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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

[X]		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
		For the quarterly period ended September 27, 2003
[  ]		Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
		For the transition period from ___________________ to _____________________

Commission File Number 0-21074

SUPERCONDUCTOR TECHNOLOGIES INC.

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]     No [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the ExchangeAct).

Yes [  ]     No [X]

As of November 1, 2003 there were 64,945,968 shares of the Registrant’s Common Stock outstanding.

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SUPERCONDUCTOR TECHNOLOGIES INC.

INDEX TO FORM 10-Q

Three and Nine Months Ended September 27, 2003

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SUPERCONDUCTOR TECHNOLOGIES INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)

See accompanying notes to the consolidated financial statements.

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SUPERCONDUCTOR TECHNOLOGIES INC.
CONSOLIDATED BALANCE SHEET

See accompanying notes to the consolidated financial statements

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SUPERCONDUCTOR TECHNOLOGIES INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)

See accompanying notes to the consolidated financial statements.

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SUPERCONDUCTOR TECHNOLOGIES INC.

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

1. General

     Superconductor Technologies Inc. was incorporated in Delaware on May 11, 1987 and maintains its headquarters in Santa Barbara, California. The Company has operated in a single industry segment, the research, development, manufacture and marketing of high-performance filters to service providers and original equipment manufacturers in the mobile wireless communications industry. The Company’s principal commercial product, the SuperLink™ Rx incorporates patented high-temperature superconductor (HTS) technology to create a cryogenic receiver front-end (CRFE) used by wireless operators to enhance network performance while reducing capital and operating costs. 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 SuperLink Rx (then known as the SuperFilter®) in 1997 and shipped 393 units in 2000, 438 in 2001 and 927 units in 2002.

     The Company continues to be involved as either contractor or subcontractor on a number of contracts with the United States government. These contracts have been and continue to provide a significant source of revenues for the Company. For the nine months ended September 28, 2002 and September 27, 2003, government related contracts account for 14% and 22% respectively, of the Company’s net revenues.

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

     The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates and such differences may be material to the financial statements. This quarterly report on Form 10-Q should be read in conjunction with the Company’s Form 10-K for the year ended December 31, 2002. The results of operations for the three and nine months ended September 27, 2003 are not necessarily indicative of results for the entire fiscal year ending December 31, 2003.

2. Summary of Significant Accounting Policies

Basis of Presentation

     During 2002 the Company incurred a net loss of $19,513,000 and negative cash flows from operations of $19,951,000. For the nine months ended September 27, 2003 the Company had a net loss of $12,255,000 and negative cash flows from operations of $13,407,000. The Company needs to significantly increase sales to achieve profitability and positive cash flows. If it is unable to do so, the Company may need additional debt or equity financing. The Company’s financial statements have been prepared assuming that the Company will continue as a going concern. The factors described above raise substantial doubt about the Company’s ability to continue as a going concern. These financial statements do not include any adjustments that might result from this uncertainty.

Principles of Consolidation

     The consolidated financial statements include the accounts of Superconductor Technologies Inc. and its wholly owned subsidiaries (the “Company”). All significant intercompany transactions have been eliminated from the consolidated financial statements.

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Cash and Cash Equivalents

     Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less. Cash and cash equivalents are maintained with quality financial institutions and from time to time exceed FDIC limits.

Accounts Receivable

     The Company sells predominantly to entities in the wireless communications industry and to entities of the United States Government. The Company grants uncollateralized credit to its customers. The Company performs ongoing credit evaluations of its customers before granting credit.

Revenue Recognition

     Commercial revenues are principally derived from the sale of the Company’s SuperFilter® products and are recognized once all of the following conditions have been met: a) an authorized purchase order has been received in writing, b) customer’s credit worthiness has been established, c) shipment of the product has occurred, d) title has transferred, and e) if stipulated by the contract, customer acceptance has occurred and all significant vendor obligations, if any, have been satisfied.

     Contract revenues are principally generated under research and development contracts. Contract revenues are recognized utilizing the percentage-of-completion method measured by the relationship of costs incurred to total estimated contract costs. If the current contract estimate were to indicate a loss, utilizing the funded amount of the contract, a provision would be made for the total anticipated loss. Revenues from research related activities are derived primarily from contracts with agencies of the United States Government. Credit risk related to accounts receivable arising from such contracts is considered minimal. These contracts include cost-plus, fixed price and cost sharing arrangements and are generally short-term in nature.

     All payments to the Company for work performed on contracts with agencies of the U.S. Government are subject to adjustment upon audit by the Defense Contract Audit Agency. Based on historical experience and review of current projects in process, management believes that the audits will not have a significant effect on the financial position, results of operations or cash flows of the Company.

Warranties

     The Company recognizes the estimated cost of warranty expense at the time of revenue recognition. Warranty reserves are reviewed periodically and adjusted based on actual and anticipated experience.

Guarantees

     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.

Research and Development Costs

     Research and development costs are expensed as incurred and include salary, facility, depreciation and material expenses. Research and development costs incurred solely in connection with research and development contracts are charged to contract research and development expense. Other research and development costs are charged to other research and development expense.

Inventories

     Inventories are stated at the lower of cost or market, with costs primarily determined using standard costs, which approximate actual costs utilizing the first-in, first-out method. Provision for potentially obsolete or slow moving inventory is made based on management’s analysis of inventory levels and sales forecasts.

Property and Equipment

     Property and equipment are recorded at cost. Equipment is depreciated using the straight-line method over their

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estimated useful lives ranging from three to five years. Leasehold improvements and assets financed under capital leases are amortized over the shorter of their useful lives or the lease term. Furniture and fixtures are depreciated over seven years. Expenditures for additions and major improvements are capitalized. Expenditures for minor tooling, repairs and maintenance and minor improvements are charged to expense as incurred. When property or equipment is retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts. Gains or losses from retirements and disposals are recorded as other income or expense.

Patents, Licenses and Purchased Technology

     Patents and licenses are recorded at cost and are amortized using the straight-line method over the shorter of their estimated useful lives or approximately seventeen years. Purchased technology acquired through the acquisition of Conductus, Inc. is recorded at its estimated fair value and is amortized using the straight-line method over seven years.

Goodwill

     Goodwill represents the excess of purchase price over fair value of net assets acquired. Goodwill is tested for impairment annually in the fourth quarter after the annual planning process and whenever events or circumstances occur which might indicate that goodwill is impaired. The first step of the impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying value, including goodwill. If the fair value of a reporting unit exceeds its carrying value, goodwill of the reporting unit is considered not impaired. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss. The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess.

Long-Lived Assets

     The realizability of long-lived assets is evaluated periodically as events or circumstances indicate a possible inability to recover the carrying amount. Such evaluation is based on various analyses, including cash flow and profitability projections. The analyses necessarily involve significant management judgment. In the event the projected undiscounted cash flows are less than net book value of the assets, the carrying value of the assets will be written down to their estimated fair value.

Loss Contingencies

     In the normal course of business the Company is subject to claims and litigation, including allegations of patent infringement. Liabilities relating to these claims are recorded when it is determined that a loss is probable and the amount of the loss can be reasonably estimated. The costs of defending the Company in such matters are expensed as incurred.

Income Taxes

     The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes.” SFAS 109 utilizes an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. In estimating future tax consequences, SFAS 109 generally considers all expected future events other than enactments of changes in the tax laws or rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

Marketing Costs

     All costs related to marketing and advertising the Company’s products are expensed as incurred or at the time the advertising takes place. Advertising costs were not material in the periods ended September 28, 2002 and September 27, 2003.

Net Loss Per Share

     Basic and diluted net loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding in each year. Net loss available to common stockholders is computed after deducting accumulated dividends on cumulative preferred stock, deemed dividends and accretion of redemption value on redeemable preferred stock for the period and beneficial conversion features on issuance of convertible preferred stock. Common stock equivalents are not included in the calculation of diluted loss per share because their effect is antidilutive.

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Stock-based Compensation

     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 provisions 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:

Use of Estimates

     The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The significant estimates in the preparation of the financial statements relate to the assessment of the carrying amount of accounts receivable, inventory, intangibles, estimated provisions for warranty costs, accruals for restructuring and lease abandonment costs in connection with the Conductus acquisition, income taxes and disclosures related to the litigation with ISCO International, Inc. Actual results could differ from those estimates and such differences may be material to the financial statements.

Fair Value of Financial Instruments

     The carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value due to the short-term nature of these instruments. The Company estimates that the carrying amount of the debt approximates fair value based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Comprehensive Income

     The Company has no items of other comprehensive income in any period and consequently does not report comprehensive income.

Segment Information

     The Company operates in a single business segment; the research, development, manufacture, marketing and sale of high temperature superconducting filters and low noise amplifiers and multiplexer products for the wireless communications industry. The Company also markets and sells a multi-carrier power amplifier, a related product manufactured by a third party. Net revenues derived principally from government research and development contracts are presented separately on the statement of operations for all periods presented. Management views its government research and development contracts as a supplementary source of revenue to fund its development of high temperature superconducting products.

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Certain Risks and Uncertainties

     Our two largest commercial customers accounted for 89% and 94% of our net commercial product revenues for the nine months ended September 27, 2003 and September 28, 2002, respectively, and 31% and 43% of total accounts receivable as of September 27, 2003 and December 31, 2002, respectively.

     The Company currently purchases substrates for growth of high-temperature superconductor films from one supplier because of the quality of its substrates.

Recent Accounting Pronouncements

     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 adoption of SFAS No. 146 did not have an impact on the financial statements.

     In April 2003, the FASB issued SFAS No. 149, “Amendment on Statement 133 of Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is effective for all contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively. The adoption of SFAS No. 149 will not have a material impact on our financial position, results of operations or cash flows.

     In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities, an 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 for VIEs created after February 1, 2003 and is effective for all other VIEs in the first reporting period ending after December 31, 2003. The adoption of FIN 46 is not expected to have a significant effect on the Company’s financial position or results of operations.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 changes the accounting guidance for certain financial instruments that, under previously guidance, could be classified as equity or “mezzanine” equity by now requiring those instruments to be classified as liabilities (or assets in some circumstances) in the statement of financial position. Further, SFAS No. 150 requires disclosure regarding the terms of those instruments and settlement alternatives. SFAS No. 150 is generally effective for all financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. While the effective date of certain elements of SFAS No. 150 have been deferred, the adoption of SFAS No. 150 when finalized is not expected to have a material impact on our financial position, results of operations or cash flows.

Note 3. Acquisition of Conductus, Inc.

     On December 18, 2002, the Company acquired 100 percent of the outstanding shares of Conductus, Inc. (“Conductus”). Conductus developed, manufactured, and marketed electronic components and systems based on

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superconductors for application in telecommunications markets and in defense, intelligence and law enforcement markets. The results of Conductus’ operations have been included in the consolidated financial statements for periods subsequent to the acquisition.

The following unaudited proforma information presents certain operating results as if the acquisition had taken place on January 1, 2002:

          These proforma results have been prepared for comparative purposes only and include certain adjustments such as additional amortization expense as a result of purchased technology and lower depreciation expense resulting from lower fixed assets costs. The proforma results are not necessarily indicative of the results of operations that actually would have resulted had the acquisition been in effect at January 1, 2002 or those of future periods.

4. Short Term Borrowings

          On March 28, 2003, the Company entered into an accounts receivable purchase agreement with a bank. The agreement provides for the sale of up to $5 million of eligible accounts receivable, with advances to the Company totaling 80% of the receivables sold. Advances bear interest at the prime rate (4.00% at September 27, 2003) plus 2.50% subject to a minimum monthly charge. The agreement terminates on April 1, 2004. Outstanding amounts under this borrowing facility at September 27, 2003 totaled $1,618,000.

          Advances under the agreement are collateralized by all the Company’s assets. Under the terms of the agreement, the Company continues to service the sold receivables and is subject to recourse provisions. In connection with this agreement the Company issued seven year warrants for the purchase of 94,340 shares of common stock at $1.06 per share and were valued at $78,000. The fair value of the warrants issued in connection with this agreement was calculated using the Black-Scholes option-pricing model utilizing a volatility factor of 115%, risk-free interest rate of 3.46% and expected life of 7 years. The value is accounted for as debt issuance costs and amortized over the term of the agreement.

5. Stockholders’ Equity

          Common Stock. In June 2003 the Company raised net proceeds of $10,069,000 from the private sale of 5,116,278 shares of common stock at $2.15 per share based on a negotiated discount to market and 5-year warrants to purchase an additional 1,279,069 shares of common stock exercisable at $2.90 per share. The warrants become exercisable after December 24, 2003.

          This transaction caused the exercise price and the number of shares of the warrants under the Series E Convertible Preferred Stock to be adjusted to $19.28 and 1,116,477, respectively.

          Stock Options. During the nine months ended September 27, 2003, the Company (i) issued options to purchase 3,034,607 shares of common stock under the Company’s stock option plans and (ii) cancelled options in connection with employment terminations to purchase 278,246 shares of common stock. Options for 653 shares of common stock were exercised for $2,000 during the period. At September 27, 2003, options to purchase 7,562,855 shares of common stock were issued and outstanding under the Company’s stock option plans. The original grant provisions for 2,000,000 options issued during 2003 allow for accelerated vesting if certain performance criteria are met during 2003. The outstanding options expire by the end of September 2013. The exercise prices for these options range from $0.83 to $49.38 per share,

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for an aggregate exercise price of approximately $47 million. At September 27, 2003, there were 3,741,486 shares of common stock available for granting future options.

The following is a summary of outstanding warrants at September 27, 2003:

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

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

          The estimated fair value of the warrants vesting upon receipt of this order was calculated to be $5,635,000 using the Black-Scholes option-pricing model and was recorded as a deferred warrant charge in the statement of stockholders’ equity. As SuperLink Rx systems are shipped under this purchase order, the related sales proceeds are allocated between stockholders’ equity and commercial product revenue using the percentage relationship which existed between the fair value of the warrants as recorded in September 2000 and the amount of the non-cancelable purchase order. The fair value of the warrants was calculated utilizing a volatility factor of 85%, risk-free interest rate of 6.01%, and an expected life of 3.92 years. During the three and nine months ended September 28, 2002 sales proceeds of $460,000 and $1,484,000,

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respectively, for shipments pursuant to this purchase order were allocated to the deferred warrant charge and proceeds of $170,000 and $557,000, respectively, were recorded as commercial product revenues.

          In September 2000, after the allocation of the future sales proceeds to the fair value of the related warrants, the estimated cost of providing products under the purchase order exceeded related revenue by $5.3 million. The resulting loss was reflected in the results of operations for the quarter ended September 30, 2000. During the three and nine months ended September 28, 2002, $397,000 and $1,938,000, respectively, of this reserve was amortized against the cost of product delivered under this purchase order. Deliveries under this purchase order were completed during fiscal 2002.

          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 during the three and nine months ended September 27, 2003, U.S. Cellular vested in the right to exercise the warrant and purchase a total of 5,680 and 8,968 shares of common stock, respectively, and sales proceeds of $10,000 and $12,000, respectively, were allocated to vested warrants.

          As of September 27, 2003, U.S. Cellular has 554,052 unvested warrants that can be earned from future product orders through August 27, 2004. In each period in which these remaining warrants are earned, a non-cash charge will be recorded for the fair market value of the warrants shares earned or vested in the period.

7. Legal Proceedings

          The Company is 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 our wholly owned subsidiary, Conductus, Inc. The ISCO complaint alleged that our SuperFilter product and Conductus’ ClearSite® product infringe ISCO’s patent. The matter went to trial on March 17, 2003.

          On April 3, 2003, the jury returned a unanimous verdict that our SuperFilter III product does not infringe, and that ISCO’s patent is invalid and unenforceable. The jury also awarded the Company $3.8 million in compensatory damages based upon a finding that ISCO engaged in unfair competition and acted in bad faith by issuing press releases and contacting our customers asserting rights under this patent.

          On April 17, 2003, the Company filed a Motion for Attorneys’ Fees and Disbursements, in which it asked the Court to award the Company its attorneys’ fees and other litigation expenses. On the same date, ISCO filed a motion, asking the Court to overturn the verdict and grant a new trial. The parties filed further briefs on both motions in May 2003. In August 2003, the court rejected ISCO’s request to overturn the jury’s verdict that the patent is invalid and not infringed by the SuperFilter III product, and accepted the jury’s verdict that the patent is unenforceable because of inequitable conduct committed by one of the alleged inventors. ISCO recently filed a notice of appeal as to this portion of the court’s decision. . The court overturned the jury’s verdict of unfair competition and bad faith on the part of ISCO and the related $3.8 million compensatory damage award, and also denied the Company’s request for reimbursement of its legal fees associated with the case. The Company has filed a notice of appeal as this portion of the court’s decision.

          Litigation expenses on the ISCO matter totaled $90,000 and $4,784,000, respectively, for the three and nine month periods ended September 27, 2003, and $674,000 and $2.5 million, respectively, in the three and nine month periods ended September 28, 2002.

8. Earnings Per Share

          The computation of per share amounts is based on the average number of common shares outstanding for the period. Options and warrants to purchase 18,664,666 and 6,180,019 shares of common stock during the three and nine months ended September 27, 2003 and September 28, 2002, respectively, were not considered in the computation of diluted earnings per share because their inclusion would be antidilutive. Preferred stock convertible into 2,155,261 shares of common stock was also not considered in the computation of diluted earnings per share for the three and nine months ended September 28, 2002 because their inclusion would also be antidilutive.

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9.     Details of Certain Financial Statement Components and Supplemental Disclosures of Cash Flow Information and Non-Cash Activities

Balance sheet data:

Unbilled accounts receivable represent costs and profits in excess of billed amounts on contracts-in-progress at year-end. Such amounts are billed based upon the terms of the contractual agreements. Such amounts are substantially collected within one year.

At December 31, 2002 and September 27, 2003, equipment includes $1,448,000 of assets financed under capital lease arrangements, net of $1,090,000 and $1,227,000 of accumulated amortization, respectively. Depreciation expense amounted to $628,000 and $1,769,000 for the three and nine months ended September 27, 2003, respectively. Depreciation expense amounted to $403,000 and $1,150,000 for the three and nine months ended September 28, 2002, respectively.

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Amortization expense related to these items totaled $191,000 and $570,000 for the three and nine months ended September 27, 2003, respectively. Amortization expense related to these items totaled $69,000 and $199,000 for the three and nine months ended September 28, 2002, respectively. Amortization expenses are expected to total $757,000 in 2003, $775,000 in 2004 and $794,000 in each of the years 2005, 2006 and 2007.

(1)

Amounts are related to the acquisition of Conductus, Inc. on December 18, 2002.

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

General

          We develop, manufacture and market high performance wireless infrastructure products to commercial service providers, systems integrators and original equipment manufacturers as well as government entities. 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 family, SuperLink™ Rx, and work in concert to provide Total Link^SM 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, SuperLink™ Tx and SuperPlex™. Together, these solutions empower service providers to do “more with less” by improving network performance while reducing capital and operating costs. Service providers also realize enhanced revenues as subscribers

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experience fewer dropped and blocked calls and better overall call quality.

•		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 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. This is particularly true 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.

         Our government products utilize many of the same advanced technologies as found in our SuperLink Rx 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 SuperLink Rx family of products in 1997 and shipped 927 units in 2002 and 1,243 units in 2003 through September 27, 2003. 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 $117 million from inception to September 27, 2003.

          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 periods following its acquisition.

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 restructuring reserves. We base our estimates on historical experience and on various other assumptions that we believe 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.

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          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.

          Contract revenues are principally generated under research and development contracts. Contract revenues are recognized utilizing the percentage-of-completion method measured by the relationship of costs incurred to total estimated contract costs. If the current contract estimate were to indicate a loss, utilizing the funded amount of the contract, a provision would be made for the total anticipated loss. Revenues from research related activities are derived primarily from contracts with agencies of the United States Government. Credit risk related to accounts receivable arising from such contracts is considered minimal. These contracts include cost-plus, fixed price and cost sharing arrangements and are generally short-term in nature.

     All payments to the Company for work performed on contracts with agencies of the U.S. Government are subject to adjustment upon audit by the Defense Contract Audit Agency. Based on historical experience and review of current projects in process, management believes that the audits will not have a significant effect on the financial position, results of operations or cash flows of the Company.

     In connection with the acquisition of Conductus we recognized $20 million of goodwill. The first time this goodwill will be tested for impairment will be in the fourth quarter of 2003 unless required earlier. 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

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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.

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 September 27, 2003 to be $2.0 million, as compared to $1.4 million at December 31, 2002.

Results of Operations

Quarter and Nine Months ended September 27, 2003 as Compared with Quarter and Nine Months ended September 28, 2002

          On December 18, 2002, the Company acquired 100 percent of the outstanding shares of Conductus, Inc. Therefore, the results of Conductus, Inc. are included in the consolidated financial statements for the three and nine month periods ended September 27, 2003 and not in the three and nine month periods ended September 28, 2002.

          Total net revenue increased by $9.4 million, or more than 100%, from $4.7 million in third quarter of 2002 to $14.1 million in the third quarter of 2003. Total net revenues increased by $17.6 million, or more than 100%, from $15.4 million in the first nine months of 2002 to $33.0 million in the same period this year. These increases are primarily due to higher commercial product and government and other contract sales and the acquisition of Conductus in December 2002.

          Our commercial revenue is generated from (i) the sales of our SuperLink Rx product line which combines specialized filters using high-temperature superconducting (HTS) technology with a proprietary cryogenic cooler and 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. The following table summarizes the calculation of net commercial product revenue for 2003 and 2002:

          Net commercial product revenues in the third quarter of 2003 increased to $11.6 million from $4.3 million in the same period last year, an increase of $7.3 million, or more than 100%. For the first nine months of 2003, net commercial product revenues increased to $25.6 million from $13.3 million in the same period of last year, an increase of $12.3 million, or 93%. This increase is the result of higher sales of our SuperLink Rx products, a shift in the product mix toward higher-priced SIX-Pak units and the decease in the amount of sales proceeds allocated to warrants, partially offset by lower average selling prices. Gross commercial product sales proceeds was partially offset by $460,000 and $10,000 in the third quarter of 2002 and in 2003, respectively, and by $1.5 million and $12,000 in the first nine months of 2002 and 2003, 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 89% of our net commercial revenues in the nine months ended September 27, 2003 and 94% in the nine months ended September 28, 2002.

          Government contract revenues increased by $2.2 million, or more than 100%, from $429,000 in the third quarter of

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2002 to $2.6 million in the same quarter of 2003. For the first nine months of 2003, government contract revenues increased to $7.3 million from $2.1 million in the same period last year, an increase of $5.2 million, or more than 100%. These increases result primarily from the acquisition of Conductus and to an increase in other government contracts.

          Cost of commercial product revenue includes all direct costs, manufacturing overhead and related start-up costs. The cost of commercial product revenues totaled $8.2 million and $19.5 million for the third quarter and first nine months of 2003, respectively. The cost of commercial product revenues totaled $4.7 million and $15.1 million for the third quarter and first nine months of 2002, respectively, and was reduced by amortization credits of $397,000 and $1.3 million, respectively, relating to the accrual for non-cash contract loss on the purchase order from U.S. Cellular. Increased costs resulting from increased unit shipments and higher costs associated with ramping up the Company’s manufacturing capacity, were offset by lower material and labor costs per unit and the effect of increased manufacturing efficiencies.

For the quarter and nine months ended September 27, 2003 we generated positive gross margins of $3.4 million and $6.2 million, respectively from sale of our commercial products as compared to negative gross margins of $405,000 and $1.8 million for the quarter and nine months ended September 28, 2002. Based on current prices and forecasted product mix and costs, we expect to continue to achieve positive commercial gross margins for the remainder of 2003.

          Contract research and development expenses totaled $1.7 million and $316,000 in the third quarter of 2003 and 2002, respectively. In the first nine months of 2003 and 2002, these expenses totaled $4.7 million and $1.5 million, respectively. These increases result from the higher government revenues resulting from the acquisition of Conductus and the increase in other government contracts revenues.

          Other research and development expenses relate to development of our commercial products. These expenses decreased to $985,000 in the third quarter of 2003, as compared to $1.2 million in the same period last year. This decrease is due to a decrease in commercial development efforts in the third quarter of 2003. In the first nine months of 2003, these expenses totaled $4.3 million, as compared to $4.0 million in the first nine months of 2002. This increases is due to a higher level of commercial development efforts during the nine months ended September 27, 2003.

          Selling, general and administrative expenses totaled $4.1 million in the third quarter of 2003 as compared to $3.3 million in the same period last year. This increase results primarily from increased domestic and international marketing and sales efforts and higher expenses related to the acquired Conductus operations, partially offset by lower ISCO litigation expenses. In the first nine months of 2003 these expenses totaled $16.6 million as compared to $11.6 million in the first nine months of 2002. This increase results primarily from increased domestic and international marketing and sales efforts, higher expenses related to the acquired Conductus operations and higher ISCO litigation expenses. ISCO litigation expenses totaled $90,000 and $4.8 million for the third quarter and first nine months of 2003 respectively, as compared to $674,000 and $2.5 million, respectively, in the same periods last year.

          Interest income decreased in the third quarter and first nine months of 2003 as compared to the same periods in the prior year due to decreased levels of cash available for investment and the decline in interest rates.

          Interest expense increased in the third quarter and first nine months of 2003 as compared to the same periods in the prior year and resulted from the increase debt incurred in the fourth quarter of 2002 and from short-term borrowings in 2003

          We had a net loss of $851,000 million for the current quarter ended September 27, 2003 as compared to $4.8 million in the same period last year. For the first nine months of 2003, the net loss totaled $12.3 million as compared to $16.6 million last year.

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          The net loss available to common shareholders totaled $851,000 million in the current quarter, or $0.01 per common share, as compared to $5.4 million, or $0.23 per common share, in the same period last year. The amounts for the third quarter of 2002 include a charge of $570,000 for a non-cash deemed distribution on preferred stock. The net loss available to common shareholders totaled $12.3 million in the first nine months of 2003, or $0.20 per common share, as compared to $18.3 million, or $0.85 per common share, in the same period last year. The loss for the first nine months of 2002 includes a charge of $1.8 million for a non-cash deemed distribution on preferred stock.

Liquidity and Capital Resources

          Cash and cash equivalents decreased by $5.1 million from $18.2 million at December 31, 2002 to $13.1 million at September 27, 2003. Cash used in operations and investing activities during the first nine months of 2003 was partially offset by cash received from the sale of common stock and warrants in a private placement during the second quarter.

          Cash used in operations totaled $13.4 million in the first nine months of 2003. We used $9.9 million to fund the cash portion of our net losses. We also used cash to fund a $4.1 million increase in accounts receivable, inventory, patents and licenses and other assets. Cash generated from the increase in accounts payable and other accrued expenses totaled $589,000. Cash used in operations in the first nine months of 2002 totaled $13.9 million and was used primarily to fund the $15.0 million cash portion of our losses and $1.6 million for the increase in accounts receivable, inventories, patents and licenses and other assets. These increases were partially offset by the increase in accounts payable and accrued expenses, which totaled $2.7 million. Since a significant portion of our accounts payable at September 27, 2003 relate to the recently completed ISCO litigation we do not expect accounts payable and accrued liabilities to increase for the remainder of the year.

          Net cash used in investing activities totaled $2.4 million in the first nine months of 2003 and $5.2 million the same period last year and primarily related to the purchase of manufacturing related equipment and tenant improvements.

          Net cash provided by financing activities totaled $10.7 million in the first nine months of 2003. Cash received from the sale of common stock and warrants totaled $10.1 million and net borrowings against our credit facility totaled $1.6 million and was partially offset by the reduction in long-term borrowings of $948,000. In the same period of 2002, cash provided by financing activities totaled $11.9 million and resulted from the sale of common stock and warrants totaling $12.2 million and was partially offset by the reduction in borrowings of $220,000.

          On March 28, 2003, the Company entered into an accounts receivable purchase agreement with a bank. The agreement provides for the sale of up to $5 million of eligible accounts receivable, with advances to the Company totaling 80% of the receivables sold. Advances bear interest at the prime rate (4.00% at September 27, 2003) plus 2.50% subject to a minimum monthly charge and the agreement terminates April 1, 2004. Outstanding amounts under this borrowing facility at September 27, 2003 totaled $1,618,000.

All the Company’s assets collateralize advances under the agreement. Under the terms of the agreement, the Company continues to service the sold receivables and is subject to recourse provisions. In connection with this agreement the Company issued seven year warrants for the purchase of 94,340 shares of common stock at $1.06 per share.

          In June 2003 we raised net proceeds of $10.1 million from the private sale of 5,116,278 shares of common stock at $2.15 per share and 5-year warrants to purchase an additional 1,279,069 shares of common stock at $2.90 per share. Pursuant to the transaction documents, we filed a registration statement covering the shares of common stock issued at the closing and upon exercise of the warrants. The registration statement became effective July 11, 2003.

At September 27, 2003, we had the following cash commitments:

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          Additionally, we plan to invest approximately $300K in fixed assets during the remainder of 2003 to continue to expand manufacturing ability. With our present SuperLink Rx product mix, we have the ability to manufacture about 700 units per quarter and have the ability to expand that capacity to approximately 1,250 units per quarter by the end of 2004. In addition, we expect that sales will continue to increase which will result in higher inventory and accounts receivable balances being maintained. Although revenues have increased in 2003, through September 2003 the Company has continued to incur losses. Our long-term prospects are dependent upon the continued and increased market acceptance for our products.

Based on current forecasts, STI believes it will have sufficient resources to fund normal operations until it reaches profitability, expected in either the fourth quarter of 2003 or in early 2004. We need to increase sales to achieve profitability and positive cash flows. If we are unable to do so, we may need additional debt or equity financing. 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.

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 resulted from the 1999 ownership change.

Future Accounting Requirements

     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 adoption of SFAS No. 146 did not have an impact on the financial statements.

          In April 2003, the FASB issued SFAS No. 149, “Amendment on Statement 133 of Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies the accounting guidance on derivative instruments (including certain derivative instruments embedded in other contracts) and hedging activities that fall within the scope of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 is effective for all contracts entered into

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or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively. The adoption of SFAS No. 149 will not have a material impact on our financial position, results of operations or cash flows.

     In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities, an 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 for VIEs created after February 1, 2003 and is effective for all other VIEs in the first reporting period ending after December 31, 2003. The adoption of FIN 46 is not expected to have a significant effect on the Company’s financial position or results of operations.

     In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 changes the accounting guidance for certain financial instruments that, under previously guidance, could be classified as equity or “mezzanine” equity by now requiring those instruments to be classified as liabilities (or assets in some circumstances) in the statement of financial position. Further, SFAS No. 150 requires disclosure regarding their terms of those instruments and settlement alternatives. SFAS No. 150 is generally effective for all financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period beginning after June 15, 2003. While the effective date of certain elements of SFAS No. 150 have been deferred the adoption of SFAS No. 150 when finalized is not expected to have a material impact on our financial position, results of operations or cash flows.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

          There was no material change in our exposure to market risk at September 27, 2003 as compared with our market risk exposure on December 31, 2002. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk” in our 2002 Annual Report on Form 10K.

Item 4. Disclosure Controls and Procedures.

          Within the 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company that is required to be included in the Company’s periodic SEC filings. There were no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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.