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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

(Mark One)

OR

Commission File Number 0-21074

SUPERCONDUCTOR TECHNOLOGIES INC.

460 Ward Drive, Santa Barbara, California 93111-2310
(Address of principal executive offices) (Zip Code)

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

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

     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 [   ]                      No [X]

     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. [ ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [   ]                      No [X]

     The aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $40.5 million based on the closing price of $1.65 per share of common stock as reported on The NASDAQ Stock Market® on June 30, 2002. 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 15, 2003 was 59,823,553.

DOCUMENTS INCORPORATED BY REFERENCE

     Item 5 of Part II and Items 10, 11, 12 and 13 of Part III incorporate information by reference from the definitive proxy statement for the Registrant’s Annual Meeting of Stockholders to be held on May 22, 2003.

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SUPERCONDUCTOR TECHNOLOGIES INC.

FORM 10-K ANNUAL REPORT
Fiscal Year Ended December 31, 2002

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PART I

ITEM 1.           BUSINESS

Forward-Looking Statements

          The discussion in this section of our annual report contains forward-looking statements that involve risks and uncertainties. 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. Please read the discussion under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Forward Looking Statements” for a description of our forward-looking statements and some of the factors that might affect those 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.

Overview

          We develop, manufacture and market high performance products to service providers, systems integrators and original equipment manufacturers in the commercial wireless telecommunications industry. Our products, known commercially 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 are built around our flagship, SuperLink Rx, and work in concert to provide Total LinkSM Enhancement, combining the benefits of our complementary solutions to meet the growing demand of the wireless telecommunications industry for improved capacity, reduced interference, and greater coverage for their network base stations. Our products for the government provide enhanced performance in a variety of communications, surveillance and signal detection applications for military, intelligence and law enforcement agencies.

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

	•		SuperLink Rx. 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. Deployed in base stations, these products combine specialized filters using high-temperature superconducting (HTS) technology with a proprietary cryogenic cooler and a cryogenically cooled low-noise amplifier. The result is the ultimate uplink, a highly compact and reliable cryogenic receiver front-end (CRFE) that can simultaneously deliver both high selectivity (interference rejection) and high sensitivity (detection of low level signals). SuperLink Rx products thereby offer significant advantages over conventional filter systems.
	•		SuperLink Tx . Wireless networks also suffer from insufficient transmit power on the downlink signal path. Especially after the uplink has been improved by using SuperLink Rx. In this situation, operators can achieve superior downlink performance from SuperLink Tx, a family of compact, robust, and technologically advanced multi-carrier high-power amplifiers.
	•		SuperPlex. For antenna sharing without compromise, we offer SuperPlex, a line of multiplexers that provide extremely low insertion loss and excellent cross-band isolation.

          We have undergone three unique phases of development since our incorporation in 1987. From 1987 to 1996, we focused primarily on the research and development of HTS technologies. From 1997 to 2001, our second phase, we made the transition from a research and development firm to a commercial operating company. During this time we launched our first commercial HTS product, the SuperFilter System, and concentrated on commercializing HTS technology for the U.S. wireless

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market. We are now in our third phase of development. Our Company has evolved from one oriented solely around HTS technology to one that is committed to providing best-in-class link enhancement solutions to the global wireless infrastructure market. Following our strategy of Total Link Enhancement, (simultaneously optimizing the performance of the uplink, the downlink and the antenna), we now offer innovative technologies across multiple product lines and in multiple geographic markets.

          Our expanded product line of SuperLink Solutions combined with our increased sales and marketing activities, has resulted in multiple product orders over the last year. In September 2002, we introduced SuperLink Rx 850, the industry’s most compact and lowest-power CRFE, and in January 2003 we reached another major milestone, shipping our 2,000^th system of the SuperLink Rx family, only 14 months after hitting the 1,000-unit mark. At the close of 2002, approximately 2,000 SuperLink Rx products were deployed in networks worldwide, with approximately 23 million cumulative hours of operation.

          Over the last year, we have expanded our Santa Barbara manufacturing facilities to satisfy the increasing demand for SuperLink Rx units. In early 2002 we increased our available manufacturing space and added to our state-of-the-art equipment to improve capacity. These activities allowed us to increase our production capacity from 200 systems per quarter at the end of 2001 to approximately 600 units per quarter capacity at the end of 2002.

          On December 18, 2002, the Company acquired 100 percent of the outstanding shares of Conductus, Inc. (“Conductus”), a competing supplier of HTS technology for wireless networks as well as a manufacturer of high-performance HTS products for government customers. Conductus developed, manufactured, and marketed electronic components and systems based on superconductors for application in telecommunications markets and in defense, intelligence and law enforcement markets. Conductus’ government products utilize many of the same advanced technologies as found in our SuperLink Rx Solutions products for commercial wireless networks. Government products are tailored to the specialized needs of individual government customers yet a significant percentage of these products are based on common platforms to allow for improved economies of scale.

Industry Background

The Wireless Communications Market

          Despite the slowdown in the telecommunications infrastructure sector, we expect the underlying strengths of the wireless communications market will allow it to “weather the storm” and to gradually benefit from increased but more efficient capital spending. Some of these strengths include: continued worldwide growth in subscribers, particularly in the developing world; rising minutes of use; and wider availability of advanced air interfaces that permit faster data throughput.

          New subscribers. According to the Yankee Group, at the end of 2002 there were approximately 961 million cellular and PCS wireless subscribers in North America, Latin America, Europe and Asia Pacific. The Yankee Group expects this number to increase to more than 1.3 billion subscribers by the close of 2006, representing a compound annual growth rate of 9%. The developing world, led by the Peoples Republic of China, is expected to continue to experience the fastest subscriber growth rates.

          Increased usage (minutes of use). Cut-rate prices for wireless calls have lead to significant increases in minutes of use for the average subscriber. According to the Cellular Telecommunications & Internet Association (CTIA), total billable minutes of use are up 48 percent year over year since 1993. We expect that minutes of use will continue to increase as new data and Internet services such as e-mail and instant messaging gain in popularity, and will also rise as consumers gradually shift toward using mobile devices instead of fixed telephones as their primary telecommunications device.

          New air interfaces. Advanced wireless transmission technologies, or “air interfaces,” are finally becoming available to consumers in the United States and other nations. With their faster data speeds and increased bandwidth, these new air interfaces are expected to usher in a broad range of wireless services, from music downloads to image and video file sharing. One such new wireless transmission technology is CDMA IXRTT, which represents an upgrade to the current technology known as Code Division Multiple Access (commonly referred to as CDMA). Verizon Wireless and Sprint, two of the largest wireless carriers in the U.S., have already deployed CDMA 1XRTT technology in many of their networks across the country. We expect the onset of the “data era” in mobile communications will help operators to reverse declining annual revenues per

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user and move closer to long-term financial health.

Strains on Wireless Networks

          We believe the ability to provide high quality service to customers will become increasingly difficult for wireless operators as the number of subscribers rises, minutes of use increase, and the market for wireless data services expands. We expect that wireless service providers in both rural and urban areas will encounter higher levels of radio frequency, or RF, interference due to greater subscriber density and a larger number of users on adjacent channels. Operators can expect that this reduced signal quality and higher percentage of dropped calls will lead to lower system utilization, decreased revenue, and ultimately, higher rates of customer churn.

          Service providers are also expected to face network capacity constraints. For example, wireless carriers in some urban areas are reaching their spectrum capacity and therefore must acquire more spectrum or do more with the available infrastructure. In particular, CDMA operators, whose networks employ the same wide communications channels for both data and voice transmission, are learning that as higher-speed data transmissions proliferate their networks will have less capacity available for voice users.

          In order to reduce the strain on their wireless networks, providers must find a way to “do more with less,” to cost-effectively reduce interference and increase capacity, expand coverage, and improve the quality of their systems. Today’s restricted corporate budgets and tougher zoning laws make operators far less likely to have the option of simply deploying new base stations to achieve these performance goals.

Our Solution

          Our empirical data show that our premium SuperLink Solutions provide dramatic and cost-effective improvements to RF signal quality and network capacity utilization. In February 2002, an all-day session on superconductor technology was held at the International Engineering Consortium’s fifth annual National Wireless Engineering Conference. At this session, a “top-five” U.S. cellular operator presented data illustrating the benefits of deploying SuperLink Rx in an urban environment. Over four weeks in November 2001, this CDMA operator monitored data from a cluster of ten urban cell sites, each outfitted with SuperLink Rx units. The operator stated that on average, STI’s solutions provided the following quality-of-service improvements across the cluster:

	•		6 dB reduction in base station noise figure— effectively doubling base station sensitivity and therefore uplink capacity and coverage;
	•		14 dB reduction in handset transmit power— prolonging handset battery life and available talk time;
	•		46% reduction of dropped calls (with one site registering a 62% reduction) and 28.5% reduction of access failures— both helping to reduce subscriber churn;
	•		Elimination of inference from Specialized Mobile Radio handsets and base stations; and
	•		Increased in-building penetration

          We expect that our more recently introduced product lines, SuperLink Tx and SuperPlex, will also provide substantial advantages for wireless networks.

          Products in our SuperLink Tx line of premium multi-carrier power amplifiers employ advanced linearization technology and are optimized for CDMA base stations. Relative to competing technologies, we believe that these products offer:

	•		Superior reliability;
	•		Improved peak power handling; and
	•		Lowest cost of ownership

          Products in our SuperPlex line of high-performance multiplexers are designed to eliminate the need for additional base station antennas and reduce infrastructure costs. These products provide very low transmit and receive insertion loss and excellent cross-band isolation. Relative to competing technologies, we believe that these products offer:

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	•		Increased transmit power delivered to base station antennas;
	•		Higher sensitivity to customers’ handset signals; and
	•		Fast and cost-effective network overlays (such as PCS network infrastructure on top of cellular network infrastucture)

	Both SuperLink Tx and SuperPlex product families offer network performance benefits synergistic with SuperLink Rx, and in many cases the optimal solution is to combine multiple products from the different families.

Our Strategy

          We have mastered the use of high-temperature superconducting (HTS) technology to improve the quality of wireless networks. Our strategy is to provide Total Link Enhancement by teaming our field-proven HTS solutions with high-performance multiplexers and multi-carrier power amplifiers. Our SuperLink Solutions provide the ultimate package of RF link performance enhancement solutions.

          The primary elements of our strategy include:

          Enhance and Extend Current Product Offerings. There is a constant demand for more compact, more efficient, and more sophisticated wireless communication technology. In response, we expect to use our technical expertise to expand our primary product lines, as represented by SuperLink Rx (uplink enhancement), SuperLink Tx (downlink enhancement), and SuperPlex (antenna sharing).

          Expand Domestic and International Sales Channels. We intend to continue to expand our sales efforts to domestic wireless communication providers, system integrators and OEMs. We also expect to expand our international distribution channels, particularly in Asia and Latin America.

          Enhance Our Productivity and Lower Our Costs. We intend to continue developing our manufacturing infrastructure and organization to meet our expected production requirements. We plan to continue manufacturing in-house certain key components of our products such as our proprietary HTS filters and cryogenic coolers. We believe that this will enable us to: (1) produce highly reliable, quality products; (2) protect the proprietary nature of our technology and processes; (3) properly control our manufacturing processes; and (4) achieve significant cost reductions.

          Continue our emphasis on government products and R&D. Recent world events have elevated the government’s interest in advanced technologies, particularly those of value in communications and surveillance systems. We plan to continue our focus on government-oriented HTS products and HTS research and development in accordance with this higher demand. With the merger with Conductus in late 2002, we expect that our product sales to and contracts with the government will greatly increase our presence in the government marketplace, as well as positively impact our ability to produce ever-greater product volumes and expand commercial sales.

          Maintain Our Focus on Technical Excellence and Innovation. We are committed to maintaining our leadership role in the wireless communication market for link enhancement solutions. In order to expand and protect our technology, we will continue to seek patent protection and/or licenses of key technology owned by others. We also will continue to engage in government research and development contracts to fund our commercial technology and product development.

          Pursue Strategic Partnerships, Alliances and Acquisitions. In addition to our internal development efforts, we may acquire new products and technologies that address the complementary issues of uplink enhancement, downlink enhancement, and antenna optimization. In November 2002, STI formed a strategic alliance with Heinz Corporation, a leading provider of services to the wireless industry. As part of this new alliance, the two companies will jointly provide, design and install solutions to improve the quality of wireless networks, especially in high-volume urban areas. Initial efforts have focused on collecting and analyzing RF data for use in designing solutions that reduce or eliminate the adverse effects of RF interference on network performance. In December 2002, we completed a merger with Conductus, Inc. The combined entity is expected to benefit from Conductus’ strengths in high-performance HTS products for government applications and STI’s dominance of commercial HTS applications for wireless infrastructure.

Merger with Conductus, Inc.

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          On December 18, 2002, STI completed a merger with Conductus, Inc. of Sunnyvale, California and concurrently closed a related $20-million equity private placement that was contingent upon the merger. The acquisition of Conductus is expected to have a long-term, positive impact on STI, allowing the company to become a considerably stronger force within the telecommunications equipment sector. Conductus’ facility is now known as Superconductor Technologies’ Sunnyvale Government Business and Engineering Center. This facility is dedicated to the development and manufacture of products for government customers as well as to advanced technology development in material filter design and other areas of interest to the Company.

          The merger between STI and Conductus was effected in order to exploit synergies that exist between the two organizations. The combination of these two companies represents 30 years of collective experience in the development of HTS technology. Even though Conductus and STI had focused on many of the same applications and markets, particularly over the past five years, the strengths of the two organizations were actually quite different. As a result, we believe that the capabilities of the combined company far exceed those of the parent organizations and these enhanced capabilities will provide improvements, solve problems, streamline processes, reduce costs and accelerate our overall progress.

          Whereas STI is the global leader in the development, manufacture, and marketing of commercial HTS products for wireless infrastructure, Conductus has excelled in the development, manufacture, and marketing of HTS products for government applications, specifically for military, intelligence, and law-enforcement customers. One particular area of technological excellence for Conductus has been the development of superconducting, tunable filters that can be adjusted to operate over a variety of frequency ranges. Technology developed by Conductus for government applications is in many cases synergistic with the needs of commercial product applications and will therefore complement and enhance STI’s commercial HTS solutions.

          Conductus owns 24 patents alone or with others, and has 19 pending applications in the United States. Conductus has international patents and a number of international applications pending under the Patent Cooperation treaty or in various countries worldwide. Several of Conductus’ patents and patent applications relate to various aspects of its communications products, including thin-film processing, filer design and tuning, and other aspects of interference devices or digital electronics and some of which are licensed to one or more entities.

Our Wireless Products

          Commercial wireless providers can use our SuperLink Solutions to keep pace with the growing demand for wireless communications. Wireless providers may deploy our products in connection with the installation of additional base stations in a network, as well as with the installation of an entirely new network. They can also improve the performance of existing base stations and networks by retrofitting their equipment with our link enhancement products.

          Our SuperLink Solutions are comprised of three unique product families: SuperLink Rx, SuperLink Tx, and SuperPlex.

	•		SuperLink Rx products are uplink solutions that combine specialized filters using 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 and high sensitivity. This product family includes systems for 850 MHz and 1900 MHz in addition to systems designed to assist in overlays of different technology at the same frequency.
	•		The small size and low power consumption of our SuperLink Rx product is largely the result of our choice of cooling technology. In order to incorporate a compact, efficient, and reliable cooling system, we developed a proprietary Stirling cryogenic cooler. Approximately 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 as well as the need for scheduled maintenance. Our cooler requires approximately 100 watts of power— far less than other cryogenic systems.
	•		SuperLink Tx is our line of premium multi-carrier power amplifiers. These solutions are geared toward downlink-limited environments and serve as a key element in our Total Link Enhancement strategy.
	•		The SuperPlex family consists of antenna sharing solutions such as HTS-Ready™ Duplexers. These high-performance products are designed to eliminate the need for additional antennas and reduce costs. SuperPlex products have extremely low insertion loss and excellent cross-band isolation; making them highly effective HTS companion products. They are available for 850 MHz as well as 1900 MHz wireless networks and in regular and high power versions.

          In 2002, we introduced several new SuperLink Solutions products. In March 2002, we expanded our SuperPlex Solutions family with the introduction of the HTS-Ready™ Duplexer. This product delivers superior duplexing functionality in the 850 MHz cellular band and provides twice the amount of average (1200 watts versus 600 watts)

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and four times as much peak power handling (40 kilowatts versus 10 kilowatts) as found in our standard HTS-Ready Duplexer 850 Series. In September 2002, STI launched the SuperLink Rx 850, the most compact and lowest power cryogenic receiver front end in the industry. SuperLink Rx 850 is half the size, uses one-third less power and delivers an even lower noise figure than its predecessor, SuperFilter II. SuperLink Rx 850 represents a significant step forward in the evolution of commercial HTS. Early HTS products, which came to market in the late 1990s, were expensive, power-hungry and unproven in the field. In addition, some of these early CRFEs were nearly the size of a refrigerator and required ten times the power. SuperLink Rx 850 is approximately the size of a breadbox and uses less power than a light bulb.

          Government customers utilize our HTS products and technology development services to enhance the performance of various types of specialized communications and surveillance systems. For example, our superconducting technology offers the capability to simultaneously provide enhanced sensitivity and strong interference rejection that is particularly valuable in the complex radio frequency environment found aboard military aircraft. Many government applications require the ability to detect weak radio-frequency signals in the presence of strong signals at adjacent frequencies, and HTS technology is uniquely suited to this task. STI’s recent acquisition of Conductus, Inc. has strengthened our abilities to supply these types of products.

          During the years ended December 31, 2000 and 2001 our net commercial product revenues totaled $5.3 million and $7.6 million, respectively, and related primarily to the sales of our SuperFilter System. For the year ended December 31, 2002 our net commercial product revenues totaled $17.6 million and was comprised of $15.3 million from sales of our SuperFilter System, $2.3 millions from sales of our multiplexers, and $57,000 from sales of our multi-carrier power amplifiers.

Marketing and Sales

          We presently sell solutions to wireless communication service providers in the Americas and have plans to expand worldwide. Our earliest experience was with small rural providers who had the most immediate need for the SuperFilter® for range extension and coverage enhancement. We sold our first systems in the fourth quarter of 1997. We sold 83 more systems in 1998, 123 systems in 1999, 393 systems in 2000, 438 systems in 2001 and 927 systems in 2002. We continue to increase systems sales in spite of a shift in our sales focus to the large service providers where the sales cycle requires numerous trials and is very long. This shift in focus was undertaken to begin a move to the suburban and urban markets where the majority of base stations are located and where the need for interference rejection is greatest. In mid 1999, we signed a five-year supply agreement with U.S. Cellular Corporation, one of the five largest cellular providers in the country. In March 2000, we signed a supply agreement with ALLTEL, an even larger domestic wireless service provider, designating STI as their supplier of HTS base station receiver solutions. In December 2001, we signed a follow-on agreement with a major customer for 1,000 SuperFilter Systems, to be delivered over five quarters. U.S. Cellular and ALLTEL are our two largest customers and accounted for 92% of our net commercial revenues in 2002 as compared to 85% in 2001.

          We sell using a direct sales force in the U.S. and internationally. We have only recently begun efforts to market our products internationally and have not yet had significant international sales. We plan to supplement our direct sales by building a network of international distributors. We are also working with many consulting firms to provide data that illustrates the benefits of deploying our products in their customers’ networks. We also demonstrate our products at trade shows, participate in industry conferences, utilize advertising and direct mailings, and provide technical and application reports to recognized trade journals. We also advertise our products through our website, brochures, data sheets, application notes, trade journal reports, and press releases. Our sales and marketing efforts are supplemented by a team of engineers who manage field trials and initial customer installations and educate customers.

Backlog

          Our commercial backlog consists of accepted product purchase orders scheduled for delivery within 24 months and consists of purchase orders for both dollar and unit purchase commitments. The exact dollar commitment for unit commitments may vary depending on the exact units purchased. Based on past purchasing patterns and expected purchasing trends of customers with unit commitments, we estimate our backlog at December 31, 2002 to be $1.4 million, as compared to $21.3 million at December 31, 2001. The backlog at December 31, 2001 included two unusually large purchase orders, $3.1 million remaining from a $7.8 million purchase order from U.S. Cellular and $17.9 million remaining from a 1,000 unit SuperFilter order received in late 2001. Deliveries under these purchase orders were substantially complete by December 31, 2002.

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Our Technology

          Superconducting Technology

          We use superconducting technology to improve both the selectivity (rejection of adjacent band interference) and the sensitivity (ability to “hear” signals better) of a base station receiver. 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 normal conductors encounter resistance that requires power to overcome and generates 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 (one of the members of our Board of Directors and Chairman of our 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°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°C) were discovered. In early 1987, yttrium barium copper oxide (“YBCO”) was discovered, which has a critical temperature of 93K (-180°C). Shortly thereafter, thallium barium calcium copper oxide (“TBCCO”) was discovered, which has a critical temperature of 125K (-148°C). These discoveries were important because these high temperature superconductors allowed for operating temperatures higher than 77K (-196°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. Our Company was formed following this discovery for the initial purpose of developing and commercializing high temperature superconductors.

          How We Develop Our Technology

          As part of our strategy to maintain our technological leadership, we have focused our research and development activities on high temperature superconducting (HTS) materials, RF circuitry, and cryogenics design and product application. We have internally developed our key technologies from a standard set of technology platforms. We utilize a proprietary manufacturing process for HTS thin-film production, the base material for our 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 our 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. We believe that our filter systems provide our targeted markets with the smallest and most cost-effective products and that we are 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. We primarily utilize TBCCO, which has one of the highest known critical temperatures, allowing for reduced cooling needs in order to achieve superconducting properties. We hold 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. As part of our strategy to stimulate the development and use of TBCCO, we granted DuPont a non-exclusive worldwide sublicense to develop processes and market TBCCO thin-films. Thin-film superconductors are the base materials used by us to produce RF components, such as wireless communications filters. We hold twelve patents for technologies related to thin-film production. We believe that the process technology we have developed produces state of the art HTS thin-films of the highest quality.

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     RF Circuitry

     We have devoted a significant portion of our engineering resources to design and model the complex RF circuitry that is basic to our products. Our RF engineering team is led by Vice President of Engineering Dr. Gregory Hey-Shipton and includes Dr. George Matthaei, recognized international leaders in RF filter design. In addition, Dr. J. Robert Schrieffer, a Nobel laureate, is head of our Technical Advisory Board. The expertise of this highly qualified team has allowed us to design and fabricate very precise individual components, such as RF signal filters. We have implemented computer simulation systems to design our products and this RF circuitry design has allowed us to produce extremely small, high-performance circuits. Some of our design and engineering innovations have been patented; others are the subjects of pending patent applications. We believe that our RF engineering expertise provides us with a unique competitive advantage.

     Cryogenic Cooling Technology

     The availability of a low-cost, highly reliable, compact cooling technology is critical to the successful commercialization of our superconducting products. Prior to the Company’s efforts no such cryogenic cooler has been commercially available. In response to this lack of availability, we developed a low-cost, highly reliable low-power cooler designed to cool to 77K (-196°C) with sufficient cooling capacity for our superconducting applications. Our cryogenic cooler, with over 23,000,000 hours of operation in wireless base stations worldwide, has demonstrated a mean time between failure of greater than 850,000 hours. Its development was based in part on patents licensed by us from Sunpower, Inc. We believe that our internally developed cooler that is uniquely both compact and reliable enough to meet the most demanding wireless industry standards provides us with a significant and unique competitive advantage.

     Cryogenic Packaging

     Cooling to cryogenic temperatures requires proper thermal isolation 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. We have developed a variety of proprietary and patented cryogenic packaging innovations to satisfy this requirement.

How we use Government Contracts to fund technology development

          Our strategy is to pursue government research and development contract awards, which complement our commercial product and technology development. For example, we are currently working on a project to develop rapid tuning of superconducting filters funded by the Department of Defense Advanced Research Projects Agency (DARPA). This capability would greatly increase the effectiveness of our systems in blocking interference in government and potentially also commercial applications.

          Since our inception in 1987, a substantial part of our 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 these revenues were paid under contracts with the U.S. Department of Defense. We have marketed to various government agencies to identify opportunities and actively solicit partners for product development proposals. Since 1988, we have successfully obtained a number of classified and non-classified government contracts for superconductor research, including one of the largest non-classified HTS awards from DARPA through the Office of Naval Research. In addition to actively soliciting government contracts, we have participated in the Small Business Innovative Research, or SBIR, program. We have been awarded 32 Phase I SBIR contracts, each of which typically generates from $70,000 to $100,000 of revenues. We have 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, and we converted one of these contracts into a Phase III program valued at $2.2 million. Since our formation, government contracts have provided us approximately $70 million of revenue, and remain a significant source of revenue today, supporting our research and development programs.

Our Manufacturing Capabilities

          We currently manufacture all of our SuperLink Rx systems and SuperPlex products at our facilities in Santa Barbara, California. In 1998, we opened a state-of-the-art manufacturing facility in Santa Barbara. As the demand for our products grew in 2002 and into 2003 we increased our internal manufacturing capacity by three fold, expanding manufacturing within

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the existing site. The expansion will include additional class “100” clean rooms, semi-automated assembly and test area, along with new customer service and quality assurance functions. We also have plans in place to expand our manufacturing capacity through subcontractors as volumes increase. We expect our manufacturing capacity to be approximately 2,500 units in 2003 and we plan on doubling again for a capacity of 5,000 units in 2004.

Some of our manufacturing processes, including thin-film production, are performed in “clean rooms.” Other manufacturing stages, including system assembly, are conducted in a standard manufacturing environment. We have demonstrated a proprietary manufacturing process for thin-film TBCCO materials that we believe is scaleable for high volume production. We have established a production operation, which we use to produce TBCCO thin films on wafers for wireless electronics applications. We currently purchase wafers for growth of our HTS thin films from a single supplier. Our radio frequency circuitry is designed, modeled and tested by internal engineering resources. We have in-house capabilities to pattern the superconducting material and all other aspects of radio frequency component production, including packaging the filters. We also have in-house capabilities to manufacture our cryogenic coolers at a pace consistent with current quantity requirements.

Our multi-carrier power amplifier is purchased from a third party manufacturer.

Intellectual Property

          We regard our product designs, design tools, fabrication equipment and manufacturing processes as proprietary and seek to protect our rights in them through a combination of patent, trademark, trade secret and copyright law and internal procedures and non-disclosure agreements. We also seek licenses from third parties for HTS materials and processes used by us, which have been patented by other parties. We believe that our success will depend, in part, on the protection of our proprietary information, patents and the licensing of key technologies from third parties.

          We have focused our HTS materials development efforts on TBCCO. We have 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.

          In January 1993, as part of our strategy to stimulate the development and use of TBCCO, we granted DuPont a non-exclusive worldwide sublicense to develop processes and market TBCCO thin-films. DuPont pays us royalties on sales of TBCCO thin-films or devices containing TBCCO thin-films. In the event that we grant another sublicense to a third party on more favorable terms, we will be obligated to extend those terms to DuPont. DuPont and their customers are current or potential competitors of ours, and we can give no assurance that these sublicenses will not materially and adversely affect our financial condition.

          As of December 31, 2002, we held 62 U.S. patents, including those acquired in the Conductus acquisition. Of these patents, 25 are for technologies directed toward producing thin-film materials, including our proprietary thin-film process for TBCCO production, expiring in 2008 to 2016. In addition, we currently hold 14 U.S. patents for circuit designs expiring in 2010 to 2019 and 16 U.S. patents covering cryogenics, packaging and systems expiring in 2012 to 2021. Another 7 U.S. patents are in other superconducting technologies expiring in 2010 to 2017. As of December 31, 2002, we had 40 U.S. patents pending.

          As of December 31, 2002, we held 40 foreign published or issued patents and 72 foreign patents pending. We also have license rights to 14 issued patents in the United States and to 57 patents issued or pending internationally.

          We have trade secrets and unpatented technology and proprietary knowledge about the sale, promotion, operation, development and manufacturing of our products. We have confidentiality agreements with our employees and consultants to protect these rights.

          We own federally registered trademarks to the names Superconductor Technologies, Conductus and SuperFilter with several other registrations pending. We own other registered and unregistered trademarks, and have certain trademark rights in foreign jurisdictions.

Competition

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          The wireless communication market is intensely competitive. We face competition in various aspects of our technology and product development and in each of our targeted markets. Our current and potential competitors include conventional RF filter manufacturers and both established and newly emerging companies developing similar or competing HTS technologies. We also compete with companies that design, manufacture, or market conventional downlink enhancement products such as power amplifiers, as well as with companies that sell antenna-optimizing multiplexers. With respect to our HTS filter systems we compete primarily with ISCO International, Inc., formerly Illinois Superconductor Corporation. We also compete against companies that seek to enhance base station range and selectivity by means other than a superconducting filter. The primary competitors use tower mount and ground mount amplifiers, conventional filters, repeaters or “smart” antenna technologies. Tower mount and ground mount amplifiers pass an RF signal received by an antenna through a broad filter, followed by a low noise amplifier. These units are produced by a number of companies, which include most of the base station original equipment manufacturers (OEMs) such as Ericsson and Nokia. Filter manufacturers, including Allen Telecom, REMEC, Allgon and Radio Frequency Systems (formerly Celwave), also produce these units. “Smart antennas” allow base stations to focus energy more directly on individual wireless devices in order to improve capacity. Arraycom is among the leading independent companies that produce these systems. Base station manufactures, such as Ericsson, Nokia, Nortel and Lucent are also developing smart antennas for their base stations.

          In addition, we currently supply components and license technology to several companies that may eventually decide to manufacture or design their own HTS components, rather than simply purchasing or licensing our technology. With respect to our HTS materials, we compete with DuPont among others. In the government sector, we compete with universities, national laboratories and both large and small companies for research and development contracts, and with larger defense contractors, such as Raytheon and Northrop Grumman for government products. We expect increased competition both from existing competitors and a number of companies that may enter the wireless communications market.

Employees

          We employed a total of 240 persons as of December 31, 2002: 118 in manufacturing, 63 in research and development, 27 in sales and marketing and 32 in administration. Twenty-one of our employees have Ph.D.s, and thirty-six others hold advanced degrees in physics, materials science, electrical engineering and other fields. Our employees are not represented by a labor union, and we believe that our employee relations are good.

          We are highly dependent upon the efforts of our senior management. Due to the specialized technical nature of our business, we are also highly dependent upon our 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 our senior management or technical teams could hinder our ability to achieve our product development and commercialization objectives. There is intense competition for qualified personnel in our market areas and we can give no assurance that we will be able to continue to attract and retain qualified personnel necessary for the development of our business.

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. Current or future laws and regulations could require substantial expenditures for preventative or remedial action, reduction of chemical exposure or waste treatment or disposal. Although the Company believes that its safety procedures for the handling and disposing of hazardous materials comply with the standards prescribed by state and federal regulations, there is always the risk of accidental contamination or injury from these materials. To date, the Company has not incurred substantial expenditures for preventive action with respect to hazardous materials or for remedial action with respect to any hazardous materials accident, but the use and disposal of hazardous materials involves the risk that the Company could incur substantial expenditures for such preventive or remedial actions. If such an accident occurred, the Company could be held liable for resulting damages. The liability in the event of an accident or the costs of such remedial actions could exceed the Company’s resources or otherwise have a material adverse effect on the Company’s financial condition and results of operations.

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ITEM 2.           PROPERTIES

          We lease all of our properties. Most of our operations, including our manufacturing facility, are located in an industrial complex in Santa Barbara, California. We occupy approximately 60,000 square feet under a lease that expires in 2011. Through the acquisition of Conductus, in December 2002, STI expanded its operations base to Sunnyvale, California. This operations center will serve primarily as a facility for the development, manufacture, and marketing of government-oriented products. It is currently comprised of two 20,000 square feet buildings under leases, which expire in 2006, with offices, labs and cleanrooms. One building will remain occupied and the other has been abandoned and is available for sublease. We believe that our facilities are adequate to meet current and reasonably anticipated needs for approximately the next year.

ITEM 3.           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 were cooperating with Conductus in the defense of this lawsuit, and we acquired Conductus on December 18, 2002.

          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 parties completed the discovery process by June 28, 2002. The judge held a “Markman hearing” on October 15, 2002 to receive evidence concerning the scope and meaning of the patent claims asserted by ISCO. The judge issued his rulings from the Markman hearing on October 30, 2002. The trial began March 17, 2003 and is expected to last approximately two weeks. The litigation could have material adverse effect on our business. Please see the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”

ITEM 4.           SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

          During the quarter ended December 31, 2002, we submitted the following to stockholders at a special meeting held on December 17, 2002, all of which were approved as follows:

     (1)  A proposal to approve the merger of Conductus, Inc. (Conductus), a Delaware corporation, with and into Superconductor. This was accomplished by merging STI Acquistion Inc., a Delaware corporation and a wholly owned subsidiary of Superconductor, with and into Conductus, under the terms of the Agreement and Plan of Merger. In the merger, stockholders of Conductus received 0.6 shares of newly issued common stock of Superconductor for each share of Conductus common stock owned.

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     (2)  A proposal to approve the terms of Superconductor’s private financing transaction of $20 million which would result in the issuance of stock concurrently with the closing of the merger at a below market price. Stockholder approval was required under Nasdaq corporate governance rules because the shares were sold at a below market price and the total number of shares issued at closing would be in excess of 20% of Superconductor’s outstanding shares of common stock. The receipt of a minimum of $15 million of financing on these terms was a condition to the closing of the merger.

     (3)  A proposal to approve an amendment to Superconductor’s Amended and Restated Certificate of Incorporation (referred to as the Superconductor Certificate) that would enable Superconductor’s board of directors, at its descretion, to effect a reverse stock split of Superconductor common stock at an exchange ratio ranging from one newly issued share for each two outstanding shares to one newly issued share for each ten outstanding shares.

     (4)  A proposal to approve an amendment to Superconductor’s Restated Certificate of Incorporation, as amended, increasing the authorized common stock of Superconductor from 75,000,000 shares to 125,000,000 shares.

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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® under the symbol “SCON”. The following table sets forth for the periods indicated the high and low intraday sales prices for our common stock as reported on The NASDAQ Stock Market®.

Holders of Record

          As of March 20, 2003, we had approximately 313 holders of record of our common stock. We estimate that there are more than 24,000 round lot beneficial owners of our common stock.

Dividends

          The Company intends to employ all available funds in the development of its business and does not expect to pay any cash dividends for the foreseeable future.

Sales of Unregistered Securities

          During the fourth quarter of 2002, in a private placement we issued equity securities that were not registered under the Securities Act of 1933. The placement was for a total of $20 million in proceeds and was in connection with the Conductus acquisition. The investors received 21,096,954 shares of the Company’s common stock and 5,274,240 warrants to purchase common stock at $1.19 per share.

          The investors provided us with written representations confirming their status as “accredited investors” under Regulation D and their intent to acquire the securities for their own accounts and not with a view to resale or distribution in violation of the Securities Act of 1933. We did not engage in general solicitation or advertising, and the securities issued in the transaction bear appropriate restrictive legends concerning the registration requirements of the Securities Act of 1933. We agreed to file a registration statement covering public resales by the investors of the shares of common stock issued at the closing and issuable upon exercise of the warrants. We believe this transaction was exempt from the registration requirements of the Securities Act of 1933 based on Regulation D and Section 4(2) of the Securities Act of 1933.

Securities Authorized for Issuance Under Equity Compensation Plans

         The securities authorized for issuance under equity compensation plans is incorporated by reference to the information set forth in the caption, “Equity Compensation Plan Information” in the Company’s Proxy Statement for the annual meeting of stockholders to be filed with the commission within 120 days of the end of the Company’s year ended December 31, 2002.

ITEM 6.           SELECTED FINANCIAL DATA

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          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 15 of Part IV of this Report.

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ITEM 7.           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 commercial wireless telecommunications industry. Our products, known commercially 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 are built around our flagship product, SuperLink Rx, and work in concert to provide Total Link Enhancement, combining the benefits of our complementary solutions 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. 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. 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 the ultimate uplink, 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 products thereby offer significant advantages over conventional filter systems.
•		SuperLink Tx. Wireless networks also suffer from insufficient transmit power on the downlink signal path. Especially after the uplink has been improved by using SuperLink Rx. In this situation, operators can achieve superior downlink performance from SuperLink Tx, a family of compact, robust, and technologically advanced multi-carrier high-power amplifiers.
•		SuperPlex. For antenna sharing without compromise, we offer SuperPlex, a line of multiplexers that provide extremely low insertion loss and excellent cross-band isolation.

          Conductus’ government products utilize many of the same advanced technologies as found in our SuperLink Rx Solutions products for commercial wireless networks. Government products are tailored to the specialized needs of individual government customers yet a significant percentage of these products are based on common platforms to allow for improved economies of scale.

     •     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. 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 $104 million from inception to December 31, 2002.

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          On December 18, 2002, the Company acquired 100 percent of the outstanding shares of Conductus, Inc. The results of Conductus, Inc. are included in the consolidated financial statement for 13 days following its acquisition through December 31, 2002. As a result of the acquisition of Conductus, the Company is currently evaluating whether, commencing in 2003, it operates in a second business segment, U.S. government technology and product development services.

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.

          In connection with the sales of its commercial products, the Company indemnifies, without limit or term, its customers against all claims, suits, demands, damages, liabilities, expenses, judgments, settlements and penalties arising from actual or alleged infringement or misappropriation of any intellectual property relating to its products or other claims arising from its products. The Company cannot reasonably develop an estimate of the maximum potential amount of payments that might be made under its guarantee because of the uncertainty as to whether a claim might arise and how much it might total.

          As described in Note 9 to the December 31, 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, 2000, 2001and 2002, $1,059,000, $2,243,000 and $1,998,000, respectively, of this reserve was reversed against the cost of product delivered under this purchase order.

          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

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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.

          In connection with the acquisition of Conductus we recognized $20 million of goodwill. The first time the goodwill will be tested for impairment will be in the fourth quarter of 2003. If the carrying amount exceeds its implied fair value, an impairment loss will be recognized equal to the excess.

          As permitted under Statement of Financial Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-Based Compensation”, the Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” in accounting for its stock options and other stock-based employee awards. Pro forma information regarding net loss and loss per share, as calculated under the provisions of SFAS 123, are disclosed in the notes to the financial statements. The Company accounts for equity securities issued to non-employees in accordance with the provision of SFAS 123 and Emerging Issues Task Force 96-18.

          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:

          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.

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Backlog

          Our commercial backlog consists of accepted product purchase orders scheduled for delivery within 24 months and consists of purchase orders for both dollar and unit purchase commitments. The exact dollar commitment for unit commitments may vary depending on the exact units purchased. Based on past purchasing patterns and expected purchasing trends of customers with unit commitments, we estimate our backlog at December 31, 2002 to be $1.4 million, as compared to $21.3 million at December 31, 2001. The backlog at December 31, 2001 included two unusually large purchase orders, $3.1 million remaining from a $7.8 million purchase order from U.S. Cellular and $17.9 million remaining from a 1,000 unit SuperFilter order received in late 2001. Deliveries under these purchase orders were substantially complete by December 31, 2002.

Results of Operations

2002 Compared to 2001

          On December 18, 2002, the Company acquired 100 percent of the outstanding shares of Conductus, Inc. The results of Conductus, Inc. are included in the consolidated financial statements for 13 days following its acquisition through December 31, 2002. Except for the write off of in-process research and development acquired in the acquisition, the consolidation of Conductus’ operations for the 13-day period ended December 31, 2002 did not have a significant impact on the results of operations for the year ended December 31, 2002.

          Total net revenues increased by $10.0 million, or more than 81%, from $12.4 million for 2001 to $22.4 million for 2002. The increase is primarily due to higher commercial product sales.

          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:

          For 2002, net commercial product revenues increased to $17.6 million from $7.6 million in 2001, an increase of $10.0 million, or more than 100%. 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 2002 totaled $2.3 million, as compared to $635,000 in 2001. The increase in gross commercial product sales proceeds was partially offset by $2.2 million and $2.3 million in 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 85% in 2001.

          Government contract revenues totaled $4.8 million in 2002 and are comparable to the prior year.

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          Cost of commercial product revenue includes all direct costs, manufacturing overhead and related start-up costs. The cost of commercial product revenues totaled $19.3 million for 2002, and was reduced by amortization credits of $2.0 million 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. For 2002, excluding these amortization credits, the cost of commercial revenues totaled $21.3 million as compared to $12.9 million in 2001. This increase resulted 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.

          For the year ended December 31, 2002 we generated negative gross margins on our commercial products at current sales levels primarily due to fixed manufacturing overhead costs. However, in the fourth quarter of 2002 we generated positive gross margins of $112,000 from net commercial sales of $4.3 million. Based on current prices and forecasted product mix and costs, we expect to continue to achieve positive commercial gross margins in 2003.

           Contract research and development expenses totaled $2.5 million in 2002 as compared to $3.4 million in the prior year and included subcontract expenses of $93,000 and $1.4 million, respectively. Excluding subcontract expenses, contract research and development expenses decreased to $2.4 million in 2002, as compared to $2.0 million last year. This decrease results from the increased focus on commercial research efforts.

          Other research and development expenses relate to development of our commercial products. These expenses totaled $4.5 million in 2002 and are comparable to the prior year.

          Write-off of in-process research and development (IPR&D) totaled $700,000 and resulted from the acquisition of Conductus. The amount of the purchase price allocated to purchased IPR&D was expensed upon acquisition, because the technological feasibility of products under development has not been established and no alternative future uses existed. The IPR&D relates to technologies representing processes and expertise employed to make new high temperature superconducting materials technology and device design and cryopackaging and systems integration technology. At the time of the acquisition, the products under development were about 50% complete and it was expected that the remaining efforts would be completed by the end of 2004 at a cost of approximately $2.5 million. The remaining efforts include completion of development processes, manufacturing processes, final product integration and testing. All of the IPR&D projects are subject to the normal risks and uncertainties.

          Selling, general and administrative expenses totaled $15.0 million in 2002 as compared to $11.9 million in 2001. This increase results primarily from increased domestic and international marketing and sales efforts and ISCO litigation expenses. ISCO litigation expenses totaled $3.1 million for 2002 as compared to $976,000 in 2001.

          Interest income decreased in 2002 as compared to 2001 due to decreased levels of cash available for investment and the decline in interest rates.

          Interest expense in 2002 is comparable to the prior year.

          We had a net loss of $19.5 million in 2002 as compared to $17.2 million in 2001.

          The net loss available to common shareholders totaled $21.3 million in 2002, or $0.89 per common share, as compared to $19.8 million, or $1.10 per common share, in 2001. The amounts for 2002 and 2001 include a $1.8 million and $2.6 million, respectively, non-cash deemed distribution on preferred stock.

          2001 as Compared to 2000

          Total net revenues increased by $2.4 million, or 24%, from $10.0 million in 2000 to $12.4 million in 2001. The increase is primarily due to higher commercial product sales.

          The following table summarizes the calculation of net commercial product revenues for 2000 and 2001:

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          Net commercial product revenues in 2001 increased to $7.6 million from $5.3 million in 2000, an increase of $2.3 million, or 43%. 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. Multiplexer sales in 2001 totaled $635,000. The increase in gross commercial product sales proceeds was partially offset by $2.3 million in 2000 and $2.2 million in 2001 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 85% of our net commercial revenues in 2001 as compared to 49% in 2000.

          In 2001, government contract revenue totaled $4.8 million as compared to $4.6 million in 2000. These revenues included government subcontract revenue, which totaled $1.4 million in 2001 as compared to $689,000 in 2000. Excluding the impact of subcontract revenues, government contract revenues declined this last year as we focused more of our research and development resources on our commercial business.

          Cost of commercial product revenues includes all direct costs, manufacturing overhead and related start-up costs. The cost of commercial product revenues totaled $10.6 million for 2001 and was reduced by the amortization of $2.2 million, relating to the accrual for non-cash contract loss on the purchase order received from U.S. Cellular. The cost of commercial product revenues was $15.7 million for 2000 and included an accrued non cash loss of $4.2 million relating to the purchase order received from U.S. Cellular and other non-cash warrant charges relating to U.S. Cellular of $482,000. Please read the subsection below entitled “Non-Cash Charges for Warrants Issued To U.S. Cellular.” Excluding these non-cash charges and credits relating to the supply agreement with U.S. Cellular, cost of commercial revenues increased to $12.9 million in 2001, or 17%, from $11.0 million in 2000. This increase was the result of 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.

          Contract research and development expenses totaled $3.4 million in 2001 as compared to $4.2 million in the prior year and included subcontract expenses of $1.4 million and $689,000, respectively. Excluding subcontract expenses, contract research and development expenses decreased to $2.0 million in 2001, as compared to $3.5 million in 2000. This decrease results from the increased focus on commercial research efforts.

          Other research and development expenses relate to development of our commercial products. These expenses totaled $4.6 million in 2001, as compared to $2.6 million in 2000. This increase is due to increased spending on product line expansion, further development of the SuperFilter product line, including product pilots, and product line cost reduction efforts.

          Selling, general and administrative expenses totaled $11.9 million in 2001 as compared to $8.4 million in 2000, an increase of $3.5 million, or 42%. This increase results primarily from increased corporate development, domestic and international marketing and sales efforts, management recruitment activities, insurance premiums and ISCO litigation expenses. ISCO litigation expenses totaled $976,000 for the last six months in 2001 and are expected to, increase

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throughout 2002 as we approach the trial, which is scheduled for January 2003.

     Interest income increased to $1.1 million in 2001 as compared to $806,000, in the prior year, due to higher levels of cash available for investment.

     Interest expense decreased by $337,000 to $146,000 in 2001 as compared to $483,000 in the prior year and resulted from decreased borrowings in the current year.

     We had a net loss of $17.2 million in 2001, as compared to $20.7 million in 2000.

     The net loss available to common shareholders totaled $19.8 million in 2001, or $1.10 per common share, as compared to $33.5 million, or $2.09 per common share, in 2000. The amounts for 2001 include a $2.6 million non-cash deemed distribution on preferred stock. The amounts for 2000 included $10.6 million for the non-cash cumulative effect of an accounting change and $2.2 million of non-cash deemed dividends on preferred stock.

Liquidity and Capital Resources

     We have financed our operations since 1998 through equity transactions. These transaction include:

     In March 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. In August 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. In September 1998 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.

     Also in September 1998, the Company completed a private placement of 500,000 shares of Series B Cumulative Convertible Preferred Stock to certain investors at $8.00 per share. Each share of Series B preferred stock carried a cumulative dividend rate of 7% per annum, was convertible into two shares of common stock, had voting rights and liquidation preferences. The proceeds of the offering, net of offering expenses, totaled approximately $4 million. The Company also issued warrants to purchase up to 120,000 shares of Common Stock at $5.70 per share.

     In February 1999, the Company entered into an agreement to exchange all of the then outstanding redeemable preferred shares and related warrants for shares in a new series of preferred stock and modified warrants. The impact of the exchange was to eliminate the redemption provision of the then outstanding redeemable preferred stock. The Series A preferred stock and related warrants were exchanged for 64,584 shares of Series A-2 preferred stock and warrants to purchase 100,000 shares of common stock. The Series A-1 preferred stock and related warrants were exchanged for 12,500 shares of Series A-3 preferred stock and warrants to purchase 66,669 shares of common stock. The Series B preferred stock and related warrants were exchanged for 50,000 shares of Series B-1 preferred stock and warrants to purchase 120,000 shares of common stock. The warrants received in the exchange generally have the same terms as the warrants surrendered. In connection with the exchange, the Company issued to the preferred stockholders warrants to purchase up to 75,000 shares of common stock at $7.00.

     Each share of the Series A-2, Series A-3 and Series B-1 Convertible Preferred Stock was convertible into twenty shares of common stock and had voting rights. The Series A-2 Convertible Preferred Stock carried a cumulative annual dividend of 6% per share and a liquidation preference of $72 per share until March 26, 2001, and $60 per share plus accrued dividends, thereafter. Each share of the Series A-3 Convertible Preferred Stock carried a cumulative annual dividend of 6% per share and a liquidation preference of $96 per share until March 26, 2000, and $80 per share plus accrual dividends, thereafter. Each share of the Series B-1 Convertible Preferred Stock carried a cumulative annual dividend of 7% per share and had a liquidation preference of $80 per share plus unpaid dividends.

     In March 1999, the Company completed a private placement of 41,667 shares of Series C Convertible Preferred Stock to certain investors at $72 per share. The gross proceeds of the offering totaled $3 million. Each share of preferred stock carried a cumulative dividend of 7% per annum, had voting rights and a liquidation preference of the greater of $86.40 or $72 per share

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plus accrued dividends. A five-year warrant to purchase 120,000 shares of common stock at $4.50 per share was also issued in connection with this financing.

     In June 1999, the Company entered into a private equity financing agreement providing for the sale of securities in two traunches with gross proceeds of up to $5.3 million. Under the first transaction, the Company sold 77,296 shares of Series D Convertible Preferred Stock at $50 per share, which resulted in gross proceeds of approximately $3.9 million. Under the second transaction, the Company sold 28,704 shares of Series D Convertible Preferred Stock at $50 per share, resulting in gross proceeds of approximately $1.4 million. Each share was convertible into twenty shares of common stock, and carried a cumulative dividend of 6% per annum, had voting rights and a liquidation preference of $65 per share until December 17, 2003 and $50 per share plus accrued dividends per share thereafter. In connection with this financing, the Company also issued five year warrants for the purchase of up to 212,000 shares of common stock at $3 per share.

     On February 11, 2000, the Company completed the registration and sale of 2,473,701 shares of common stock, priced at $3.25 per share, of which 2,319,855 shares of common stock were sold for a cash payment totaling $7,540,000 and 153,846 shares of common stock were exchanged for short-term indebtedness of $500,000. Net proceeds to the Company totaled $7.4 million. Concurrent with the offering, the holders of the Series A-2, A-3 and C Redeemable Convertible Preferred Stock converted their holdings into 2,458,391 shares of common stock. As an inducement to convert the preferred shares, the Company issued the preferred stockholders warrants to purchase 250,000 shares of common stock at $3.58 per share. Also during the year ended December 31, 2000, the holders of the outstanding Series B-1 and D preferred shares elected to convert their holdings into 3,175,409 shares of common 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.

     The preferred stock was 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.

     During 2001, 3,000 Series E preferred shares were converted into 625,093 shares of common stock and 51,212 shares of common stock were issued in connection with the conversion premium. During 2002 the remaining 34,500 shares were converted into 2,878,351 shares of common stock. The associated conversion premium totaled $4,686,000 and was paid with $3.0 million in cash and an eighteen-month $1.7 million subordinated note. The subordinated note carries eight percent interest with interest only payable for the first six months and monthly amortization of principal and interest for the remaining twelve months.

     In connection with the sale of the Series E Preferred stock, the Company also issued two five-year warrants to purchase shares of common stock at an exercise price of $21.54 per share. The first warrant is for the purchase of 313,370 shares and the second warrant is for the purchase of up to 731,198 additional shares of common stock. Both warrants are currently exercisable and contain “weighted average” antidilution provisions which adjust the warrant exercise price and number of shares in the event the Company sells equity securities at a discount to then prevailing market prices. The amount of the adjustment depends on the size of the below-market transaction and the amount of the discount to the market price. The warrant exercise price cannot be reduced below a minimum of $18.91 as the result of adjustments under this provision. As a result of the issuance of common shares during 2002 the exercise price and the number of shares of these warrants was adjusted to $19.53 and 1,151,819, respectively.

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     In March 2002 the Company raised net proceeds of $12,122,000 from the private sale of 3,714,286 shares of common stock at $3.50 per share based on a negotiated discount to market and 5-year warrants to purchase an additional 557,143 shares of common stock exercisable at $5.50 per share. 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.

     In connection with the acquisition of Conductus, Inc. in December 2002 the Company raised net proceeds of $19,704,000 from the private sale of 21,096,954 shares of common stock at $0.95 per share based on a negotiated discount to market and 5-year warrants to purchase an additional 5,274,240 shares of common stock exercisable at $1.19 per share. The warrants become exercisable on June 17, 2003.

     Cash and cash equivalents increased by $3.0 million from $15.2 million at December 31, 2001 to $18.2 million at December 31, 2002. Cash used in operations and investing activities during 2002 was offset by cash received from the sale of common stock and warrants in a private placement during the first and fourth quarters.

     Net cash used in operations totaled $14.5 million, $14.7 million and $20.0 million in 2000, 2001 and 2002, respectively. The increase in cash used in operations in the comparison periods is primarily the result of the increased cash portion of our net loss during the comparison periods, and to a lesser extent, increases in accounts receivable and inventories resulting from the growth in our sales.

     Net cash used in investing activities totaled $2.2 million, $1.9 million and $5.5 million in 2000, 2001 and 2002 primarily related to the purchases of manufacturing equipment and facilities improvements. In 2002, cash of $429,000 was used in the acquisition of Conductus, Inc. and $374,000 was provided by the release of restrictions on $374,000 of cash also obtained through the Conductus acquisition.

     Net cash provided by financing activities totaled $48.4 million and $28.4 million in 2000 and 2002, respectively. Net cash provided by financing activities in 2000 primarily resulted from the private sales of common stock and Series E convertible preferred stock, as well as from the exercise of outstanding warrants and stock options which totaled $50.1 million and was partially offset by the net reduction in borrowings of $1.7 million. The net cash provided by financing activities in 2002 primarily resulted from the sale of common stock and warrants for $12.2 million in March 2002 and for $19.7 million in December 2002 relating to the Conductus acquisition. These amounts were partially offset by the payments on long-term debt and $3.0 million premium paid on the conversion of the Series E convertible preferred stock. In 2001, cash provided by financing operations resulted from the exercise of stock options, which totaled $218,000 and was partially offset by the net reduction in borrowings of $242,000.

          At December 31, 2002, we had the following cash commitments:

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          Additionally, we plan to invest an additional $2.5-$3.0 million in fixed assets during 2003 to continue to expand manufacturing ability. With our present SuperFilter product mix, we have the ability to manufacture about 600 units per quarter and have the ability to easily expand that capacity to 1,000 units per quarter. In addition, we expect that sales will continue to increase which will result in higher inventory and accounts receivable balances being maintained. Although revenues are expected to increase in 2003, through March 2003 the Company has continued to incur losses. Our long-term prospects are dependent upon the continued and increased market acceptance for our products.

          We presently cannot predict whether our capital resources will be sufficient to fund operations for the coming year. The Company’s future capital requirements will depend largely on the outcome and impact of the pending litigation with ISCO International, Inc. We are currently engaged in a patent dispute with ISCO relating to U.S. Patent No. 6,263,215 entitled “Cryoelectronically Cooled Receiver Front End for Mobile Radio Systems” (the “215 Patent”). The trial began on March 17, 2003 and is expected to last approximately two weeks. While we continue to believe that we have meritorious defenses to this lawsuit, we cannot predict the outcome of a jury trial. See the discussion under the heading “Item 3- Legal Proceedings.”

          The ISCO litigation could adversely affect our liquidity and capital resources in three ways. First, ISCO is seeking financial damages of approximately $16 million and alleging willful infringement which could result in treble damages. We do not have adequate financial resources to pay a significant damage award.

          Second, ISCO is seeking an injunction to halt sales of our SuperFilter I, II and III products and any other infringing products. We no longer market those versions of the SuperFilter and have upgraded our product line to the SuperLink 850 Rx. We do not believe the SuperLink 850 Rx infringes ISCO’s 215 patent, and the trial court is not being asked to decide this issue. Therefore, we face two ongoing business risks if the trial court upholds the validity of the 215 Patent. ISCO may file another lawsuit alleging that our SuperFilter 850 Rx infringes the 215 patent (or request that the judge in the pending matter decide this issue) and ultimately obtain an injunction halting sales of our primary product. Separately, the continued uncertainty regarding this issue could adversely affect future sales to our customers which would have a material adverse affect on our liquidity.

          Finally, the cost of defending this lawsuit constitutes a major financial burden and could by itself have an adverse impact on our capital resources and the ability to implement our 2003 business plan. As of December 31, 2002, we and our Conductus subsidiary have incurred approximately $7.0 million in defense costs for this lawsuit. We estimate that we will incur an additional $3.0 million in the first quarter of 2003 defending this lawsuit and, in the event of an adverse outcome at

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trial, could continue incurring significant defense costs for post-trial motions and appeals. We may not have adequate financial resources to fund ongoing defense costs while fully implementing our business plan for 2003.

          Therefore, we may need additional debt or equity financing to pay damages to ISCO, continue defending the ISCO lawsuit or future lawsuits and/or fully implement our 2003 business plan. We cannot give assurance that additional financing will be available on acceptable terms or at all. If we issue additional equity securities to raise funds, the ownership percentage of our existing stockholders would be reduced. New investors may demand rights, preferences or privileges senior to those of existing holders of common stock. If we cannot raise any needed funds, we would be forced to make substantial reductions in our operating expenses, which could adversely affect the ability to implement our current business plan and ultimately our viability as a company. We might also be forced to seek court protection from our creditors.

          Our auditors have included an explanatory paragraph relating to our ability to continue as a going concern in their Report of Independent Accountants included in our audited financial statements for the year ended December 31, 2002. Last year, we incurred a net loss of $19.5 million and negative cash flows from operations of approximately $20.0 million. We need to significantly increase sales to achieve profitability and positive cash flows. The auditors consider that these factors, along with the pending ISCO litigation, raise substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts and classifications of liabilities that might be necessary should we be unable to continue in existence.

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 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, we are allocating proceeds from sales under this agreement 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. U.S. Cellular vested in the right to exercise 48,980 shares of common stock for product purchases in 1999 and 53,460 shares of common stock for product purchases in 2000. As a result, we allocated $124,000 of sales proceeds to vesting warrants in 1999 and $1,660,000 of sales proceeds to vesting warrants in 2000. We also allocated $482,000 to cost of commercial product revenues in the second quarter of 2000 for the estimated value of vesting warrants in excess of related sales to U.S. Cellular.

          In September 2000, the Company received a $7.8 million noncancelable 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.

          We estimated the fair value of the warrants vesting upon receipt of this order at $5,635,000 using the Black-Scholes option-pricing model and recorded this amount as a deferred warrant charge in the statement of stockholders’ equity. As SuperFilter systems are shipped under this purchase order, the related sales proceeds will be 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. In 2000, 2001 and 2002, we allocated sales proceeds of $1,118,000, $2,238, 000 and $2,280,000, respectively, for shipments under this purchase order to the deferred warrant charge and recorded $1,765,000, $879,000, and $967,000, respectively, as gross commercial product sales proceeds.

          After the allocation of sales proceeds to the related warrants, the estimated cost of providing products under the purchase order exceeds related revenue by $5.3 million. We included the resulting loss in the results of operations for the

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year ended December 31, 2000. In 2000, 2001 and 2002, we amortized $1,059,000, $2,243,000 and $1,998,000, respectively, of this reserve against the cost of product delivered under this purchase order.

          During the fourth quarter of 2002, deliveries under the $7.8 million purchase order were completed. For accounting purposes proceeds from subsequent sales to U.S. Cellular under this agreement are again being allocated between commercial product revenue and the estimated value of the warrants vesting using the Black-Scholes option-pricing model. For subsequent product sales in the fourth quarter of 2002 U.S. Cellular vested in the right to exercise the warrant and purchase a total of 22,540 shares of common stock and sales proceeds allocated to warrants vesting in 2002 totaled $3,000.

          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 years indicated:

          As of December 31, 2002, U.S. Cellular had 563,020 unvested warrants that can be earned from future product orders through August 27, 2004.

Net Operating Loss Carryforward

          At December 31, 2002, we had a federal net operating loss carryforward of approximately $162.7 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. Recently the Company completed an analysis of its equity transactions and determined that it had a change in ownership in August 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 by Superconductor Technologies Inc. subsequent to the change totaled $67.4 million and are not subject to this limitation, however, they may be subject to limitation should a subsequent change in ownership occur. Conductus has net operating loss carryforwards of $89.2 million. Conductus may have already had an ownership change because of its previous equity transactions. It is likely that the consummation of the merger with Conductus and the contemporaneous offering caused another ownership change for purposes of Section 382, further restricting utilization of net operating loss carryforwards incurred through the ownership change date and acquired through the acquisition of Conductus. If such an ownership change occurred, the applicable Section 382 Limitation may be significantly lower than the $2.3 million limitation that

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resulted from the 1999 ownership change.

Future Accounting Requirements

     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 December 31, 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 adoption of the Standard did not have a material impact on the Company’s 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.

     In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No. 123. This Statement amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The amendments to Statement 123 in paragraphs 2(a)-2(e) of this Statement shall be effective for financial statements for fiscal years ending after December 15, 2002. Earlier application of the transition provisions in paragraphs 2(a)-2(d) is permitted for entities with a fiscal year ending prior to December 15, 2002, provided that financial statements for the 2002 fiscal year have not been issued as of the date this Statement is issued. Early application of the disclosure provisions in paragraph 2(e) is encouraged. The amendment to Statement 123 in paragraph 2(f) of this Statement and the amendment to Opinion 28 in paragraph 3 shall be effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. The Company does not believe it will have a material impact on its financial position or results of its operations.

     In November 2002, the FASB issued FASB Interpretation Number 45, or FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (an interpretation of SFAS No. 5, 57 and 107 and rescission of FIN 34.” FIN 45 clarifies the requirements of SFAS No. 5, “Accounting for Contingencies, “ relating to a guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 is effective on January 1, 2003 and is not expected to have a significant effect on our financial position or results of operations.

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          In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities, and Interpretation of ARB 51.” The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (“variable interest entities” or “VIE’s”) and how to determine when and which business enterprise should consolidate the VIE (the “primary beneficiary”). This new model for consolidation applies to an entity in which either (1) the equity investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46 is effective January 1, 2003 and is not expected to have a significant effect on the Company’s financial position or results of operations.

Market Risk

          We are exposed to various market risks, including changes in interest rates. Market risk is the potential loss arising from adverse changes in market rates and prices. We do not enter into derivatives or other financial instruments for trading or speculation purposes.

          At December 31, 2002, we had approximately $16.2 million invested in a money market account yielding approximately 1.70%. Assuming a 1% decrease in the yield on this money market account and no liquidation of principal for the year, our total interest income would decrease by $160,000 per annum.

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.

          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.

Inflation

          The Company does not foresee any material impact on its operations from inflation.

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ITEM 7A.           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk.”

ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

          All information required by this item is listed in the Index to Financial Statements in Part IV, Item 15(a) 1.

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, 2002.

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, 2002.

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, 2002.

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, 2002.

ITEM 14.           CONTROLS AND PROCEDURES

          Within ninety (90) days prior to the date of this report, we completed an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in alerting them on a timely basis of material information relating to us (including our consolidated subsidiaries) required to be included in our periodic Securities and Exchange Commission filings.

          No significant changes were made to our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

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PART IV

ITEM 15.           EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)

The following documents are filed as part of this Report:

1.

Index to 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:

	2.		Financial Statement Schedule Covered by the Foregoing
			Report of Independent Accountants

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(1)

Incorporated by reference from the Registrant’s Registration Statement on Form S-1 (Reg. No. 33-56714).

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(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 Registration Statement on Form S-1 (Reg. No. 333-10569).
(6)		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.
(7)		Incorporated by reference from the Registrant’s Annual Report on Form 10-K filed for the year ended December 31, 1997.
(8)		Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed for the quarter ended April 3, 1999.
(9)		Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed for the quarter ended July 3, 1999.
(10)		Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed for the quarter ended October 2, 1999.
(11)		Incorporated by reference from the Registrant’s Registration Statement on Form S-8 (Reg. No. 333-90293).
(12)		Incorporated by reference from the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1999.
(13)		Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed October 4, 2000.
(14)		Incorporated by reference from the Registrant’s Registration Statement on Form S-8 (Reg. No. 333-56606).
(15)		Incorporated by reference from the Registrant’s Quarterly Report on Form 10-Q filed for the quarter ended June 30, 2001.
(16)		Incorporated by reference from Registrants Annual Report on Form 10-K for the year ended December 31, 2001.
(17)		Incorporated by reference from Registrants Annual Report on Form 10-K for the year ended December 31, 2000.
(18)		Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed October 2, 2002.
(19)		Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed October 14, 2002.
(20)		Incorporated by reference from the Registrant’s Registration Statement on Form S-4 (Reg. No. 333-100908).
(21)		Incorporated by reference from the Conductus, Inc.’s Registration Statement on Form S-3 (Reg. No. 333-85928), filed on April 9, 2002.
(22)		Incorporated by reference from Conductus, Inc.’s Quarterly Report on Form 10-Q, filed with the SEC on November 14, 2000.
(23)		Incorporated by reference from Conductus, Inc.’s Quarterly Report on Form 10-Q, filed with the SEC on November 16, 1998.
(24)		Incorporated by reference from Conductus, Inc.’s Annual Report on Form 10-K, for the year ended December 31, 1999.
*		Confidential treatment has been previously granted for certain portions of these exhibits.

(b) Reports on Form 8-K. On December 23, 2002, we filed a report on Form 8-K announcing the completion of the merger with Conductus, Inc. and concurrent $20 million private placement. On October 15, 2002 we filed a report on Form 8-K announcing that it had signed an agreement to merge with Conductus, Inc. and received commitments for a concurrent $15 million private placement. On October 15, 2002, we filed a report on Form 8-K announcing our third quarter 2002 preliminary results. On October 2, 2002 we filed a report on Form 8-K announcing the conversion of the remainder of its Series E Convertible Preferred Stock. (c) Exhibits. See Item 15(a) above.

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REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
and Stockholders of
Superconductor Technologies Inc.

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) on page 32, present fairly, in all material respects, the consolidated financial position of Superconductor Technologies Inc. and subsidiaries at December 31, 2001 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion the financial statement schedule listed in the index appearing under Item 15(a)(2) on page 32 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. These consolidated financial statements and financial statement schedule 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 and financial statement schedule in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 4 to the financial statements, in 2000 the Company changed its method of calculating the beneficial conversion feature associated with the issuance of convertible preferred stock.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has had recurring losses and used $20.0 million in cash for operations in 2002. In addition, as more fully described in Note 2, the Company commenced jury trial on March 17, 2003 regarding a patent infringement claim made by ISCO International, Inc. All of these matters raise a substantial doubt about the Company's ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ PRICEWATERHOUSECOOPERS LLP

Los Angeles, California
March 14, 2003, except
for Note 2-“Basis of Presentation” and Note 15 “Subsequent Event”
for which the dates are March 17 and 28, 2003, respectively.

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SUPERCONDUCTOR TECHNOLOGIES INC.
CONSOLIDATED BALANCE SHEET