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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

Commission File Number 0-21074

SUPERCONDUCTOR TECHNOLOGIES INC.
(Exact name of registrant as specified in its charter)

460 Ward Drive,
Santa Barbara, California 93111-2356
(Address of principal executive offices & zip code)

(805) 690-4500
(Registrant’s telephone number including area code)

     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 [   ]

     As of July 31, 2002 there were 23,043,009 shares of the Registrant’s Common Stock outstanding.

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SUPERCONDUCTOR TECHNOLOGIES INC.

INDEX TO FORM 10-Q

Six Months Ended June 29, 2002

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SUPERCONDUCTOR TECHNOLOGIES INC.

STATEMENT OF OPERATIONS
(Unaudited)

See accompanying notes to the financial statements

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SUPERCONDUCTOR TECHNOLOGIES, INC.

BALANCE SHEET

See accompanying notes to the financial statements

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SUPERCONDUCTOR TECHNOLOGIES INC.

STATEMENT OF CASH FLOWS
(Unaudited)

See accompanying notes to the financial statements

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SUPERCONDUCTOR TECHNOLOGIES INC.

NOTES TO FINANCIAL STATEMENTS

1. General

     The unaudited financial information furnished herein has been prepared in accordance with generally accepted accounting principles and reflects all adjustments, consisting only of normal recurring adjustments, which in the opinion of management, are necessary to fairly state the Company’s financial position, the results of its operations and its cash flows for the periods presented.

     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. This quarterly report on Form 10-Q should be read in conjunction with the Company’s Form 10-K for the year ended December 31, 2001. The results of operations for the three and six months ended June 29, 2002 are not necessarily indicative of results for the entire fiscal year ending December 31, 2002.

     The Company reports on a 13-week quarter period ending on the Saturday nearest the calendar quarter end. The Company’s fiscal year-end is December 31.

     Certain reclassifications have been made to the 2001 financial statements to conform to the 2002 presentation.

2. Inventories

     Inventories are stated at the lower of cost (first-in, first out) or market and consist of the following:

3. Short Term Borrowings

     The Company had a revolving line of credit that matured unused on July 20, 2002. The revolving line of credit was not to exceed the lesser of (i) $2.5 million or (ii) 80% of eligible accounts receivable. The revolving line of credit had an interest rate at the prime rate (4.75% at June 29, 2002) plus 1%. No amounts were outstanding under this line at December 31, 2001 and June 29, 2002. The Company was required to maintain certain minimum tangible net worth, debt, cash flow and other financial and business covenants. Borrowings under the revolving line of credit were collateralized by substantially all of the Company’s assets.

4. Stockholders’ Equity

     Convertible Preferred Stock

     On September 29, 2000, the Company issued in a private placement 37,500 shares of a newly created Series E Convertible Preferred Stock and warrants to purchase up to an additional 1,044,568 shares of common stock. Proceeds, net of issuance costs, totaled approximately $35,155,000.

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     The preferred stock is non-voting, has a stated value and a liquidation preference of $1,000 per share, and is convertible into common stock at the lower of $17.95 per common share or the market price of the common stock at the time of conversion, subject to an implicit floor. The preferred stock automatically converts into common stock on the second anniversary of the closing and has no antidilution features. The optional and automatic conversions of preferred stock are limited to an aggregate maximum of 3,554,656 shares of common stock. Any preferred shares not converted through optional and the automatic conversions due to the limit on the number of shares that can be issued will be cancelled without any other obligation except to pay any accumulated conversion premium through the automatic conversion date. The preferred stock carries a 7% conversion premium, payable upon conversion in cash or common stock subject to certain limitations, at the Company’s option. The conversion premium is being included in the calculation of net loss available to common shareholders over the period it is earned by the preferred stockholder.

     At December 31, 2001, 34,500 Series E preferred shares were outstanding and were convertible into a maximum of 2,929,563 shares of common stock. During three months ended June 29, 2002 2,000 Series E preferred shares were converted into 645,474 shares of common stock and 77,616 shares of common stock were issued in connection with the conversion premium. At June 29, 2002 the remaining 32,500 Series E preferred shares are convertible into a maximum of 2,284,089 shares of common stock. If the remaining preferred shares remain outstanding until September 29, 2002, a $4,550,000 conversion premium would be due. If the Company chooses to pay the conversion premium in common shares of the Company, based on the weighted average price of $1.73 per shares as of June 29, 2002 payment of the premium would require issuance of approximately 2,631,000 additional shares of common stock.

     Common Stock. In March 2002 the Company raised net proceeds of $12.2 million from the private sales of 3,714,286 shares of common stock at $3.50 per share and 5-year warrants to purchase an additional 557,143 shares of common stock exercisable at $5.50 per share. The common stock was priced on February 27, 2002 when the term sheet was signed, and the Company’s common stock closed at $4.02 per share on that date. The underlying warrants were priced on March 6, 2002 when the definitive purchase agreement was signed, and the Company’s common stock closed at $4.45 per share on that date. In conjunction with this equity issuance, the Company also issued to the placement agent 5-year warrants to purchase up to 213,571 shares of common stock at an exercise price of $5.50 per share.

     This transaction caused the exercise price and the number of shares of the warrant under the Series E Convertible Preferred Stock to be adjusted to $20.58 and 1,093,269, respectively.

     During the six months ended June 29, 2002, the Company (i) issued options to purchase 816,175 shares of common stock under the Company’s stock option plans and (ii) cancelled options in connection with employment terminations to purchase 52,617 shares of common stock. Options for 26,473 shares of common stock were exercised for $83,000 during the period. At June 29, 2002, options to purchase 3,287,573 shares of common stock were issued and outstanding under the Company’s stock option plans. The outstanding options expire by the end of June 2012. The exercise prices for these options range from $1.74 to $49.38 per share, for an aggregate exercise price of approximately $31.0 million. At June 29, 2002, there were 360,369 shares of common stock available for granting future options.

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     The following is a summary of outstanding warrants at June 29, 2002:

5. Warrants Issued To U. S. Cellular

     In August 1999, the Company entered into a warrant agreement with United States Cellular Corporation (“U.S. Cellular”) where the exercise of a warrant to purchase up to 1,000,000 shares of common stock was conditioned upon future product purchases by U.S. Cellular. Under the terms of the warrant, U.S. Cellular vests in the right to purchase one share of common stock at $4 per share for every $25 of SuperFilter systems purchased from the Company. The warrant is immediately exercisable with respect to any vested shares and expires August 27, 2004. For accounting purposes proceeds from sales to U.S. Cellular under this agreement were initially allocated between commercial product revenues and the estimated value of the warrants vesting in connection with those sales. The estimated fair value of the warrants in excess of the related sales, when applicable, is recorded in cost of commercial product revenues.

     In September 2000, the Company received a $7.8 million non-cancelable purchase order from U.S. Cellular for SuperFilter systems to be shipped over the next nine quarters. In consideration for the purchase order, the Company amended the August 1999 warrant agreement and vested 312,000 warrants to U.S. Cellular. The vested warrants are immediately exercisable, not subject to forfeiture, and U.S. Cellular has no other obligations to the Company.

     The estimated fair value of the warrants vesting upon receipt of this order was calculated to be $5,635,000 using the Black-Scholes option-pricing model and was recorded as a deferred warrant charge in the statement of stockholders’ equity. As SuperFilter systems are shipped under this purchase order, the related sales proceeds are allocated between stockholders’ equity and commercial product revenue using the percentage relationship which existed between the fair value of the warrants as recorded in September 2000 and the amount of the non-cancelable purchase order. The fair value of the warrants was calculated utilizing a volatility factor of 85%, risk-free interest rate of 6.01%, and an expected life of 3.92 years. During the three and six months ended June 29, 2002 sales proceeds of $657,000 and $1,024,000, respectively, for shipments pursuant to this purchase order were allocated to the deferred warrant charge and proceeds of $246,000 and $387,000, respectively, were recorded as commercial product revenues During the three and six months ended June 30, 2001 sales proceeds of $592,000 and $1,389,000, respectively, for shipments pursuant to this purchase order were allocated to the deferred warrant charge and proceeds of $228,000 and $534,000, respectively, were recorded as commercial product revenues.

     In September 2000, after the allocation of the future sales proceeds to the fair value of the related warrants, the estimated cost of providing products under the purchase order exceeded related revenue by $5.3 million. The resulting loss was reflected in the results of operations for the quarter ended September 30, 2000. During the three and six months ended June 29, 2002, $568,000 and $913,000, respectively, of this reserve was amortized against the cost of product delivered under this purchase order. During the three and six months ended June 30, 2001, $557,000 and $1,307,000, respectively of this reserve was amortized against the cost of product delivered under this purchase order.

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     As of June 29, 2002 U.S. Cellular has 585,560 unvested warrants that can be earned from future product orders through August 27, 2004. In each period in which these remaining warrants are earned, a non-cash charge will be recorded for the fair market value of the warrants shares earned or vested in the period.

6. Legal Proceedings

     The Company is currently engaged in a patent dispute with ISCO International, Inc. relating to U.S. Patent No. 6,263,215 entitled “Cryoelectronically Cooled Receiver Front End for Mobile Radio Systems.” ISCO filed a complaint on July 17, 2001 in the United States District Court for the District of Delaware against us and Conductus, Inc., another company involved in the high-temperature superconducting industry. The ISCO complaint alleges that our SuperFilter product and Conductus’ ClearSite® product infringe ISCO’s patent.

     After conducting separate investigations into the allegations, the Company and Conductus both filed responses denying ISCO’s allegations and asking the court to declare the ISCO patent invalid and not infringed. The Company is cooperating with Conductus in the defense of this lawsuit.

     On October 3, 2001, the Company’s response was amended to add allegations that ISCO failed to disclose relevant prior art to the U.S. Patent Office during the patent application process. At the same time, the Company also sued ISCO for threatening some of our customers. The Company’s standard terms and conditions of sale include an indemnity against any patent infringement claims, and the Company has informed our customers that it will defend them against any action brought by ISCO for any alleged infringement related to our products. The Company is seeking both compensatory and punitive damages from ISCO, as well as attorneys’ fees, arising from their threats against our customers. On March 26, 2002, ISCO added a new claim to their lawsuit alleging that the Company’s new IMT-2000 SuperFilter Tower Top System for use with third generation, or 3G, technology in international markets infringes two other ISCO patents—U.S. Patent No.’s 6,104,934 and 6,205,340. On April 17, 2002 the court ruled that these two claims are untimely and relegated ISCO to filing a separate lawsuit if it wants to pursue these claims. To date, ISCO has not pursued these claims.

     The trial is scheduled to start January 13, 2003. The parties completed the discovery process by June 28, 2002, and the judge scheduled a “Markman hearing” for September 10, 2002. At the Markman hearing, the judge will receive evidence and then decide the scope and meaning of the patent claims asserted by ISCO.

     Litigation expenses on the ISCO matter totaled $960,000 and $1.8 million for the three and six months ended June 29, 2002, respectively. The Company did not incur any litigation expenses for the ISCO matter for the comparable periods in 2001.

7. Earnings Per Share

     The computation of per share amounts for the three and six months ended June 29, 2002 and June 30, 2001 is based on the average number of common shares outstanding for the period. Options and warrants to purchase 6,275,081 and 4,506,492 shares of common stock during the three and six months ended June 29, 2002 and June 30, 2001, respectively, were not considered in the computation of diluted earnings per share because their inclusion would be antidilutive. Preferred stock convertible into 2,284,089 and 3,554,656 common shares, respectively, was also not considered in the computation of diluted earnings per share for the three and six months ended June 29, 2002 and June 30, 2001, because its inclusion would also be antidilutive.

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8. Concentration of Customers and Suppliers

     Our two largest commercial customers accounted for 92% and 92% of our net commercial product revenues for the six months ended June 29, 2002 and June 30, 2001, respectively, and 82% and 49% of accounts receivable as of June 29, 2002 and December 31, 2001, respectively.

     We currently purchase substrates for growth of high-temperature superconductor thin-films from one supplier because of the quality of its substrates.

9. Recent Accounting Pronouncements

     Adoption of Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, SFAS No. 141, Accounting for Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets did not have an impact on the Company’s financial position, results of operations or cash flows for the period ended March 30, 2002.

     In April 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This Statement rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking Fund Requirements and SFAS No. 44, Accounting for Intangible Assets of Motor Carriers. Also, this statement amends SFAS No. 13, Accounting for Leases and other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changes conditions. The provisions of this Statement related to the rescission of SFAS No. 4 shall be applied in fiscal years beginning after May 15, 2002. The provision relating to SFAS No. 13 shall be effective for transactions occurring after May 15, 2002. All other provisions of this Statement shall be effective for financial statements issued on or after May 15, 2002. The Company does not believe it will have a material impact on its financial position or results of its operations.

     In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement addresses financial reporting for costs associated with exits or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The provisions of this Statement are effective for exit or disposal activities initiated after December 31, 2002. The Company does not believe it will have a material impact on its financial position or results of its operations.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

     We develop, manufacture and market high performance products to service providers, systems integrators and original equipment manufacturers in the wireless telecommunications industry. Our products, known collectively as SuperLink Solutions, maximize the performance of wireless networks by improving the quality of “uplink” signals from subscriber terminals (wireless handsets or mobile wireless devices) to network base stations and of “downlink” signals from network base stations to subscriber terminals. These premium products work in concert to provide Total Link Enhancement, a combination of complimentary wireless products built around our flagship SuperFilter System to meet the growing demand of the wireless telecommunications industry for improved capacity, reduced interference, and greater coverage for their network base stations.

     SuperLink Solutions consist of three unique product families: SuperLink Rx Solutions, SuperLink Tx Solutions and SuperPlex Solutions. Together, these solutions allow service providers to benefit from lower capital and operating costs. They also increase the minutes of use because subscribers experience better call quality, fewer dropped calls and higher speed data transmissions.

•		SuperLink Rx Solutions. In order to receive uplink signals from wireless terminals, base stations require a wireless filter system to eliminate, or filter out, out-of-band interference. To address this need, we offer SuperLink Rx Solutions, which include our flagship product, the SuperFilter System. Deployed in base stations, these solutions combine specialized filters using high-temperature superconducting (HTS) technology with a proprietary cryogenic cooler and a low-noise amplifier. The result is a highly compact and reliable cryogenic receiver front-end that can simultaneously deliver both high selectivity (interference rejection) and high sensitivity (detection of low level signals). SuperLink Rx Solutions thereby offer significant advantages over conventional filter systems.
•		SuperLink Tx Solutions. Many wireless networks also suffer from insufficient transmit power on the downlink signal path. In this situation, operators benefit from our SuperLink Tx Solutions, a family of compact, robust, and technologically-advanced high-power amplifiers.
•		SuperPlex Solutions. For superior antenna multiplexing functionality, we offer SuperPlex Solutions, a line of multiplexers that provide extremely low insertion loss and excellent cross-band isolation.

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     From 1987 to 1997, the Company was engaged primarily in research and development and generated revenues primarily from government research contracts. The Company began full-scale commercial production of the SuperFilter in 1997 and shipped 438 units in 2001 and 466 units in the first half of 2002. As the Company continues to focus on its commercial products, commercial revenues are expected to increase as a percentage of revenues. The Company has incurred cumulative losses of $97 million from inception to June 29, 2002.

Critical Accounting Policies

     Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, intangible assets, income taxes, warranty obligations, contingencies and our loss contract with U.S. Cellular. We base our estimates on historical experience and on various other assumptions that we believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

     We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the financial statements. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

     Our net sales consist of revenue from sales of products net of trade discounts and allowances. We recognize revenue when evidence of an arrangement exists, contractual obligations have been satisfied, title and risk of loss have been transferred to the customer and collection of the resulting receivable is reasonably assured. At the time revenue is recognized, we provide for the estimated cost of product warranties if allowed for under contractual arrangements. Our warranty obligation is effected by product failure rates and service delivery costs incurred in correcting a product failure. Should such failure rates or costs differ from these estimates, accrued warranty costs would be adjusted.

     As described in Note 5 to the June 29, 2002 financial statements, in September 2000 the Company received a $7.8 million non-cancelable purchase order from U.S. Cellular for SuperFilter systems to be shipped over the next nine quarters. In consideration for the purchase order, the Company amended the August 1999 warrant agreement and vested 312,000 warrants to U.S. Cellular.

     After the allocation of sales proceeds to the related warrants, the estimated cost of providing products under the purchase order exceeded related revenue by $5.3 million. The resulting loss was reflected in the results of operations for the year ended December 31, 2000 and a loss reserve established. Through December 31, 2001 and June 29, 2002, $3,302,000 and $4,215,000, respectively, of this reserve was reversed against the cost of product delivered under this purchase order. The reserve is based on estimated future product and warranty costs and should these future cost differ from those estimated this reserve will be adjusted.

     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.

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     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.

     Our valuation allowance against the deferred tax assets is based on our assessments of historical losses and projected operating results in future periods. If and when we generate future taxable income in the U.S. against which these tax assets may be applied, some portion or all of the valuation allowance would be reversed and an increase in net income would consequently be reported in future years.

     We are currently engaged in a patent dispute with ISCO International, Inc. This case is discussed under Part II, Item 1 entitled “Legal Proceedings”. We have not recorded any liability relating to this litigation but may be required to do so if we are unsuccessful in defending ourselves.

Backlog

     Our backlog consists of accepted commercial product purchase orders scheduled for delivery within 24 months and includes purchase orders denominated in either dollar amounts or a specified number of units. For purposes of calculating our backlog, we estimate a dollar amount for unit commitments based on past purchasing patterns and expected purchasing trends. We estimate our backlog at June 29, 2002 was approximately $11.5 million, as compared to $21.3 million at December 31, 2001. We expect that this backlog will be delivered by the end of the first quarter of 2003. Our backlog also includes $1.7 million remaining under a $7.8 million purchase order from U.S. Cellular that will be delivered by December 31, 2002. The subsection below entitled “Non-Cash Charges For Warrants Issued to U.S. Cellular” includes a discussion of the accounting for this purchase order.

Results of Operations

Quarter and Six Months ended June 29, 2002 as Compared with Quarter and Six Months ended June 30, 2001

     Total net revenue increased by $1.9 million, or 44%, from $4.2 million in second quarter of 2001 to $6.1 million in the second quarter of 2002. Total net revenues increased by $3.7 million or 52% from $7.0 million in the first half of 2001 to $10.7 million in the same period this year. The increase is primarily due to higher commercial product sales, partially offset by lower government revenues.

     Our commercial revenue is generated from (i) the sales of our SuperFilter product line which combines specialized superconducting RF filters with a proprietary cryogenic cooler (and, in most cases, a low noise amplifier) in highly compact systems and (ii) starting in February 2001, from the sales of our new multiplexer product line. Net commercial product revenue consists of gross commercial product sales proceeds less sales discounts and the allocation of certain sales proceeds to a warrant issued to one customer in 1999 under a long-term supply agreement. For a discussion of the allocation to warrants, please read the discussion under the caption “Non-Cash Charges for Warrants Issued To U.S. Cellular.” The following table summarizes the calculation of net commercial product revenue for 2002 and 2001:

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     Net commercial product revenues in the second quarter of 2002 increased to $5.3 million from $2.9 million in the same period last year, an increase of $2.4 million, or 81%. For the first half of 2002, net commercial product revenues increased to $9.0 million from $4.6 million in the same period of last year, an increase of $4.4 million, or 95%. This increase is the result of higher sales of our SuperFilter products, a shift in the product mix toward higher-priced SIX-Pak units and sales of our new duplexer product introduced in 2001, partially offset by lower average selling prices. Multiplexer sales in the second quarter and first half of 2002 totaled $710,000 and $1.5 million, respectively as compared to $$436,000 and $481,000, respectively in the same periods in 2001. The increase in gross commercial product sales proceeds was partially offset by $657,000 and $592,000 in the second quarter of 2002 and in 2001, respectively, and by $1.0 million and $1.4 million in the first half 2001 and 2002, respectively, to reflect an allocation of sales proceeds to warrants issued to U.S. Cellular in connection with those sales. Our two largest customers accounted for 92% of our net commercial revenues in 2002 and in 2001.

     Government contract revenues decreased by $513,000, or 40%, from $1.3 million in the second quarter of 2001 to $785,000 in the same quarter of 2002. For the first half of 2002, government contract revenues decreased to $1.7 million from $2.4 million in the same period last year, a decrease of $712,000, or 30%. These decreases result primarily from a delay in the award of a government contract and to a lesser extent a lower negotiated cost reimbursement rate charged in 2002 as compared to 2001.

     Cost of commercial product revenue includes all direct costs, manufacturing overhead and related start-up costs. The cost of commercial product revenues totaled $6.0 million and $10.4 million for the second quarter and first half of 2002, respectively, and was reduced by amortization credits of $568,000 and $913,000, respectively, relating to the accrual for non-cash contract loss on the purchase order from U.S. Cellular. The cost of commercial product revenues totaled $3.1 million and $5.5 million for the second quarter and first half of 2001, respectively, and was reduced by amortization credits of $557,000 and $1.3 million, respectively, relating to the accrual for non-cash contract loss on the purchase order from U.S. Cellular. Please read the subsection below entitled “Non-Cash Charges for Warrants Issued To U.S. Cellular.” Excluding these amortization credits relating to the supply agreement with U.S. Cellular, cost of commercial revenues increased to $6.6 million in second quarter of 2002, or 82%, from $3.6 million in same period in 2001. For the first half of 2002, excluding these amortization credits , the cost of commercial revenues totaled $11.3 million as compared to $6.8 million in the first half of 2001. These increases result from increased unit shipments and higher costs associated with ramping up the Company’s manufacturing capacity, partially offset by lower material and labor costs per unit and the effect of increased manufacturing efficiencies.

     We generate negative gross margins on our commercial products at current sales levels primarily due to fixed manufacturing overhead costs. Based on current prices and forecasted product mix and costs, we expect to achieve positive commercial gross margins in the fourth quarter of 2002.

     Contract research and development expenses totaled $549,000 and $925,000 in the second quarter of 2002 and 2001, respectively. In the first half of 2002 and 2001, these expenses totaled $1.2 million and $1.7 million, respectively. . These decreases result from the delay in the award of a government contract.

     Other research and development expenses relate to development of our commercial products. These expenses increased $139,000 to $1.4 million in the second quarter of 2002, as compared to $1.3 million in the same period last year. In the first half of 2002, these expenses totaled $2.7 million, as compared to $2.6 million in the first half of 2001. These

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increases are due to increased commercial development efforts.

     Selling, general and administrative expenses totaled $4.2 million in the second quarter of 2002 as compared to $2.7 million in the same period last year, an increase of $1.5 million, or 54%. In the first half of 2002 these expenses totaled $8.3 million as compared to $5.2 million in the first half of 2001. These increases result primarily from increased domestic and international marketing and sales efforts and ISCO litigation expenses. ISCO litigation expenses totaled $960,000 and $1.8 million for the second quarter and first half of 2002 respectively, as compared to none in the same period last year.

     Interest income decreased in the second quarter and first half of 2002 as compared to the same periods in the prior year due to decreased levels of cash available for investment and the decline in interest rates.

     Interest expense decreased in the second quarter and first half of 2002 as compared to the same periods in the prior year and resulted from decreased borrowings in the current year.

     We had a net loss of $6.0 for the current quarter ended June 29, 2002, as compared to $3.5 million for same period last year. For the first half of 2002, the net loss totaled $11.8 million as compared to $7.4 million last year.

     The net loss available to common shareholders totaled $6.6 million in the current quarter, or $0.29 per common share, as compared to $4.1 million, or $0.23 per common share, in the same period last year. The amounts for the second quarter of 2002 and 2001 include a $590,000 and $655,000, respectively, non-cash deemed distribution on preferred stock. The net loss available to common shareholders totaled $12.9 million in the first half of 2002, or $0.62 per common share, as compared to $8.7 million, or $0.49 per common share, in the same period last year. The amounts for the first half of 2002 and 2001 include a $1.2 million and $1.3 million, respectively, non-cash deemed distribution on preferred stock.

Liquidity and Capital Resources

     Cash and cash equivalents decreased by $93,000 from $15.2 million at December 31, 2001 to $15.1 million at June 29, 2002. Cash used in operations and investing activities during the first half of 2002 was almost entirely offset by cash received from the sale of common stock and warrants in a private placement during the first quarter.

     Cash used in operations totaled $9.7 million in the first half of 2002. We used $10.8 million to fund the cash portion of our net losses. We also used cash to fund a $1,084, 000 increase in accounts receivable, prepaid assets, patents and licenses and other current assets. Cash generated from the decrease in inventory and increase in accounts payable and other accrued expenses totaled $2.1 million. Cash used in operations in the first half of 2001 totaled $6.8 million and was used primarily to fund operating losses of $6.4 million net of non-cash adjustments and $2.3 million for the increase in inventory, prepaid assets, patents and licenses and other assets. These increases were partially offset by the decrease in accounts receivable of $1.1 million and increase in accounts payable and accrued expenses.

     Net cash used in investing activities totaled $2.4 million in the first half of 2002 and $1.0 million the same period last year and related to the purchase of manufacturing equipment.

     Net cash provided by financing activities totaled $12.1 million in the first half of 2002. Cash received from the sale of common stock and warrants and exercise of stock options totaled $12.2 million and was partially offset by the net reduction in borrowings of $135,000. In the same period of 2001, cash provided by financing operations totaled $125,000 and resulted from the exercise of stock options which totaled $242,000 and was partially offset by the net reduction in borrowings of $117,000.

     We also had a revolving line of credit that matured unused on July 20, 2002. We are in discussions with other lenders to replace this credit facility.

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     In March 2002 we raised net proceeds of $12.2 million from the private sale of 3,714,286 shares of common stock at $3.50 per share and 5-year warrants to purchase an additional 557,143 shares of common stock at $5.50 per share. The common stock was priced on February 27, 2002 when the term sheet was signed, and the Company’s common stock closed at $4.02 per share on that date. The underlying warrants were priced on March 6, 2002 when the definitive purchase agreement was signed, and the Company’s common stock closed at $4.45 per share on that date. In conjunction with this equity issuance, we also issued to the placement agent 5-year warrants to purchase up to 213,571 shares of common stock at an exercise price of $5.50 per share.

     Pursuant to the transaction documents, we filed a registration statement covering the shares of common stock issued at the closing and upon exercise of the warrants. The registration statement became effective on April 5, 2002.

     At June 29, 2002, we had the following cash commitments:

     We implemented a cost reduction program early in the third quarter in response to slower-than-expected growth in our commercial product sales. We reduced the size of our workforce by approximately 11%, implemented a 10% salary reduction for senior management and eliminated bonuses for senior management. We also adjusted our facility expansion plans from an original goal of 600 systems per quarter to approximately 300 systems per quarter. We plan invest an additional $3.5 to $4.0 million during the remainder of 2002 (including $2.5 million of existing cash commitments reflected above in the table) primarily to improve our manufacturing efficiency. We believe our manufacturing capacity is easily expandable to 600 systems per quarter with an additional investment of $2.0 to $2.5 million.

     We have continued to incur losses through June 2002 and expect to incur losses for the remainder of the year, although at a decreasing rate. Our long-term prospects are dependent upon the continued and increased market acceptance for our products.

     We expect our existing cash resources on hand at June 29, 2002 will be sufficient to fund our planned operations into 2003. Thereafter, we may be required to raise additional capital, which may not be available on acceptable terms, if at all. Any inability to obtain needed financing could have a material adverse effect on our business and operating results.

Non-Cash Charges For Warrants Issued To U.S. Cellular

     In August 1999, the Company entered into a warrant agreement with United States Cellular Corporation (“U.S. Cellular”) where the exercise of a warrant to purchase up to 1,000,000 shares of common stock was conditioned upon future product purchases by U.S. Cellular. Under the terms of the warrant, U.S. Cellular vests in the right to purchase one

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share of common stock at $4 per share for every $25 of SuperFilter systems purchased from the Company. The warrant is immediately exercisable with respect to any vested shares and expires August 27, 2004. For accounting purposes proceeds from sales to U.S. Cellular under this agreement were initially allocated between commercial product revenues and the estimated value of the warrants vesting in connection with those sales. The estimated fair value of the warrants in excess of the related sales, when applicable, is recorded in cost of commercial product revenues.

     In September 2000, the Company received a $7.8 million non-cancelable purchase order from U.S. Cellular for SuperFilter systems to be shipped over the next nine quarters. In consideration for the purchase order, the Company amended the August 1999 warrant agreement and vested 312,000 warrants to U.S. Cellular. The vested warrants are immediately exercisable, not subject to forfeiture, and U.S. Cellular has no other obligations to the Company.

     The estimated fair value of the warrants vesting upon receipt of this order was calculated to be $5,635,000 using the Black-Scholes option-pricing model and was recorded as a deferred warrant charge in the statement of stockholders’ equity. As SuperFilter systems are shipped under this purchase order, the related sales proceeds are allocated between stockholders’ equity and commercial product revenue using the percentage relationship which existed between the fair value of the warrants as recorded in September 2000 and the amount of the non-cancelable purchase order. The fair value of the warrants was calculated utilizing a volatility factor of 85%, risk-free interest rate of 6.01%, and an expected life of 3.92 years. During the three and six months ended June 29, 2002 sales proceeds of $657,000 and $1,025,000, respectively, for shipments pursuant to this purchase order were allocated to the deferred warrant charge and proceeds of $246,000 and $387,000, respectively, were recorded as commercial product revenues During the three and six months ended June 30, 2001 sales proceeds of $592,000 and $1,389,000, respectively, for shipments pursuant to this purchase order were allocated to the deferred warrant charge and proceeds of $228,000 and $534,000, respectively, were recorded as commercial product revenues.

     In September 2000, after the allocation of the future sales proceeds to the fair value of the related warrants, the estimated cost of providing products under the purchase order exceeded related revenue by $5.3 million. The resulting loss was reflected in the results of operations for the quarter ended September 30, 2000. During the three and six months ended June 29, 2002, $568,000 and $913,000, respectively, of this reserve was amortized against the cost of product delivered under this purchase order. During the three and six months ended June 30, 2001, $557,000 and $1,307,000, respectively of this reserve was amortized against the cost of product delivered under this purchase order.

     As of June 29, 2002 U.S. Cellular has 585,560 unvested warrants that can be earned from future product orders through August 27, 2004. In each period in which these remaining warrants are earned, a non-cash charge will be recorded for the fair market value of the warrants shares earned or vested in the period.

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     The following table summarizes the allocation of sales proceeds to warrants issued under the U.S. Cellular agreement and the contract loss reserve for the periods indicated:

Net Operating Loss Carryforward

     At December 31, 2001, we had a federal net operating loss carryforward of approximately $84.6 million. Section 382 of the Internal Revenue Code imposes an annual limitation on the utilization of net operating loss carryforwards based on a statutory rate of return (usually the “applicable federal funds rate”, as defined in the Internal revenue Code) and the value of the corporation at the time of a “change of ownership” as defined by Section 382. We recently completed an analysis of our equity transactions and determined that we had a change in ownership in 1999. Therefore, the ability to utilize net operating loss carryforwards incurred prior to the change of ownership totaling $32.6 million will be subject in future periods to an annual limitation of $2.3 million. Net operating losses incurred subsequent to the change totaled $52.0 million and are not subject to this limitation. However, they may be subject to limitation should a subsequent change in ownership occur.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     There was no material change in our exposure to market risk at June 29, 2002 as compared with our market risk exposure on December 31, 2001. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Risk” in our 2001 Annual Report on Form 10K.

Forward-Looking Statements

     This report contains forward-looking statements that involve risks and uncertainties. We have made these statements in reliance on the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Our forward-looking statements relate to future events or our future performance and include, but are not limited to, statements concerning our business strategy, future commercial revenues, market growth, capital requirements, new product introductions, expansion plans and the adequacy of our funding. Other statements contained in this report that are not historical facts are also forward-looking statements. We have tried, wherever possible, to identify forward-looking statements by terminology such as “may,” “will,” “could,” “should,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and other comparable terminology.

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     Forward-looking statements are not guarantees of future performance and are subject to various risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed in forward-looking statements. They can be affected by many factors, including, but not limited to the following:

     •     fluctuations in product demand,

     •     the impact of competitive filter products, technologies and pricing,

     •     manufacturing capacity constraints and difficulties,

     •     market acceptance risks, and

     •     general economic conditions.

     Please read Exhibit 99 to this report entitled “Disclosure Regarding Forward-Looking Statements” for a description of additional uncertainties and factors that may affect our forward-looking statements. Forward-looking statements are based on information presently available to senior management, and we do not assume any duty to update our forward-looking statements.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

     We are currently engaged in a patent dispute with ISCO International, Inc. relating to U.S. Patent No. 6,263,215 entitled “Cryoelectronically Cooled Receiver Front End for Mobile Radio Systems.” ISCO filed a complaint on July 17, 2001 in the United States District Court for the District of Delaware against us and Conductus, Inc., another company involved in the high-temperature superconducting industry. The ISCO complaint alleges that our SuperFilter product and Conductus’ ClearSite® product infringe ISCO’s patent. After conducting separate investigations into the allegations, we and Conductus both filed responses denying ISCO’s allegations and asking the court to declare the ISCO patent invalid and not infringed. We are cooperating with Conductus in the defense of this lawsuit.

     On October 3, 2001, we amended our response to add allegations that ISCO failed to disclose relevant prior art to the U.S. Patent Office during the patent application process. At the same time, we also sued ISCO for threatening some of our customers. Our standard terms and conditions of sale include an indemnity against any patent infringement claims, and we have informed our customers that we will defend them against any action brought by ISCO for any alleged infringement related to our products. We are seeking both compensatory and punitive damages from ISCO, as well as attorneys’ fees, arising from their threats against our customers. On March 26, 2002, ISCO added a new claim to their lawsuit alleging that our new IMT-2000 SuperFilter Tower Top System for use with third generation, or 3G, technology in international markets infringes two other ISCO patents—U.S. Patent No.’s 6,104,934 and 6,205,340. On April 17, 2002 the court ruled that these two claims are untimely and relegated ISCO to filing a separate lawsuit if it wants to pursue these claims. To date, ISCO has not pursued these claims.

     The trial is scheduled to start January 13, 2003. The parties completed the discovery process by June 28, 2002, and the judge scheduled a “Markman hearing” for September 10, 2002. At the Markman hearing, the judge will receive evidence and then decide the scope and meaning of the patent claims asserted by ISCO.

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

     The following matters were submitted to the shareholders at the Company’s Annual Meeting of Shareholders held May 16, 2002:

     (1)  All of the following nominated Class 1 Directors were elected to serve for a three year period and until their successors are duly elected and qualified.

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     (2)  The appointment of PricewaterhouseCoopers LLP as independent auditors of the Company was ratified for the year ending December 31, 2002.

Item 6. Exhibits and Reports on Form 8-K

     (a)  Exhibits

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(4)		Incorporated by reference from the Registrant’s Registration Statement on Form S-1 (Reg. No. 33-56714).
(5)		Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended October 2, 1999.
(6)		Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1999.
(7)		Incorporated by reference from the Registrant’s Current Report on Form 8-K filed October 4, 2000.
(8)		Incorporate by reference from the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001.
(9)		Filed herewith.

     (b)  Reports on Form 8-K

     The Company filed the following reports on Form 8-K during the quarter ended June 29, 2002:

     (1)  Current Report on Form 8-K filed on April 8, 2002 regarding lawsuit filed against us by ISCO.

     (2)  Current Report on Form 8-K filed on April 8, 2002 regarding the completion of a private equity offering.

SIGNATURE

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

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