Back to GetFilings.com
1
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, 1998
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
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
460 WARD DRIVE, 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 Stock Market(R) on February 16, 1999) was approximately $30,135,942. 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 23, 1999 was
7,729,716.
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 June 2, 1999.
2
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" include, but are not limited to, under
the caption entitled "Factors Affecting Future Business Operations--Disclosure
Regarding Forward-Looking Statements", "Item 7- Management's Discussion and
Analysis of Financial Condition and Results of Operations," and "Fluctuations in
Periodic Results."
INTRODUCTION AND OVERVIEW
Superconductor Technologies Inc. ("STI" or the "Company") operates in a
single business segment to develop, manufacture and market products made from
superconducting 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
developed its SuperFilter(R) 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(R) 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.
In 1998, the Company completed the transition from its focus on research and
development by successfully manufacturing and delivering its SuperFilter(R)
TWO-Pak products. STI introduced the TWO-Pak SuperFilter(R) for application in
the AMPS/B segment of the cellular market in 1997 and introduced the AMPS/A
product in 1998. Recently, STI also introduced the SIX-Pak SuperFilter(R) for
both A Band and B Band in order to enhance coverage in urban areas. As a result
of these product introductions, the Company significantly expanded its sales and
marketing efforts. STI employs three Regional Sales Managers and a Director of
Sales to cover the United States and Latin America. Additionally, the Company
recently added a Senior Vice President of Sales and Marketing to bring focused
senior-level management experience to its sales and marketing efforts. The
Company's initial sales and marketing efforts were directed primarily at rural
and suburban cellular providers because the Company believed they were likely to
be early users of the product. The Company's products address the critical needs
of these service providers: range coverage and call quality. In addition, STI
now actively markets its new SIX-Pak SuperFilter(R) as a practical urban
application and expects that sales will increase significantly in this area.
The augmented SuperFilter(R) product line and increased sales activities
resulted in multiple product orders in 1998. The Company conducted field trials
of its products with more than thirty cellular service providers, including nine
of the top ten carriers in the country, resulting in orders for over 100
systems. The Company shipped eighty-three SuperFilter(R) systems in 1998 as a
result of these orders. In order to prove the economic benefits of the product,
the Company continues to actively conduct numerous demonstrations and field
trials in the United States and in Latin America.
In order to support the SuperFilter(R) product line, the Company built a new
18,000 square foot state of the art manufacturing facility in Santa Barbara,
which opened in 1998. Currently, this facility, along with the manufacturing
equipment and tooling procured in 1998, has the capacity to produce up to three
SuperFilter(R) products a day. Operating units within this facility are capable
of producing all the critical components of STI's products including
superconducting filters, cryogenic coolers, cryogenic packaging and final
enclosures, as well as system assembly and test, quality and material control
functions. Additionally, the Company doubled the number of manufacturing
personnel as production has increased.
In addition to strengthening its manufacturing capability, STI also
strengthened its management capability in 1998 by adding a Vice President of
Wireless Manufacturing, a Director of Marketing, by promoting a Regional Sales
Manager to Director of Sales and making the previous Vice President of
Operations the Vice President of Material Operations. The Company believes it
has the management structure to allow for its projected growth.
A critical component of all superconducting applications is the cryogenic
cooling system. STI developed a proprietary cryogenic cooler, which, in addition
to being integrated into its SuperFilter(R) systems, has the potential to be
used in other applications. These other applications include medical products,
cold computing to increase the processing speed of computers and components of
various kinds of instrumentation. 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 associated with volume production.
Since its formation in 1987, the Company has received over $51 million
dollars in revenue from government research and development contracts, through
which it developed much of the technology used in its commercial products. STI
2
3
continues to secure government contracts, primarily to fund its research and
development efforts, and to address potential wireless product opportunities in
the government sector.
STI'S STRATEGY
STI's objective is to establish commercial leadership by marketing its
SuperFilter(R) products to wireless service providers. Utilizing HTS thin-film
technology, the Company's products offer superior filter selectivity and
sensitivity, which produce enhanced range extension and minimize interference.
Wireless service providers are able to enhance their revenue through the use of
STI products.
Several years ago, the Company identified the wireless market as the most
viable path to commercialization of HTS because of 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 worldwide wireless market is expected to grow at an
annual compounded growth rate of over 20% during the next five years. The United
States market for tower mount amplifiers and repeaters, products that also
extend coverage, is projected by World Information Technologies to grow at the
rate of 30% through 2001. The Company believes that market acceptance for its
products will increase, providing an opportunity to displace some of the other
coverage enhancement products in this segment. STI's approach to product
development is to harness the power of superconductivity with a high degree of
technology 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 are designed, developed and manufactured
in-house, which the Company believes provides strategic and cost advantages.
Through the use of proprietary computer simulation software developed
internally, STI designs advanced RF circuitry and prototypes using HTS
materials. The result is 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 that its standard platform is the smallest and most energy-efficient
superconducting filter system in the industry.
The Company believes the early market acceptance for its product will be
from wireless service providers because they are faced with resolving critical
performance issues within the wireless networks. In particular, cellular service
providers, who are encountering increasing competition from new Personal
Communication Services (PCS) providers, are most likely to test and use this
advanced technology to solve their performance problems. Service enhancements
such as coverage in "dead zones," increased range of the base station, reduction
in dropped calls and decreased static respond to some of the most common user
complaints, which give rise to customer churn among service providers. The
Company believes its SuperFilter(R) products provide effective and economical
solutions to these critical problems. In order to penetrate the wireless service
provider market, STI must appeal directly to the service providers and
effectively demonstrate the superior return on investment provided by its
products.
Due to the proprietary and technological nature of the Company's product and
in order to produce a high quality product, the Company decided to manufacture
the key components of its product internally. These key components include
superconducting filters, cryogenic coolers, cryogenic packaging and final
enclosures, as well as system assembly and test, quality and material control
functions. 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 1998, the Company began volume production of SuperFilter(R) systems
within its newly expanded manufacturing facility. Additional capital equipment
was acquired and the manufacturing employee base doubled 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(R) 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 products provide 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.
THE WIRELESS MARKET
Several wireless industry analysts estimates the worldwide number of
wireless subscribers will double in less than 4 years from 257 million in 1998
to 550 million in 2002. To provide services to these customers it is estimated
that the number of installed base stations will increase from 200,000 in 1998 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
3
4
high performance products could receive a wider range of use to resolve these
increasing problems.
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. This is evidenced by the many different rate plans offered to users of
wireless telephones by the wireless service providers. 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 landline communications system. Accordingly, many
developing regions, including Latin America, 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. As a result of the PCS frequency
auctions, the number of licensed wireless service providers in any given service
area has increased from two to as many as five, thereby increasing competition
and creating pressure for cellular and PCS service providers to provide the
highest quality services possible.
THE WIRELESS NETWORK AND RELATED 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.
Another issue is interference due to the imperfect RF channel selectivity of
filtering components. 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, causing poor service to
wireless customers. 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 dramatically degrade
service quality, a wireless filter system that reduces interference can provide
a meaningful advantage in this increasingly competitive market.
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.
See "Competition."
4
5
STI'S WIRELESS PRODUCT PERFORMANCE
The Company believes that its SuperFilter(R) systems offer solutions to some
of the most pressing constraints facing the wireless industry: range, size and
interference. Each SuperFilter(R) 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. Through extended use or
field trials, STI's customers observed the following results through the use of
the SuperFilter(R) product:
o Call Traffic increased by up to 101%
o Dropped call percentage decreased by up to 40%
o Calls achievable from previous "dead" spots
o Increase in average call duration by up to 33%
o Increased base station range by up to 30%
The above results are made possible by the following characteristics of the
SuperFilter(R) products:
o Range Extension. The Company's SuperFilter(R) 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.
o 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 may 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.
o Low Power Consumption. 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(R)system consumes only approximately 150 watts of power,
comparable to that of a household light bulb.
o Tower Mount and Reduced Size. The Company believes that as PCS and cellular
base stations are deployed, service providers and base station manufacturers
will seek 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 also be a key component of extending the
range of base stations. 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(R) 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(R)systems are the smallest systems
currently available in the industry.
ACCESSING THE WIRELESS MARKET
The Company markets its products to wireless service providers and OEMs
worldwide with a particular focus on domestic wireless service providers. In the
Company's experience, wireless service providers with rural base stations had
the most immediate need for the SuperFilter(R) system, particularly for range
extension. By targeting this segment of the market
5
6
STI expects to create significant interest from these service providers for
solving their wireless infrastructure problems which will allow the Company to
demonstrate its product capabilities in the suburban and urban markets as well.
In addition, the Company expects the interest in its products to create a "pull
through" interest from industry OEMs by creating additional market demand for
the Company's products. The Company has been successful at receiving orders for
its products from wireless service providers in small quantities for field
trials and deployment. In the case of smaller wireless service providers, orders
have been received for deployment of 50% to 100% of the base stations within
their region. The Company has also established relationships with major wireless
service providers and OEMs from which STI expects to seek volume orders. See
"Factors Affecting Future Business Operations--Dependence on Sales to Service
Providers and OEMs."
At a major industry trade show in February 1998, the Company introduced the
SuperFilter(R) system for use in AMPS/A cellular networks. The AMPS/A product
offers range extension, with a diplexed filter for reduced interference. The
AMPS/A product offers the same advantages as the AMPS/B product, 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. In addition, the Company continues to develop product enhancements
that allow the customer more flexibility when installing and utilizing the
SuperFilter(R) product. In some cases, the Company's product can replace the
entire receiver filter system within a base station. STI has chosen to offer
these two core cellular products initially as the Company believes cellular
service providers utilizing AMPS networks are the most immediately receptive
customer base for its products. The Company believes that cellular service
providers will be receptive to its products due to the increasing competition
from PCS providers, which will cause cellular providers to enhance service in
order to retain customers. The Company has also 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."
CRYOGENIC COOLER PRODUCTS
Superconducting materials require cooling to temperatures as low as 77
Kelvin (-196(Degree) 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, which requires 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(R)
systems. The Company has focused on opportunities for cryogenic cooling products
in the high-speed computing and medical markets, as well as potential
opportunities in the research and development industry. The Company believes
that the successful commercialization of its cryogenic cooler as a stand-alone
product will assist in its ability to achieve economies of scale through higher
volumes, which will result in lower manufacturing costs.
GOVERNMENT CONTRACTS
The Company's strategy is to pursue government research and development
contract awards to supplement its funding of superconducting wireless and
cryogenic product development. Since inception, 92% of the Company's net
revenues have been from research and development contracts, sales directly with
the U.S. government or resellers to the U.S. 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 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 $750,000 in revenues for the Company and one into a Phase
III program valued at $2.2 million dollars. Since the Company's inception,
government contracts have provided over $51 million dollars of revenue to the
Company.
PRODUCTS DEVELOPED UNDER GOVERNMENT CONTRACTS
STI pursues U.S. 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
6
7
Company believes it has developed products that can be marketed to the
government communications industry, with the potential for volume sales.
The Government is working with military communications equipment contractors
on government wireless programs. The focus is generally to improve the integrity
of digital communications links through the use of superconducting filters and
cryogenic low noise amplifiers. The Company also developed a proprietary
switched filter bank ("SFB") system in conjunction with Wright Laboratory at
Wright-Patterson Air Force Base ("WP-SFB") with funding from DARPA. The SFB
demonstrated an ability to mitigate the problem of signal interference, which
DARPA believes can increase aircraft and pilot survival rates. The Company is
currently working on a DARPA funded effort to develop rapid tuning of
superconducting filters. This capability will greatly increase the effectiveness
in blocking interference in both government and commercial applications.
CURRENT GOVERNMENT R&D CONTRACTS
At December 31, 1998, the Company was working with the U.S. government under
seven separate research and development contracts with a total award value of
$21 million dollars, of which $13.9 million dollars are funded under these
contracts and $56,000 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(Degree)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(Degree)C) were discovered. In early 1987 yttrium barium copper oxide
("YBCO") was discovered, which has a critical temperature of 93K
(-180(Degree)C). Shortly thereafter, thallium barium calcium copper oxide
("TBCCO") was discovered, which has a critical temperature of 125K
(-148(Degree)C). These discoveries were important because these high temperature
superconductors allowed for operating temperatures higher than 77K
(-196(Degree)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
7
8
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 subjects 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(Degree)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
Since late 1997, the Company has been developing its manufacturing
infrastructure and organization. During 1998, STI continued to formalize its
manufacturing structure by hiring a Vice President of Wireless Manufacturing. He
oversees all operating units that support the production of critical components
including assembly of superconducting filters, cryogenic coolers, cryogenic
packaging and final enclosures, as well as quality and material control
functions. In addition, the Company also has a Vice President of Material
Operations. He oversees the production of the HTS material and production of the
RF circuitry, which are key building blocks of the product. In 1998, the Company
opened its new 18,000 state of the art manufacturing facility in Santa Barbara.
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.
During 1998, STI began high volume production of its SuperFilter(R) product.
Capacity for production of TWO-Pak SuperFilter(R) products increased from 30
systems in each of the first two quarters of 1998, to 60 and 180 systems in the
third and fourth quarters, respectively. The number of manufacturing employees
doubled in 1998 in order to support this increased capacity.
Due to the proprietary and technical nature of the Company's products and
the need 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. 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(R) product to order to meet expected 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 products. STI
utilizes a direct sales
8
9
force of three Regional Sales Managers, a Director of Sales and a Senior Vice
President of Sales and Marketing. Additionally, the Company has agreements with
six domestic and one international independent organizations that perform as
Sales Representatives for STI's products. 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 an internal sales and marketing support
staff with extensive experience in wireless marketing and sales, contracts and
sales administration and marketing communications. 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. The Company has an exclusive worldwide license
(including the right to sublicense) under several U.S. patents which have been
issued to the University of Arkansas covering TBCCO, 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. Since 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, 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
days' notice to the Company. During early 1999, the Company ended its 1997
supply agreement with DuPont, but maintained its 1997 cross-licensing agreement
with DuPont. The related royalty payments revert back to the original licensing
agreement. In 1994, the Company granted a nonexclusive license for TBCCO to
Superconducting Core Technologies, Inc., currently in bankruptcy status and in
default under the license agreement, 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 condition.
The Company is also focusing development efforts on YBCO. 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, 1998 the Company holds 17 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 two
patents covering cryogenics and packaging. As of December 31, 1998, the Company
has fifteen patents pending, including five related to materials, four covering
STI designs and six related to cryogenics and packaging. As the Company has
developed prototype products, it has increased the number of design patents
9
10
applied for in an effort to protect all phases of product development. See
"Factors Affecting Future Business Operations-Uncertainty of Patents and
Proprietary Rights."
SuperFilter(R) is a registered trademark of Superconductor Technologies Inc.
All other marks herein are properties of their respective owners.
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, and cryogenics design and product application. At December 31, 1998,
the Company's research and development department consisted of 51 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 in 1996, 1997
and 1998, contract research and development expenses were approximately $5.7
million, $6.2 million and $4.7 million, respectively. The Company's revenues
from government-related contracts were approximately $7.1 million, $8.1 million,
and $6.0 million, respectively, during these same periods. These contracts
accounted for 96%, 97% and 76% of the Company's total revenues in the fiscal
years ended 1996, 1997 and 1998, respectively.
Since the Company's inception, it has received approximately $51million 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 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. The Company competes primarily with
Conductus, Inc. and Illinois Superconductor Corporation with respect to its
superconducting filter systems. The Company also competes with alternative means
of enhancing base stations' range and selectivity other than by superconducting
filter. The primary competition comes from tower mount and ground mount
amplifiers and "smart" antennas. Tower mount and ground mount amplifiers pass
the signal received by the antenna through a broad low level filter, which then
amplifies the signal. These units are produced by a number of companies, which
include most of the OEMs of base stations such as Motorola, Lucent, Nortel and
Nokia. Filter manufacturers including Allen Telecom and Celwave also produce
these units. The "smart" antennas allow the antennas to focus on the signal they
are trying to receive to enhance the ability to receive the signal. Among the
companies that produce these systems are Metawave and Arraycom.
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 competes with
IBM, DuPont, Matsushita and Amtel, a Japanese consortium, among others, with
respect to its HTS materials. In the government sector, the Company competes
with universities, national laboratories and both large and small companies for
research and development contracts. The Company expects increased competition
both from existing competitors and a number of companies that may enter the
wireless communications market.
The Company also competes in the market for cryogenic coolers with companies
such as CTI Cryogenics, Leybold and Ricor. CTI Cryogenics uses a different
cooling method that is not as efficient as that which is employed by the
Company, and thus requires additional power. Leybold and Ricor have produced
similar units to those produced by the Company in limited or prototype
quantities. See "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 the
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
10
11
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, 1998, the Company employed a total of 142 persons, 61 of
whom were employed in manufacturing and 51 in research and development. Ten of
the Company's employees have Ph.D.s and 30 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(R) 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.
FUTURE CAPITAL NEEDS
To support increased sales of its SuperFilter(R) product, the Company is
currently ramping up its manufacturing operations. In order to fully implement
its business plan, the Company is in the process of seeking additional debt and
equity financing. There can be no assurance that the Company will be successful
in obtaining such additional debt or equity financing on acceptable terms or at
all. In the event that the Company is unable to obtain additional financing
throughout the course of 1999, the Company will have insufficient cash to fund
operations. The Company's independent auditors, PricewaterhouseCoopers LLP, have
indicated in their report accompanying the Company's 1998 year end financial
statements that, based on generally accepted accounting principles, the
Company's viability as a going concern is in question. In addition, the
Company's inability to fully implement its business plan would have a material
adverse effect on the Company's business, operating results and financial
condition. If the Company is successful in obtaining additional equity
financing, future dilution to existing or future stockholders is likely to
result.
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 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
11
12
the company, reduction of manufacturing expenses in order to price products
competitively, continued product development to meet customer demands and
availability of financing on terms acceptable to the Company. While the
Company's products have been field tested by its customers and have passed
performance and reliability testing, there can be no assurance that the products
will continue to pass these tests or meet the customers' performance
expectations 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 sufficient volume to meet market demand
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 or other complex systems.
Therefore, to gain market acceptance, particularly in the wireless market, 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 base station range 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(R) 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 field testing as well as development and prototypes. During 1998, the
Company significantly increased its manufacturing capacity in order to meet the
increased demand for its products as well as expected future requirements. While
the Company has increased its manufacturing capacity, 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. For example, the Company is incurring significant ramp-up costs
and 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. In addition,
a portion of the components of the SuperFilter(R) system will be manufactured
outside the Company. There can be no assurance that the Company will be able to
identify manufacturers of these components 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, 92% 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 earned 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 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
12
13
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. The Company competes primarily with
Conductus, Inc. and Illinois Superconductor Corporation, with respect to its
superconducting filter systems. The Company also competes with alternative means
of enhancing base stations' range and selectivity other than by superconducting
filter. The primary competition comes from tower mount and ground mount
amplifiers and "smart" antennas. Tower mount and ground mount amplifiers pass
the signal received by the antenna through a broad low level filter, which then
amplifies the signal. These units are produced by a number of companies, which
include most of the OEMs of base stations such as Motorola, Lucent, Nortel and
Nokia. These units are also produced by filter manufacturers including Allen
Telecom and Celwave. The "smart" antennas allow the antennas to focus on the
signal they are trying to receive to enhance the ability to receive the signal.
Among the companies that produce these systems are Metawave and Arraycom.
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 competes with
IBM, DuPont, Matsushita and Amtel, a Japanese consortium, among others, with
respect to its HTS materials. In the government sector, the Company competes
with universities, national laboratories and both large and small companies for
research and development contracts. The Company expects increased competition
both from existing competitors and a number of companies that may enter the
wireless communications market.
The Company also competes in cryogenic coolers with companies such as CTI
Cryogenics, Leybold and Ricor. CTI Cryogenics uses a different cooling method
that is not as efficient as that which is employed by the Company, and thus
requires additional power. Leybold and Ricor have produced similar units to
those produced by the Company in limited or prototype quantities.
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.
ACCUMULATED DEFICIT AND ANTICIPATED FUTURE LOSSES
The Company has incurred net losses each year since its inception and, as of
December 31, 1998, had an accumulated deficit of $36,215,000. The Company
expects to continue to incur significant operating losses over the next several
quarters as it continues to devote significant financial resources to the
commercialization of wireless and cryogenic products, the expansion of Company
operations and product development activities. The success of the Company in
this regard is dependent upon the Company's successful commercialization of its
HTS filter systems for the worldwide wireless communications market, and there
can be no assurance that the Company will be able to successfully commercialize
such products. As a result, the timing of when the Company will be profitable
and the amount of net losses until that time are uncertain.
DEPENDENCE OF KEY PERSONNEL
The Company is highly dependent upon the efforts of its technical workforce
and 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
13
14
retain qualified technical personnel, primarily in the areas of wireless
communications and cryogenics. The loss of the services of one or more members
of the senior management or technical teams could impede the Company'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.
LIMITED MARKETING AND SALES CAPABILITIES
In order for the Company to successfully reach full market acceptance in its
targeted markets, it must continue to develop appropriate marketing, sales,
technical, customer service and distribution capabilities, or it must enter into
agreements with third parties to provide such services. There can be no
assurance that the Company's continuing efforts in developing its marketing and
sales capabilities, including customer service and distribution, will be
successful. Furthermore, there can be no assurance that such third party
agreements can be obtained upon acceptable terms. Failure to develop such
capabilities or obtain such third party agreements 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.
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 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
14
15
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 that 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."
RAPID TECHNOLOGICAL CHANGE
The field of superconductivity is characterized by rapidly advancing
technology. The future success of the Company will depend in large part upon its
ability to keep pace with advancing 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,
particularly in the wireless communication industry. 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.
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. There are additional components that the Company sources from a
single vendor due to the present volume. 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
15
16
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 involves 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."
VOLATILITY OF COMMON STOCK PRICE
The market price of the Common Stock, like that of many other
high-technology companies, has fluctuated significantly and is likely to
continue to fluctuate in the future. Announcements by the Company or others
regarding the receipt of customer orders, quarterly variations in operating
results, additional equity financings, changes in recommendations of securities
analysts, results of customer field trials, scientific discoveries,
technological innovations, litigation, product developments, patent or
proprietary rights, government regulation and general market conditions may have
a significant impact on the market price of the Common Stock. In addition, the
securities markets have experienced volatility that is often unrelated to the
operating performance of particular companies. In the past, following a period
of volatility in the market price of a company's securities, securities class
action lawsuits have been instituted against some companies. If brought, the
costs of defending such litigation could have a material adverse effect on the
Company's business, results of operation and financial condition.
DILUTION AND DIVIDEND POLICY
The market value of the Company's Common Stock will likely be diluted by the
issuance of Common Stock upon the conversion of the Company's Series A-2, Series
A-3, Series B-1 and Series C Preferred Stock and the exercise of options and
warrants for the purchase of Company Common Stock, including the warrants issued
in connection with the Company's Preferred Stock financings and the Exchange
Agreement. At its annual meeting of stockholders to be held on June 2, 1999 the
Company will seek stockholder approval of the elimination of current limitations
on conversions of the Company's Preferred Stock and exercises of warrants issued
in connection with the Preferred Stock financings and the Exchange Agreement.
Upon receipt of such approval the Series A-2, Series A-3, Series B-1 and Series
C Preferred Stock may be fully converted into shares of Common Stock,
potentially at a discount to the market price of the Common Stock on the date of
conversion. Similarly, after stockholder approval is obtained, the holders of
warrants issued in connection with the Preferred Stock financings and the
Exchange Agreement may fully exercise warrants for the purchase of Company
Common Stock at prices that may be below the market value of the Company's
Common Stock on the date of such exercise. The total number of shares that may
be issued upon such Preferred Stock conversions and warrant exercises is
3,856,687 shares. This number of shares is subject to adjustment certain for
future dilutive stock issuances by the Company and for recapitalizations, stock
combinations, stock dividends, stock splits and the like.
The Company anticipates issuing additional securities in the foreseeable
future to satisfy its capital requirements. In addition, as a means of obtaining
benefits for the Company without the expenditure of cash, the Company has in the
past and may in the future offer equity participation to parties in connection
with debt, leasing or similar arrangements. In such cases, the Company may issue
warrants or other securities providing for the purchase of Common Stock. These
future financing and operating arrangements will likely result in the eventual
issuance of Company Common Stock that may be dilutive to the Company's current
holders of Common Stock.
The Company has never paid a cash dividend on its Common Stock and does not
expect to do so in the foreseeable future. Cumulative dividends on the Series
A-2, Series A-3, Series B-1, and Series C Preferred Stock are payable at the
rates of 6%, 6% and 7%, and 7% per annum, respectively. In the event that the
Company's stockholders do not approve the elimination of limitations placed on
Preferred Stock conversions and certain warrant exercises at the 1999 annual
stockholders meeting, the dividend rate on the Series A-2, Series A-3, Series
B-1 and Series C Preferred Stock shall increase to 20% per annum. The 20%
dividend shall apply retroactively and be deemed to have begun on March 26,
1998, August 11, 1998, September 2, 1998 and March 5, 1999 in the case of the
Series A-2, Series A-3, Series B-1 and Series C Preferred Stock, respectively.
While the Series A-2, Series A-3, Series B-1 and Series C Preferred Stock are
outstanding, the Company is limited in its ability to pay dividends on the
Common Stock.
ANTI-TAKEOVER PROVISIONS
The Company's Certificate of Incorporation and Bylaws, each as amended to
date, contain provisions that could delay, deter or prevent a merger, tender
offer or other business combination or change in control involving the Company
that some or a majority of the stockholders might consider to be in their best
interests, including offers or attempted takeovers that might otherwise result
in such stockholders receiving a premium over the market price of the Common
Stock. The Company's Certificate of Incorporation and Bylaws, among other
things, (i) restrict the ability of stockholders to call
16
17
stockholders meetings by allowing only stockholders holding shares in the
aggregate entitled to cast not less than 10% of the votes at such meetings to
call such meetings, (ii) eliminate such right to call stockholders meetings if
the shares of capital stock of the Company are (A) designated as qualified for
trading on the Nasdaq National Market and (B) the Company has at least 800
holders of shares of its capital stock, (iii) preclude stockholders from raising
new business for consideration at stockholders meetings unless the proponent has
provided notice to the company not less than 90 days prior to the meeting and
(iv) limit business which may be conducted at stockholders meetings to those
matters properly specified in notices to the Company. Moreover, the Company has
not opted out of Section 203 of the Delaware General Corporation Law, which
prohibits mergers, sales of material assets and certain self-dealing
transactions between the corporation and a holder of 15% or more of the
corporation's outstanding voting stock for a period of three years following the
date the stockholder became a 15% holder, subject to certain qualifications.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept only two-digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four-digit entries to
distinguish 21st century dates from 20th century dates. As a result, in
approximately two years, computer systems and/or software used by many companies
may need to be upgraded to comply with such "Year 2000" requirements.
Significant uncertainty exists concerning the potential effects associated with
compliance. The Company currently uses a limited number of software products
that are not Year 2000 compliant. However, the Company has acquired
manufacturing software, which replaces substantially all non-Year 2000 compliant
software, in order to support its expansion efforts. The software developer has
represented that the new software is Year 2000 compliant. The Company has
reviewed the remaining software programs that are not Year 2000 compliant and
believes that with modification to existing software or cessation of utilization
of non-compliant software, the Year 2000 problem will not pose significant
operational problems. Nonetheless, there can be no assurance that coding errors
or other defects will not be discovered in the future and any Year 2000
compliance problem of the Company could result in a material adverse effect on
the Company's business, operating results and financial condition. The Company
currently does not expect the amounts required to be incurred to become Year
2000 compliant to have a material effect on its financial position or results of
operations. The above statements are Year 2000 Readiness Disclosure Statements
within the meaning of the Year 2000 Readiness Information and Disclosure Act.
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company and their ages as of
March 23, 1999 are as follows:
NAME AGE POSITION
---- --- --------
Glenn E. Penisten 67 Chairman of the Board of Directors
M. Peter Thomas 57 President, Chief Executive Officer and
Director
E. Ray Cotten 68 Senior Vice President, Sales and Marketing
and Director
Robert B. Hammond, Ph.D. 50 Senior Vice President and Chief Technical
Officer
James G. Evans, Jr. 47 Vice President and Chief Financial Officer
Benson Chin 50 Vice President, Wireless Manufacturing
Michael M. Eddy, Ph.D. 38 Vice President, Materials Operations
Neal O. Fenzi 38 Vice President, Engineering
Robert P. Caren, Ph.D. (1)(2) 66 Director
Dennis Horowitz (1)(2) 52 Director
John D. Lockton (1) (2) 61 Director
J. Robert Schrieffer, Ph.D. (1)(2) 67 Director
(1) Member of Compensation Committee.
(2) Member of Audit Committee.
17
18
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.
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 that 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 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.
E. Ray Cotten became Senior Vice President, Sales and Marketing in March
1999. He joined the Board of Directors in July 1996 and served as Vice Chairman
of the Board from August 1996 to February 1999. 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.
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, 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
Corporation, 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.
Benson Chin joined the Company as Vice President, Wireless Manufacturing in
August 1998. Prior to joining the Company, from October 1989 to July 1998, Mr.
Chin held a variety of managerial positions at Harman International Industries,
Inc., a worldwide manufacturer of audio products, most recently as Executive
Director of Manufacturing. From 1971 to 1983 Mr. Chin held managerial and
technical positions at Burroughs/UNISYS, Pertec Computer Corporation, Data
Products and GTE. Mr. Chin holds a M.B.A. from California Lutheran College and a
B.S. in industrial engineering from San Jose State University. Mr. Chin is also
a registered Professional Engineer in the state of California and is certified
in Production and Inventory Management (CPIM).
Michael M. Eddy, Ph.D., became Vice President, Operations in July 1997 and
Vice President of Materials Operations in August 1998. 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 M.B.A. from Pepperdine University.
18
19
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 B.S.E.E. 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 May 1997 until
September 1998, Dr. Caren was Chairman of the Board of Litex, Inc., an
automobile emissions technology company. 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 Chief Executive Officer and a
Director of Wolverine Tube, Inc., a manufacturer and distributor of copper and
copper alloy tubes and fabricated products. 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. Philips 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 Chairman of IPWireless, Inc, a wireless internet access
and IP telephony service provider. From August 1991 to March 1998, he was
President, Chief Executive Officer and a Director of International Wireless
Communications, Inc. ("IWC"), an operator of cellular systems which filed for
bankruptcy in September 1998 under Chapter 11 of the U.S. Bankruptcy Code. He
was the Vice-Chairman and a director of IWC from March 1998 until June 1998 and
remained involved with the company until September 1998. 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 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 M.B.A. 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.
19
20
ITEM 2. PROPERTIES.
The Company's primary operations, including its manufacturing line, are
located in approximately 36,000 square feet of space in Santa Barbara,
California. The Company occupies approximately 33,000 square feet of this space
under a lease that expires on December 31, 2009. The remaining 3,000 square feet
is occupied under a lease that expires in January 2001. The Company also has
sales offices in Illinois, Texas and Massachusetts, which are occupied under
leases expiring in 1999 and 2000. The Company believes its 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, 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
MARKET FOR COMMON STOCK
The Company's Common Stock is listed on The Nasdaq Stock Market(R) 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 Stock
Market(R).
HIGH LOW
------ ------
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
Quarter ended June 27, 1998 ............... $ 6.63 $ 3.41
Quarter ended September 26, 1998 .......... $ 6.56 $ 4.00
Quarter ended December 31, 1998 ........... $ 5.75 $ 3.25
1999
Quarter ended April 3, 1999 ............... $ 4.63 $ 3.31
(Through March 23, 1999)
HOLDERS OF RECORD
As of March 23, 1999, there were approximately 180 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.
20
21
RECENT SALES OF UNREGISTERED SECURITIES
Between March 26, 1998 and the filing date of this Form 10-K, the Company
raised a total of $11,875,000 through the sale of securities to an institutional
investor in private offerings (the "Financings") of Preferred Stock and warrants
for the purchase of Common Stock. The Company issued Series A, Series A-1 and
Series B Preferred Stock and related warrants that were exchanged for Series
A-2, Series A-3, Series B-1, and modified warrants, respectively, on February
26, 1999 (the "Exchange"). Following the Exchange, the Company, by action of its
Board of Directors, eliminated the Series A, Series A-1 and Series B Preferred
Stock. On March 5, 1999 the Company issued Series C Preferred Stock and related
warrants. The chart below reflects the private securities outstanding following
completion of the Financings and the Exchange:
- ---------------------------------------------------------------------------------------------------
Common Stock
Issuable Warrants for
Series of Number of upon Purchase of Total Date of
Preferred Shares Issued Conversion Common Consideration Issuance(3)
Stock(1) of Preferred Stock(2) Received
Shares
- ---------------------------------------------------------------------------------------------------
Series A-2 64,584 1,291,680 100,000 $3,875,000 February 26, 1999
- ---------------------------------------------------------------------------------------------------
Series A-3 12,500 250,000 66,667 $1,000,000 February 26, 1999
- ---------------------------------------------------------------------------------------------------
Series B-1 50,000 1,000,000 120,000 $4,000,000 February 26, 1999
- ---------------------------------------------------------------------------------------------------
Series C 41,667 833,340 120,000 $3,000,000 March 5, 1999
- ---------------------------------------------------------------------------------------------------
(1) In the event that the Company's stockholders do not approve the
elimination of the Preferred Stock conversion limitation, as described
below, each share of Preferred Stock shall be entitled to a cumulative
dividend equal to 20% of the purchase price of the Preferred Stock. Such
dividends shall be deemed to have accrued daily from the date of the
issuance of the Preferred Stock as described in footnote 3 to this
table.
(2) The exercise prices and expiration dates of the warrants are as follows:
Series A-2, $4.00 per share, expiring March 26, 2003; Series A-3, $4.00
per share, expiring August 11, 2003; Series B-1, $5.70 per share,
expiring September 2, 2003; and Series C, $4.50 per share, expiring
March 5, 2004. In connection with the Exchange the Company issued
warrants for the purchase of up to 75,000 shares of Common Stock at a
purchase price of $7.00 per share, expiring February 26, 2004.
(3) The Exchange occurred on February 26, 1999. The Series A-2 Preferred
Stock was exchanged for 500,000 shares of Series A Preferred Stock
issued on March 26, 1998 and 145,833 shares of Series A Preferred Stock
issued on September 3, 1998. The Series A-3 Preferred Stock was
exchanged for Series A-1 Preferred Stock issued on August 11, 1998 and
the Series B-1 Preferred Stock was exchanged for Series B Preferred
Stock issued on September 2, 1998.
A maximum of 1,533,709 shares of Common Stock may be issued upon conversions
and exercises of the Preferred Stock and warrants described above until the
Company's stockholders approve the elimination of such limitations. All of the
Financings were effected pursuant to an exemption from federal registration
requirements provided under Rule 506 of federal Regulation D. The purchaser in
each case was an accredited investor. The Exchange was effected through an
exemption from registration for exchanges with existing security holders
provided under Section 3(a)(9) of the Securities Act of 1933, as amended (the
"Securities Act").
During the past three years the Company has also issued warrants in private
placements in connection with the Company's leasing and financing activities. On
December 21, 1998 the Company issued warrants to Silicon Valley Bank for the
purchase of 40,000 shares of Common Stock at a price of $4.00 per share. On
November 22, 1996 the Company issued warrants to Van Kasper & Company, the
underwriter of the Company's secondary offering, for the purchase of 150,000
shares of Common Stock at a price of $4.50 per share. In each case the
securities were issued pursuant to a private placement registration exemption
under Section 4(2) of the Securities Act. All of the warrant holders are
sophisticated institutional investors that obtained the warrants for investment
purposes.
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.
21
22
Year Ended December 31,
-----------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
STATEMENT OF OPERATIONS DATA:
Net Revenues:
Government contract revenues ....... $ 4,979 $ 7,310 $ 7,104 $ 8,104 $ 6,029
Commercial product revenues ........ 450 300 250 175 1,954
Sublicense royalties ............... 75 0 38 38 0
-------- -------- -------- -------- --------
Total net revenues .............. 5,504 7,610 7,392 8,317 7,983
Costs and expenses:
Cost of commercial product revenues 0 0 0 0 5,873
Contract research and development .. 4,030 5,414 5,721 6,218 4,693
Other research and development ..... 2,085 2,397 2,260 1,809 1,161
Selling, general and administrative 2,928 2,871 2,967 4,076 5,435
-------- -------- -------- -------- --------
Total operating expenses ....... 9,043 10,682 10,948 12,103 17,162
-------- -------- -------- -------- --------
Loss from operations .................. (3,539) (3,072) (3,556) (3,786) (9,179)
Other income (expense), net ........... 280 253 85 245 17
-------- -------- -------- -------- --------
Net loss .............................. ($ 3,259) ($ 2,819) ($ 3,471) ($ 3,541) ($ 9,162)
======== ======== ======== ======== ========
Basic and diluted loss per share ...... ($ 0.55) ($ 0.47) ($ 0.57) ($ 0.46) ($ 1.22)
Weighted average number of shares
outstanding ........................... 5,971 6,026 6,117 7,701 7,725
December 31,
------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments ........................ $ 7,930 $ 5,244 $ 6,871 $ 3,537 $ 310
Working capital ....................... 8,242 5,695 7,178 3,500 1,349
Total assets .......................... 14,613 11,878 13,344 10,087 12,509
Long-term debt ........................ 724 453 77 13 932
Redeemable preferred stock ............ 0 0 0 0 8,982
Total stockholders' equity (deficit) .. 12,640 10,087 11,290 8,166 (1,197)
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. was founded in 1987 and is focused on the
commercialization and manufacture of its high temperature superconducting
("HTS") products, primarily targeted toward commercial applications in the
worldwide wireless communications market through its SuperFilter(R) product. The
Company also pursues communication products and related applications in the
government business sector. Historically, the Company had been principally
engaged in research and development activities related to advanced electronic
products that incorporate HTS materials. The Company continues to be involved as
either contractor or subcontractor on a number of contracts with the United
States government. These contracts have been and continue to provide a
significant source of revenues for the Company. Superconductor Technologies is a
development stage company and has incurred cumulative losses of $36,215,000 from
inception to December 31, 1998.
22
23
RESULTS OF OPERATIONS
1998 AS COMPARED WITH 1997
Net revenues. Net revenues decreased by $334,000, or 4%, from $8.3 million
in 1997 to $8.0 million in 1998, due to a decrease in government contract
revenues and sublicense royalties offset by an increase in commercial product
revenues.
Government contract revenues decreased by $2.1 million, or 26% from $8.1
million in 1997 to $6.0 million in 1998, which is primarily attributable to the
completion of certain government programs and the transition period associated
with entering into new government contracts. Government contract revenues
constituted 97% and 76% of net revenues in 1997 and 1998, respectively.
Commercial product revenues from the sale of the Company's HTS wireless
products increased by $1.8 million, or 1017%, from $175,000 in 1997 to $2.0
million in 1998. This increase in commercial product revenues is the result of
the Company's increased sales of the SuperFilter(R) product. A substantial
portion of the increase results from the shipment of 83 SuperFilter(R) systems
in 1998 compared to 1 system in 1997.
Sublicense royalties were $38,000 in 1997. There were no sublicense
royalties in 1998, as the Company did not offer any new sublicense agreements on
its patents during this time period and collected only minimal amounts under
existing licenses.
Cost of commercial product revenues. The cost of commercial product revenues
was $5.9 million in 1998. Included in the cost of commercial product revenues
are all direct costs of manufacturing, manufacturing overhead and related
start-up costs, which substantially increased over 1997.
Contract research and development. Contract research and development
expenses decreased by $1.5 million, or 25%, from $6.2 million in 1997 to $4.7
million in 1998. This decrease is attributable to the decrease in government
contract revenue that is directly related to contract expenses.
Other research and development expenses. Other research and development
expenses decreased by $648,000, or 36%, from $1.8 million in 1997 to $1.2
million in 1998. This decrease is the result of the Company's continued focus on
commercial production and ramp-up of manufacturing capacity.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased by $1.3 million, or 33%, from $4.1 million in
1997 to $5.4 million in 1998. This increase is due to increased labor-related
expenses attributable to the expansion of the Company's sales force, as well as
increased efforts in the Company's marketing program which included advertising
and trade shows.
Other income (expense), net. Interest income decreased by $196,000, or 71%,
from $275,000 in 1997 to $79,000 in 1998, as a result of the reduction in the
interest-earning investment balances used to fund and expand operations.
Interest expense increased by $32,000, or 107%, from $30,000 in 1997 to $62,000
in 1998, as the Company entered into new financing agreements in 1998.
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 in 1996 to $8.1 million in 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(R) 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 and related to an initial
sublicensing agreement in 1996.
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 that is directly related to contract expenses as well as increased
research and development efforts that 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(R) product and to develop the appropriate manufacturing
infrastructure to support these efforts. During the second half of 1997, the
Company hired two additional sales and marketing professionals and embarked on
an advertising campaign to promote the awareness of its product among wireless
service providers. In addition, the Company
23
24
appointed a Vice-President of Operations to establish the appropriate
manufacturing infrastructure in order to product the SuperFilter(R) 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.
FLUCTUATIONS IN PERIODIC RESULTS
A significant portion of the Company's revenues has historically consisted
of government research and development contract revenues. The Company expects
that government contract revenue will continue to account for a 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. "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, 1998, the Company's cash and cash equivalents totaled
$310,000. The Company considers investments with original maturities of three
months or less to be cash equivalents. The Company did not have any short-term
investments at December 31, 1998. Cash and cash equivalents and short-term
investments decreased $3.2 million, or 91%, from $3.5 million at December 31,
1997 to $310,000 at December 31, 1998. The decrease is the result of funding
operating losses of $9.2 million and purchases of new equipment in the amount of
$3.4 million for the expansion of manufacturing operations and working capital
increases of $3.0 million (accounts receivable increase of $900,000 and
inventory increase of $2.1 million), offset by proceeds of $8.9 million from the
sale of preferred stock in private placements (before offering costs of
$164,000), capital lease financing of $1.1 million, a revolving line of credit
of $633,000 and an increase in accounts payable of $1.1 million.
The Company has financed its operations from inception through December 31,
1998 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, $8.9
million in private placements of preferred stock in 1998, $51.1 million in
government development contract revenues and $4.4 million in product and license
revenues. Operating activities used $2.4 million, $1.9 million and $10.3 million
of cash and cash equivalents in 1996, 1997 and 1998, respectively. Investing
activities used cash of $1.7 million in 1996, provided cash of $744,000 in 1997
and used cash of $1.3 million in 1998. Financing provided cash of $4.3 million
in 1996 (primarily from the proceeds of the secondary offering), used cash of
$6,000 in 1997 and provided cash of $10.4 million in 1998 (primarily from the
proceeds of the private placements and capital lease financing). The Company
expects to rely on external financing to meet its cash needs for the foreseeable
future.
The Company's principal resource commitments at December 31, 1998 consisted
of accounts payable and accrued employment compensation of $2.4 million and
$583,000, respectively, and approximately $1.7 million of obligations under
equipment financing commitments.
During December 1998, the Company amended its Loan and Security Agreement,
which includes a revolving line of credit maturing in December 1999. Pursuant to
this transaction, the Company issued warrants to purchase 40,000 shares of
Common Stock at $4.00 per share. The revolving line of credit is not to exceed
the lesser of (i) $1.5 million or (ii) 75% of eligible accounts receivable. The
revolving line of credit bears interest at the prime rate plus 1% (8.75% at
December 31, 1998). The Company is required to maintain certain minimum tangible
net worth, debt, and other financial and business covenants. Borrowings under
the revolving line of credit are secured by substantially all of the Company's
assets. The agreement is renewable annually. All outstanding borrowings under
all previous agreements were fully paid at December 31, 1998. At December 31,
1998, the Company had $633,000 outstanding under this agreement.
On March 26, 1998, the Company sold 500,000 shares of Series A Preferred
Stock in a private placement at a price of $6.00 per share. The Company sold an
additional 145,833 shares of Series A Preferred Stock on September 3, 1998 at a
price of $6.00 per share. On August 11, 1998 the Company sold 125,000 shares of
Series A-1 Preferred Stock at a price of $8.00 per share. In connection with
these financings, the Company issued warrants for the purchase of up to 166,667
shares
24
25
of Common Stock at a price of $4.00 per share. Proceeds from the sale of Series
A and Series A-1 Preferred Stock totaled approximately $4.875 million. Each
share of Series A and Series A-1 Preferred Stock was initially convertible
without limitation into two shares of Common Stock, and had redemption features
either allowing or requiring the Company to redeem the stock at future points in
time. On February 26, 1999, the Company entered into an Exchange Agreement with
the holders of the Preferred Stock. In the Exchange all of the Series A and
Series A-1 Preferred Stock were exchanged for Series A-2 and Series A-3
Preferred Stock, respectively. The features of the Series A-2 and Series A-3
Preferred Stock are similar to the Series A and Series A-1 Preferred Stock,
except for convertibility, redemption and dividends. Unlike the Series A and
Series A-1 Preferred Stock, the Series A-2 and Series A-3 Preferred Stock are
not redeemable and may not be freely converted until the Company's stockholders
approve the removal of the conversion limitation. The Series A-2 and Series A-3
Preferred Stock each carry a cumulative dividend of 6% per annum but will be
entitled to dividends of 20% per annum if the Company's stockholders do not
approve the elimination of the conversion restrictions on the Series A-2 and
Series A-3 Preferred Stock. The warrants issued in connection with the Series A
and Series A-1 Preferred Stock financing were exchanged in the Exchange for
warrants with restrictions on exercise pending stockholder approval of
elimination of the exercise limitations but otherwise similar terms.
The Company raised $4 million in total proceeds on September 2, 1998 through
the private placement of 500,000 shares of Series B Preferred Stock at a price
of $8.00 per share. In connection with this financing the Company issued
warrants for the purchase of up to 120,000 shares of Common Stock at a price of
$5.70 per share. Under certain conditions, which were not met, the Company was
to have issued the Series B Preferred Stock purchaser additional warrants. Each
share of Series B Preferred Stock was initially convertible without limitation
into two shares of Common Stock, and had redemption features either allowing or
requiring the Company to redeem the stock at future points in time. On February
26, 1999, the Company entered into an Exchange Agreement with the holders of the
Preferred Stock. In the Exchange all of the Series B Preferred Stock was
exchanged for Series B-1 Preferred Stock which has features similar to the
Series B Preferred Stock, except for convertibility, redemption and dividends.
Unlike the Series B Preferred Stock, the Series B-1 Preferred Stock is not
redeemable and may not be freely converted until the Company stockholders
approve the removal of the conversion limitation. The Series B-1 Preferred Stock
bears a cumulative dividend of 7% per annum that will increase to 20% per annum
if the Company's stockholders do not approve the elimination of the conversion
restrictions on the Series B-1 Preferred Stock. The warrants issued in
connection with the Series B Preferred Stock financing were exchanged in the
Exchange for warrants with restrictions on exercise pending stockholder approval
of elimination of the exercise limitations but otherwise similar terms.
On March 5, 1999 the Company raised $3 million in total proceeds through the
private placement of 41,667 shares of Series C Preferred Stock at a price of
$72.00 per share and the issuance of warrants for purchase of up to 120,000
shares of Common Stock at a price of $4.50 per share. Each share of Series C
Preferred Stock is initially convertible into 20 shares of Common Stock. The
Series C Preferred Stock may not be freely converted until the Company's
stockholders approve the removal of the conversion limitation. The Series C
Preferred Stock bears a dividend of 7% per annum that increases to 20% per annum
if the Company's stockholders do not approve of the elimination of the Series C
Preferred Stock conversion restrictions.
Accretion of the redemption value of the Series A, Series A-1 and Series B
Preferred Stock was not material to the period ended December 31, 1998. None of
the Company's Preferred Stock is currently redeemable.
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.
To date, inflation has not had a material impact on the Company's financial
results.
In 1998, the Company entered into a $1.1 million capital lease financing
commitment with two different leasing companies. The lease financing carries an
implicit interest rate of approximately 14.8% for 60 months. At December 31,
1998, the amounts outstanding under these agreements were $961,000.
The Company has signed a master lease agreement for an additional $1.5
million in capital lease financing and expects to draw upon approximately
$900,000 during the next several months. In addition, the Company is also
exploring the expansion of its working capital lines of credit in order to
provide additional flexibility to fund its working capital needs. The Company is
also reviewing other means of equity infusion in order to support the Company's
growth potential and operations. The Company anticipates relying on external
sources of financing to meet its cash needs over the next 12 months. There can
be no assurance that additional financing will be available to the Company, on
terms acceptable to the Company, if at all. In addition, if the Company does not
meet its operating objectives for market penetration and manufacturing
production, the need for capital will increase substantially.
FUTURE ACCOUNTING REQUIREMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities ("SFAS 133"). SFAS 133 will become effective for the
25
26
Company in 2000. The adoption of SFAS 133 is not expected to have a material
effect on the Company's financial position, results of operations or cash flow.
YEAR 2000
The Company currently uses a limited number of software products that are
not Year 2000 compliant. However, the Company has acquired manufacturing
software, which replaces substantially all non-Year 2000 compliant software, in
order to support its expansion efforts. The software developer has represented
that the new software is Year 2000 compliant. The Company has reviewed the
remaining software programs that are not Year 2000 compliant and believes that
with modification to existing software or cessation of utilization of
non-compliant software, the Year 2000 problem will not pose significant
operational problems. The Company currently does not expect the amounts required
to be incurred to become Year 2000 compliant to have a material effect on its
business, operating results or financial condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
All information required by this item is included on pages 29 to 43 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.
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, 1998.
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, 1998.
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, 1998.
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, 1998.
26
27
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 PricewaterhouseCoopers LLP,
Independent Accountants, are included in Part IV of this
Report on the pages indicated:
PAGE
----
Report of Independent Accountants............................................... 29
Balance Sheet as of December 31, 1997 and 1998................................. 30
Statement of Operations for the years ended December 31, 1996, 1997 and 1998
and for the period May 11, 1987 (inception) to December 31, 1998................ 31
Statement of Stockholders' Equity for the period from May 11, 1987 (inception)
to December 31, 1998............................................................ 32
Statement of Cash Flows for the years ended December 31, 1996, 1997 and
1998 and for the period May 11, 1987 (inception) to December 31, 1998........... 33
Notes to Financial Statements................................................... 34
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or the notes thereto.
2. Exhibits:
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
3.1 Amended and Restated Certificate of Incorporation of the
Company
3.2(1) Bylaws of the Registrant
4.1(1) Form of Common Stock Certificate
4.2 Form of Series A-2 Preferred Stock Certificate
4.3 Form of Series A-3 Preferred Stock Certificate
4.4 Form of Series B-1 Preferred Stock Certificate
4.5 Form of Series C Preferred Stock Certificate
4.6(1) Form of Representative's Warrant Agreement
4.7(2) Form of warrant issued to Van Kasper & Company
4.8 Form of warrant issued to holders Series A-2 and Series A-3
Preferred Stock
4.9 Form of warrant issued to holders of Series B-1 Preferred Stock
4.10 Form of warrant issued to holders of Series C Preferred Stock
4.11 Form of warrant issued in connection with the Exchange
Agreement dated February 26, 1999
4.12 Form of warrant issued to Silicon Valley Bank dated December
21, 1998
4.13 Series C Preferred Stock Purchase Agreement dated March 5, 1999
4.14 Second Amended and Restated Stockholder Rights Agreement dated
February 26, 1999
4.15 Amended and Restated Registration Rights Agreement dated
February 26, 1999
4.16 Registration Rights Agreement with Silicon Valley Bank dated
December 21, 1998
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 d.b.a.
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) 1992 Director Option Plan
10.7(1) Form of Indemnification Agreement
10.8(1) License Agreement between the Registrant and the University of
Arkansas dated April 9, 1992, as amended
10.9(1) Loan and Security Agreement between the Registrant and Silicon
Valley Bank dated May 17, 1991,as amended
10.10(1) 1992 Stock Option Plan
27
28
10.11(1) Proprietary Information & Patents Inventions Agreement among
the Registrant, E-Systems, Inc. and various other parties;
Purchase Order dated October 10, 1991
10.12(1)* Joint Venture Company (JVC) Agreement between the Registrant
and Sunpower Incorporated dated April 2, 1992
10.13(1) Government Contract issued to Registrant by the Defense
Advanced Research Projects Agency through the Office of Naval
Research dated September 4, 1991
10.14(2)* License Agreement between the Registrant and E.I. DuPont de
Nemours and Company dated December 1992
10.15(1) Note and Warrant Purchase Agreement dated December 28, 1992
10.16(3)* Superconductor Technologies Inc. Purchase Agreement
10.17(4) Loan and Security Agreement between Registrant and Silicon
Valley Bank dated August 26, 1994
10.18(4) Form of Distribution Agreement
10.19(4) Amended and Restated 1988 Stock Option Plan, as amended, with
form of stock option agreement
10.20(5) Loan and Security Agreement between Registrant and Silicon
Valley Bank dated June 27, 1995
10.21(6)* Joint Venture Agreement between Registrant and Alantac
Technologies (S) Pte Ltd., dated May 20, 1996
10.22(7) Employment Offer Letter to M. Peter Thomas dated April 3, 1997
10.23(8) Employment Agreement with E. Ray Cotten dated July 1, 1997
10.24 Amendment dated December 21, 1998 to the Loan and Security
Agreement between Registrant and Silicon Valley Bank dated
August 26, 1994.
23.1 Consent of Independent Accountants
24.1 Power of Attorney (included on signature page hereto)
(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.
(8) Incorporated by reference from the Registrant's Annual Report on Form
10-K filed for the year ended December 31, 1997.
* Confidential treatment has been previously granted for certain
portions of these exhibits.
(b) Reports on Form 8-K. The Company filed no reports on Form 8-K
during the last quarter of the year ended December 31, 1998.
(c) Exhibits. See Item 14(a) above.
28
29
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, 1997 and 1998, and the results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1998, and the period from May 11, 1987 (inception) to
December 31, 1998, 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 that 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.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 11 to the
financial statements, the Company has suffered recurring losses from operations
and has a net capital deficiency that raise substantial doubt about its ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 11. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
February 19, 1999, except as to Note 12, which is as of March 26, 1999
29
30
SUPERCONDUCTOR TECHNOLOGIES INC.
(A Development Stage Enterprise)
BALANCE SHEET
ASSETS DECEMBER 31, DECEMBER 31,
1997 1998
------------ ------------
Current assets:
Cash and cash equivalents ............................... $ 1,438,000 $ 310,000
Short-term investments .................................. 2,099,000 0
Accounts receivable ..................................... 1,048,000 1,939,000
Inventory ............................................... 677,000 2,719,000
Prepaid expenses and other current assets ............... 146,000 173,000
------------ ------------
Total current assets ............................... 5,408,000 5,141,000
Property and equipment, net of accumulated depreciation
of $6,534,000 and $6,985,000, respectively ................. 2,456,000 5,114,000
Patents and licenses, net of accumulated amortization
of $1,057,000 and $1,285,000, respectively ................. 2,152,000 2,070,000
Other assets ................................................. 71,000 184,000
------------ ------------
Total assets ....................................... $ 10,087,000 $ 12,509,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................ $ 1,407,000 $ 2,396,000
Accrued compensation .................................... 437,000 583,000
Current portion of long-term debt and capitalized
lease obligations .................................... 64,000 813,000
------------ ------------
Total current liabilities .......................... 1,908,000 3,792,000
Long-term debt ............................................... 13,000 932,000
------------ ------------
Total liabilities .................................. 1,921,000 4,724,000
------------ ------------
Redeemable Preferred Stock, $.001 par value, 2,000,000
shares authorized, Series A 645,833 shares issued and
outstanding, Series A-1 125,000 shares issued and outstanding,
Series B 500,000 shares issued and outstanding ............. 8,982,000
Commitments and contingencies
Stockholders' equity:
Common Stock, $.001 par value, 30,000,000 shares
authorized, 7,699,581 and 7,722,591 shares issued
and outstanding ...................................... 8,000 8,000
Capital in excess of par value .......................... 35,211,000 35,010,000
Deficit accumulated during development stage ............ (27,053,000) (36,215,000)
------------ ------------
Total stockholders' equity (deficit) ............... 8,166,000 (1,197,000)
------------ ------------
Total liabilities and stockholders' equity (deficit) $ 10,087,000 $ 12,509,000
============ ============
See accompanying notes to the financial statements.
30
31
SUPERCONDUCTOR TECHNOLOGIES INC.
(A Development Stage Enterprise)
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED
DECEMBER 31, MAY 11, 1987
------------ (INCEPTION) TO
1996 1997 1998 DECEMBER 31, 1998
------------ ------------ ------------ -----------------
Net Revenues:
Government contract revenues $ 7,104,000 $ 8,104,000 $ 6,029,000 $ 51,137,000
Commercial product revenues 250,000 175,000 1,954,000 3,852,000
Sublicense royalties 38,000 38,000 0 539,000
------------ ------------ ------------ ------------
Total net revenues 7,392,000 8,317,000 7,983,000 55,528,000
------------ ------------ ------------ ------------
Costs and expenses:
Cost of commercial product revenues 0 0 5,873,000 5,873,000
Contract research and development . 5,721,000 6,218,000 4,693,000 40,121,000
Other research and development 2,260,000 1,809,000 1,161,000 19,196,000
Selling, general and administrative 2,967,000 4,076,000 5,435,000 28,086,000
------------ ------------ ------------ ------------
Total costs and expenses 10,948,000 12,103,000 17,162,000 93,276,000
------------ ------------ ------------ ------------
Loss from operations (3,556,000) (3,786,000) (9,179,000) (37,748,000)
Interest income 156,000 275,000 79,000 2,969,000
Interest expense (71,000) (30,000) (62,000) (1,317,000)
Other income (expense), net 0 0 0 (119,000)
------------ ------------ ------------ ------------
Net loss ($ 3,471,000) ($ 3,541,000) ($ 9,162,000) ($36,215,000)
============ ============ ============ ============
Basic and diluted loss per share ($ 0.57) ($ 0.46) ($ 1.22)
============ ============ ============
Weighted average number of
shares outstanding 6,117,126 7,701,435 7,724,829
============ ============ ============
See accompanying notes to the financial statements.
31
32
SUPERCONDUCTOR TECHNOLOGIES INC.
(A Development Stage Enterprise)
STATEMENT OF STOCKHOLDERS' EQUITY
DEFICIT
CAPITAL COMMON ACCUMULATED
COMMON STOCK CONVERTIBLE PREFERRED IN EXCESS STOCK DURING
---------------- --------------------- OF PAR SUBSCRIPTIONS DEVELOPMENT
SHARES AMOUNT SHARES AMOUNT VALUE RECEIVABLE STAGE TOTAL
------ ------ ------ ------ ----------- ----------- ------------- ------------
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 441,000 441,000
Initial public offering
of shares 1,500,000 1,000 12,730,000 12,731,000
Conversion of
preferred stock 2,777,885 3,000 (5,555,770) (6,000) 3,000
Exercise of
stock options 451,939 306,000 306,000
Repayment of
stockholder note 150,000 150,000
Unrealized loss on
available-for-sale
securities
Net loss from 5/11/87
(inception)
through 12/31/95 (20,041,000) (20,041,000)
--------- ------ ------- -------- ----------- ----------- ------------- ------------
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
Exercise of
stock options 23,010 70,000 70,000
Dividends accrued
not paid (271,000) (271,000)
Net loss (9,162,000) (9,162,000)
--------- ------ ------- -------- ----------- ----------- ------------- ------------
Balance at 12/31/98 7,722,591 $8,000 $ -- $ -- $35,010,000 $ -- ($36,215,000) ($1,197,000)
========= ====== ======= ======== =========== =========== ============= ============
See accompanying notes to the financial statements.
32
33
SUPERCONDUCTOR TECHNOLOGIES INC.
(A Development Stage Enterprise)
STATEMENT OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(NOTE 10)
FOR THE YEAR ENDED MAY 11, 1987
DECEMBER 31, (INCEPTION) TO
------------------------------------------ DECEMBER 31,
1996 1997 1998 1998
------------ ------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($ 3,471,000) ($ 3,541,000) ($ 9,162,000) ($36,215,000)
Adjustments to reconcile net loss to net cash used for
operating activities:
Depreciation and amortization 1,101,000 995,000 941,000 8,772,000
Compensation expense associated with stock 16,000 0 0 457,000
options granted
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 (286,000) 551,000 (891,000) (1,939,000)
Note receivable from related party 0 150,000 0 0
Inventory (274,000) (175,000) (2,042,000) (2,719,000)
Prepaid expenses and other current assets 65,000 37,000 (27,000) (173,000)
Patents and licenses (156,000) (171,000) (145,000) (1,913,000)
Other assets 1,000 (35,000) (113,000) (282,000)
Accounts payable and accrued expenses 515,000 596,000 1,135,000 2,923,000
Billings in excess of costs and earnings on
uncompleted contracts 106,000 (306,000) 0 0
------------ ------------ ------------ ------------
Net cash used in operating activities (2,383,000) (1,899,000) (10,304,000) (30,958,000)
------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale (purchases of) short-term investments (1,458,000) 2,173,000 2,099,000 0
Purchases of property and equipment (289,000) (1,429,000) (3,372,000) (10,112,000)
Proceeds from sale of property and equipment 0 0 0 922,000
------------ ------------ ------------ ------------
Net cash (used in) provided by investing activities (1,747,000) 744,000 (1,273,000) (9,190,000)
------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings 57,000 0 1,786,000 3,702,000
Principal payments on long-term obligations (416,000) (423,000) (118,000) (4,797,000)
Net proceeds from sale of preferred and common stock 4,658,000 417,000 8,781,000 41,553,000
------------ ------------ ------------ ------------
Net cash provided by (used in) financing activities 4,299,000 (6,000) 10,449,000 40,458,000
------------ ------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 169,000 (1,161,000) (1,128,000) 310,000
Cash and cash equivalents at beginning of period 2,430,000 2,599,000 1,438,000 0
------------ ------------ ------------ ------------
Cash and cash equivalents at end of period $ 2,599,000 $ 1,438,000 $ 310,000 $ 310,000
============ ============ ============ ============
See accompanying notes to the financial statements.
33
34
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 headquarters in Santa Barbara,
California. The Company, which operates in a single industry segment, is focused
on the commercialization and manufacture of its high temperature superconducting
("HTS") products, primarily targeted toward commercial applications in the
worldwide wireless communications market through its SuperFilter(R) product. The
Company also pursues communication products and related applications in the
government business sector. Historically, the Company had been principally
engaged in research and development activities related to advanced electronic
products that incorporate HTS materials. The Company continues to be involved as
either contractor or subcontractor on a number of contracts with the United
States government. These contracts have been and continue to provide a
significant source of revenues for the Company. For the years ended December 31,
1996, 1997 and 1998, government related contracts accounted for 96%, 97% and
76%, 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
Contract 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. Credit risk related to accounts receivable arising from such
contracts is considered minimal. 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.
Commercial revenues are principally derived from the sale of the Company's
SuperFilter(R) product and are recognized upon shipment of the product to the
customer.
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 being
primarily determined using standard costs, which approximate costs utilizing 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 twelve 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
34
35
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.
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 accounts for taxes under the provisions of 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
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. Net loss available to common stockholders is computed by deducting
dividends accumulated on cumulative preferred stock and accretion of redemption
value on redeemable preferred stock for the period. Diluted net loss per share
is computed by dividing loss 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. Potential Common Stock issuable upon exercise of options and
warrants to purchase shares of the Company's Common Stock (and conversion of the
outstanding Preferred Stock to Common Stock) is not included 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 in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." 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 debt approximates fair value based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Comprehensive Income" ("SFAS 130").
SFAS 130 was effective for the Company during 1998. This statement divides
comprehensive income into net income and other comprehensive income. The Company
has no items of other comprehensive income in any period and is consequently not
required to report comprehensive income.
Segment Information
The Company operates in a single business segment, the research, development
and manufacture of high temperature superconducting products for the wireless
communications industry. Net revenues derived principally from government
research and development contracts are presented separately on the statement of
income for all periods presented. Management views its
35
36
government research and development contracts as a supplementary source of
revenue to fund its development of high temperature superconducting products. No
other single customer accounted for more than 10% of net revenues. Asset
information by reportable segment is not reported, since the Company does not
produce such information internally.
NOTE 3--SHORT-TERM INVESTMENTS
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, 1997, the aggregate fair market value of the debt securities was
$2,690,000, which approximated the aggregate cost. At December 31, 1998, the
Company had no investments in any securities.
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). Since 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. 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-- DEBT
Debt consists of the following:
DECEMBER 31,
----------------------------
1997 1998
---------- ----------
Revolving line of credit $ 64,000 $ 633,000
Capital lease obligations 13,000 1,112,000
---------- ----------
$ 77,000 $1,745,000
Less: current portion 64,000 813,000
========== ==========
$ 13,000 $ 932,000
========== ==========
During December 1998, the Company amended its Loan and Security Agreement,
which includes a revolving line of credit maturing in December 1999. The
revolving line of credit is not to exceed the lesser of (i) $1.5 million or (ii)
75% of eligible accounts receivable. The revolving line of credit bears interest
at the prime rate plus 1% (8.75% at December 31, 1998). The Company is required
to maintain certain minimum tangible net worth, debt, and other financial and
business covenants. Borrowings under the revolving line of credit are secured by
substantially all of the Company's assets. The agreement is renewable annually.
All outstanding borrowings under all previous agreements were fully paid at
December 31, 1998. At December 31, 1998, the Company had $633,000 outstanding
under this agreement.
NOTE 6--INCOME TAXES
The Company has incurred a net loss in each year of operation since inception
resulting in no current or deferred tax expense for the years ended December 31,
1996, 1997 and 1998.
36
37
The significant components of deferred tax assets (liabilities) at December 31
are as follows:
1997 1998
------------ ------------
Loss carryforwards $ 6,569,000 $ 9,709,000
Capitalized R&D 1,874,000 2,175,000
Depreciation 1,712,000 1,726,000
Tax credits 1,044,000 1,402,000
Inventory 37,000 56,000
Less: valuation allowance (11,236,000) (15,068,000)
------------ ------------
Net deferred tax asset $ 0 $ 0
============ ============
As of December 31, 1998, the Company had federal net operating loss
carryforwards of approximately $26,993,000 and California net operating loss
carryforwards of approximately $9,728,000. The federal carryforwards will expire
during the years 1999 through 2018 and the California carryforwards will expire
during the years 1999 through 2003. As a result of research and development
activities to date, the Company has accumulated research and development credit
carryforwards of $761,000 and $324,000 for federal and California purposes,
respectively. These federal credit carryforwards will expire during the years
2002 through 2018, while the California credit has no expiration date.
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
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 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.
The Company completed a private placement of Series A and Series A-1 6%
Cumulative Convertible Preferred Stock, with three different closing dates, to a
certain investor over the first nine months of 1998. Each share of Preferred
Stock is convertible into two shares of Common Stock. The Preferred Stock
carries a cumulative dividend of 6% per annum and also has voting rights and
liquidation preferences. The Preferred Stock is not redeemable by the Company
prior to March 26, 2001. Thereafter, the Company may redeem the Preferred Stock
at 110% of the liquidation preference plus accrued dividends. Subsequent to
March 26, 2005, until fully redeemed, the holders of the Preferred Stock have
the option to cause the Company to redeem the Preferred Stock at their
liquidation preference plus accrued dividends. On March 26, 1998, the Company
raised approximately $3,000,000 from the sale of 500,000 shares of Series A
Preferred Stock at $6.00 per share, and issued warrants to purchase up to
100,000 shares of Common Stock at an exercise price of $4.00 per share. On
August 11, 1998, the Company raised approximately $1,000,000 from the sale of
125,000 shares of Series A-1 Preferred Stock at $8.00 per share with warrants to
purchase up to 66,667 shares of Common Stock at an exercise price of $4.00 per
share. On September 3, the Company raised approximately $875,000 from the sale
of 145,833 shares of Series A Preferred Stock at $6.00 per share with no
warrants.
37
38
On September 2, 1998, the Company completed a private placement of 500,000
shares of Series B 7% Cumulative Convertible Preferred Stock to certain
investors at $8.00 per share. The proceeds of the offering, net of offering
expenses, totaled approximately $4 million. The Series B Preferred Stock is not
redeemable prior to September 2, 2001. Thereafter, the Company may redeem the
Series B Preferred Stock at 110% of the liquidation preference plus accrued
dividends. Subsequent to September 2, 2005, until fully redeemed, the holders of
the Series B Preferred Stock have the option to cause the Company to redeem the
Preferred Stock at their liquidation preference plus accrued dividends. The
Company also issued warrants to purchase up to 120,000 shares of Common Stock at
$5.70 per share.
Stock Options
The Company has three stock option plans, the 1992 Stock Option Plan, and the
nonstatutory 1992 Directors' and 1998 Stock Option Plans (collectively, the
"Stock Option Plans"). The 1988 Stock Option Plan expired October 1998. Stock
awards may be made to directors, key employees, consultants, and non-employee
directors of the Company under the Stock Option Plans at prices no less than
100% of the market value on the date of grant. The stock options become
exercisable in four equal installments beginning one year after the date of
grant, and expire not more than ten years from the date of grant, with the
exception of 10% or greater stockholders which may have options granted at
prices no less than 50% of the market value on the date of grant, and expire not
more than five years from the date of grant. At December 31, 1998, options for
859,642 shares of Common Stock were exercisable.
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, ("SFAS 123"), "Accounting for
Stock-Based Compensation." Accordingly, no compensation cost has been recognized
for the stock-based compensation other than for non-employees. If the Company
had elected to recognize compensation expense for employee awards based upon the
fair value at the grant date consistent with the methodology prescribed by SFAS
123, the Company's net loss and net loss per share would have been increased to
the pro forma amounts indicated below:
1996 1997 1998
------------ ------------ ------------
Net loss:
As reported ($ 3,471,000) ($ 3,541,000) ($ 9,162,000)
Pro forma ($ 4,300,000) ($ 4,268,000) ($ 9,963,000)
Loss per share:
As reported ($0.57) ($0.46) ($1.22)
Pro forma ($0.70) ($0.56) ($1.33)
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, 1996, 1997 and 1998, respectively:
dividend yields of zero percent each year; expected volatilities of 52, 51 and
50 percent; risk-free interest rates of 6.16, 6.12 and 5.31 percent; and
expected life of 3.38, 3.50 and 3.9 years. The weighted average fair value of
options granted for which the exercise price equals the market price on the
grant date was $2.97, $1.47 and $2.08, respectively.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that 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.
38
39
At December 31, 1998, 219,858 shares of Common Stock were available for
future grants and 1,765,297 options had been granted but not yet exercised.
Option activity during the three years ended December 31, 1998 was as follows:
NUMBER OF WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- ----------------
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
Granted 450,950 $ 4.733
Canceled (124,315) $ 5.038
Exercised (15,010) $ 1.991
---------
Outstanding at December 31, 1998 1,765,297 $ 4.406
=========
The following table summarizes information concerning currently outstanding and
exercisable stock options:
Weighted
Average Weighted
Number of Remaining Average Number Weighted
Range of Outstanding Contractual Exercise Exercisable Exercise
Exercise Prices Options Life Price 12/31/98 Price
- --------------- ----------- ----------- -------- ----------- --------
$0.70-$3.125 378,426 7.00 $2.8175 216,679 $2.779
$3.25-$3.75 404,404 8.34 $3.656 167,805 $3.654
$3.875-$4.875 442,773 7.74 $4.557 280,052 $4.730
$4.938-$6.125 403,409 8.84 $5.487 94,578 $5.669
$6.25-$7.625 136,285 6.99 $7.346 100,528 $7.277
--------- ---- ------ ------- ------
$0.70-$7.625 1,765,297 7.91 $4.406 859,642 $4.429
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 Stock
Market(R) on October 29, 1997. 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.
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
39
40
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. These warrants expired in 1998. 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.
On March 26, 1998, August 11, 1998, and September 2, 1998, in conjunction
with the Company's private placements, the Company issued warrants to purchase
up to 100,000 shares, 66,667 shares and 120,000 shares, respectively, at an
exercise price of $4.00, $4.00 and $5.70 per share, respectively. These warrants
are exercisable for a five-year period beginning March 26, 1998, August 11,
1998, and September 2, 1998, respectively.
In December 1998, the Company amended its Loan and Security Agreement to
include a revolving line of credit. For this commitment, the Company issued
warrants to purchase 40,000 shares of commons stock at a price of $4.00 per
share. These warrants are exercisable for a five-year period beginning December
21, 1998.
The following table summarizes warrant activity through December 31, 1998:
COMMON STOCK
---------
Outstanding at December 31, 1996 315,197
Expired (44,447)
---------
Outstanding at December 31, 1997 270,750
Granted 326,667
Expired (120,750)
---------
Outstanding at December 31, 1998 476,667
---------
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 that 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--COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases its facilities under non-cancelable operating leases that
contain escalation clauses for increases in annual rent. The escalation clause
for the Company's primary facility in Santa Barbara is based upon increases in
the Los Angeles area consumer price index. Lease expiration dates range from May
1999 to December 2009. Future minimum payments required under the operating
lease commitments are as follows:
YEAR ENDING OPERATING
DECEMBER 31, LEASES
------------ ---------
1999 $489,000
2000 468,000
2001 427,000
2002 430,000
2003 441,000
Thereafter 2,888,000
---------
Total minimum payments $5,143,000
==========
For the years ended December 31, 1996, 1997 and 1998, rent expense was $266,000,
$318,000, and $499,000, respectively.
Capital Leases
The Company leases certain property and equipment under capital lease
arrangements that expire at various dates through
40
41
2003. The leases bear interest at various rates ranging from 14.27% to 18.84%.
The minimum lease payments under these capital lease obligations are as follows:
YEAR ENDING CAPITAL
DECEMBER 31, LEASES
------------ ----------
1999 $ 334,000
2000 331,000
2001 327,000
2002 327,000
2003 231,000
----------
1,550,000
Less: amount representing interest (438,000)
----------
Present value of net minimum lease payments $1,112,000
==========
Other Matters
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.
NOTE 10--DETAILS OF CERTAIN FINANCIAL COMPONENTS AND SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION AND NON-CASH ACTIVITIES
Balance sheet data:
DECEMBER 31,
------------
1997 1998
------------ ------------
Accounts receivable:
Accounts receivable-trade $ 0 $ 1,043,000
U.S. government accounts receivable-billed 621,000 926,000
U.S. government accounts receivable-unbilled 427,000 0
Less: allowance for doubtful accounts 0 (30,000)
------------ ------------
$ 1,048,000 $ 1,939,000
============ ============
Inventories:
Raw materials $ 336,000 $ 817,000
Work-in-process 302,000 1,666,000
Finished goods 39,000 236,000
------------ ------------
$ 677,000 $ 2,719,000
============ ============
Property and equipment:
Equipment $ 7,319,000 $ 10,099,000
Leasehold improvements 1,591,000 1,915,000
Furniture and fixtures 80,000 85,000
------------ ------------
8,990,000 12,099,000
Less: accumulated depreciation and amortization (6,534,000) (6,985,000)
------------ ------------
$ 2,456,000 $ 5,114,000
============ ============
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
41
42
one year.
At December 31, 1997 and 1998, property and equipment includes $7,000 and
$1,018,000 of assets financed under capital lease arrangements, net of $66,000
and $158,000 of accumulated amortization, respectively. Depreciation expense
amounted to $863,000, $772,000 and $713,000 for the years ended December 31,
1996, 1997 and 1998, respectively.
Supplemental Cash Flow Information:
December 31,
------------
1996 1997 1998
------- ------- --------
Cash paid for interest $71,000 $30,000 $ 62,000
Non-cash investing and financing activities:
Dividends accrued not paid -- -- $271,000
Disposal of fully depreciated property and equipment -- -- $277,000
NOTE 11--FINANCIAL CONDITION
The Company's financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has recurring losses from
operations and a net capital deficiency which raise substantial doubt about the
Company's ability to continue as a going concern. The financial statements do
not include adjustments that might result from this uncertainty. Management
believes that despite the funding uncertainties presently facing the Company,
it has in place a business plan that will be successfully funded and executed,
and will enable the Company to continue operations in the normal course.
In order to penetrate the market for its SuperFilter(R) products, during
1998 the Company undertook significant efforts in both the marketing and
manufacturing of its product. The Company performed trials with over 30 wireless
service providers, including 9 out of the top 10 domestic wireless service
providers. In order to support the market interest in its product, the Company
also established a manufacturing infrastructure, which previously had not been
in place. During 1998, the Company manufactured over 100 SuperFilter(R) units
and shipped over 80 units which it recognized as sales. The successful product
introductions in 1998 are indicative of the beginning of commercial viability
and acceptance of the Company's products. While significant
progress has been made during the past year in gaining market presence and
establishing manufacturing capability, the Company continued to incur a net
loss amounting to $9.2 million for the year ended December 31, 1998.
The Company believes that it will continue to generate interest in the
SuperFilter(R) product, which will lead to substantial orders. The recent
prospect for additional orders have been positive as the Company has started to
receive orders from one of the top ten service providers and believes that
another large service provider will follow shortly. Despite the positive market
response, through March 1999 the Company has continued to incur an operating
loss and the potential exists to incur operating losses for the remainder of the
year. Thus, capital formation continues to be an integral part of the Company's
business plans.
Despite its negative cash flow, the Company has continued to secure
financing to support its growth and implement its business plan. In 1998, the
Company successfully completed private placements of preferred stock raising
$8.9 million. In addition, the Company secured $1.1 million in capital lease
financing and a revolving line of credit of up to $1.5 million (based on
eligible accounts receivable). Through March 1999, the Company has raised $3
million from the additional private placement of Preferred Stock, has executed a
master lease agreement for an additional $1.5 million in capital lease financing
and expects to draw upon $0.9 million of such financing in the next several
months. In order to fund working capital requirements and to fully implement its
business plan, the Company will however, require additional financing. In this
regard, the Company is negotiating another private placement of preferred stock
with an investor group expected to raise an additional $3 million and is
negotiating a $1 million working capital line of credit with another bank. The
Company also plans to explore alternative sources of financing, which include
among others, raising additional equity or debt financing, expanding working
capital financing and continuing to obtain lease financing for manufacturing
equipment. The Company believes that this financing along with currently
available cash balances and other sources of liquidity, will be sufficient to
meet the Company's projected working capital requirements through at least the
end of 1999.
42
43
NOTE 12--SUBSEQUENT EVENTS
On February 26, 1999, the Company completed an Exchange Agreement with the
prior holders of Preferred Stock. The Exchange Agreement limits the holder of
the preferred stock to convert the shares into common stock of the Company at
19.9% of the current outstanding shares, requires the Company to seek
shareholders approval for removing the limitations on convertibility and
eliminates the holder's ability to redeem the shares. In exchange for the
elimination of the redemption feature the Company issued warrants to purchase up
to 75,000 shares of common stock at $7.00.
On March 5, 1999, the Company completed a private placement of 41,667 shares
of Series C 7% Cumulative Convertible Preferred Stock to a certain investor at
$72.00 per share. The gross proceeds of the offering totaled $3 million. Each
share of Preferred Stock is convertible into twenty shares of Common Stock at
$3.60 per share and carries a cumulative dividend of 7% per annum. The Preferred
Stock also has voting rights and liquidation preferences.
43
44
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
1999.
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:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ M. Peter Thomas President, Chief Executive Officer and March 30, 1999
- ------------------------- Director (Principal Executive Officer)
M. Peter Thomas
/s/ James G. Evans, Jr. Vice President, Chief Financial Officer and March 30, 1999
- ------------------------- Secretary (Principal Financial and Accounting
James G. Evans, Jr. Officer)
/s/ Glenn E. Penisten Chairman of the Board March 30, 1999
- -------------------------
Glenn E. Penisten
/s/ E. Ray Cotten Senior Vice President, Sales and Marketing March 30, 1999
- ------------------------- and Director
E. Ray Cotten
/s/ Robert P. Caren Director March 30, 1999
- -------------------------
Robert P. Caren
/s/ Dennis Horowitz Director March 30, 1999
- -------------------------
Dennis Horowitz
/s/ John D. Lockton Director March 30, 1999
- -------------------------
John D. Lockton
/s/ J. Robert Schrieffer Director March 30, 1999
- -------------------------
J. Robert Schrieffer
43
45
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
3.1 Amended and Restated Certificate of Incorporation of the
Company
3.2(1) Bylaws of the Registrant
4.1(1) Form of Common Stock Certificate
4.2 Form of Series A-2 Preferred Stock Certificate
4.3 Form of Series A-3 Preferred Stock Certificate
4.4 Form of Series B-1 Preferred Stock Certificate
4.5 Form of Series C Preferred Stock Certificate
4.6(1) Form of Representative's Warrant Agreement
4.7(2) Form of warrant issued to Van Kasper & Company
4.8 Form of warrant issued to holders Series A-2 and Series A-3
Preferred Stock
4.9 Form of warrant issued to holders of Series B-1 Preferred Stock
4.10 Form of warrant issued to holders of Series C Preferred Stock
4.11 Form of warrant issued in connection with the Exchange
Agreement dated February 26, 1999
4.12 Form of warrant issued to Silicon Valley Bank dated December
21, 1998
4.13 Series C Preferred Stock Purchase Agreement dated March 5, 1999
4.14 Second Amended and Restated Stockholder Rights Agreement dated
February 26, 1999
4.15 Amended and Restated Registration Rights Agreement dated
February 26, 1999
4.16 Registration Rights Agreement with Silicon Valley Bank dated
December 21, 1998
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 d.b.a.
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) 1992 Director Option Plan
10.7(1) Form of Indemnification Agreement
10.8(1) License Agreement between the Registrant and the University of
Arkansas dated April 9, 1992, as amended
10.9(1) Loan and Security Agreement between the Registrant and Silicon
Valley Bank dated May 17, 1991,as amended
10.10(1) 1992 Stock Option Plan
46
10.11(1) Proprietary Information & Patents Inventions Agreement among
the Registrant, E-Systems, Inc. and various other parties;
Purchase Order dated October 10, 1991
10.12(1)* Joint Venture Company (JVC) Agreement between the Registrant
and Sunpower Incorporated dated April 2, 1992
10.13(1) Government Contract issued to Registrant by the Defense
Advanced Research Projects Agency through the Office of Naval
Research dated September 4, 1991
10.14(2)* License Agreement between the Registrant and E.I. DuPont de
Nemours and Company dated December 1992
10.15(1) Note and Warrant Purchase Agreement dated December 28, 1992
10.16(3)* Superconductor Technologies Inc. Purchase Agreement
10.17(4) Loan and Security Agreement between Registrant and Silicon
Valley Bank dated August 26, 1994 10.18(4) Form of Distribution
Agreement
10.19(4) Amended and Restated 1988 Stock Option Plan, as amended, with
form of stock option agreement
10.20(5) Loan and Security Agreement between Registrant and Silicon
Valley Bank dated June 27, 1995
10.21(6)* Joint Venture Agreement between Registrant and Alantac
Technologies (S) Pte Ltd., dated May 20, 1996
10.22(7) Employment Offer Letter to M. Peter Thomas dated April 3, 1997
10.23(8) Employment Agreement with E. Ray Cotten dated July 1, 1997
10.24 Amendment dated December 21, 1998 to the Loan and Security
Agreement between Registrant and Silicon Valley Bank dated
August 26, 1994.
23.1 Consent of Independent Accountants
24.1 Power of Attorney (included on signature page hereto)
(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.
(8) Incorporated by reference from the Registrant's Annual Report on Form
10-K filed for the year ended December 31, 1997.
* Confidential treatment has been previously granted for certain
portions of these exhibits.