations and financial
condition. See "Business-- Wireless Filter Products--Accessing the Wireless
Market" and "--Marketing and Sales".
LIMITED MANUFACTURING EXPERIENCE
To date, the Company has sold products only in limited quantities,
primarily for use in the development and demonstration of prototypes, for
laboratory and field testing, and for field trials. The Company's current
manufacturing facilities are sufficient for limited volume production. There
can be no assurance that the Company will be successful in overcoming the
technological, engineering and management challenges associated with the
production of commercial quantities of superconducting or cryogenic products at
acceptable costs and on a timely basis. The Company could incur significant
ramp-up costs and unforeseen expenses and delays in connection with attempts to
manufacture commercial quantities of superconducting and cryogenic products,
which could have a material adverse effect on the Company's business, results
of operations and financial condition. When the Company receives volume orders
for its products, it expects to outsource the manufacturing of certain hardware
components. There can be no assurance that the Company will if at all be able
to identify manufacturers that will meet the Company's requirements as to
reliability, timeliness and cost-effectiveness. Any such failure will limit
the Company's ability to satisfy customer orders and would have a material
adverse effect on the Company's business, results of operations and financial
condition. See "Business--Manufacturing."
HIGH DEGREE OF DEPENDENCE ON GOVERNMENT CONTRACTS
Since inception, 95% of the Company's net revenues have been from research
and development contract sales directly to the government or to resellers to
the government. Nearly all of such revenues were paid under contracts between
the Company and the DoD. The Company uses these contracts to help fund its
research and development programs. Although the Company recently has been
devoting substantial resources to the development of commercial markets for its
products, the Company is, and expects to continue to be in the near term,
dependent on government funding for its research and development projects. The
DoD has been reducing total expenditures over the past few years, and while to
date DoD research and development funding for electronics has been relatively
stable despite overall cutbacks, there can be no assurance that such funding
will not be reduced in the future. Absent significant future revenues from
commercial sales, a significant loss of government funding would have a
material adverse effect on the Company's business, results of operations
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and financial condition. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Overview."
Virtually all of the Company's government contracts are terminable at any
time at the option of the government. Although the Company historically has
complied with applicable government regulations and contract provisions, there
can be no assurance as to such compliance in the future. Noncompliance with
government procurement regulations or contract provisions could result in
termination of government contracts, substantial monetary fines or damages,
suspension or debarment from doing business with the government and possible
civil or criminal liability. During the term of any suspension or debarment by
a government agency, the Company could be prohibited from competing for or
being awarded any contract by any government agency. The termination of the
Company's significant government contracts, the imposition of fines, damages,
suspension or debarment, or the adoption of new or modified procurement
regulations or practices could have a material adverse effect on the Company's
business, results of operations and financial condition.
Inventions conceived or actually reduced to practice under a government
contract generally result in the government obtaining a royalty- free, paid-up,
non-exclusive license to practice the invention. Similarly, technologies
developed in whole or in part at government expense generally result in the
government obtaining unlimited rights to use, duplicate or disclose technical
data produced under the contract. There can be no assurance that such licenses
and rights will not result in a loss by the Company of potential revenues or
the disclosure of any of the Company's proprietary information, either of which
could have a material adverse effect on the Company's business, results of
operations and financial condition. See "Business--Government Contracts."
INTENSE COMPETITION
The markets for the Company's products are intensely competitive. The
Company faces competition in various aspects of its technology and product
development and in each of the markets targeted by the Company. The Company's
current and potential competitors include conventional RF filter manufacturers
and both established and newly emerging companies developing similar or
competing superconducting technologies. In addition, the Company currently
supplies components and licenses technology to large companies and industry
leaders that may decide to manufacture or design their own superconducting
components instead of purchasing them, or licensing the technology, from the
Company. The Company expects increased competition both from existing
competitors and a number of companies that may enter the wireless
communications markets.
In the wireless communications market, the Company competes primarily with
Conductus, Inc. and Illinois Superconductor Corporation, with respect to its
superconducting filter systems. In addition, the Company competes with IBM,
DuPont, Matsushita and Amtel, a Japanese consortium, among others, with respect
to its HTS materials. The Company is not currently aware of another company
that is targeting the cryogenic cooler markets with a compact, low-cost
cryogenic cooler; however, there can be no assurance that there is no other
company designing or developing cryogenic cooling technology similar to or in
direct competition with the Company's products. In the government sector, the
Company competes with universities, national laboratories and both large and
small companies for research and development contracts.
The Company believes that it competes on the basis of technological
sophistication, product performance, reliability, quality, cost- effectiveness
and product availability. Many of the Company's current and potential
competitors have significantly greater financial, technical, manufacturing and
marketing resources than the Company. The Company's ability to effectively
compete will require it to successfully manufacture and market its current
products at a sufficiently low cost to achieve commercial acceptance, develop
and maintain technologically advanced products, attract and retain highly
qualified personnel and obtain patent or other protection for its technology
and products. There can be no assurance that the Company will be able to
compete successfully in the future. See "Business--Competition."
UNCERTAINTY OF PATENTS AND PROPRIETARY RIGHTS
The Company relies on a combination of patent, trademark, trade secret and
copyright law and internal procedures and nondisclosure agreements to protect
its intellectual property. There can be no assurance that the Company's
intellectual property rights can be successfully asserted in the future or will
not be invalidated, circumvented or challenged. In addition, the laws of
certain foreign countries in which the Company's products may be produced or
sold do not protect the Company's intellectual property rights to the same
extent as the laws of the United States. The failure of the Company to protect
its proprietary information could have a material adverse effect on the
Company's business, results of operations and financial condition.
The Company has an exclusive, worldwide license, in all fields of use, to
formulations covered by patents held by the University of Arkansas covering
TBCCO, the material upon which the Company primarily relies for its HTS
products and product development. There can be no assurance that the validity
of these patents will not be subject to challenge. In addition, other parties
may have developed similar materials utilizing TBCCO formulations and may
design around the
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patented aspects of this material. Under the terms of its exclusive license,
the Company has agreed to assume litigation expenses for infringement actions,
subject to a right of setoff against future royalty obligations. If the
Company is required to incur significant expenses under this agreement, the
Company's results of operations and financial condition could be materially and
adversely affected. In addition, the Company has granted each of DuPont and
Superconducting Core Technologies, Inc. and its affiliates a non-exclusive
worldwide sublicense under its license with the University of Arkansas to
develop and market TBCCO materials and superconducting technologies. There can
be no assurance that these sublicenses will not adversely affect the Company's
business, results of operations and financial condition.
The Company believes that a number of patent applications are pending that
cover the composition YBCO including applications filed by IBM, AT&T and other
large potential competitors of the Company. YBCO is an HTS material upon which
the Company also relies, although to a lesser extent than TBCCO. The Company
understands that such applications are the subject of interference proceedings
currently pending in the U.S. Patent and Trademark Office. The Company is not
involved in these proceedings. In addition, the Company has been issued
patents for specific compounds that it uses. The Company believes that a
number of international patents may be pending regarding other specific YBCO
compounds. There is a substantial risk that one or more third parties will be
granted patents covering YBCO and that the Company's use of these materials may
require a license. As with other patents, there can be no assurance that the
Company will be able to obtain licenses to any such patents for YBCO or other
materials or that such licenses would be available on commercially reasonable
terms. The Company's efforts to develop products based on YBCO would be
substantially impaired by its failure to obtain any such license for YBCO, and
such failure could have a material adverse effect on the Company's business,
results of operations and financial condition.
The Company owns or has rights under a number of patents and pending patent
applications related to the processing of TBCCO and YBCO. There can be no
assurance that the patent applications filed by the Company will result in
patents being issued, that any patents issued will afford meaningful protection
against competitors with similar technology, or that any patents issued will
not be challenged by third parties. Since U.S. patent applications are
maintained in secrecy until patents are issued, and since publications of
discoveries in the scientific or patent literature tend to lag behind actual
discoveries by several months, the Company cannot be certain that it was the
first creator of inventions covered by issued patents or pending patent
applications or that it was the first to file patent applications for such
inventions. Moreover, there can be no assurance that other parties will not
independently develop similar technologies, duplicate the Company's
technologies or, if patents are issued to the Company or rights licensed by the
Company, design around the patented aspects of any technologies developed or
licensed by the Company. The Company may have to participate in interference
proceedings declared by the U.S. Patent and Trademark Office to determine the
priority of inventions, which could result in substantial costs to the Company.
Litigation may also be necessary to enforce any patents held by or issued to
the Company or to determine the scope and validity of others' proprietary
rights, which could result in substantial costs to the Company.
The rapid rate of inventions and discoveries in the superconductivity field
has raised many patent issues which are not resolved at this time. The claims
in the granted patents often overlap and there are disputes involving rights to
inventions claimed in pending patent applications. As a result, the patent
situation in the HTS field is unusually complex. It is likely that there will
be patents held by third parties relating to the Company's products or
technology. Therefore, the Company may need to acquire licenses to design
around or successfully contest the validity or enforceability of such patents.
The extent to which the Company may be able to acquire necessary licenses is
not known. It is also possible that because of the number and scope of patents
pending or issued, the Company may be required to obtain multiple licenses in
order to use a single material. If the Company is required to obtain multiple
licenses, the cost to the Company of HTS materials will increase. Furthermore,
there can be no assurance that such licenses would be available on commercially
reasonable terms or at all. The likelihood of successfully contesting the
validity or enforceability of such patents is also uncertain; and, in any
event, the Company could incur substantial costs in defending the validity or
scope of its patents or challenging the patents of others. See
"Business--Intellectual Property."
The field of superconductivity is characterized by rapidly advancing
technology. The future success of the Company will depend in large part upon
its ability to keep pace with advancing superconductor technology, including
superconducting materials and processes and industry standards. The Company
has focused its development efforts on TBCCO and, to a lesser extent, YBCO.
There can be no assurance that either TBCCO or YBCO will ultimately prove
commercially competitive against other currently known materials or materials
that may be discovered in the future. The Company intends to continue to
develop and integrate advances in wireless filter and cryogenic cooling
technologies in the manufacture of commercial quantities of products. The
Company will also need to continue to develop and integrate advances in
complementary technologies. There can be no assurance that the Company's
development efforts will not be rendered obsolete by research efforts and
technological advances made by others or that materials other than those
currently used by the Company will not prove more advantageous for the
commercialization of HTS products. See "--Intense Competition" and
"--Uncertainty of Patents and Proprietary Rights" and "Business-- Intellectual
Property" and "--Competition."
14
<PAGE> 15
MATERIALS RISKS
To date, the Company has principally focused its development efforts on
TBCCO. Although TBCCO has one of the highest critical temperatures of any HTS
material verified by the scientific community to date, other HTS materials are
currently known to have advantages over TBCCO with respect to certain
applications. There can be no assurance that TBCCO will ultimately prove
commercially competitive against YBCO or against other currently known
materials. Moreover, there is no assurance that other materials will not be
discovered with higher critical temperatures or other superior qualities or
that the Company will be able to obtain the rights to any such superior
material.
The Company currently purchases substrates for growth of HTS thin films
from two primary suppliers because of the quality of the substrate provided by
such suppliers. While the Company is aware of alternative sources for its
substrates, the establishment of relationships with additional or replacement
suppliers could be time consuming and result in a supply interruption which
would have a material adverse effect on the Company's ability to manufacture
its products in commercial quantities and, correspondingly, upon its business,
results of operations and financial condition. See "Business--Manufacturing."
BUSINESS INTERRUPTIONS AND DEPENDENCE ON A SINGLE U.S. FACILITY
The Company's primary operations, including engineering, manufacturing,
customer service, distribution and general administration, are housed in a
single facility in Santa Barbara, California. Any material disruption in the
Company's operations, whether due to fire, natural disaster or otherwise, could
have a material adverse effect on the Company's business, results of operations
and financial condition. See "Business--Manufacturing" and "--Properties."
HAZARDOUS MATERIALS; ENVIRONMENTAL REGULATIONS
The Company uses certain hazardous materials in its research, development
and manufacturing operations. As a result, the Company is subject to stringent
federal, state and local regulations governing the storage, use and disposal of
such materials. It is possible that current or future laws and regulations
could require the Company to make substantial expenditures for preventive or
remedial action, reduction of chemical exposure, or waste treatment or
disposal. There can be no assurance that the operations, business or assets of
the Company will not be materially and adversely affected by the interpretation
and enforcement of current or future environmental laws and regulations. In
addition, although the Company believes that its safety procedures for handling
and disposing of such materials comply with the standards prescribed by state
and federal regulations, nevertheless there is the risk of accidental
contamination or injury from these materials. To date, the Company has not
incurred substantial expenditures for preventive action with respect to
hazardous materials or for remedial action with respect to any hazardous
materials accident. If such an accident occurred, the Company could be held
liable for any resulting damages. Furthermore, the use and disposal of
hazardous materials involved the risk that the Company could be required to
incur substantial expenditures for such preventive or remedial actions. The
liability in the event of an accident or the costs of such actions could exceed
the Company's resources or otherwise have a material adverse effect on the
Company's business, results of operations and financial condition. See
"Business- -Environmental Issues."
15
<PAGE> 16
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company and their ages as
of March 10, 1998 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Glenn E. Penisten 66 Chairman of the Board of Directors
E. Ray Cotten 66 Vice Chairman of the Board of Directors
M. Peter Thomas 56 President, Chief Executive Officer and Director
Robert B. Hammond, Ph.D. 49 Senior Vice President and Chief Technical Officer
James G. Evans, Jr. 46 Vice President and Chief Financial Officer
James P. Simmons, Jr. 48 Vice President, Marketing and Sales
Michael M. Eddy, Ph.D. 37 Vice President, Operations
Neal O. Fenzi 37 Vice President, Engineering
Robert P. Caren, Ph.D. (1)(2) 65 Director
Dennis Horowitz (1)(2) 51 Director
John D. Lockton (1) (2) 60 Director
J. Robert Schrieffer, Ph.D. (1)(2) 66 Director
</TABLE>
(1) Member of Compensation Committee.
(2) Member of Audit Committee.
Glenn E. Penisten has served as Chairman of the Board since May 1994. Mr.
Penisten is a founder of the Company and has served on its Board of Directors
since May 1987. He served as STI's Chief Executive Officer from August 1987 to
June 1988. He has been a General Partner of Alpha Partners, a venture capital
firm, since 1985. Mr. Penisten was Chairman of the American Electronics
Association in 1982, while he was Chairman of the Board of Directors and Chief
Executive Officer of American Microsystems Inc., a semiconductor company. Mr.
Penisten is a director of Bell Microproducts Inc., IKOS Systems, Inc., Network
Peripherals, Inc. and Pinnacle Systems. Mr. Penisten holds a B.S. in
electrical engineering from Oklahoma State University.
E. Ray Cotten joined the Board of Directors in July 1996 and since August
1996 has served as Vice Chairman of the Board. Since August 1994, he has
served as Chairman of the Board of Impulse Telecommunications Corporation, a
wireless communications consulting and engineering firm ("Impulse"). Prior to
joining Impulse, from December 1992 to August 1994, Mr. Cotten was President,
Chief Executive Officer and Chief Operating Officer of Scott Instruments
Corporation, a pioneer in voice recognition systems and from December 1990 to
November 1992, he was President and Chief Executive Officer of ACS Software
Products Group, a software company for the apparel industry. Prior to that, he
also served as Vice-Chairman and co-founder of NetAmerica, a digital networking
company, held vice-president positions at Microdynamics, Inc., a CAD/CAM
company for the apparel industry, Northern Telecom, Inc., a telecommunications
company, Data Transmission Corporation, a digital networking company, and
Danray, a communications switch manufacturing company, and spent nearly 10
years with Texas Instruments, where he held various management positions. Mr.
Cotten received his B.A. in business from Oklahoma State University.
M. Peter Thomas joined the Company as President and Chief Executive Officer
and member of the Board of Directors of the Company in April 1997. Prior to
joining the Company, Mr. Thomas was President and Chief Executive Officer of
First Pacific Networks, Inc., a telecommunications company, from June 1995 to
January 1997, which company filed for bankruptcy in February 1997 under Chapter
11 of the U.S. Bankruptcy Code. From August 1991 to May 1995, Mr. Thomas
engaged in general business consulting in conjunction with the Stanbridge
Group, a consulting firm which he co-founded in 1989. From January 1990 to
July 1991, he was President and Chief Executive Officer of Data-Design
Laboratories, Inc., an electronics company, and from 1989 to 1990, he
consulted for The Stanbridge Group. Prior to 1989, Mr. Thomas also served as
President and Chief Executive Officer of Ericsson North America, Inc., the
North American operating subsidiary of Sweden's L.M. Ericsson, a
telecommunications company, as President and Chief Operating Officer of
Telenova, Inc., a
16
<PAGE> 17
telecommunications company, and as President of the Telecom Network Systems
Division of ITT, Inc., a telecommunications company. Mr. Thomas received his
B.S.E. in Aerospace Engineering from Princeton University and his M.B.A. from
the Harvard Business School.
Robert B. Hammond, Ph.D. has served as Senior Vice President and Chief
Technical Officer of the Company since December 1992, having served as Vice
President, Technology, and Chief Technical Officer since August 1990. From May
1991 to December 1991 and July 1992 to December 1992, he served as Acting Chief
Operating Officer of the Company, and from December 1987 to August 1990, he
served as Program Manager of the Company. Dr. Hammond also serves on STI's
Technical Advisory Board. For over eleven years prior to joining the Company,
he was at Los Alamos National Laboratory, most recently as Deputy Group Leader
of Electronics Research and Development, a group that performs research,
development and pilot production of solid state electronics and optics. Dr.
Hammond received his Ph.D. and M.S. in applied physics and his B.S. in physics
from the California Institute of Technology.
James G. Evans, Jr. joined the Company in March 1995 as Vice President,
Chief Financial Officer and Secretary. Prior to joining the Company, from 1983
to 1995, Mr. Evans held several senior executive positions within finance and
operations at Applied Magnetics Corporation, a manufacturer of magnetic record
heads for hard disk drives ("Applied Magnetics"), most recently as Customer
Business Director and Financial Director of Thin-Film Products, where he was
responsible for the design, off-shore manufacturing, pricing, planning and
quality of the product for one-third of that company's customers. Before
joining Applied Magnetics, Mr. Evans was Director of Financial Planning for
Tiger International, a transportation company. Mr. Evans has an M.B.A. in
Accounting from the University of Southern California and a B.A. in Business
Economics from the University of California at Santa Barbara. Mr. Evans is a
certified public accountant.
James P. Simmons, Jr. joined the Company as Vice President, Marketing and
Sales in May 1994. Prior to joining the Company, from September 1990 to May
1994, Mr. Simmons was the Product Marketing and Applications Manager at
Therma-Wave, Inc., a semiconductor equipment company, where he was responsible
for all strategic and tactical marketing activities for a major product family.
Mr. Simmons has over 20 years of marketing management and production experience
within the high-technology industry and has held management positions with
Hewlett-Packard Company, as well as KLA Instruments Corp. and Nanometrics,
Inc., both of which are semiconductor equipment companies. Mr. Simmons holds
an M.B.A. from the Harvard Business School and a B.S. in applied physics from
the California Institute of Technology.
Michael M. Eddy, Ph.D., became Vice President, Operations in July, 1997.
Dr. Eddy joined STI in 1988 and most recently held the position of Director of
Materials. Prior to that Dr. Eddy held research positions at Rutherford
Appleton Laboratory in England and the University of California at Santa
Barbara. Dr. Eddy holds a Bsc in chemistry from Sheffield University, a Ph.D.
in chemistry from Oxford University and an MBA from Pepperdine University.
Neal O. Fenzi became Vice President, Engineering in July, 1997. Mr. Fenzi
joined STI in 1992 and most recently held the position of Director of RF
Engineering. From 1982 to 1992 Mr. Fenzi worked in various engineering and
management positions at Hughes Aircraft Company, Space and Communications Group
and Amplica, Inc., a developer of microwave amplifier and sub-assemblies. Mr.
Fenzi received his BSEE in 1982 from New Mexico State University.
Robert P. Caren, Ph.D., has served on both the Board of Directors and the
Technical Advisory Board of the Company since January 1988. From 1988 to 1995,
when he retired, Dr. Caren served as Corporate Vice President, Sciences and
Engineering, for Lockheed Martin Corporation. Dr. Caren is a fellow of the
American Institute of Aeronautics and Astronautics, American Astronautics
Society and the American Association for the Advancement of Science. He is a
member of the National Academy of Engineering, a member of the California
Commission on Science and Technology and past Chairman of the Research Division
of the Defense Preparedness Association. Dr. Caren received his Ph.D., M.S.
and B.S. in physics from Ohio State University.
Dennis Horowitz has served on the Board of Directors of the Company since
June 1990. Mr. Horowitz is currently President and Chief Executive Officer of
Wolverine Tube, Inc., a manufacturer and distributor of copper and copper alloy
tube. From September 1994 to April, 1997, he served as Corporate Vice President
and President of the Americas, AMP Incorporated, an interconnection device
company. From October 1993 to August 1994, Mr. Horowitz served as President
and Chief Executive Officer of Philips Technologies, a Philips Electronics
North America company. From April 1990 to September 1993, Mr. Horowitz served
as President and Chief Executive Officer of Philips Components, Discrete
Products Division. From 1988 to 1990, he served as President and Chief
Executive Officer of Magnavox CATV, and from 1980 to 1988 he was involved in
the general administration of North American Philips Corporation. Philip
Components and Magnavox CATV are divisions of North American Philips
Corporation. Mr. Horowitz is a director of Aerovox Corporation. Mr. Horowitz
holds an M.B.A and a B.A. in economics from St. John's University.
John Lockton joined the Board of Directors of the Company in December,
1997. Mr. Lockton is currently President, Chief Executive Officer and a
Director of International Wireless Communications, Inc., an operator of
cellular systems, of which he was a co-founder in 1992. From May 1990 to August
1991 he was Managing Partner of Corporate Technology Partners, a joint-venture
with Bell Canada Enterprises. In 1988, Mr. Lockton founded Cellular Data,
Inc., a cellular wireless data
17
<PAGE> 18
technology company, and Star Associates, Inc., a cellular radio RSA company.
He founded and was a director of Interactive Network, Inc. a wireless-based
television company, and was Chairman of the Board of Directors until December
1994. From 1983 to 1987 Mr. Lockton was Executive Vice President of Pacific
Bell (now Pacific Telesis). From 1980 to 1983 he was President of Warner Amex
(now Time Warner) Cable Television, Inc. From 1968 to 1980 Mr. Lockton served
in various capacities at Dun & Bradstreet. Mr. Lockton is the primary inventor
of a patented wireless technology for Personal Communication Services (PCS).
Mr. Lockton is a graduate of Yale University (Phi Beta Kappa), Harvard Law
School and received an Executive MBA from Columbia University.
J. Robert Schrieffer, Ph.D. founded the Technical Advisory Board of the
Company in August 1987 and has served as its Chairman since that time. He has
also served on the Board of Directors of the Company since October 1988. He
received the Nobel Prize in Physics in 1972 for work in superconductivity
theory, and he has received many other professional honors including the
National Medal of Science. Dr. Schrieffer is currently the President of the
American Physical Society. He is also the University Eminent Scholar of the
State of Florida University System and has been the Chief Scientist of the
National High Magnetic Field Laboratory since January 1992. Dr. Schrieffer was
Chancellor's Professor of Physics and Director of the Institute for Theoretical
Physics at the University of California, Santa Barbara from 1980 to 1991. Dr.
Schrieffer serves on a number of government and industrial committees and is a
Fellow of the Los Alamos National Laboratory, heading its Advanced Study
Program in High Temperature Superconductivity Theory from 1988 to 1993. Dr.
Schrieffer received his Ph.D. and M.S. in physics from the University of
Illinois and his B.S. in physics from the Massachusetts Institute of
Technology.
ITEM 2. PROPERTIES.
The Company's operations, including its pilot scale manufacturing line, are
located in approximately 33,000 square feet of space in Santa Barbara,
California. The Company occupies this space under a lease which expires on
December 31, 1999. The Company believes that such facilities will be adequate
to meet its current and reasonably anticipated needs for the next year. See
"Factors Affecting Business Operations- -Business Interruptions and Dependence
on a Single U.S. Facility".
ITEM 3. LEGAL PROCEEDINGS
There are currently no pending or threatened material legal actions against
the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's stockholders during
the quarter ended December 31, 1997.
18
<PAGE> 19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
MARKET FOR COMMON STOCK
Pursuant to the Company's initial public offering, the Company's
Common Stock commenced trading on the Nasdaq National Market on March 7, 1993.
The Company's Common Stock is listed on the Nasdaq National Market under the
symbol "SCON". The following table sets forth for the periods indicated the
high and low sales prices for the Common Stock as reported on the Nasdaq
National Market.
<TABLE>
<CAPTION>
HIGH LOW
----------- -----------
1995
<S> <C> <C>
Quarter ended April 1, 1995 ........................ $ 7.75 $ 5.25
Quarter ended July 1, 1995 ......................... $ 6.88 $ 5.25
Quarter ended September 30, 1995 ................... $ 7.13 $ 4.88
Quarter ended December 31, 1995 .................... $ 6.13 $ 3.63
1996
Quarter ended March 30, 1996 ....................... $ 9.50 $ 4.00
Quarter ended June 30, 1996 ........................ $ 8.75 $ 6.53
Quarter ended September 29, 1996 ................... $ 8.34 $ 6.25
Quarter ended December 31, 1996 .................... $ 7.50 $ 3.38
1997
Quarter ended March 29, 1997 ....................... $ 4.75 $ 3.38
Quarter ended June 28, 1997 ........................ $ 4.13 $ 2.50
Quarter ended September 27, 1997 ................... $ 5.31 $ 2.00
Quarter ended December 31, 1997 .................... $ 4.25 $ 2.19
1998
Quarter ended March 28, 1998 ....................... $ 3.75 $ 2.50
(Through March 10, 1998)
</TABLE>
HOLDERS OF RECORD
As of March 10, 1998, there were approximately 165 holders of record of the
Common Stock.
DIVIDENDS
The Company has never paid cash dividends on its capital stock and does not
expect to pay any dividends in the foreseeable future. Furthermore, the
Company's equipment lease lines prohibit it from paying cash dividends. The
Company intends to retain future earnings, if any, for use in its business.
19
<PAGE> 20
ITEM 6. SELECTED FINANCIAL DATA. (IN THOUSANDS, EXCEPT PER SHARE DATA)
The information set forth below is not necessarily indicative of results of
future operations and should be read in conjunction with the Company's
Financial Statements and Notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" appearing in Item 14
of Part IV of this Report.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net Revenues:
Government contract revenues ...... $ 4,334 $ 4,979 $ 7,310 $ 7,104 $ 8,104
Commercial product revenues ....... 280 450 300 250 175
Sublicense royalties .............. 388 75 0 38 38
-------- -------- -------- -------- --------
Total net revenues .............. 5,002 5,504 7,610 7,392 8,317
Costs and expenses:
Contract research and development .. 2,862 4,030 5,414 5,721 6,218
Other research and development .... 1,998 2,085 2,397 2,260 1,809
Selling, general and administrative 2,468 2,928 2,871 2,967 4,076
-------- -------- -------- -------- --------
Total operating expenses ....... 7,328 9,043 10,682 10,948 12,103
-------- -------- -------- -------- --------
Loss from operations .................. (2,326) (3,539) (3,072) (3,556) (3,786)
Other income (expense), net ........... 188 280 253 85 245
-------- -------- -------- -------- --------
Net loss ............................. ($ 2,138) ($ 3,259) ($ 2,819) ($ 3,471) ($ 3,541)
======== ======== ======== ======== ========
Basic and diluted loss per share ..... ($ 0.42) ($ 0.55) ($ 0.47) ($ 0.57) ($ 0.46)
Weighted average number of shares
outstanding ........................... 5,032 5,971 6,026 6,117 7,701
</TABLE>
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments ....................... $10,583 $ 7,930 $ 5,244 $ 6,871 $ 3,537
Working capital ..................... 11,134 8,242 5,695 7,178 3,500
Total assets ........................ 16,616 14,613 11,878 13,344 10,087
Long-term debt ...................... 56 724 453 77 13
Total stockholders' equity .......... 15,741 12,640 10,087 11,290 8,166
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This "Item 7-Management's Discussion and Analysis of Financial Condition
and Results of Operations" and other parts of this report contain
forward-looking statements that involve risks and uncertainties. The Company's
actual results may differ significantly from the results discussed in the
forward-looking statements. Factors that might cause such a difference
include, but are not limited to, those discussed below and under the caption
entitled "Factors Affecting Future Business Operations."
Superconductor Technologies Inc. is a development stage company founded in
1987 to develop and market advanced electronics products incorporating high
temperature superconductor materials. Since its inception, the Company has
been primarily engaged in research and development activities, recruiting
technical and administrative personnel, and raising capital.
20
<PAGE> 21
The Company has recently shifted its focus to the commercialization and
manufacture of its HTS products, while continuing to pursue product development
activities. The Company has targeted its products toward commercial
applications in the worldwide wireless communications and government markets.
To date, the Company has received revenue primarily from government research
contracts and, to a limited extent, from sales of its products. The Company
has incurred cumulative losses of $27,053,000 from inception to December 31,
1997.
RESULTS OF OPERATIONS
1997 AS COMPARED WITH 1996
Net revenues. Net revenues increased by $925,000, or 13% from $7.4 million
in 1996 to $8.3 million in 1997, due to an increase in government contract
revenues.
Government contract revenues increased by $1,000,000, or 14% from $7.1
million for 1996 to $8.1 million for 1997 which is primarily attributable to
revenues associated with a government contract which the Company was awarded in
the third quarter of 1996. Government contract revenues constituted 96% and
97% of net revenues in 1996 and 1997, respectively.
Commercial sales of the Company's HTS products decreased by $75,000, or
30%, from $250,000 in 1996 to $175,000 in 1997. This decrease in commercial
revenues is the result of the Company's continuing efforts to shift its
emphasis towards SuperFilter(TM) products and cryogenic cooler sales and away
from sales of components such as films and development hardware.
Sublicense royalties were $38,000 in 1996 and 1997.
Contract research and development. Contract research and development
expenses increased by $497,000 or 9%, from $5.7 million in 1996 to $6.2 million
in 1997. This increase is attributable to the increase in government contract
revenue which is directly related to contract expenses as well as increased
research and development efforts which are allowable expenses under these
contracts.
Other research and development expenses. Other research and development
expenses decreased by $451,000, or 20%, from $2.3 million in 1996 to $1.8
million in 1997. This decrease is the result of the Company directing its
research and development efforts towards contract research and development
projects.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased by $1.1 million, or 37%, from $3.0 million in
1996 to $4.1 million in 1997. This increase is the result of the Company's
strategy to increase its sales and marketing efforts related to the
SuperFilter(TM) product and to develop the appropriate manufacturing
infrastructure to support these marketing efforts. During the second half of
the year the Company hired two additional sales and marketing professionals and
embarked on an advertising campaign to promote the awareness of the product
among wireless service providers in particular. In addition, the Company
appointed a Vice-President of Operations to establish the appropriate
manufacturing infrastructure in order to produce the SuperFilter(TM) product
in an efficient and cost- effective manner.
Other income (expense), net. Interest income increased by $119,000, or 76%,
from $156,000 in 1996 to $275,000 in 1997 as a result of an increase in the
interest-earning investment balances during this period due to the successful
completion of the Company's secondary offering in the fourth quarter of 1996.
Interest expense decreased by $41,000, or 58%, from $71,000 in 1996 to $30,000
in 1997 due to the reduction in the Company's long-term portion of note payable
and capitalized lease obligations.
1996 AS COMPARED WITH 1995
Net revenues. Net revenues decreased by $218,000, or 3% from $7.6 million
in 1995 to $7.4 million in 1996, due primarily to a decrease in government
contract revenues.
Government contract revenues decreased by $206,000, or 3% from $7.3 million
for 1995 to $7.1 million for 1996 as a result of delays in government funding
in the first half of the year. Government contract revenues constituted 96% of
net revenues in 1995 and 1996. In 1996, the Company was awarded $20.6 million
in incrementally-funded government contracts, 51% of which has been funded
through 1997 and beyond.
Commercial sales of the Company's HTS products decreased by $50,000, or
17%, from $300,000 in 1995 to $250,000 in 1996. However, 1996 sales were
primarily comprised of sales of the Company's SuperFilter(TM) prototypes and
cryogenic coolers as compared to prior years in which commercial sales were
associated with sales of superconducting films. All film production is now
being used internally for expanding the Company's efforts to develop products
for commercialization.
Sublicense royalties increased $38,000, or 100% in 1996 as the Company
entered into one sublicense agreement with respect to its patents in 1996 and
none during 1995.
Contract research and development. Contract research and development
expenses increased by $307,000 or 6%, from $5.4 million in 1995 to $5.7 million
in 1996. This increase is the result of the increased use of subcontractors
and increased research and development efforts which are allowable expenses
under contracts.
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<PAGE> 22
Other research and development expenses. Other research and development
expenses decreased by $137,000, or 6%, from $2.4 million in 1995 to $2.3
million in 1996. This decrease is the result of some costs being expensed
under contract research and development expenses.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased by $96,000, or 3%, from $2.9 million in 1995
to $3.0 million in 1996. This increase is primarily attributable to start-up
costs for Cryo-Asia, the joint venture.
Other income (expense), net. Interest income decreased by $197,000, or 56%,
from $353,000 in 1995 to $156,000 in 1996 due to a decline in interest-earning
investment balances during the first ten months of 1996 as these funds were
utilized to fund operations. Interest expense decreased by $29,000, or 29%,
from $100,000 in 1995 to $71,000 in 1996 due to the reduction in the Company's
long-term portion of note payable and capitalized lease obligations.
FLUCTUATIONS IN PERIODIC RESULTS
A significant portion of the Company's revenues have historically consisted
of government research and development contract revenues. The Company expects
that government contract revenue will continue to account for a substantial
portion of total net revenues over the next several quarters. Government
contract revenues have historically fluctuated from period to period. This
variability is attributable to government contract budgeting and funding
patterns, as the government procurement process is lengthy and may involve
competing budget considerations, making the timing of the Company's revenues
difficult to predict. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations--Net Revenues" and
"Item 1--Business--Government Contracts" and -- "Factors Affecting Future
Business Operations-High Degree of Dependence on Government Contracts".
As the Company continues to focus on its commercial products, commercial
revenues are expected to increase as a percentage of revenues over the next
several quarters; however, there can be no assurance that such commercial
revenue will increase. Furthermore, as the Company attempts to achieve
commercialization of products, it could encounter seasonality or other
currently unforeseen factors causing additional variability in its results. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Net revenues" and "Item 1 -- Business --
Government Contracts".
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company's cash and cash equivalents totaled $1.4
million and short-term investments totaled $2.1 million. The Company considers
investments with original maturities of three months or less to be cash
equivalents. Cash and short-term investments decreased $3.3 million, or 49%,
from $6.8 million at December 31, 1996 to $3.5 million at December 31, 1997.
The decrease is the result of funding operating losses and the related net
change in working capital items of $1.9 million, purchases of new equipment for
expansion of manufacturing operations of $1.4 million and repayment of debt of
$423,000. These cash outflows were partially offset by proceeds of $416,000
from the sale of common stock primarily from the exercise of the over-allotment
option made by the Underwriter of the Company's secondary offering in the first
quarter of 1997.
The Company financed its operations from inception through December 31,
1997 primarily from net proceeds of $12.7 million raised in its initial public
offering, $15.0 million raised in private placements prior to the initial
public offering, $4.6 million from net proceeds raised in its secondary
offering, $45.0 million in government development contract revenues and $2.4
million in product and license revenues. Operating activities used $2.3
million, $2.4 million and $1.9 million of cash and cash equivalents in 1995,
1996 and 1997, respectively. Investing activities provided cash of $2.3
million in 1995, used cash of $1.7 million in 1996 and provided cash of
$744,000 in 1997. Financing activities used cash of $104,000 in 1995, provided
cash of $4.3 million in 1996 (primarily from the proceeds of the secondary
offering) and used cash of $6,000 in 1997.
The Company's principal resource commitments at December 31, 1997 consisted
of accounts payable and accrued employment compensation of $1,407,000 and
$437,000, respectively, and approximately $77,000 of obligations under
equipment financing commitments.
In August 1994, the Company entered into an equipment financing agreement
which provided for borrowings of up to $1.5 million through the end of 1994 at
an annual interest rate of prime plus 1%. Borrowings under the financing
agreement are secured by substantially all the Company's assets, and are to be
repaid in 36 monthly installments which began in January 1995. During the third
quarter of 1995, the Company extended and amended its equipment financing
arrangement to permit an additional $500,000 in borrowings through the end of
1995 at the same interest rate of the initial agreement. As of December 31,
1997, borrowings of $64,000 were outstanding under this agreement with no
additional borrowings permitted.
The Company invests available funds in short-term, investment grade
investments, including without limitation government obligations, corporate
commercial paper, certificates of deposit and money market funds. The Company
may also invest available funds in intermediate-term investment grade
securities.
22
<PAGE> 23
To date, inflation has not had a material impact on the Company's financial
results.
On March 26, 1998, the Company completed a private placement of 500,000
shares of Series A 6% Cumulative Convertible Preferred Stock ("Preferred
Shares") to certain investors at $ 6.00 per share. The proceeds of the offering,
net of offering expenses, totaled $3 million. Each Preferred Share is
convertible into two shares of Common Stock at $3 per share and carries a
cumulative dividend of 6% per annum. The Preferred Shares also have voting
rights and liquidation preferences. The Preferred Shares are not redeemable
prior to March 26, 2001. Thereafter, the Company may redeem the Preferred Shares
at 110% of the carrying amount plus accrued dividends. Subsequent to March 26,
2005, the holders of the Preferred Shares have the option to redeem the
Preferred Shares at their carrying amount plus accrued dividends. The Company
has an option, exercisable through March 26, 1999, to sell up to an additional
$2 million of Preferred Shares under the same terms provided the Company meets
a certain milestone.
On March 25, 1998, the Company accepted and signed a proposal to enter into
a master lease agreement for up to $3 million in lease financing at an annual
rate indexed to the yield of U.S. Treasury notes of similar maturity. The
Company can draw upon the master lease agreement as it acquires capital assets
during the year. The lease term is sixty months for each drawdown. As of March
26, 1998, no amounts were outstanding under the lease line.
Upon execution of the master lease agreement, the Company believes that the
financing which has recently been secured, is adequate to meet its operational
needs over the next 12 months. However, in the event that the master lease
agreement is not successfully executed, the Company will be required to seek
alternative financing. Depending upon the timing of market acceptance of the
Company's products and the manufacturing ramp-up necessary to support the market
acceptance, additional working capital financing may be required to fully
implement the Company's business plan.
FUTURE ACCOUNTING REQUIREMENTS
In June, 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Comprehensive Income" ("SFAS 130"),
and No. 131, "Disclosures about Segments of an Enterprise and Related
Information" ("SFAS 131"). SFAS 130 and 131 will become effective for the
Company in 1998. The adoption of SFAS 130 and 131 is not expected to have a
material effect on the Company's financial statements disclosures.
YEAR 2000
The Company currently uses a limited number of software products which are
not Year 2000 compliant. However, the Company currently plans to acquire
manufacturing software in order to support its expansion efforts. The new
software will be Year 2000 compliant and is expected to replace substantially
all non-Year 2000 compliant software. Accordingly, the Company does not expect
the amounts required to be expensed to become Year 2000 compliant to have a
material effect on its financial position or results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
All information required by this item is included on pages 26 to 38 in Item
14 of Part IV of this Report and is incorporated into this item by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL
DISCLOSURE.
Not applicable.
23
<PAGE> 24
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information regarding the executive officers and directors of the Company
is incorporated by reference to the information set forth under the caption
"Business--Executive Officers and Directors" and under the caption "Proposal
One: Election of Directors" in the Company's Proxy Statement for the Annual
Meeting of Stockholders to be filed with the Commission within 120 days after
the end of the Company's year ended December 31, 1997.
ITEM 11. EXECUTIVE COMPENSATION.
Information regarding executive compensation is incorporated by reference
to the information set forth under the caption "Executive Compensation" in the
Company's Proxy Statement for the Annual Meeting of Stockholders to be filed
with the Commission within 120 days after the end of the Company's year ended
December 31, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information regarding security ownership of certain beneficial owners and
management is incorporated by reference to the information set forth under the
caption "Voting Securities of Principal Stockholders and Management" in the
Company's Proxy Statement for the Annual Meeting of Stockholders to be filed
with the Commission within 120 days after the end of the Company's year ended
December 31, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information regarding certain relationships and related transactions is
incorporated by reference to the information set forth under the caption
"Executive Compensation -Certain Transactions" in the Company's Proxy Statement
for the Annual Meeting of Stockholders to be filed with the Commission within
120 days after the end of the Company's year ended December 31, 1997.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this Report:
1. Financial Statements. The following financial statements
of the Company and the Report of Price Waterhouse LLP,
Independent Accountants, are included in Part IV of this Report
on the pages indicated:
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Balance Sheet as of December 31, 1996 and 1997 . . . . . . . . . . . . . . . . . . . . . 27
Statement of Operations for the years ended December 31, 1995, 1996 and 1997
and for the period May 11, 1987 (inception) to December 31, 1997 . . . . . . . . . . . 28
Statement of Stockholders' Equity for the period from May 11, 1987 (inception)
to December 31, 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Statement of Cash Flows for the years ended December 31, 1995, 1996 and
1997 and for the period May 11, 1987 (inception) to December 31, 1997 . . . . . . . . . 30
Notes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
</TABLE>
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or the notes thereto.
24
<PAGE> 25
2. Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ -------------------------------------------------------------------------------------------------------------------
<S> <C>
3.1(2) Amended and Restated Certificate of Incorporation of the Registrant (Exhibit 3.3).
3.2(1) Bylaws of the Registrant (Exhibit 3.4).
10.1(1)* Technology Agreement between the Registrant and Lockheed Corporation dated January 8, 1988.
10.2(1) Technical Information Exchange Agreement between the Registrant and Philips dated September 1989.
10.3(1) Standard Industrial Lease between the Registrant and UML Real Estate Partnership dated January 1, 1990; Sublease
between Registrant and Consolidated Packaging Machinery Company dba Industrial Automation Corporation dated October
25, 1989.
10.4(1) Form of Consulting Agreement.
10.5(1) Form of Employee Proprietary Information Agreement.
10.6(1) Offer of Employment Letter to William D. Baker dated December 21, 1991.
10.7(1) Offer of Employment Letter to Gregory L. Hey-Shipton dated May 7, 1991, as amended.
10.9(1) 1992 Director Option Plan.
10.10(1) Form of Indemnification Agreement.
10.11(1) License Agreement between the Registrant and the University of Arkansas dated April 9, 1992, as amended.
10.15(1) Loan and Security Agreement between the Registrant and Silicon Valley Bank dated May 17, 1991, as amended.
10.17(1) 1992 Stock Option Plan.
10.19(1) Proprietary Information & Patents Inventions Agreement among the Registrant, E-Systems, Inc. and various other
parties; Purchase Order dated October 10, 1991.
10.20(1)* Joint Venture Company (JVC) Agreement between the Registrant and Sunpower Incorporated dated April 2, 1992.
10.21(1) Government Contract issued to Registrant by the Defense Advanced Research Projects Agency through the Office of
Naval Research dated September 4, 1991.
10.22(1) Offer of Employment Letter to Daniel Hu dated November 23, 1992.
10.25(2)* License Agreement between the Registrant and E.I. DuPont de Nemours and Company dated December 1992.
10.26(1) Note and Warrant Purchase Agreement dated December 28, 1992.
10.27(2) Form of Representative's Warrant Agreement.
10.28(3)* Superconductor Technologies Inc. Purchase Agreement.
10.29(4) Loan and Security Agreement between Registrant and Silicon Valley Bank dated August 26, 1994.
10.30(4) Form of Distribution Agreement.
10.31(4) Amended and Restated 1988 Stock Option Plan, as amended, with form of stock option agreement.
10.32(5) Loan and Security Agreement between Registrant and Silicon Valley Bank dated June 27, 1995.
10.33(6)* Joint Venture Agreement between Registrant and Alantac Technologies (S) Pte Ltd., dated May 20, 1996.
10.34(7) Employment Offer Letter to M. Peter Thomas dated April 3,1997.
10.35 Employment Agreement with E. Ray Cotten dated July 1, 1997.
24.1 Power of Attorney (see page 39).
</TABLE>
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (Reg. No. 33-56714).
(2) Incorporated by reference from Amendment No. 1 to the Registrant's
Registration Statement on Form S-1 (Reg. No. 33-56714).
(3) Incorporated by reference from the Registrant's Annual Report on Form
10-K filed for the year ended December 31, 1993.
(4) Incorporated by reference from the Registrant's Annual Report on Form
10-K filed for the year ended December 31, 1994.
(5) Incorporated by reference from the Registrant's Annual Report on Form
10-K filed for the year ended December 31, 1995.
(6) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (Reg. No. 333-10569).
(7) Incorporated by reference from the Registrant's Report on Form 10-Q
filed on May 8, 1997 for the quarter ended March 29,1997. The exhibit
listed is incorporated by reference to Exhibit 10.1 of Registrant's
Report on Form 10-Q.
* Confidential treatment has been previously granted for certain portions
of these exhibits.
(b) Reports on Form 8-K. No reports on Form 8-K were filed by the
Company during the last quarter of the year ended December 31,
1997.
(c) Exhibits. See Item 14(a) above.
25
<PAGE> 26
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Stockholders of
Superconductor Technologies Inc. (a Development Stage Enterprise)
In our opinion, the accompanying balance sheet and the related statements of
operations, of stockholders' equity and of cash flows present fairly, in all
material respects, the financial position of Superconductor Technologies Inc.
(a Development Stage Enterprise) at December 31, 1996 and 1997, and the results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1997, and the period from May 11, 1987 (inception) to
December 31, 1997, in conformity with generally accepted accounting principles.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, 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.
PRICE WATERHOUSE LLP
Los Angeles, California
February 18, 1998, except as to Note 10,
which is as of March 26, 1998.
26
<PAGE> 27
SUPERCONDUCTOR TECHNOLOGIES INC.
(A Development Stage Enterprise)
BALANCE SHEET
<TABLE>
<CAPTION>
ASSETS DECEMBER 31, DECEMBER 31,
--------------------------------
1996 1997
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,599,000 $ 1,438,000
Short-term investments 4,272,000 2,099,000
Accounts receivable 1,599,000 1,048,000
Inventory 502,000 677,000
Prepaid expenses and other current assets 183,000 146,000
------------ ------------
Total current assets 9,155,000 5,408,000
Note receivable from related party 150,000 0
Property and equipment, net of accumulated depreciation
of $5,762,000 and $6,534,000, respectively 1,799,000 2,456,000
Patents and licenses, net of accumulated amortization
of $835,000 and $1,057,000, respectively 2,204,000 2,152,000
Other assets, net of accumulated
amortization of $86,000 in both years 36,000 71,000
------------ ------------
Total assets $ 13,344,000 $ 10,087,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 935,000 $ 1,407,000
Accrued compensation 313,000 437,000
Current portion of long-term debt 423,000 64,000
Billings in excess of cost and earnings on uncompleted
contracts 306,000 0
------------ ------------
Total current liabilities 1,977,000 1,908,000
Long-term debt 77,000 13,000
------------ ------------
Total liabilities 2,054,000 1,921,000
------------ ------------
Commitments and contingencies
Stockholders' equity:
Preferred Stock, $.001 par value, 2,000,000 shares authorized,
none issued and outstanding 0 0
Common Stock, $.001 par value, 15,000,000 shares authorized,
7,575,660 and 7,699,581 shares issued and outstanding 8,000 8,000
Capital in excess of par value 34,794,000 35,211,000
Deficit accumulated during development stage (23,512,000) (27,053,000)
------------ ------------
Total stockholders' equity 11,290,000 8,166,000
------------ ------------
Total liabilities and stockholders' equity $ 13,344,000 $ 10,087,000
============ ============
</TABLE>
See accompanying notes to the financial statements.
27
<PAGE> 28
SUPERCONDUCTOR TECHNOLOGIES INC.
(A Development Stage Enterprise)
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED
DECEMBER 31,
<TABLE>
<CAPTION>
MAY 11, 1987
(INCEPTION) TO
1995 1996 1997 DECEMBER 31, 1997
------------ ------------ ------------ -----------------
<S> <C> <C> <C> <C>
Net Revenues:
Government contract revenues $ 7,310,000 $ 7,104,000 $ 8,104,000 $ 45,108,000
Commercial product revenues 300,000 250,000 175,000 1,898,000
Sub license royalties 0 38,000 38,000 539,000
------------ ------------ ------------ ------------
Total net revenues 7,610,000 7,392,000 8,317,000 47,545,000
------------ ------------ ------------ ------------
Costs and expenses:
Contract research and development 5,414,000 5,721,000 6,218,000 35,428,000
Other research and development
and commercial 2,397,000 2,260,000 1,809,000 18,035,000
Selling, general and administrative 2,871,000 2,967,000 4,076,000 22,651,000
------------ ------------ ------------ ------------
Total costs and expenses 10,682,000 10,948,000 12,103,000 76,114,000
------------ ------------ ------------ ------------
Loss from operations (3,072,000) (3,556,000) (3,786,000) (28,569,000)
Interest income 353,000 156,000 275,000 2,890,000
Interest expense (100,000) (71,000) (30,000) (1,255,000)
Other income (expense), net 0 0 0 (119,000)
------------ ------------ ------------ ------------
Net loss $ (2,819,000) $ (3,471,000) $ (3,541,000) $(27,053,000)
============ ============ ============ ============
Basic and diluted loss per share $ (0.47) $ (0.57) $ (0.46)
============ ============ ============
Weighted average number of
shares outstanding 6,025,790 6,117,126 7,701,435
============ ============ ============
</TABLE>
See accompanying notes to the financial statements.
28
<PAGE> 29
SUPERCONDUCTOR TECHNOLOGIES INC.
(A Development Stage Enterprise)
STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
UNREALIZED
DEFICIT GAIN/(LOSS)
CAPITAL ACCUMULATED ON
COMMON STOCK CONVERTIBLE PREFERRED IN EXCESS COMMON STOCK DURING AVAILABLE
--------------- ----------- --------- OF PAR SUBSCRIPTIONS DEVELOPMENT FOR-SALE
SHARES AMOUNT SHARES AMOUNT VALUE RECEIVABLE STAGE SECURITIES TOTAL
------- ------ ----------- ---------- --------- ------------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Issued to directors 310,000 $1,000 $ 99,000 $ 100,000
Issued for acquisition 250,000 25,000 25,000
Issued to employees
and consultants 772,542 1,000 222,000 $ (176,000) 47,000
Issued for services 6,000 42,000 42,000
Payment received on
common stock sub-
scription receivable 3,000 3,000
Series A preferred
stock issued 615,000 $ 1,000 427,000 428,000
Series B preferred
stock issued 2,546,482 3,000 7,576,000 7,579,000
Repurchase of common
stock and elimination
of related sub-
scription receivable (42,301) (17,000) 23,000 6,000
Series D preferred
stock issued 2,394,288 2,000 8,268,000 8,270,000
Compensation expense 371,000 371,000
Initial public offering
of shares 1,500,000 1,000 12,730,000 12,731,000
Conversion of
preferred shares 2,777,885 3,000 (5,555,770) (6,000) 3,000
Exercise of
stock options 381,044 245,000 (33,000) 212,000
Repayment of
stockholder note 150,000 150,000
Unrealized loss on
available-for-sale
securities $(102,000) (102,000)
Net loss from 5/11/87
(inception)
through 12/31/94 ($17,222,000) (17,222,000)
========= ====== ========== ====== ============ ========== ============ ========= ==========
Balance at 12/31/94 5,955,170 6,000 29,991,000 (33,000) (17,222,000) 102,000 12,640,000
Exercise of
stock options 70,895 61,000 33,000 94,000
Compensation expense 70,000 70,000
Unrealized gain on
available-for-sale
securities 102,000 102,000
Net loss (2,819,000) (2,819,000)
========= ====== =========== =========== ========= ========== ==========
Balance at 12/31/95 6,026,065 6,000 30,122,000 (20,041,000) 10,087,000
Exercise of
stock options 48,248 74,000 74,000
Cashless exercise
of warrants 1,347
Secondary offering 1,500,000 2,000 4,582,000 4,584,000
Compensation expense 16,000 16,000
Net loss (3,471,000) (3,471,000)
--------- ------ --------- --------- ------------ -------- ----------- --------- ----------
Balance at 12/31/96 7,575,660 8,000 -- -- 34,794,000 -- (23,512,000) 11,290,000
Exercise of
stock options 123,921 417,000 417,000
Net loss (3,541,000) (3,541,000)
========= ====== ========= ========= =========== ========= =========== ========= ==========
Balance at 12/31/97 7,699,581 $8,000 -- $ -- $35,211,000 $ -- ($27,053,000) $ -- $8,166,000
========= ====== ========= ========= =========== ========= =========== ========= ==========
</TABLE>
See accompanying notes to the financial statements
29
<PAGE> 30
SUPERCONDUCTOR TECHNOLOGIES INC.
(A Development Stage Enterprise)
STATEMENT OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(NOTE 11)
<TABLE>
<CAPTION>
MAY 11, 1987
FOR THE YEAR ENDED (INCEPTION) TO
DECEMBER 31, DECEMBER 31,
1995 1996 1997 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (2,819,000) $ (3,471,000) $ (3,541,000) $(27,053,000)
Adjustments to reconcile net loss to net cash used for
operating activities:
Depreciation and amortization 1,145,000 1,101,000 995,000 7,831,000
Compensation expense associated with stock options granted 70,000 16,000 0 457,000
Loss on disposal of property and equipment 0 0 0 89,000
Common stock issued for services 0 0 0 42,000
Changes in assets and liabilities:
Accounts receivable (156,000) (286,000) 551,000 (1,048,000)
Note receivable from related party 0 0 150,000 0
Inventory 66,000 (274,000) (175,000) (677,000)
Prepaid expenses and other current assets (139,000) 65,000 37,000 (146,000)
Patents and licenses (441,000) (156,000) (171,000) (1,768,000)
Other assets 0 1,000 (35,000) (169,000)
Accounts payable and accrued expenses (184,000) 515,000 596,000 1,788,000
Billings in excess of cost and earnings on
uncompleted contracts 200,000 106,000 (306,000) 0
------------ ------------ ------------ ------------
Net cash used in operating activities (2,258,000) (2,383,000) (1,899,000) (20,654,000)
------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Change in short-term investments 2,766,000 (1,458,000) 2,173,000 (2,099,000)
Purchases of property and equipment (426,000) (289,000) (1,429,000) (6,740,000)
Proceeds from sale of property and equipment 0 0 0 922,000
------------ ------------ ------------ ------------
Net cash provided by (used in) by investing activities 2,340,000 (1,747,000) 744,000 (7,917,000)
------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings 134,000 57,000 0 1,916,000
Principal payments on long-term obligations (332,000) (416,000) (423,000) (4,679,000)
Proceeds from sale of preferred and common stock 94,000 4,658,000 417,000 32,772,000
------------ ------------ ------------ ------------
Net cash (used in) provided by financing activities (104,000) 4,299,000 (6,000) 30,009,000
------------ ------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents (22,000) 169,000 (1,161,000) 1,438,000
Cash and cash equivalents at beginning of period 2,452,000 2,430,000 2,599,000
------------ ------------ ------------ ------------
0
------------
Cash and cash equivalents at end of period $ 2,430,000 $ 2,599,000 $ 1,438,000 $ 1,438,000
============ ============ ============ ============
</TABLE>
See accompanying notes to the financial statements.
30
<PAGE> 31
SUPERCONDUCTOR TECHNOLOGIES INC.
(A Development Stage Enterprise)
NOTES TO FINANCIAL STATEMENTS
NOTE 1--THE COMPANY
Superconductor Technologies Inc. (the "Company") was incorporated in
Delaware on May 11, 1987 and maintains its facilities at a single location in
Santa Barbara, California. Since formation, the Company has been principally
engaged in research and development activities relating to advanced electronic
products that incorporate high temperature superconducting ("HTS") materials.
The Company has recently shifted its focus to the commercialization and
manufacture of its HTS products, while continuing to pursue product development
activities. The Company has targeted its products toward commercial
applications in the worldwide wireless communications and government markets.
In addition, the Company is involved as either contractor or subcontractor on a
number of contracts with the United States Government. Credit risk related to
accounts receivable arising from such contracts is considered minimal. For the
years ended December 31, 1995, 1996 and 1997, government related contracts
accounted for 96%, 96% and 97%, respectively, of the Company's revenues.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
Cash and cash equivalents consist of highly liquid investments with
original maturities of three months or less.
Short-Term Investments
Short-term investments consist of highly liquid investments with original
maturities in excess of three months. Such investments are stated at fair
market value. Management believes that the financial institutions and
companies in which it has made such short-term investments are financially
sound and, accordingly, minimal credit risk exists with respect to these
investments.
Revenue Recognition
Revenues are principally generated under research and development
contracts. Contract revenues are recognized utilizing the percentage-of-
completion method measured by the relationship of costs incurred to total
estimated contract costs. If the current contract estimate were to indicate a
loss, utilizing the funded amount of the contract, a provision would be made
for the total anticipated loss. Revenues from research related activities are
derived primarily from contracts with agencies of the United States Government.
These contracts include cost-plus, fixed price and cost sharing arrangements
and are generally short-term in nature.
All payments to the Company for work performed on contracts with agencies
of the U.S. Government are subject to adjustment upon audit by the Defense
Contract Audit Agency. Based on historical experience and review of current
projects in process, management believes that the audits will not have a
significant effect on the financial position, results of operations or cash
flows of the Company.
Research and Development Costs
Research and development costs are expensed as incurred. Research and
development costs incurred solely in connection with research and development
contracts are charged to contract research and development expense. Other
research and development costs are charged to research and development expense.
Inventories
Inventories are stated at the lower of cost or market. Costs are
determined using the first-in, first-out method.
Property and Equipment
Property and equipment are recorded at cost. Property and equipment and
furniture and fixtures are depreciated using the straight-line method over
their estimated useful lives ranging from three to seven years. Leasehold
improvements and assets financed under capital leases are amortized over the
shorter of their useful lives or the lease term. Expenditures for additions
and major improvements are capitalized. Expenditures for repairs and
maintenance and minor improvements are charged to expense as incurred. When
property or equipment is retired or otherwise disposed of, the related cost and
accumulated depreciation are removed from the accounts. Gains or losses from
retirements and disposals are recorded as other income or expense.
31
<PAGE> 32
Patents and Licenses
Patents and licenses are recorded at cost and are amortized using the
straight-line method over their estimated useful lives or seventeen years,
whichever is shorter. The recoverability of carrying values of patents and
licenses is evaluated on a recurring basis.
Income Taxes
The Company has adopted Statement of Financial Accounting Standards No. 109
("SFAS 109"), "Accounting for Income Taxes". SFAS 109 utilizes an asset and
liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that have been
recognized in the Company's financial statements or tax returns. In estimating
future tax consequences, SFAS 109 generally considers all expected future
events other than enactments of changes in the tax law or rates.
Net Loss Per Share
In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128 ("SFAS 128"), "Earnings per Share". Basic net loss per share is
computed by dividing net loss available to common stockholders by the weighted
average number of common shares outstanding in each year. Diluted net loss per
share is computed by dividing income available to common stockholders plus
income associated with dilutive securities by the weighted average number of
common shares outstanding plus any potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock in each year. Exercise of options and warrants or other
potential common stock is not assumed as the result would have been
antidilutive considering the Company's reported net loss from operations for
all periods presented.
Stock-based Compensation
The Company measures and records compensation expense relating to stock
options as the difference, if any, between the market value of shares on the
date of option grant and the exercise price of the option. Such expense is
accrued ratably over the period to be benefited.
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 amounts reported in the financial statements and
the accompanying notes. Actual results could differ from those estimates and
such differences may be material to the financial statements.
Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts receivable,
accounts payable and accrued expenses approximates fair value due to the short
term nature of these instruments. The Company estimates that the carrying
amount of the note payable approximates fair value based on the Company's
current incremental borrowing rates for similar types of borrowing
arrangements.
NOTE 3--SHORT-TERM INVESTMENTS
In accordance with the provisions of Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 115"), the Company classifies investments in short-term debt
securities as "available-for-sale" and reports them at fair value on the
balance sheet with unrealized gains and losses charged or credited to a
separate component of stockholders' equity. Available-for-sale securities are
those securities that may be sold prior to maturity in response to liquidity or
other factors. At December 31, 1996 and 1997, the aggregate fair market value
of the debt securities was $5,840,000 and $2,690,000, respectively, which
approximates the aggregate cost.
NOTE 4--PATENTS AND LICENSES
The Company has focused its development efforts on thallium barium calcium
copper oxide ("TBCCO") materials and, to a lesser extent, on yttrium barium
copper oxide ("YBCO") materials. Several U.S. patents have been issued to the
University of Arkansas covering TBCCO, and the Company has an exclusive
worldwide license (including the right to sublicense) under these patents,
subject to the University of Arkansas' right to conduct research related to the
patents. The consideration for the license included $250,000 in cash, prepaid
royalties of $750,000 through April 1995 and an aggregate of 400,000 shares of
Series D preferred stock valued at $1,382,000 (such Series D shares were
subsequently converted into 200,000 shares of common stock). Commencing April
1995, the Company has been obligated to pay royalties of 4% on sales of
TBCCO-based products, subject to a $100,000 annual minimum beginning after
April 1997, and royalties of 35% of sublicense revenues received by the
Company.
32
<PAGE> 33
In the event that the Company fails to pay minimum annual royalties, the
license automatically becomes non-exclusive. The license terminates upon
expiration of the right to claim damages for infringement of all the patents
covered. The license is being amortized over thirteen years which represents
the estimated useful life of the patent and the underlying material (TBCCO). As
the Company places reliance on its exclusive license, total or partial loss of
the license could have a material adverse effect on manufacturing, sales or
operating results.
The Company sublicensed certain of its rights in 1993, 1994 and 1996 in
exchange for non-refundable payments and royalties based on future sales, if
any, by the sublicensor. The Company has no future obligations with respect to
such sublicenses.
NOTE 5--LONG-TERM DEBT
In August 1994, the Company and its bank entered into an equipment financing
agreement. The agreement provided for borrowings of up to $1,500,000 through
the end of 1994, which are secured by substantially all of the Company's
assets. Amounts borrowed pursuant to this agreement accrue interest at the
annual rate of prime plus 1% and are to be repaid in 36 monthly installments
beginning January 1995. In October 1995, the Company extended and amended its
equipment financing arrangement in order to borrow an additional $500,000
through the end of 1995 at the same interest rate of the initial agreement.
Equipment financing and capital lease obligations comprise the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------- --------
1996 1997
-------- --------
<S> <C> <C>
Note payable to bank $467,000 $ 64,000
Capitalized lease obligations (Note 9) 33,000 13,000
-------- --------
Total 500,000 77,000
Current portion 423,000 64,000
-------- --------
Noncurrent portion $ 77,000 $ 13,000
======== ========
</TABLE>
NOTE 6--INCOME TAXES
As of December 31, 1997, the Company had federal net operating loss
carryforwards of approximately $18,277,000 and California net operating loss
carryforwards of approximately $5,914,000. The federal carryforwards will
expire during the years 1999 through 2012 and the California carryforwards will
expire during the years 1998 through 2002. As a result of research and
development activities to date, the Company has accumulated research and
development credit carryforwards of $640,000 and $257,000 for federal and
California purposes, respectively. These federal credit carryforwards will
expire during the years 2002 through 2012, while the California credit has no
expiration date. As of June 30, 1995, the provisions of the federal research
and development credit expired. It was reinstated on January 1, 1996.
Accordingly, no federal research and development credits may be claimed for
expenses incurred for the period June 30, 1995 through December 31, 1995.
Due to the uncertainty surrounding the realization of the favorable tax
attributes of such net operating loss carryforwards in future tax returns, the
Company has recorded a valuation allowance against its otherwise recognizable
deferred tax assets. Accordingly, no deferred tax asset has been recorded in
the accompanying balance sheet.
Under the provisions of the Tax Reform Act of 1986, when there has been a
change in an entity's ownership of fifty percent or greater, utilization of net
operating loss carryforwards may be limited. As a result of certain equity
transactions, the Company will be subject to such limitations. The annual
limitations have not been determined.
NOTE 7--STOCKHOLDERS' EQUITY
Public Offering
On November 27, 1996, the Company completed a secondary public offering for
1,500,000 shares of common stock resulting in approximately $4,584,000 of cash
proceeds to the Company, net of offering costs of $1,041,000. On January 9,
1997, the underwriter of the secondary offering exercised the option to
purchase an additional 100,000 shares of common stock resulting in $345,000 of
cash proceeds to the Company, net of offering costs of $30,000.
Preferred Stock
Pursuant to the Company's Certificate of Incorporation, the Board of
Directors is authorized to issue up to 2,000,000 shares of Preferred Stock (par
value $.001 per share) in one or more series and to fix the rights,
preferences, privileges, and restrictions, including the dividend rights,
conversion rights, voting rights, redemption price or prices, liquidation
preferences, and the number of shares constituting any series or the
designation of such series, without further vote or action by the stockholders.
The
33
<PAGE> 34
issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change of control of the Company without further action of the
stockholders. The issuance of Preferred Stock with voting and conversion
rights may adversely affect the voting power of the holders of Common Stock,
including the loss of voting control to others.
Stock Options
The Company has three stock option plans, the 1988 Stock Option Plan, the
1992 Stock Option Plan and the 1992 Directors' Stock Option Plan, a
nonstatutory stock option plan (collectively, the "Stock Option Plans"). Stock
awards may be made to directors, key employees, consultants, and non-employee
directors of the Company under the Stock Option Plans at prices no less than
100% of the market value on the date of grant. The stock options become
exercisable in four equal installments beginning one year after the date of
grant, and expire not more than ten years from the date of grant, with the
exception of 10% or greater stockholders which may have options granted at
prices no less than 50% of the market value on the date of grant, and expire
not more than five years from the date of grant. At December 31, 1997, options
for 599,292 shares of Common Stock were exercisable.
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, ("SFAS 123"), "Accounting for
Stock-Based Compensation." Accordingly, no compensation cost has been
recognized for the stock-based compensation other than for non-employees. If
the Company had elected to recognize compensation expense for employee awards
based upon the fair value at the grant date consistent with the methodology
prescribed by SFAS 123, the Company's net loss and net loss per share would
have been increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1995 1996 1997
------------- ------------- -------------
<S> <C> <C> <C>
Net loss:
As reported $(2,819,000) $(3,471,000) $(3,541,000)
Pro forma $(2,968,000) $(4,300,000) $(4,268,000)
Loss per share:
As reported $ (0.47) $ (0.57) $ (0.46)
Pro forma $ (0.49) $ (0.70) $ (0.56)
</TABLE>
These pro forma amounts may not be representative of future disclosures
since the estimated fair value of stock options is amortized to expense over
the vesting period, and additional options may be granted in future years. The
fair value of these options was estimated at the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions for the years ended December 31, 1995, 1996 and 1997, respectively:
dividend yields of zero percent each year; expected volatilities of 59, 52 and
51 percent; risk-free interest rates of 5.83, 6.16 and 6.12 percent; and
expected life of 2.84, 3.38 and 3.50 years. The weighted average fair value of
options granted for which the exercise price equals the market price on the
grant date was $2.00, $2.97 and $1.47, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value estimate,
in management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
34
<PAGE> 35
At December 31, 1997, 382,737 shares of Common Stock were available for
future grants and 1,453,672 options had been granted but not yet exercised.
Option activity during the three years ended December 31, 1997 was as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED AVERAGE
SHARES EXERCISE PRICE
------ --------------
<S> <C> <C>
Outstanding at December 31, 1994 1,016,179 $ 5.786
Granted 865,018 5.254
Canceled (742,854) 6.828
Exercised (70,895) 0.824
----------
Outstanding at December 31, 1995 1,067,448 4.959
Granted 565,034 6.958
Canceled (84,933) 6.278
Exercised (48,248) 1.609
----------
Outstanding at December 31, 1996 1,499,301 5.746
Granted 845,302 3.524
Canceled (882,494) 6.048
Exercised (8,437) 0.800
----------
Outstanding at December 31, 1997 1,453,672 4.333
==========
</TABLE>
The following table summarizes information concerning currently outstanding and
exercisable stock options:
<TABLE>
<CAPTION>
Number of Weighted Average Weighted Average Number Weighted Average
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices Options Contractual Life Price 12/31/97 Price
- --------------- ------- ---------------- ----- -------- -----
<S> <C> <C> <C> <C> <C>
$0.70-$3.125 306,826 7.29 $ 2.712 172,744 $ 2.639
$3.25-$3.75 418,550 9.34 $ 3.651 49,167 $ 3.725
$3.875-$4.75 123,300 9.16 $ 4.072 10,344 $ 4.204
$4.875-$4.875 311,875 7.85 $ 4.875 229,152 $ 4.875
$5.00-$7.625 293,121 8.23 $ 6.536 137,885 $ 6.555
======= ==== ========== ======= ==========
$0.70-$7.625 1,453,672 8.35 $ 4.333 599,292 $ 4.511
</TABLE>
Based upon certain factors, the Company subsequently determined that options
granted during the period June 1991 through October 1992 were issued at
exercise prices which were less than fair market value. As such, the
difference between the fair market value of these options and their exercise
price was charged against results of operations as compensation expense over
the options' vesting period. Related compensation expense recorded was
$92,000, $70,000 and $16,000 for the years ended December 31, 1994, 1995 and
1996, respectively. Deferred compensation was fully amortized at December 31,
1996.
In October 1997, the Board of Directors approved a Stock Option Repricing
Program for all directors. The Repricing Program was offered on an optional
basis to reprice the outstanding options held by the directors to $3.125, the
closing price of the Company's Common Stock as quoted on the Nasdaq National
Market on October 29, 1997. If the director elected to reprice the options, the
vesting schedule for the options was unchanged, however, the number of options
were reduced by one-third. Five directors with a total of 24 grants equal to
378,434 shares were eligible for repricing. The directors had until December 5,
1997 to exercise the repricing option. Three directors submitted 13 grants
totaling 232,500 shares for repricing. The original grants were canceled and
new options were issued totaling 155,002 shares. There was no recognizable
compensation expense as a result of the Repricing Program.
35
<PAGE> 36
Warrants
In May 1991, the Company entered into an equipment financing agreement with
certain lessors and entered into a new agreement with a bank. In connection
with these agreements, Series D warrants were granted to purchase 28,571 shares
of preferred stock at a price of $3.50 per share. These warrants were
partially exercised in 1996 and the remaining portion expired in 1996. In
December 1992, certain investors committed to make a line of credit available
to the Company. For this commitment, warrants were issued to purchase 44,447
shares of common stock at a price of $9.00 per share. The Company never drew
upon the line of credit. The warrants expired in 1997.
In March 1993, in conjunction with the Company's initial public offering,
the Company issued to the underwriter a warrant to purchase up to 120,750
shares of Common Stock at an exercise price equal to 120% of the offering
price. The Underwriter's Warrant is exercisable for a four year period
beginning March 9, 1994. Also in connection with the Company's initial public
offering all series of preferred stock warrants were automatically converted
into common stock warrants at a rate of two shares to one. In November 1996, in
conjunction with the Company's secondary offering, the Company issued to the
underwriter a warrant to purchase up to 150,000 shares of common stock at an
exercise price equal to 120% of the offering price. The Underwriter's Warrant
is exercisable for a four year period beginning November 22, 1997.
The following table summarizes warrant activity through December 31, 1997:
<TABLE>
<CAPTION>
COMMON STOCK
------------
<S> <C>
Outstanding at December 31,1994 and 1995 179,482
Granted 150,000
Exercised (11,175)
Expired (3,110)
--------
Outstanding at December 31, 1996 315,197
Expired (44,447)
========
Outstanding at December 31, 1997 270,750
========
</TABLE>
NOTE 8--EMPLOYEE SAVINGS PLAN
In December 1989, the Board of Directors approved a 401(k) savings plan
(the "401(k) Plan") for the employees of the Company which became effective in
1990. Eligible employees may elect to make contributions under the terms of
the 401(k) Plan, however, contributions by the Company are made at the
discretion of management. The Company has made no contributions to the Plan.
NOTE 9--LEASES
The Company leases its facilities under operating leases which contain
escalation clauses for increases in annual rent based upon increases in the Los
Angeles area consumer price index. Lease expirations range from December 1997
to December 1999. In addition, the Company leases certain property and
equipment under capital lease arrangements. Future minimum payments under
lease commitments are as follows:
<TABLE>
<CAPTION>
YEAR ENDING OPERATING
DECEMBER 31, LEASES
------------ ------
<S> <C>
1998 $284,000
1999 295,000
Thereafter 0
--------
Total minimum obligations $579,000
========
</TABLE>
For the years ended December 31, 1995, 1996 and 1997, rent expense was
$252,000, $266,000, and $318,000, respectively.
36
<PAGE> 37
Note 10--Subsequent Events
On March 26, 1998, the Company completed a private placement of 500,000
shares of Series A 6% Cumulative Convertible Preferred Stock ("Preferred
Shares") to certain investors at $6.00 per share. The proceeds of the offering,
net of offering expenses, totaled $3 million. Each Preferred Share is
convertible into Common Stock at $3 per share and carries a cumulative dividend
of 6% per annum. The Preferred Shares also have voting rights and liquidation
preferences. The Preferred Shares are not redeemable prior to March 26, 2001.
Thereafter, the Company may redeem the Preferred Shares at 110% of the carrying
amount plus accrued dividends. Subsequent to March 26, 2005, the holders of the
Preferred Shares have the option to redeem the Preferred Shares at their
carrying amount plus accrued dividends. The Company has an option, exercisable
through March 26, 1999, to sell up to an additional $2 million of Preferred
Shares under the same terms provided the Company meets a certain milestone.
On March 25, 1998 the Company accepted and signed a proposal to enter into a
master lease agreement for up to $3 million in lease financing at an annual rate
indexed to the yield of U.S. Treasury notes of similar maturity. The Company can
draw upon the master lease agreement as it acquires capital assets during the
year. The lease term is sixty months for each drawdown. As of March 26, 1998, no
amounts were outstanding under the lease line.
Upon execution of the master lease agreement, the Company believes that the
financing will be adequate to meet its operational needs over the next 12
months. However, in the event that the master lease agreement is not
successfully executed, the Company will be required to seek alternative
financing. Depending upon the timing of market acceptance of the Company's
products and the manufacturing ramp-up to support the market acceptance,
additional working capital financing may be required to fully implement the
Company's business plan.
NOTE 11--DETAILS OF CERTAIN FINANCIAL COMPONENTS AND SUPPLEMENTAL DISCLOSURES
OF CASH FLOW INFORMATION AND NON-CASH ACTIVITIES
Balance sheet data:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1996 1997
----------- -----------
<S> <C> <C>
Accounts receivable:
-----------
Billed accounts receivable $ 1,486,000 $ 621,000
Unbilled accounts receivable 113,000 427,000
----------- -----------
$ 1,599,000 $ 1,048,000
=========== ===========
Inventories:
-----------
Raw materials $ 200,000 $ 336,000
Work-in-process 281,000 302,000
Finished goods 21,000 39,000
----------- -----------
$ 502,000 $ 677,000
=========== ===========
Property and equipment:
-----------
Equipment $ 6,119,000 $ 7,319,000
Leasehold improvements 1,362,000 1,591,000
Furniture and fixtures 80,000 80,000
----------- -----------
7,561,000 8,990,000
Less: accumulated depreciation and amortization (5,762,000) (6,534,000)
----------- -----------
$ 1,799,000 $ 2,456,000
=========== ===========
</TABLE>
37
<PAGE> 38
Unbilled accounts receivable represent costs and profits in excess of billed
amounts on contracts-in-progress at year end. Such amounts are billed based
upon the terms of the contractual agreements. Such amounts are substantially
collected within one year.
At December 31, 1996 and 1997, property and equipment includes $36,000 and
$7,000 of assets financed under capital lease arrangements, net of $47,000 and
$66,000 of accumulated amortization, respectively. Depreciation expense
amounted to $933,000, $863,000 and $772,000 for the years ended December 31,
1995, 1996 and 1997, respectively.
Supplemental Cash Flow data:
The Company paid $100,000, $71,000 and $30,000 in interest expense during
the years ended December 31, 1995, 1996 and 1997, respectively.
NOTE 12--COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company, from time to time, is a
defendant on certain litigation, claims and inquiries. In addition, the Company
makes various commitments and can incur contingent liabilities. While it is not
feasible to predict the outcomes of these matters, the Company is not presently
aware of nor expects that any sum it may be required to pay in connection with
these matters would have a material effect on its financial position or results
of operation.
38
<PAGE> 39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized, on this 30th day of March
1998.
SUPERCONDUCTOR TECHNOLOGIES INC.
By:/s/ M. Peter Thomas
-------------------------------------
M. Peter Thomas
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints M. Peter Thomas and James G. Evans, Jr.
and each of them, jointly and severally, his attorneys-in-fact, each with full
power of substitution, for him in any and all capacities, to sign any and all
amendments to this Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each said
attorneys-in-fact or his substitute or substitutes, may do or cause to be done
by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K 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
--------- ----- ----
<S> <C> <C>
/s/ M. Peter Thomas President, Chief Executive Officer and Director March 30, 1998
- -------------------------------- (Principal Executive Officer)
M. Peter Thomas
/s/ James G. Evans, Jr. Vice President, Chief Financial Officer and March 30, 1998
- -------------------------------- Secretary (Principal Financial and Accounting
James G. Evans, Jr. Officer)
/s/ Glenn E. Penisten Chairman of the Board March 30, 1998
- --------------------------------
Glenn E. Penisten
/s/ E. Ray Cotten Vice Chairman of the Board March 30, 1998
- --------------------------------
E. Ray Cotten
/s/ Robert P. Caren Director March 30, 1998
- --------------------------------
Robert P. Caren
/s/ Dennis Horowitz Director March 30, 1998
- --------------------------------
Dennis Horowitz
/s/ John D. Lockton Director March 30, 1998
- --------------------------------
John D. Lockton
/s/ J. Robert Schrieffer Director March 30, 1998
- --------------------------------
J. Robert Schrieffer
</TABLE>
39
<PAGE> 40
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ -------------------------------------------------------------------------------------------------------------------
<S> <C>
3.1(2) Amended and Restated Certificate of Incorporation of the Registrant (Exhibit 3.3).
3.2(1) Bylaws of the Registrant (Exhibit 3.4).
10.1(1)* Technology Agreement between the Registrant and Lockheed Corporation dated January 8, 1988.
10.2(1) Technical Information Exchange Agreement between the Registrant and Philips dated September 1989.
10.3(1) Standard Industrial Lease between the Registrant and UML Real Estate Partnership dated January 1, 1990; Sublease
between Registrant and Consolidated Packaging Machinery Company dba Industrial Automation Corporation dated October
25, 1989.
10.4(1) Form of Consulting Agreement.
10.5(1) Form of Employee Proprietary Information Agreement.
10.6(1) Offer of Employment Letter to William D. Baker dated December 21, 1991.
10.7(1) Offer of Employment Letter to Gregory L. Hey-Shipton dated May 7, 1991, as amended.
10.9(1) 1992 Director Option Plan.
10.10(1) Form of Indemnification Agreement.
10.11(1) License Agreement between the Registrant and the University of Arkansas dated April 9, 1992, as amended.
10.15(1) Loan and Security Agreement between the Registrant and Silicon Valley Bank dated May 17, 1991, as amended.
10.17(1) 1992 Stock Option Plan.
10.19(1) Proprietary Information & Patents Inventions Agreement among the Registrant, E-Systems, Inc. and various other
parties; Purchase Order dated October 10, 1991.
10.20(1)* Joint Venture Company (JVC) Agreement between the Registrant and Sunpower Incorporated dated April 2, 1992.
10.21(1) Government Contract issued to Registrant by the Defense Advanced Research Projects Agency through the Office of
Naval Research dated September 4, 1991.
10.22(1) Offer of Employment Letter to Daniel Hu dated November 23, 1992.
10.25(2)* License Agreement between the Registrant and E.I. DuPont de Nemours and Company dated December 1992.
10.26(1) Note and Warrant Purchase Agreement dated December 28, 1992.
10.27(2) Form of Representative's Warrant Agreement.
10.28(3)* Superconductor Technologies Inc. Purchase Agreement.
10.29(4) Loan and Security Agreement between Registrant and Silicon Valley Bank dated August 26, 1994.
10.30(4) Form of Distribution Agreement.
10.31(4) Amended and Restated 1988 Stock Option Plan, as amended, with form of stock option agreement.
10.32(5) Loan and Security Agreement between Registrant and Silicon Valley Bank dated June 27, 1995.
10.33(6)* Joint Venture Agreement between Registrant and Alantac Technologies (S) Pte Ltd., dated May 20, 1996.
10.34(7) Employment Offer Letter to M. Peter Thomas dated April 3,1997.
10.35 Employment Agreement with E. Ray Cotten dated July 1, 1997.
24.1 Power of Attorney (see page 39).
</TABLE>
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (Reg. No. 33-56714).
(2) Incorporated by reference from Amendment No. 1 to the Registrant's
Registration Statement on Form S-1 (Reg. No. 33-56714).
(3) Incorporated by reference from the Registrant's Annual Report on Form
10-K filed for the year ended December 31, 1993.
(4) Incorporated by reference from the Registrant's Annual Report on Form
10-K filed for the year ended December 31, 1994.
(5) Incorporated by reference from the Registrant's Annual Report on Form
10-K filed for the year ended December 31, 1995.
(6) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (Reg. No. 333-10569).
(7) Incorporated by reference from the Registrant's Report on Form 10-Q
filed on May 8, 1997 for the quarter ended March 29, 1997. The exhibit
listed is incorporated by reference to Exhibit 10.1 of Registrant's
Report on Form 10-Q.
* Confidential treatment has been previously granted for certain portions
of these exhibits.
<PAGE> 1
Exhibit 10.35
SUPERCONDUCTOR TECHNOLOGIES, INC.
EMPLOYMENT AGREEMENT
This Agreement is entered into as of July 1, 1997, (the "Effective
Date") by and between Superconductor Technologies, Inc. (the "Company"), and E.
Ray Cotten (the "Employee").
In consideration of the promises and mutual covenants herein contained,
and other good and valuable consideration, the receipt and sufficiency of which
is hereby acknowledged, it is mutually covenanted and agreed by and between the
parties as follows:
1. POSITION AND DUTIES. Employee shall be employed, as of the Effective
Date, as Vice Chairman of the Company, reporting to the Company's Board of
Directors and President and CEO and assuming and discharging such
responsibilities as are commensurate with Employee's position. Employee
acknowledges that frequent travel may be necessary in carrying out his duties
hereunder. Employee shall perform his duties faithfully and to the best of his
ability and shall devote his full business time and effort to the performance of
his duties hereunder.
2. AT-WILL EMPLOYMENT. The parties agree that the Employee's employment
with the Company shall be "at-will" employment and may be terminated at any time
with or without cause or notice. No provision of this Agreement shall be
construed as conferring upon Employee a right to continue as an employee of the
Company.
3. COMPENSATION. For all services to be rendered by Employee pursuant
to this Agreement, Employee shall receive an annual base salary of $154,000 (the
"Base Salary"), payable monthly in accordance with the Company's normal payroll
practices.
4. OTHER BENEFITS. Employee shall be entitled to participate in the
employee benefit plans and programs of the Company, if any, to the extent that
his position, tenure, salary, age, health and other qualifications make him
eligible to participate in such plans or programs, subject to the rules and
regulations applicable thereto. The Company reserves the right to cancel or
change the benefit plans and programs it offers to its employees at any time.
5. EXPENSES. The Company shall reimburse Employee for reasonable
travel, entertainment or other expenses incurred by Employee in the furtherance
of or in connection with the performance of Employee's duties hereunder, in
accordance with the Company's expense reimbursement policy as in effect from
time to time.
-1-
<PAGE> 2
6. TERMINATION.
(A) INVOLUNTARY TERMINATION. If Employee's employment with the
Company terminates in an Involuntary Termination, then (i) Employee shall be
entitled to receive continuing payments of severance pay at a rate equal to
Employee's current Base Salary, and (ii) the Company shall make available to
Employee and Employee's spouse and dependents, at the Company's expense for a
period of twelve (12) months following Employee's termination, group health,
life and other similar insurance plans substantially comparable to the group
health, life and other similar insurance plans in which Employee or such
dependents participated on the date of such termination.
(B) OTHER TERMINATION. If Employee's employment terminates
other than in an Involuntary Termination, then Employee shall not be entitled to
receive severance or other benefits pursuant to this Agreement, but may be
eligible for those benefits (if any) as may then be established under the
Company's severance and benefits plans and policies existing at the time of such
termination.
7. DEFINITIONS.
(A) CAUSE. "Cause" shall mean the occurrence of any one or
more of the following: (i) Employee's conviction by, or entry of a plea of
guilty or nolo contendere in, a court of final jurisdiction for any crime which
constitutes a felony in the jurisdiction involved; (ii) Employee's
misappropriation of funds or commission of an act of fraud, whether prior or
subsequent to the date hereof, upon the Company; (iii) negligence by Employee in
the scope of Employee's services to the Company; (iv) a breach by Employee of a
material provision of this Agreement; or (v) a failure of Employee to
substantially perform his duties hereunder. Notwithstanding the foregoing,
Employee shall not be deemed to have been terminated for Cause without (i)
reasonable notice to Employee setting forth the reasons for Company's intention
to terminate for Cause, and (ii) an opportunity for Employee, together with his
counsel, if any, to be heard before the Board.
(B) INVOLUNTARY TERMINATION. "Involuntary Termination" shall
mean (i) without Employee's express written consent, a material reduction of
Employee's duties, position or responsibilities relative to Employee's duties,
position or responsibilities in effect immediately prior to such reduction, or
the removal of Employee from such position, duties and responsibilities, unless
Employee is provided with comparable duties, position and responsibilities; (ii)
without Employee's express written consent, a material reduction of the
facilities and perquisites (including office space and location) available to
Employee immediately prior to such reduction; (iii) without Employee's express
written consent, a reduction by the Company of Employee's Base Salary in effect
immediately prior to such reduction; (iv) a material reduction by the Company in
the kind or level of employee benefits to which the Employee is entitled
immediately prior to such reduction with the result that the Employee's overall
benefits package is significantly reduced; (v) any purported termination of the
Employee by the Company which is not effected for Cause or for which the grounds
relied upon are not valid; or (vi) the failure of the Company to obtain the
assumption of this Agreement by any successors contemplated in Section 11 below.
-2-
<PAGE> 3
8. RIGHT TO ADVICE OF COUNSEL. Employee acknowledges that he has had
the right to consult with counsel and is fully aware of his rights and
obligations under this Agreement.
9. SUCCESSORS.
(A) COMPANY'S SUCCESSORS. Any successor to the Company
(whether direct or indirect and whether by purchase, lease, merger,
consolidation, liquidation or otherwise) to all or substantially all of the
Company's business and/or assets shall assume the obligations under this
Agreement and agree expressly to perform the obligations under this Agreement in
the same manner and to the same extent as the Company would be required to
perform such obligations in the absence of a succession. For all purposes under
this Agreement, the term "Company," shall include any successor to the Company's
business and/or assets which executes and delivers the assumption agreement
described in this subsection (a) or which becomes bound by the terms of this
Agreement by operation of law.
(B) EMPLOYEE'S SUCCESSORS. Without the written consent of the
Company, Employee shall not assign or transfer this Agreement or any right or
obligation under this Agreement to any other person or entity. Notwithstanding
the foregoing, the terms of this Agreement and all rights of Employee hereunder
shall inure to the benefit of, and be enforceable by, Employee's personal or
legal representatives, executors, administrators, successors, heirs,
distributees, devisees and legatees.
10. NOTICE CLAUSE.
(A) MANNER. Any notice hereby required or permitted to be
given shall be sufficiently given if in writing and upon mailing by registered
or certified mail, postage prepaid, to either party at the address of such party
or such other address as shall have been designated by written notice by such
party to the other party.
(B) EFFECTIVENESS. Any notice or other communication required
or permitted to be given under this Agreement will be deemed given on the day
when delivered in person, or the third business day after the day on which such
notice was mailed in accordance with Section 12(a).
11. GOVERNING LAW. This Agreement shall be governed by and construed in
accordance with the internal substantive laws, but not the choice of law rules,
of the state of California.
12. SEVERABILITY. The invalidity or unenforceability of any provision
of this Agreement, or any terms hereof, shall not affect the validity or
enforceability of any other provision or term of this Agreement.
13. INTEGRATION. This Agreement represents the entire agreement and
understanding between the parties as to the subject matter herein and supersedes
all prior or contemporaneous agreements whether written or oral. No waiver,
alteration, or modification of any of the provisions of this Agreement shall be
binding unless in writing and signed by duly authorized representatives of the
parties hereto.
-3-
<PAGE> 4
14. TAXES. All payments made pursuant to this Agreement shall be
subject to withholding of applicable income and employment taxes.
IN WITNESS WHEREOF, each of the parties has executed this Agreement, in
the case of the Acquiror and the Company by their duly authorized officers, as
of the day and year first above written.
SUPERCONDUCTOR TECHNOLOGIES, INC.
By: /s/ James G. Evans, Jr.
------------------------------------
Title: Vice President and Chief Financial Officer
-------------------------------------------
EMPLOYEE:
/s/ E. Ray Cotten
-----------------------------------
Name
-4-
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<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 847,000
<SECURITIES> 2,690,000
<RECEIVABLES> 1,048,000
<ALLOWANCES> 0
<INVENTORY> 677,000
<CURRENT-ASSETS> 5,408,000
<PP&E> 8,990,000
<DEPRECIATION> 6,534,000
<TOTAL-ASSETS> 10,087,000
<CURRENT-LIABILITIES> 1,908,000
<BONDS> 0
0
0
<COMMON> 8,000
<OTHER-SE> 35,211,000
<TOTAL-LIABILITY-AND-EQUITY> 10,087,000
<SALES> 0
<TOTAL-REVENUES> 8,317,000
<CGS> 0
<TOTAL-COSTS> 10,294,000
<OTHER-EXPENSES> 1,809,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 30,000
<INCOME-PRETAX> (3,541,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (23,512,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,541,000)
<EPS-PRIMARY> (0.46)
<EPS-DILUTED> (0.46)
</TABLE>
