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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
COMMISSION FILE NUMBER 0-22302
ILLINOIS SUPERCONDUCTOR CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 36-3688459
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
451 KINGSTON COURT
MT. PROSPECT, ILLINOIS 60056
(847) 391-9400
(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
---------------------------
Common Stock, par value $0.001 per share
Preferred Stock Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
On January 31, 2001, 107,746,807 shares of the registrant's Common
Stock were outstanding. The aggregate market value on January 31, 2001 of the
registrant's Common Stock held by non-affiliates of the registrant was
$148,094,000.
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DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's definitive proxy statement for the
annual meeting of stockholders to be held on June 22, 2001 are incorporated by
reference in Part III of this Form 10-K (the "2001 Proxy Statement").
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TABLE OF CONTENTS
PART I
Item 1. Business..........................................................................3
Item 2. Properties.......................................................................25
Item 3. Legal Proceedings................................................................26
Item 4. Submission of Matters to a Vote of Security Holders..............................29
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............29
Item 6. Selected Financial Data..........................................................31
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................31
Item 7a. Quantitative and Qualitative Disclosures About Market Risk.......................35
Item 8. Financial Statements and Supplementary Data......................................36
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.......................................................................61
PART III
Item 10. Directors and Executive Officers of the Registrant...............................61
Item 11. Executive Compensation...........................................................61
Item 12. Security Ownership of Certain Beneficial Owners and Management...................61
Item 13. Certain Relationships and Related Transactions...................................61
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports..............................62
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A NOTE CONCERNING
FORWARD-LOOKING STATEMENTS
Because Illinois Superconductor Corporation (the "Company" or "ISCO")
wants to provide investors with more meaningful and useful information, this
Annual Report on Form 10-K ("Form 10-K") contains, and incorporates by
reference, certain forward-looking statements that reflect the Company's current
expectations regarding the Company's future results of operations, performance
and achievements. The Company has tried, wherever possible, to identify these
forward-looking statements by using words such as "anticipates," "believes,"
"estimates," "expects," "designs," "plans," "intends" and similar expressions.
These statements reflect the Company's current beliefs and are based on
information currently available to the Company. Accordingly, these statements
are subject to certain risks, uncertainties and contingencies, including the
factors set forth under the caption "Risk Factors," which could cause the
Company's actual results, performance or achievements for 2001 and beyond to
differ materially from those expressed in, or implied by, any of these
statements. You should not place undue reliance on any forward-looking
statements. Except as otherwise required by federal securities laws, the Company
undertakes no obligation to release publicly the results of any revisions to any
such forward-looking statements that may be made to reflect events or
circumstances after the date of this Annual Report or to reflect the occurrence
of unanticipated events.
PART I
ITEM 1. BUSINESS
The Company provides a wide array of interference-management solutions
for the wireless telecommunications industry. It uses both its patented and
proprietary adaptive notch filter technology ("ANF") and its patented and
proprietary high temperature superconductor ("HTS") technology to monitor and
suppress in-band and out-of-band interference in a wireless base station. The
Company believes it is the only company in the world that has proprietary
products to address the wireless operator's need to reduce or eliminate
interference that comes from in-band and out-of-band sources.
The Company believes that the benefits of using the Company's products
include: increased cell site capacity and utilization (as much as 70% or more),
increased revenues per cell site (as much as 100% increase based on minutes of
use), easier location of new cell sites due to tolerance of interference,
improved voice quality and reduced drop calls (up to 40%). These benefits have
been documented in field trials with wireless operators involving existing
cellular and PCS systems.
In addition, the Company believes, that based on test results conducted
by NTT DoCoMo ("NTT"), the next generation of wireless systems ("3G" or 3rd
Generation) will not be able to operate effectively without an HTS filter as
part of the overall system. The Company believes that with the increased data
bit rates required of 3G systems and the increased usage of 3G systems due to
the "wireless internet", that interference levels will increase substantially,
thereby requiring an improved filtering system in the base station.
HTS Technology
The Company's patented HTS technology includes the use of
superconducting materials, radio frequency ("RF") filter designs and cryogenic
technologies that are needed to develop, manufacture and market high performance
RF filter products. These products are designed to enhance the quality,
capacity, coverage and flexibility of wireless telecommunications services.
RF filters refine the radio signals by passing radio waves through a
series of resonators (poles), which allow certain frequencies to pass while
rejecting other frequencies. Generally, the more poles in the RF filter, the
more effective the RF filter. Each pole, however, has electrical resistance
which causes the loss (insertion loss) of desired radio waves. Therefore, the
more poles in a conventional RF filter, the greater the insertion loss.
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Superconductive materials, when cooled below a critical temperature,
are able to transmit an electric current with no loss or minimal loss of energy.
The advantage of using superconductors in RF filters is that more poles can be
added without significant increases in insertion loss, thereby creating a more
effective RF filter.
HTS filters can be designed with a variety of structures and materials,
each with different results. The Company is able to produce RF filters using the
two main HTS filter designs, thin-film and thick-film design. The Company
believes it is the only Company in the world that uses thick-film design and the
Company believes it has an extensive patent position in the thick-film area that
will protect its proprietary position.
One benefit of thick-film technology is that, according to published
data of tests conducted by NTT DoCoMo, it produces an almost theoretically
perfect RF filter for suppression of out-of-band interference (see diagram on
page 18).
Another benefit of thick-film design is already incorporated in the
Company's patented "All-Temperature Performance" ("ATP") feature, which
eliminates the need for certain redundant backup systems in a wireless base
station. One of the hurdles of incorporating an HTS RF filter in a base station
is that the HTS filter has an active feature, the cryo-cooler, which may be
subject to failure or power loss. Non-HTS filters do not have an active
component and therefore non-HTS filter performance is not hindered by a lack of
power. The incorporation of the ATP function in an HTS RF filter eliminates the
need for a backup system in case of power failure, because even without power,
it has filtering capabilities at least equal to a non-HTS filter. Thin-film
technology requires a back-up system or a by-pass system to continue to operate
the filtering component of the base station, both of which adds cost and size to
the overall product presentation.
The Company also uses its patented thin-film superconducting technology
for its patented tower-mount RF filters. The Company believes that its
tower-mount products will become an increasing source of competitive advantage
in the deployment of HTS filters worldwide. The Company believes that there is a
trend toward the outdoor mounting of equipment in the domestic base station
market. In addition, the Company believes that a significant percentage of base
stations in Asia have already adapted to an outdoor mount configuration.
Finally, the Company believes that once the wireless operator accepts a
cryo-cooler in a base station for HTS filter applications, the entire front-end
of the base station will be open to improved performance through the use of HTS
materials, known as the Cryogenic Front End "(CRFE"). The Company has studied
all the components of the front end and believes that a hybrid of thin-film and
thick-film technologies will greatly improve the performance of the Digital
Wireless Communications System (see diagram on page 21).
ANF Technology
One of the difficult tasks facing any wireless operator trying to
suppress interference is determining its source and location. In general,
wireless operators do not care about the source (whether it is in-band or
out-of-band interference), just that it interferes with the efficiency of the
base station.
With the acquisition of the ANF (Adaptive Notch Filter) division of
Lockheed Martin Canada Corporation during 2000, the Company now owns proprietary
technologies to produce filters that monitor RF spectrum and block spontaneous
interference occurring within that spectrum. This allows the Company to offer
what it believes to be the only product in the world that locates and suppresses
in-band interference within 20 milliseconds.
HISTORY
The Company was founded in 1989 by ARCH Development Corporation, an
affiliate of the University of Chicago, to commercialize superconductor
technologies initially developed by Argonne National Laboratory. The Company was
incorporated in Illinois on October 18, 1989 and reincorporated in Delaware on
September 24, 1993. The Company's facilities and principal executive offices are
located at 451 Kingston Court, Mt. Prospect, Illinois 60056 and its telephone
number is (847) 391-9400.
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BUSINESS STRATEGY
The Company's objective is to be a global leader in supplying high
performance interference-management products to the growing wireless
telecommunications market. Key elements of the Company's strategy include the
following:
- DEVELOPING OR ACQUIRING RELEVANT INTELLECTUAL PROPERTY ("IP").
The Company is building what it believes to be the strongest
intellectual property portfolio in HTS wireless technology and
other areas of interference management. Unlike many other fields
of telecom technology, the base of HTS expertise is very narrow.
Today, the Company believes it has the largest patent portfolio
in the industry and is aggressively expanding the scope of its
patent program. The Company believes that as HTS technology moves
to center-stage in 3G application, in particular, the IP
portfolio will become a powerful element of the Company's overall
business strategy.
- MAINTAINING TECHNOLOGICAL LEADERSHIP IN THE INDUSTRY. The Company
believes it has the best filter performance of any HTS product
today and this allows the Company to design products over the
full range of performance requirements from rural 2G to urban 3G.
The Company intends to focus on products with unique (and
patented) value-added features that connect to operational
objectives of the wireless service providers. These include
products such as the patented tower-mount HTS RF front-end and
the ATP feature that allows HTS filters to operate as a
conventional filter in case of power loss.
- SUPPLYING PRICE COMPETITIVE PRODUCTS. The Company has been able
to continually reduce its product cost, which has permitted the
Company to more competitively price its products. The Company
believes that it can continue to achieve further cost reductions
due to design and development projects and strategic partnering
with vendors and other manufacturers.
- DEVELOPING STRATEGIC RELATIONSHIPS. The Company believes that in
order to adequately address the potential world-wide market for
HTS RF products and interference-management solutions, the
Company will need to develop and maintain strategic relationships
with well-established manufacturers and marketers of wireless
telecommunications equipment in various parts of the world. A
case in point of this strategic partnering includes the KMW, Inc.
joint development agreement.
- FOCUSING ON FAST GROWING COMMERCIAL MARKETS. The Company has
focused its efforts on developing the HTS market for 3G in Asia.
The Company believes it is well positioned to become a strategic
supplier to the first implementers of 3G systems in the world.
The Company believes that 3G will become a reality and that HTS
is an enabling technology for 3G. The Company has also restarted
its marketing efforts for the domestic 2G and 2.5G systems. The
Company believes that system operators with capacity concerns
will increasingly turn towards HTS as a cost-effective solution.
RECENT DEVELOPMENTS/SUBSEQUENT EVENTS
Change in Certifying Accountants
On December 7, 2000, we advised Ernst & Young LLP that we intended to
retain a different firm of independent auditors for the audit of our financial
statements for the fiscal year ending December 31, 2000. We have engaged Grant
Thornton LLP as our new independent public accountants to audit our consolidated
financial statements. This engagement was effective as of December 7, 2000. As
noted in the form 8K filed December 18, 2001, related to this event, there have
been no disagreements with Ernst & Young on any matter of accounting principles
or practices, financial statement disclosure or auditing scope or procedure
during the Registrant's two most recent fiscal years or in the subsequent
interim period through December 7, 2000 (date of termination), which
disagreement(s), if not resolved to Ernst & Young's satisfaction, would have
caused Ernst & Young to make reference to the subject matter of disagreement(s)
in connection with its report. There were no "reportable events" as that term is
described in Item 304(a)(1)(v) of Regulation S-K.
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Conversion of Senior Convertible Notes
On December 29, 2000, holders of the Company's senior convertible notes
converted $14,354,778 principal amount of such notes plus accrued interest into
63,283,309 shares of common stock.
Joint Development with KMW
On January 3, 2001, the Company announced an agreement with KMW, Inc., of
Korea to jointly develop an advanced-design cryogenic receiver front-end (CRFE)
system to meet the requirements of third-generation (3G) Wideband-CDMA wireless
systems to be deployed, beginning this year, in Japan and Korea.
Filing of Rights Offering Statement
On January 8, 2001, the Company filed with the SEC on Form S-3 a
registration statement for a proposed common stock rights offering for up to $20
million. The purpose of the rights offering filing was to put the Company in the
position to access funds on a pro rata, non-dilutive basis from existing
shareholders as of a certain holding date. As of the date of this 10K filing,
the Company has not yet determined whether it will proceed with the Rights
Offering, in light of the settlements described elsewhere in this report.
Filing of a Universal Shelf Offering Statement
On January 12, 2001, the Company filed with the SEC on Form S-3 a
registration statement for the purpose of offering up to $50 million of common
stock, warrants, or preferred stock of the Company. The filing, known as a
Universal Shelf was put in place by the Company to allow the Company to access
funds in the open market on an opportunistic or on an as needed basis. To date,
the Company has not sold any securities registered under the Universal Shelf.
$15 Million Settlement Expected to be Received
On February 22, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $15 million, less legal fees and
certain other expenses. Two of the Company's stockholders, Elliott Associates,
L.P. and Elliott International, L.P. (formerly Westgate International, L.P.),
have agreed to make this settlement payment in order to resolve claims asserted
against them and certain present and former directors. The shareholder
litigation remains outstanding against other third parties. A notice regarding
the settlement has been mailed to all shareholders. The court hearing to
consider the settlement is scheduled for March 30, 2001.
Short-Term Bridge Loan with Elliott Associates, L.P.
On February 23, 2001, the Company secured a short-term bridge loan from
Elliott Associates, L.P. for up to $3.5 million to fund working capital needs.
The loan matures in 120 days and bears a market rate of interest at 12%. The
purpose of the short-term bridge loan was to fund working capital needs of the
Company until such time that the funds from the above-described settlement have
been received by the Company. The Company accessed the first $2 million of the
loan at closing and the remaining $1.5 is available, at the Company's option,
during the first week in April, 2001.
$5 Million Settlement Expected to be Received
On March 16, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $5 million, less legal fees and
certain other expenses. Alexander Finance has agreed to make this settlement
payment in order to resolve claims asserted against them. A notice regarding the
settlement has been mailed to all shareholders. The court hearing to consider
the settlement is scheduled for April 27, 2001.
Repricing of Employee Stock Options
On February 5, 2001, the Company's Board of Directors elected to reprice
certain options granted to employees and directors during 2000. In total,
2,676,000 options with prices ranging from $2.9688 to $6.6094 were repriced to
$1.9375, the closing price of the Company's common stock on the repricing date.
The Board elected to reprice the options to maintain employee morale and to more
clearly align the management and employee goals with those of the shareholders.
The resulting variable accounting may lead to
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substantial non-cash expense charges in the future. No other terms of the
options were affected.
$20 Million Equity Commitment Line
During March, 2001, the Company entered into an agreement with Paul Revere
Capital Partners, Ltd., whereby Paul Revere Capital commits to acquire up to $20
million of the Company's stock over the next 24 months upon demand by the
Company, subject to the conditions contained in the agreement. Pursuant to this
facility, the Company may, at its discretion, sell shares of its common stock to
Paul Revere Capital Partners at a discount to the market price of 94% of the
average weighted volume price over a 22 day period. Each draw down is limited to
the lesser of $4 million or 20% of the trading volume over a specified period of
time. The Company will also issue a warrant to Paul Revere Capital Partners to
purchase a number of shares equal to 0.5% of the shares issued in each draw
down. The Company has also agreed to pay its placement agent a fee equal to 4%
of each draw down and issue a warrant to the placement agent to purchase a
number of shares equal to 0.5% of the shares issued in each draw down.
Name Change
The Company applied for the right to do business as "ISCO International"
and intends to present a formal name change resolution to the shareholders at
the next annual meeting.
RISK FACTORS
The following factors, in addition to other information contained herein, should
be considered carefully in evaluating the Company and its business.
RISKS RELATED TO THE OPERATIONS AND FINANCING OF OUR COMPANY
Limited Operating History; History of Losses; and Uncertainty of Financial
Results
We were founded in October 1989 and through 1996 were engaged
principally in research and development, product testing, manufacturing,
marketing and sales activities. We have incurred net losses since our inception.
As of December 31, 2000, our accumulated deficit was approximately $101,673,000.
We have only recently begun to generate revenues from the sale of our RF filter
products. Prior to the commencement of these sales, the majority of our revenues
were derived from R&D contracts, primarily from the U.S. government. We do not
expect revenues to increase dramatically until we ship a significantly larger
amount of our RF products. Accordingly, we expect to continue to experience net
losses, and we cannot be certain if or when we will become profitable. Spectral
Solutions and the Adaptive Notch Filtering business unit of Lockheed Martin
Canada, both of which we recently acquired, have similar operating histories and
financial uncertainties.
We have only a limited operating history upon which an evaluation of us
and our prospects can be based. We must therefore be considered in light of the
risks, expenses and difficulties frequently encountered by companies in their
early stages of product commercialization.
Future Capital Needs
To date, the Company has financed its operations primarily through
public and private equity and debt financings. The Company believes that it has
sufficient funds to operate its business as identified herein without the need
for substantial future capital sources other than those described herein until
the end of the first quarter 2002. In addition, the Company has put in place
mechanisms to raise additional capital when and if needed. The company intends
to augment its existing capital position through the funding mechanisms
identified and through other strategic sources of capital. Although the Company
believes it has sufficient capital resources available to meet its obligations
over the next year, there is no guarantee that the funding mechanisms identified
will allow to the company to access additional funds.
The actual amount of our future funding requirements will depend on
many factors, including: the amount and timing of future revenues, the level of
product marketing and sales efforts to support our commercialization plans, the
magnitude of our research and product development programs, our ability to
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improve product margins, the cost of additional plant and equipment for
manufacturing and the costs involved in protecting our patents or other
intellectual property.
Limited Experience in Manufacturing, Sales and Marketing
For us to be financially successful, we must either manufacture our
products in substantial quantities, at acceptable costs and on a timely basis or
enter into an outsourcing arrangement with a qualified manufacturer that will
allow us the same. In the event that we are unable to enter into a manufacturing
arrangement on acceptable terms with a qualified manufacturer, the Company would
have to produce the products in commercial quantities in our own facilities.
Although to date we have produced limited quantities of our products for
commercial installations and for use in development and customer field trial
programs, production of large quantities of our products at competitive costs
presents a number of technological and engineering challenges for us. We may be
unable to manufacture such products in sufficient volume. We have limited
experience in manufacturing, and substantial costs and expenses may be incurred
in connection with attempts to manufacture larger quantities of our products. We
may be unable to make the transition to large-scale commercial production
successfully.
Our sales and marketing experience to date is very limited. The Company
will be required to further develop its marketing and sales force in order to
effectively demonstrate the advantages of our products over more traditional
products, as well as other competitors' HTS products. The Company also may elect
to enter into arrangement with third parties regarding the commercialization and
marketing of its products. If the Company enters into such agreements or
relationships, it will be substantially dependent upon the efforts of others in
deriving commercial benefits from its products. The Company may be unable to
establish adequate sales and distribution capabilities, it may be unable to
enter into marketing arrangements or relationships with third parties on
financially acceptable terms, and any such third party may not be successful in
marketing the Company's products. There is no guarantee that our sales and
marketing experience will be successful.
Management of Growth
Our growth to date has caused, and will continue to cause, a
significant strain on our management, operational, financial and other
resources. Our ability to manage growth effectively will require us to implement
and improve our operational, financial, manufacturing and management information
systems and expand, train, manage and motivate our employees. These demands may
require the addition of new management personnel and the development of
additional expertise by management. Any increase in resources devoted to product
development and marketing and sales efforts could have an adverse effect on our
financial performance in the next several fiscal quarters. If we were to receive
substantial orders, we may have to expand our current facilities, which could
cause an additional strain on our management personnel and development
resources. The failure of our management team to effectively manage growth could
have a material adverse effect on our business, operating results and financial
condition.
RISKS RELATED TO OUR COMMON STOCK AND CHARTER PROVISIONS
Delisting of Common Stock
Our common stock was de-listed from trading on the NASDAQ National
Market in June 1999 due to our inability to meet the net tangible assets
requirement for continued listing. Our common stock is now traded in the
over-the-counter market and quoted on the over-the-counter bulletin board
("OTCBB"). While to date, the OTCBB market has not diminished the liquidity of
the common stock, there is no guarantee that the OTCBB will provide the same
liquidity for the trading of securities as the NASDAQ National Market in the
future. We intend to apply for relisting on the NASDAQ National Market when we
are reasonably confident that our application would be approved. However, there
is no guarantee that our application for relisting will be approved.
Volatility of Common Stock Price
The market price of our common stock, like that of many other
high-technology companies, has fluctuated significantly and is likely to
continue to fluctuate in the future. Since January 1, 1999 and through December
31, 2000, the closing price of our common stock has ranged from a low of $0.3438
per share to a high of $39.00 per share. Announcements by us or others regarding
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the receipt of customer orders, quarterly variations in operating results,
acquisitions or divestitures, additional equity or debt financings, results of
customer field trials, scientific discoveries, technological innovations,
litigation, product developments, patent or proprietary rights, government
regulation and general market conditions may have a significant impact on the
market price of our common stock. In addition, fluctuations in the price of our
common stock could affect our ability to have our common stock accepted for
listing on a securities market or exchange.
Risk of Dilution
As of December 31, 2000, we had (i) outstanding warrants to purchase
95,533 shares of common stock at a weighted average exercise price of $10.20 per
share and (ii) outstanding options to purchase 5,442,596 shares of common stock
at a weighted average exercise price of $3.02 per share (3,876,578 of which have
not yet vested) issued to employees, directors and consultants pursuant to our
1993 Stock Option Plan, the merger agreement with Spectral Solutions, and
individual agreements with our management and directors. In order to attract and
retain key personnel, we may issue additional securities, including stock
options, in connection with our employee benefit plans, or may lower the price
of existing stock options.
On January 8, 2001 we filed a registration statement on Form S-3 for
the sale of up to $20 million of shares of our common stock in a rights
offering to common shareholders as of a certain holding date not yet determined.
On January 12, 2001, we filed a registration statement on Form S-3 for the sale
of up to $50 million of shares of our common stock in a "universal shelf"
offering. During March, 2001, the Company entered into an agreement with Paul
Revere Capital Partners, Ltd., whereby Paul Revere Capital commits to acquire up
to $20 million of the Company's stock over the next 24 months upon demand by the
Company, subject to the conditions contained in the agreement. Pursuant to this
facility, the Company may, at its discretion, sell shares of its common stock to
Paul Revere Capital Partners at a discount to the market price of 94% of the
average weighted volume price over a 22 day period. Each draw down is limited to
the lesser of $4 million or 20% of the trading volume over a specified period of
time. The Company will also issue a warrant to Paul Revere Capital Partners to
purchase a number of shares equal to 0.5% of the shares issued in each draw
down. The Company has also agreed to pay its placement agent a fee equal to 4%
of each draw down and issue a warrant to the placement agent to purchase a
number of shares equal to 0.5% of the shares issued in each draw down.
The exercise of options and warrants for common stock and the issuance
of additional shares of common stock and/or rights to purchase common stock at
prices below market value will be dilutive to existing stockholders and may have
an adverse effect on the market value of the common stock.
Concentration of Our Stock Ownership
Our officers, directors and principal stockholders (holding greater
than 5% of outstanding shares) together control approximately 66% of our
outstanding voting power. Consequently, these stockholders, if they act
together, would be able to exert significant influence over all matters
requiring stockholder approval, including the election of directors and approval
of significant corporate transactions. In addition, this concentration of
ownership may delay or prevent a change of control of our company, even when a
change may be in the best interests of our stockholders. The interests of these
stockholders may not always coincide with our interests as a company or the
interests of other stockholders. Accordingly, these stockholders could cause us
to enter into transactions or agreements that we would not otherwise consider.
Anti-Takeover Provisions
We have certain arrangements which may be deemed to have a potential
"anti-takeover" effect in that such provisions may delay, defer or prevent a
change of control of our company. In February 1996, our Board of Directors
adopted a stockholders rights plan. In addition, our Certificate of
Incorporation and By-Laws provide that (i) stockholder action may be taken only
at stockholders meetings; (ii) the Board of Directors has authority to issue
series of our preferred stock with such voting rights and other powers as the
Board of Directors may determine; (iii) prior specified notice must be given by
a stockholder making nominations to the Board of Directors or raising business
matters at stockholders meetings; and (iv) the Board of Directors is divided
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into three classes, each serving for staggered three-year terms. The effect of
the rights plan and the anti-takeover provisions in our charter documents may be
to deter business combination transactions not approved by our Board of
Directors, including acquisitions that may offer a premium over market price to
some or all of our stockholders.
TECHNOLOGY AND MARKET RISKS
We are Dependent on the Build-out of 3G Networks and the Capital Spending
Patterns of Wireless Network Operators
Increased sales of our products is dependent on the build-out of 3G
enabled wireless communications networks. Building these networks is capital
intensive, as is the process of upgrading existing second generation equipment.
Further, the capital spending patterns of wireless network operators is beyond
our control and depends on a variety of factors, including access to financing,
the status of federal, local and foreign government regulation and deregulation,
changing standards for wireless technology, the overall demand for wireless
services, competitive pressures and general economic conditions. The build-out
of 3G enabled networks may take years to complete and is dependent upon the
level of capital spending by wireless network operators. The magnitude and
timing of capital spending by these operators for constructing, rebuilding or
upgrading their systems significantly impacts the demand for our products. Any
decrease or delay in capital spending patterns in the wireless communication
industry, whether because of a general business slowdown or a reevaluation of
the prospective demand for 3G services, would delay the build-out of 3G networks
and significantly harm our business prospects.
Uncertain Market Acceptance of HTS Telecommunications Products
Our radio frequency ("RF") filter products, which are based on our high
temperature superconductor ("HTS") technology, and our ANF technology, have not
been sold in very large quantities and a sufficient market may not develop for
our products. Our customers establish demanding specifications for performance
and reliability, and although we believe we have met or exceeded these
specifications to date, there is no guarantee that the wireless service
providers will elect to use the HTS or ANF solutions to solve their interference
problems.
Rapid Technological Change and Future Competitive Technologies
The field of superconductivity is characterized by rapidly advancing
technology. Our success will depend in large part upon our ability to keep pace
with advancing superconducting technology, high performance RF filter design and
efficient, low cost cryogenic technologies. Rapid changes have occurred, and are
likely to continue to occur, in the development of superconducting materials and
processes. Our development efforts may be rendered obsolete by the adoption of
alternative solutions to current wireless operator problems or by technological
advances made by others. In addition, other materials or processes, including
other superconducting materials or fabrication processes, may prove more
advantageous for the commercialization of high performance wireless products
than the materials and processes selected by us.
Focus on Wireless Telecommunications Market and on the 3G Market
Our principal target market for our products is wireless
telecommunications. The devotion of substantial resources to the wireless
telecommunications market makes us vulnerable to adverse changes in this market.
Adverse developments in the wireless telecommunications market, which could come
from a variety of sources, including future competition, new technologies or
regulatory decisions, could affect the competitive position of wireless systems.
Any adverse developments in the wireless telecommunications market during the
foreseeable future would have a material adverse effect on our business,
operating results and financial condition.
Our principal focus within the wireless telecommunications market has
been on the emerging 3G wireless systems in Asia. The devotion of substantial
resources to this emerging market makes us vulnerable to adverse developments in
this market, including the potential decisions by 3G wireless operators to not
adopt HTS RF filters into their system specifications or on a retrofit schedule;
to delay in the roll-out of 3G systems; to future competition, new technologies
or regulatory decisions, all of which could have an adverse effect on our
business, operating results and financial condition.
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BUSINESS RISKS
Dependence on a Limited Number of Customers
To date, our sales and marketing efforts have focused on cellular and
PCS service providers in retrofit applications. Sales to three of our customers
accounted for over 80% and 65% of our company's total revenues for 2000 and
1999, respectively. In addition, we have focused a significant amount of our
technical and managerial resources to working with the limited number of 3G
license holders in Japan and Korea, as well as, established Original Equipment
Manufacturers ("OEMs") who may provide telecommunications equipment to these 3G
wireless operators in these markets.
We expect that if our RF filter products achieve market acceptance, a
limited number of wireless service providers and OEMs will account for a
substantial portion of our revenue during any period. Sales of many of our
company's RF filter products depend in significant part upon the decision of
prospective customers and current customers to adopt and expand their use of our
products. Wireless service providers, wireless equipment OEMs and our other
customers are significantly larger than, and are able to exert a high degree of
influence over us. Customers' orders are affected by a variety of factors such
as new product introductions, regulatory approvals, end user demand for wireless
services, customer budgeting cycles, inventory levels, customer integration
requirements, competitive conditions and general economic conditions. The
failure to attract new customers would have a material adverse effect on our
business, operating results and financial condition.
Lengthy Sales Cycles
Prior to selling our products to our customers, we must generally
undergo lengthy approval and purchase processes. Technical and business
evaluation by potential customers can take up to a year or more for products
based on new technologies such as HTS. The length of the approval process is
affected by a number of factors, including, among others, the complexity of the
product involved, priorities of the customers, budgets and regulatory issues
affecting customers. We may not obtain the necessary approvals or ensuing sales
of such products may not occur. The length of our customers' approval process or
delays could have a material adverse effect on our business, operating results
and financial condition.
Dependence on Limited Sources of Supply
Certain parts and components used in our RF filter products, including
substrates, vacuum components, and cryogenic coolers, are only available from a
limited number of sources. Our reliance on these limited source suppliers
exposes us to certain risks and uncertainties, including the possibility of a
shortage or discontinuation of certain key components and reduced control over
delivery schedules, manufacturing capabilities, quality and costs. Any reduced
availability of such parts or components when required could materially impair
our ability to manufacture and deliver our products on a timely basis and result
in the cancellation of orders, which could have a material adverse effect on our
business, operating results and financial condition.
In addition, the purchase of certain key components involves long lead
times and, in the event of unanticipated increases in demand for our products,
we may be unable to manufacture products in quantities sufficient to meet our
customers' demand in any particular period. We have no guaranteed supply
arrangements with our limited source suppliers, do not maintain an extensive
inventory of parts or components, and customarily purchase parts and components
pursuant to purchase orders placed from time to time in the ordinary course of
business.
To satisfy customer requirements, we may be required to stock certain
long lead time parts in anticipation of future orders. The failure of such
orders to materialize as forecasted could limit resources available for other
important purposes or accelerate our requirement for additional funds. In
addition, such excess inventory could become obsolete, which would adversely
affect our financial performance. Business disruption, production shortfalls or
financial difficulties of a limited source supplier could materially and
adversely affect us by increasing product costs or reducing or eliminating the
availability of such parts or components. In such events, our inability to
develop alternative sources of supply quickly and on a cost-effective basis
could materially impair our ability to manufacture and deliver our products on a
timely basis and could have a material adverse effect on our business, operating
results and financial condition.
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Dependence on Key Personnel
Our success will depend in large part upon our ability to attract and
retain highly qualified management, engineering, manufacturing, marketing, sales
and R&D personnel. Due to the specialized nature of our business, it may be
difficult to locate and hire qualified personnel. The loss of services of one of
our executive officers or other key personnel, or the failure to attract and
retain other executive officers or key personnel, could have a material adverse
effect on our business, operating results and financial condition.
Product Liability
To date, our products have been installed in more than 300 cell sites
with a wide geographic dispersion. Although we believe our products have not
experienced any significant reliability problems to date, our products may
develop reliability problems in the future. Repeated or widespread quality
problems could result in significant warranty expenses and/or the loss of
customer confidence. The occurrence of such quality problems could have a
material adverse effect on our business, operating results and financial
condition.
Competition
The wireless telecommunications equipment market is very competitive.
Our products compete directly with products which embody existing and future
competing commercial technologies. Many of these companies have substantially
greater financial resources, larger R&D staffs and greater manufacturing and
marketing capabilities than we do. Other emerging wireless technologies,
including "smart antennas" and tower mounted amplifiers, may also provide
protection from RF interference and offer enhanced range to wireless
communication service providers at lower prices and/or superior performance, and
may therefore compete with our products. High performance HTS RF filters may not
become a preferred technology to address the needs of wireless communication
service providers. Failure of our products to improve performance sufficiently,
reliably, or at an acceptable price or to achieve commercial acceptance or
otherwise compete with conventional and new technologies will have a material
adverse effect on the our business, operating results and financial condition.
Although the market for superconductive electronics currently is
small, we believe it will become intensely competitive, especially if products
with significant market potential are successfully developed. In addition, if
the superconducting industry develops, additional competitors with significantly
greater resources are likely to enter the field. In order to compete
successfully, we must continue to develop and maintain technologically advanced
products, reduce production costs, attract and retain highly qualified
personnel, obtain additional patent or other protection for our technology and
products and manufacture and market our products, either alone or with third
parties. We may be unable to achieve these objectives. Failure to achieve these
objectives would have a material adverse effect on our business, operating
results and financial condition.
LEGAL RISKS
Intellectual Property and Patents
Our success will depend in part on our ability to obtain patent
protection for our products and processes, to preserve our trade secrets and to
operate without infringing upon the patent or other proprietary rights of others
and without breaching or otherwise losing rights in the technology licenses upon
which any of our products are based. As of December 31, 2000, we had been issued
35 U.S. and 4 foreign patents, had filed and were actively pursuing applications
for 13 other U.S. and 23 other patents, and were the licensee of 7 U.S. patents
and patent applications held by others. We acquired additional patent rights in
connection with our purchase of the Adaptive Notch Filtering business unit of
Lockheed Martin Canada. One of our patents is jointly owned with Lucent
Technologies, Inc. We believe that, since the discovery of HTS materials in
1986, a large number of patent applications have been filed worldwide, and many
patents have been granted in the U.S. relating to HTS materials. The claims in
those patents often appear to overlap and there have been interference
proceedings pending in the United States Patent and Trademark Office (not
currently involving our company) regarding rights to inventions claimed in some
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of the HTS materials patent applications. We also believe there are a large
number of patents and patent applications covering RF filter products and other
products and technologies that we are pursuing. Accordingly, the patent
positions of companies using HTS materials technologies and RF technologies,
including our company, are uncertain and involve complex legal and factual
questions. The patent applications filed by us or by our licensors may not
result in issued patents or the scope and breadth of any claims allowed in any
patents issued to us or our licensors may not exclude competitors or provide
competitive advantages to us. In addition, patents issued to us, our
subsidiaries or our licensors may not be held valid if subsequently challenged
or others may claim rights in the patents and other proprietary technologies
owned or licensed by us. Others may have developed or may in the future develop
similar products or technologies without violating any of our proprietary
rights. Furthermore, our loss of any license to technology that we now have or
acquire in the future may have a material adverse effect on our business,
operating results and financial condition.
Some of the patents and patent applications owned or licensed by us
are subject to non-exclusive, royalty-free licenses held by various U.S.
governmental units. These licenses permit these U.S. government units to select
vendors other than us to produce products for the U.S. Government, which would
otherwise infringe our patent rights that are subject to the royalty-free
licenses. In addition, the U.S. Government has the right to require us to grant
licenses (including exclusive licenses) under such patents and patent
applications or other inventions to third parties in certain instances.
Older patent applications in the U.S. are currently maintained in
secrecy until patents are issued. In foreign countries and for newer U.S. patent
applications, this secrecy is maintained for a period of time after filing.
Accordingly, publication of discoveries in the scientific literature or of
patents themselves or laying open of patent applications in foreign countries or
for newer U.S. patent applications tends to lag behind actual discoveries and
filing of related patent applications. Due to this factor and the large number
of patents and patent applications related to HTS materials, RF technologies and
other products and technologies that we are pursuing, comprehensive patent
searches and analyses associated with HTS materials, RF technologies and other
products and technologies that we are pursuing are often impractical or not
cost-effective. As a result, our patent and literature searches cannot fully
evaluate the patentability of the claims in our patent applications or whether
materials or processes used by us for our planned products infringe or will
infringe upon existing technologies described in U.S. patents or may infringe
upon claims in patent applications made available in the future. Because of the
volume of patents issued and patent applications filed relating to HTS
materials, RF technologies and other products and technologies that we are
pursuing, we believe there is a significant risk that current and potential
competitors and other third-parties have filed or will file patent applications
for, or have obtained or will obtain, patents or other proprietary rights
relating to materials, products or processes used or proposed to be used by us.
In any such case, to avoid infringement, we would have to either license such
technologies or design around any such patents. We may be unable to obtain
licenses to such technologies or, if obtainable, such licenses may not be
available on terms acceptable to us or we may be unable to successfully design
around these third-party patents.
Participation in litigation or patent office proceedings in the U.S.
or other countries, which could result in substantial cost to and diversion of
effort by our company, may be necessary to enforce patents issued or licensed to
us, to defend our company against infringement claims made by others or to
determine the ownership, scope or validity of the proprietary rights of our
company and others. The parties to such litigation may be larger, better
capitalized than us and better able to support the cost of litigation. An
adverse outcome in any such proceedings could subject us to significant
liabilities to third parties, require us to seek licenses from third parties
and/or require us to cease using certain technologies, any of which could have a
material adverse effect on our business, operating results and financial
condition.
We believe that a number of patent applications, including
applications filed by International Business Machines Corporation, Lucent
Technologies, Inc., and other potential competitors of our company are pending
that may cover the useful compositions and uses of certain HTS materials
including yttrium barium copper oxide ("YBCO"), the principal HTS material used
by us in our present and currently proposed products. Therefore, there is a
substantial risk that one or
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more third parties may be granted patents covering YBCO and other HTS materials
and their uses, in which case we could not use these materials without an
appropriate license. As with other patents, we have no assurance that we will be
able to obtain licenses to any such patents for YBCO or other HTS materials,
processes for manufacturing those materials, or their uses or that such licenses
would be available on commercially reasonable terms. Any of these problems would
have a material adverse effect on our business, operating results and financial
condition.
Litigation
The Company has been subject to a number of lawsuits and currently has
a number of legal proceedings against it involving various claims. Although the
Company has been successful in defending itself against these claims to date,
there is no guarantee that this success will continue. If the Company is not
successful in defending itself against these claims, there may be a material and
adverse effect on our business, operating results and financial condition.
Government Regulations
Although we believe that our wireless telecommunications products
themselves would not be subject to licensing by, or approval requirements of,
the FCC, the operation of base stations is subject to FCC licensing and the
radio equipment into which our products would be incorporated is subject to FCC
approval. Base stations and the equipment marketed for use therein must meet
specified technical standards. Our ability to sell our wireless
telecommunications products is dependent on the ability of wireless base station
equipment manufacturers and wireless base station operators to obtain and retain
the necessary FCC approvals and licenses. In order for them to be acceptable to
base station equipment manufacturers and to base station operators, the
characteristics, quality and reliability of our base station products must
enable them to meet FCC technical standards. We may be subject to similar
regulations of the Canadian federal and provincial governments. Any failure to
meet such standards or delays by base station equipment manufacturers and
wireless base station operators in obtaining the necessary approvals or licenses
could have a material adverse effect on our business, operating results and
financial condition. In addition, HTS RF filters are on the U.S. Department of
Commerce's export regulation list. Therefore, exportation of such RF filters to
certain countries may be restricted or subject to export licenses.
We are subject to governmental labor, safety and discrimination laws
and regulations with substantial penalties for violations. In addition,
employees and others may bring suit against us for perceived violations of such
laws and regulations. Defense against such complaints could result in
significant legal costs for us. Although we endeavor to comply with all
applicable laws and regulations, we may be the subject of complaints in the
future, which could have a material adverse effect on our business, operating
results and financial condition.
Environmental Liability
We use certain hazardous materials in our research, development and
manufacturing operations. As a result, we are subject to stringent federal,
state and local regulations governing the storage, use and disposal of such
materials. It is possible that current or future laws and regulations could
require us to make substantial expenditures for preventive or remedial action,
reduction of chemical exposure, or waste treatment or disposal. We believe we
are in material compliance with all environmental regulations and to date we
have not had to incur significant expenditures for preventive or remedial action
with respect to the use of hazardous materials. However, our operations,
business or assets could be materially and adversely affected by the
interpretation and enforcement of current or future environmental laws and
regulations. In addition, although we believe that our safety procedures for
handling and disposing of such materials comply with the standards prescribed by
state and federal regulations, there is the risk of accidental contamination or
injury from these materials. In the event of an accident, we could be held
liable for any damages that result. Furthermore, the use and disposal of
hazardous materials involves the risk that we could incur substantial
expenditures for such preventive or remedial actions. The liability in the event
of an accident or the costs of such actions could exceed the our resources or
otherwise have a material adverse effect on our business, results of operations
and financial condition. We carry property and workman's compensation insurances
in full force and effect through nationally known carriers which include
pollution cleanup or removal and medical claims for industrial incidents.
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RISKS RELATED TO ACQUISITIONS AND BUSINESS EXPANSION
Risks Associated with Lockheed Martin Canada Transaction
We acquired the Adaptive Notch Filtering business unit of Lockheed
Martin Canada in December 2000. There are certain risks associated with this
transaction, including the risk that we will not be able to successfully
integrate the Adaptive Notch Filtering business into our existing business.
Risks Associated with Spectral Solutions Transaction
We acquired Spectral Solutions in August 2000. There are certain risks
associated with this transaction, including the risk that we will not be able to
successfully integrate the Spectral Solutions business. Spectral Solutions
develops and manufactures primarily "thin-film" HTS RF applications for the
wireless communications industry. We have concentrated our manufacturing and
marketing efforts to date on "thick-film" applications, and there can be no
assurance that we will successfully integrate thin-film technology into our
product offerings. There is also no assurance that we will be able to achieve
the synergies we believe should result from the acquisition of Spectral
Solutions.
Risks of Future Acquisitions
In the future, we may pursue acquisitions to obtain products, services
and technologies that we believe will complement or enhance our current product
or services offerings. At present, we have no agreements or other arrangements
with respect to any acquisition. An acquisition may not produce the revenue,
earnings or business synergies that we anticipated and may cause us to assume
significant unforeseen liabilities, and an acquired product, service or
technology might not perform as we expected. If we pursue any acquisition, our
management could spend a significant amount of time and effort in identifying
and completing the acquisition and may be distracted from the operations of our
business. If we complete an acquisition, we would probably have to devote a
significant amount of management resources to integrating the acquired business
with our existing business, and that integration may not be successful.
International Operations
We are in discussions with several companies in non-U.S. markets, in
particular in Japan and other parts of Asia, to form manufacturing, product
development joint ventures and other marketing or consulting arrangements.
Results of these discussions include a joint marketing agreement with CTR
Ventures in Japan and the opening of a Japanese office in Tokyo; a joint product
development and manufacturing arrangement with KMW, Inc. in Korea and the
acquisition of the ANF division from Lockheed Martin Canada.
We believe that non-U.S. markets could provide a substantial source of
revenue in the future. However, there are certain risks applicable to doing
business in foreign markets that are not applicable to companies doing business
solely in the U.S. For example, we will be subject to risks related to
fluctuations in the exchange rate between the U.S. dollar and foreign currencies
in countries in which we do business. In addition, we will be subject to the
additional laws and regulations of these foreign jurisdictions, some of which
might be substantially more restrictive than similar U.S. ones. Foreign
jurisdictions may also provide less patent protection than is available in the
U.S., and we may be less able to protect our intellectual property from
misappropriation and infringement in these foreign markets.
HTS AND WIRELESS TELECOMMUNICATIONS INDUSTRY BACKGROUND
There are two distinct market applications for HTS front-end systems.
The larger opportunity will be as an enabling technology for Third Generation
(3G) wireless systems, which is expected to be deployed in 2002 to support
mobile Internet services. The more immediate application will be based on
retrofitting existing 2G networks (principally CDMA) to provide capacity
solutions as these networks begin to run out of spectrum to support rapidly
growing customer traffic.
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THE 3G OPPORTUNITY: A TRUE WIRELESS INTERNET
Existing wireless networks are based on technical architectures that
were standardized in the late 1980s and early 1990s, and are highly optimized
for voice signals. The guiding principle of 2G systems (including TDMA, GSM,
CDMA) is signal compression to achieve spectrum efficiency. The basic user
data-rate in these networks is typically around 10 kb/s, which is adequate for
telephony voice traffic.
These networks are not capable of supporting true Internet
applications. Recent experience with the i-Mode service introduced in 1999 by
NTT DoCoMo in Japan has demonstrated a strong demand for wireless Internet type
service, while also exposing the difficulties of delivering this service over
existing 2G networks. The i-Mode service was launched in 1999 in Japan, and
rapidly became the most successful new service introduction in the history of
the wireless industry, adding six million customers in only six months. The
service itself comprises an Internet-type connectivity for email, messaging,
file transfer, as well as voice telephony, and by early 2000, more than 80% of
the new subscribers being added in NTT's wireless network were i-Mode
subscribers. However, beginning in February 2000, the network began to
experience severe technical difficulties stemming from overloading of the basic
2G transmission facilities. By July 2000, it had become necessary to suspend the
promotion of the service to new customers. While clearly demonstrating a strong
demand for wireless Internet service, the i-Mode experiment clearly showed that
a new network architecture will be needed to deliver this service effectively.
3G standards are being developed to meet the needs for a true wireless
Internet service. [There are several competing versions of the 3G standard,
including W-CDMA which is favored by most of the Europeans and by NTT DoCoMo,
and cdma2000, promoted by Qualcomm and supported by many existing IS-95 (2G
CDMA) operators. Both standards are broadly similar. They are based on wideband
CDMA architecture, and will require the same general ultra-clean interference
suppression solutions.] These new standards will allow for user data-rates of up
to 2 MB/s - nearly two hundred times faster than 2G networks. Moreover, 3G
networks will have to support traffic patterns characteristic of Internet
connectivity ("always on" service that may generate several hours of connect
time per user per day) rather than today's short voice telephony patterns.
One system element that is especially affected by 3G performance
objectives is the receiver front-end, especially the filters and low-noise
amplifiers that acquire the desired signal and block interference from other
sources. Existing 1G and 2G networks are designed around the less-than-perfect
performance characteristics of conventional front-end systems based on metallic
or ceramic (dielectric) filter technology. These systems allow for a great deal
of interference to penetrate the desired signal. There is evidence that even in
existing networks (2G CDMA) there are large losses in system capacity - up to
50% or more of nominal capacity lost, according to recent tests with major CDMA
carriers - due solely to the imperfections in receiver front-end filtering based
on conventional technology. With 3G, extensive testing by NTT DoCoMo and others
indicates that conventional front-end technology will not deliver adequate
performance. HTS-based receiver front-ends provide an almost theoretically
perfect control over out-of-band interference. Recent publications and
announcements by NTT scientists indicate that HTS is increasingly viewed as a
basic requirement for 3G networks
High-temperature superconducting materials are used to design RF
subsystems such as receiver front-end filters which eliminate interference that
can reduce the quality and capacity of wireless systems. Superconductor-based
filters far outperform the best conventional front-end filters, as shown in
Figure 1, which is adapted from [NTT DoCoMo] sponsored published test results in
Japan:
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FIGURE 1
[RELATIVE FREQUENCY GRAPH]
RELATIVE FREQUENCY (FC CENTER FREQUENCY, B:3-DB BAND WIDTH)
SIZE OF THE 3G HTS MARKET
The size of the 3G market is developed from two overarching premises:
NETWORK REPLACEMENT: 3G will require completely new networks: new base stations,
new switches, new handsets - and new technology. It is not possible to retrofit
existing 2G networks. The Company expects that the entire wireless industry,
which now encompasses almost 1 million base stations and perhaps 500 million
handsets, will eventually be completely replaced or overbuilt with new 3G
equipment.
INTERNET PRESSURE: The fundamental demand driver for 3G is Internet traffic
(pure data, email, plus mixed voice-and-data for mobile applications and various
multimedia services). As the i-Mode experience shows clearly, the demand
pressure should follow Internet growth patterns rather than conventional
circuit-switched telephony growth or even mobile telephony growth trajectories.
Taken together, these premises imply that the scope of the total 3G
equipment market will be enormous, requiring hundreds of billions of dollars of
new technology investment worldwide over the next ten years. The scope of the
HTS front-end segment could well be in the billions of dollars annually.
Based upon analysis of available information, the HTS market potential
in Japan alone could potentially be considerably more than $1 billion over the
next five years. [Equivalent single-sector (omni) base stations. Some of these
will be co-located as sectored sites, either 3 or 6 sectors per site.] The total
number of 3G base stations deployed by all three licensed operators in Japan is
estimated to be between 75,000 to 100,000 over a 5-8 year period. The Korean
market is estimated to be approximately 40% of the size of the Japanese market
overall and the European and US markets are estimated to be approximately 4 and
2 times the size of the Japanese market respectively.
TIMING OF 3G
JAPAN: NTT's stated goal is to begin commercial 3G service in mid-2001. Other
operators (KDDI and Japan Phone) have announced their intentions to deploy 3G
within a year or so of NTT. Based on information available to ISCO, we believe
that the main build-out for 3G will develop beginning about 1 year later:
mid-2002, reaching high volume in 2003. We anticipate the 2003 level will be
sustained for several years as the networks are built out.
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KOREA: We believe that Korea will be developing according to approximately the
same time-table as Japan, perhaps delayed by 6-12 months.
EUROPE: The European 3G market development is in flux. Last year there was a
consensus that 3G would be delayed in Europe, but recent auction results and
even some announced contracts indicate that the deployment schedule may be
accelerating. We estimate that European deployments (other than the UK) will lag
the Japanese deployment by 1.5 to 2 years. The UK deployment may be ahead of the
rest of the European market.
UNITED STATES: The timetable for 3G in the United States is uncertain. A signal
event will be the commencement of spectrum auctioning for the 700 MHz bands in
2002; this event should crystallize 3G service plans and timetables should
become clearer. However, the non-standard frequency band will add further timing
uncertainty.
SPECTRUM CONGESTION: Different markets may show some differences in the uptake
of HTS solutions due to different specific interference considerations. In
Japan, for example, the co-existence of PHS services in near-adjacent bands with
the new 3G systems appears to have accentuated engineering concern over
interference. In the US, the continued operation of some TV broadcasters in the
proposed 700 MHz band has also spurred the FCC and others to focus on the
problems of interference-management.
THE 2G OPPORTUNITY: CAPACITY UPGRADES FOR CDMA
Well before the arrival of 3G, there is strong market pressure
developing which the Company believes will be favorable to HTS applications.
Existing wireless operators (cellular and PCS) are now beginning to run out of
capacity in major markets. Whereas until last year most carriers were much more
concerned with coverage than capacity, we believe that capacity shortages in key
urban markets are becoming a critical concern for many operators this year, and
will intensify next year.
Adding capacity can be fundamentally quite expensive. The standard
solution is to split cells or add extra base stations, which costs anywhere from
$200,000 to $1 million per cell-site. Exotic technology solutions like "smart
antennas" are still maturing and also very expensive ($100,000 or more per
site). By contrast, HTS front-end systems can increase capacity substantially at
a modest cost ($15,000-$40,000 per site today).
The capacity gains are most significant for CDMA-based networks. CDMA
is a complex 2G air-interface which creates capacity by carefully designing
orthogonal and semi-orthogonal cross-interference patterns between different
signals sharing the same spectrum. This type of system is very sensitive to
non-optimal conditions such as uncontrolled interference from out-of-band
sources. Beginning last year, the Company has been testing the effects of HTS on
regaining lost capacity with a major US CDMA carrier. Representative results are
shown in the following Figure. Under specified test conditions, in a multi-cell
network, the standard configuration cell-site (single carrier) was capable of
supporting NINE simultaneous telephone calls.
CDMA CELL, CONVENTIONAL FRONT-END: 9 SIMULTANEOUS CALLS
[CDMA CELL GRAPH]
OEM CONFIGURATION MAXIMUM NUMBER OF STABLE CALLS = 9
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The same cell-site, with an HTS receiver, was able to support FOURTEEN
simultaneous calls. These results pertain to the downlink. Similar gains are
seen on the uplink, along with a reduction in mobile unit power of 3-5 dB on
average.
[CODE DOMAIN GRAPH]
These gains are highly significant. HTS front-end solutions are
emerging as the cheapest capacity enhancement solution available to CDMA
carriers. This could potentially lead to the deployment of HTS as a network-wide
capacity solution (rather than a site-specific interference-suppression tool).
TIMING OF THE 2G MARKET
The 2G market is beginning to develop now in the United States, and it
will be the focus of our near-term sales effort in the next 18 months. The
driver for this market is the developing capacity crisis in important CDMA
markets.
The same application also exists in Korea - an all-CDMA market - and
potentially with the current CDMA carrier in Japan (KDDI).
COMPETITION
All other HTS companies are limited to thin-film HTS. These include
two small U.S. based thin-film companies (Conductus, Inc. and Superconductor
Technologies, Inc.) which have sold systems in the U.S. for receive filter
applications. DuPont, a holder of a number of patents in the HTS materials area,
has indicated an interest in developing a CRFE. However, the Company is not
aware of DuPont having produced a functional HTS prototype, nor is it aware of
the development or delivery of any commercial system. A number of other
companies in Japan and Europe have engaged in development towards thin-film HTS,
but to our knowledge have not delivered commercial HTS systems. In Japan,
Cryodevices Ltd. is a joint venture between two Japanese companies, which has
been working on thin-film technology for several years. Toshiba has also
indicated an interest in developing a HTS filter for wireless
telecommunications. In Europe, Cryoelectrica is a university-affiliated entity
that has also been pursuing thin-film designs. To our knowledge, neither has
delivered a commercial system. There was also a European consortium called
Sucoms, which was established for the same purpose. Sucoms was apparently
disbanded earlier this year.
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The following chart summarizes the relative publicly announced
technology and product position of the current HTS competitors to the Company:
- -------------------------------------------------------------------------------------------------------------
Thin-film Thick-film Hybrid Transmit Tower- ATP Equali-
HTS Products Mount zation
- -------------------------------------------------------------------------------------------------------------
ISCO YES YES YES YES YES YES YES
- -------------------------------------------------------------------------------------------------------------
CDTS YES NO NO NO NO NO NO
- -------------------------------------------------------------------------------------------------------------
SCON YES NO NO NO NO NO NO
- -------------------------------------------------------------------------------------------------------------
The Company believes it has the broadest HTS technology base of any
company in the world. The Company's goal is to position itself to lead the
industry in HTS wireless applications as HTS solutions move toward the
mainstream with 2G and 3G applications.
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TECHNOLOGY OVERVIEW
A wireless base station is divided (roughly) into two halves: the
digital portion, and the so-called "front-end."
[DIGITAL WIRELESS COMMUNICATION SYSTEM GRAPH]
The core expertise of ISCO is the application of HTS to wireless
front-end systems. The components in the receiver front-end are designed to
acquire the desired information-bearing signal and pass it through to the
digital portion of the system, where it is processed digitally and the user
information is extracted. Typically, much of the signal is lost as it passes
through the front-end components. As well, undesired electromagnetic
interference also leaks into the system due to imperfections in the filtering
characteristics of the front-end devices. 1G and 2G systems are designed around
these losses and interference levels, and the information carrying capacity of
these systems are inherently limited.
Superconductivity is a property of certain materials, at certain
temperatures, in which electrical resistance is reduced essentially to zero.
High-temperature superconductivity (HTS) refers to materials, which exhibit this
property at relatively higher temperatures, which are suitable for practical
industry applications. [These materials were first discovered in the 1980s.
There are two main materials used today: Yttrium Barium Cupric Oxide (YBCO) and
Thallium Barium Calcium Cupric Oxide (TBCCO). These materials exhibit
superconductivity at temperatures up to 80-100(degree) K, which is suitable for
industrial applications.]
The use of HTS for wireless front-end systems is based on the following
general concept: by coating the surfaces of filter elements and other elements
of the front-end, it is possible to create front-end components which introduce
very little signal loss or degradation (no electrical resistance). In turn, this
allows for much more powerful filter architectures to be employed practically-
which results in much better performance. For example, the complexity of a
filter is related to the number of serial stages or poles in the filter design.
With conventional technology, it is impractical to construct a filter of more
than around 8-10 poles (and most are less complex). With HTS, ISCO has delivered
systems using 32 poles, with nearly perfect out-of-band filter performance.
Finally, the fact that these systems are cooled cryogenically reduces the
thermal noise component.
THIN-FILM & THICK-FILM HTS
There are two ways of designing an HTS component. So-called thin-film
techniques use vacuum deposition processes to carefully lay down extremely thin
layers of HTS material upon an appropriate substrate. The result is a wafer
which can be etched to
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create components such as a filter, in a process similar to semi-conductor chip
fabrication. The advantages of thin-film techniques are a somewhat smaller size
of the filter component, and the potential for integration with other components
in an Integrated Circuit or chip-type architecture.
THICK-FILM techniques use a series of processes more similar to the
ceramic firing of a coating to create a somewhat thicker HTS layer on the
substrate, and are typically employed to coat three-dimensional resonator
elements and other larger structures. The manufacturing process is generally
much simpler and less expensive (no clean room required as for thin-film). The
advantages of thick-film HTS are much higher filter performance [i.e., better
selectivity and ultimate rejection; much better intermodulation characteristics;
larger numbers of poles can be employed.] as well as the ability to support
high-power applications for transmit filters and other transmitter components.
ISCO is the only company in the world with both thin-film and
thick-film HTS technology. Because of this, ISCO can design products using the
best available HTS technology for a given application, and is the only company
with the ability to combine thin-film and thick-film solutions in the same
front-end platform.
FRONT-END ARCHITECTURES
ISCO has extensive experience in designing and producing a wide range
of RF front-end systems using HTS. We believe that our experience base is
greater than any other company in the world in the application of HTS to
wireless systems. Key platform technologies (all patented by ISCO) include:
Tower-mounted cryogenic RF receiver front-end (plus LNA) - the
only HTS system designed for tower-top installations
All-temperature Performance (ATP) RF filter technology,
capable of operating at either cryogenic or ambient temperatures
(eliminating system failure point and need for conventional back-up
system required by competing thin-film vendors); ATP encompasses unique
HTS materials as well as frequency-compensation filter architectures
Cryogenic equalization technologies to control group delay in
high-performance 3G systems. Group delay is the tendency of the digital
signal to spread out in time, so that information-bearing digital
pulses tend to "smear" together and cause inter-symbol interference
(ISI). ISI is combated by equalization techniques, which can be
implemented either in the front-end or in the digital domain. Digital
equalization is a significant signal processing overhead that can
eventually impose limits on system throughput; hence, it is desirable
to accomplish as much of the equalization of the signal as possible in
the analog front-end. ISCO is the only HTS company that has implemented
equalization in HTS front-end systems.
Transmit filter designs capable of handling up to 100 watts of
power.
ADAPTIVE NOTCH FILTERS
The Company also offers adaptive notch filter products that continually
scan a segment of RF spectrum for interference and block that interference
within 20 milliseconds. The blocking feature is in place as long as needed for
noise suppression. These products are especially useful in dealing with sporadic
in-band interference as they adapt the Company's interference-management
technology to the fluid environment. The complementary nature of these products
with the Company's HTS solutions for adjacent-band interference allows the
Company to offer complete interference-management solutions to its customers,
rather than force customers to try to isolate the primary cause of their
interference problems prior to looking for an effective solution.
PRODUCT BENEFITS
The Company's products are designed to address the high performance RF
front-end needs of domestic and international commercial wireless
telecommunication systems by providing the following advantages:
GREATER NETWORK CAPACITY AND UTILIZATION. The Company's interference
management solutions can increase capacity and utilization by up to 70%. In some
cases, capacity increases because channels which were previously unusable due to
interference are recovered. In other cases, system utilization increases because
of lower levels of
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blocked or dropped calls, and increases in the ability of the system to permit
weak signals to be processed with acceptable call quality. In CDMA systems,
increased capacity frequently results from lowering the system's noise floor.
IMPROVED BASE STATION RANGE. The Company's RF front-end systems can
extend the uplink range of a wireless system by up to 30%. Greater range can
reduce a service operator's capital expenditure per customer in lower density
areas by filling in coverage gaps in existing systems or by reducing the number
of required cell sites for new system deployments.
IMPROVED FLEXIBILITY IN LOCATING BASE STATIONS. The Company's RF
front-end products can allow wireless telecommunications service providers to
co-locate base stations near other RF transmitters. The Company's products allow
the base station radio to better tolerate RF interference while reducing out-of
band signals that could interfere with other nearby wireless telecommunication
operators.
IMPROVED CALL QUALITY. The Company's products improve call quality by
reducing dropped and blocked calls. During commercial installations, the
Company's RF filter products have demonstrated up to a 40% reduction in dropped
calls. The Company's products also improve audio fidelity by reducing noise and
interference.
IMPROVED DIGITAL SYSTEM CAPACITY. Tests conducted by wireless operators
show that on a single base station test, capacity of the base station increases
by as much as 30%. The Company believes that with a system wide deployment of
its products, the capacity of the system may increase by more than 70%.
COMPANY HIGHLIGHTS
Sales and Marketing
The Company has historically focused its sales and marketing effort on U.S.
wireless service providers for retrofit applications. To date, the Company has
sold its products to many of the largest cellular operators in the United States
as well as to numerous mid-size and smaller U.S. wireless operators.
Recently, the Company has also focused on international customers,
marketing both its existing products and presenting the benefits of its
interference-management technology in the design and early stages of new systems
for Third Generation Wireless ("3G") Systems. The first of these systems is
expected to be deployed during 2001 in Japan, with deployment in Korea and
Europe expected thereafter. Toward that end, the Company opened a sales office
in Japan during 2000. The Company also sold its existing products in Chile,
Spain, and Canada during 2000 and looks to continue to market its products
internationally during 2001 and beyond.
Manufacturing
The Company's manufacturing processes provide predictable product yields
and can be easily expanded to meet increased customer demand. However, it is
possible that substantial growth in demand could overwhelm existing capacity to
supply products. To deal with this possibility, the Company is in the process of
qualifying third party manufacturers of the RF filter products. The Company also
has an agreement in place with a contract manufacturer that outsources
production of its Adaptive Notch Filters (ANF units) at a facility in Toronto,
Canada.
The Company's manufacturing operations can be found in Mount Prospect, IL,
Louisville, CO and Toronto, Canada.
Research and Development
The Company's R&D efforts have been focused on developing and improving RF
filter products for wireless telecommunications systems. As a result of such
efforts, filter performance has been improved, product size has been reduced,
production costs have been lowered, product reliability has been increased, and
product packaging has been streamlined. The Company expects to continue to
invest in R&D to further improve and adapt its filter products to meet and
exceed market expectations. The Company also intends to develop related products
that are synergistic with its core filter offerings and which utilize the
Company's core technical competencies in RF filter design, superconducting
materials, and cryogenic cooling systems.
The Company's total R&D expenses during 1998, 1999 and 2000 were
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approximately $2,935,000, $1,757,000 and $3,188,000, respectively.
Intellectual Property and Patents
The Company regards certain elements of its product design, fabrication
technology and manufacturing process as proprietary and protects its rights in
them through a combination of patents, trade secrets and non-disclosure
agreements. The Company also has obtained exclusive and non-exclusive licenses
for technology developed with or by its research partners, Argonne National
Laboratory ("Argonne") and Northwestern University, and expects to continue to
obtain licenses from such research partners and others. The Company believes
that its success will depend in part upon the protection of its proprietary
information, its patents and licenses of key technologies from third parties,
and its ability to operate without infringing on the proprietary rights of
others.
As of December 31, 2000, we had been issued 35 U.S. and 4 foreign patents,
had filed and were actively pursuing applications for 13 other U.S. and 23 other
patents, and were the licensee of 7 U.S. patents and patent applications held by
others. We acquired additional patents, through assignment of a license from the
Canadian government, in connection with our purchase of the Adaptive Notch
Filtering business unit of Lockheed Martin Canada. One of our patents is jointly
owned with Lucent Technologies, Inc. We believe that, since the discovery of HTS
materials in 1986, a large number of patent applications have been filed
worldwide, and many patents have been granted in the U.S. relating to HTS
materials. The claims in those patents often appear to overlap and there are
interference proceedings pending in the United States Patent and Trademark
Office (not currently involving our company) regarding rights to inventions
claimed in some of the HTS materials patent applications. Furthermore, the
Company expects to pursue foreign patent rights on certain of its inventions and
technologies critical to its products.
In 1994, the Company purchased from Ceramic Process Systems two additional
patents and the related technical know-how covering a process for producing
yttrium barium copper oxide ("YBCO") powder and manufacturing YBCO electrical
fibers. In 1994, the Company also purchased technology relating to the
fabrication of HTS thick-film components from the University of Birmingham (UK).
This thick-film technology complements the Company's existing patented processes
for making thick-film superconducting components.
Through collaborative relationships with Argonne and Northwestern
University, the Company has licensed patents and patent applications issued or
filed in the United States and in certain foreign countries arising under or
related to such collaborative relationships. These licenses primarily relate to
the processing and composition of HTS materials, including the preferential
orientation of HTS materials and the processing of YBCO on a variety of metals,
as well as design technology for some of the Company's current and proposed
products. The Company's licenses from ARCH Development Corporation and
Northwestern University continues for the lives of the patent rights licensed
thereby, subject to termination on certain events, and permit the Company to
retain rights to its patentable improvements to the licensed technology. Certain
of the Company's research has been funded in part by Small Business Innovation
Research and other government contracts. Although the U.S. Government has or
will have certain rights in the technology developed with this funding, the
Company does not believe that these rights will have a material impact on the
Company's current RF filter products.
Non-HTS Competition
The market for wireless telecommunications products is very competitive.
The Company views its competition as (i) conventional RF filter products, (ii)
RF products based on new technologies and (iii) other superconductor-based RF
products.
The Company's RF filter products compete against conventional RF filter
products produced by such companies as Celwave, certain divisions of the Allen
Telecom Group, Inc., Filtronic Comtek, Sinclair Radio Labs, Inc., K&L Microwave,
Inc., Wacom Technology Corp., EMR Corp. and TX-RX Systems, Inc., among others.
Although these conventional RF filter products are generally less expensive than
the Company's products, the Company believes its RF filter products are superior
on a cost/benefit basis.
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Other competitive RF products based on other technologies may provide
competition in the future to the Company's RF filter products. In addition to
competitive RF filter products, other companies including, Hazeltine Corp.,
Metawave Communications Corporation, Allen Telecom Group, Inc., Repeater
Technologies, Inc. and Array Com, Inc., among others, are developing products
based on "smart antenna," digital signal processing technologies, microcells and
repeaters which are also aimed at reducing interference problems or providing
range extension by means other than RF filtering. Furthermore, various vendors
are offering tower mounted amplifiers ("TMAs") which provide similar range
extension benefits to the Company's filters with cooled LNAs. TMAs are generally
less expensive than the Company's products but require greater maintenance costs
due to their location on top of the operator's antenna tower.
Various filter companies appear to be experimenting with cooled dielectric
filters or with filters that combine dielectric materials and superconducting
technology. K&L Microwave, Inc. has been experimenting with a cooled dielectric
filter design. In addition, COM DEV International, Ltd., a Canadian corporation,
has published research in which a dielectric material is mounted on a
superconducting ground plane. The Company does not believe that either of these
efforts currently pose a competitive threat but cannot exclude them as
competition to the Company's product lines at some point in the future.
The Company believes that it competes on the basis of product performance,
price, breadth of product portfolio, customer support, quality, reliability and
focus on the wireless telecommunications market. Many of the Company's
competitors have substantially greater financial resources, larger R&D staffs
and greater manufacturing and marketing capabilities than the Company.
GOVERNMENT REGULATIONS
Although the Company believes that its wireless telecommunications products
themselves are not licensed or governed by approval requirements of the Federal
Communications Commission ("FCC"), the operation of base stations is subject to
FCC licensing and the radio equipment into which the Company's products would be
incorporated is subject to FCC approval. Base stations and the equipment
marketed for use therein must meet specified technical standards. The Company's
ability to sell its RF filter products is dependent on the ability of wireless
base station equipment manufacturers and of wireless base station operators to
obtain and retain the necessary FCC approvals and licenses. In order to be
acceptable to base station equipment manufacturers and to base station
operators, the characteristics, quality, and reliability of the Company's base
station products must enable them to meet FCC technical standards.
The Company uses certain hazardous materials in its research, development
and manufacturing operations. As a result, the Company is subject to stringent
federal, state and local regulations governing the storage, use and disposal of
such materials. It is possible that current or future laws and regulations could
require the Company to make substantial expenditures for preventive or remedial
action, reduction of chemical exposure, or waste treatment or disposal. The
Company believes it is in material compliance with all environmental regulations
and to date the Company has not had to incur significant expenditures for
preventive or remedial action with respect to the use of hazardous materials.
EMPLOYEES
As of January 31, 2001, the Company had a total of 71 employees, 19 of whom
hold advanced degrees. Of the employees, 18 are engaged in manufacturing and
production, 34 are engaged in research, development and engineering, and 19 are
engaged in general management, marketing, sales, finance and administration. The
Company also periodically employs a number of consultants and independent
contractors. None of the Company's employees are covered by a collective
bargaining agreement. The Company believes its relationship with its employees
is good.
ITEM 2. PROPERTIES
The Company maintains its corporate headquarters in a 35,000 square foot
building located in Mt. Prospect, Illinois under a lease which expires in
October 2004. Additionally, it maintains a 29,000 square foot building located
in Louisville, Colorado under a lease which expires in May 2003 and a 6,500
square foot facility located in North York, Ontario under a sublease that
expires in August, 2004. These facilities house the Company's manufacturing,
research, development, engineering
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and marketing activities. The Company believes that these facilities are
adequate and suitable for its current needs and that additional space would be
available on commercial terms as necessary to meet any future needs.
ITEM 3. LEGAL PROCEEDINGS
Siegler Litigation
On June 5, 1996, Craig M. Siegler filed a complaint against the Company
in the Circuit Court of Cook County, Illinois, County Department, Chancery
Division. The complaint alleged that, in connection with the Company's private
placement of securities in November 1995, the Company breached and repudiated an
oral contract with Mr. Siegler for the issuance and sale by the Company to Mr.
Siegler of 370,370.37 shares of the Common Stock, plus warrants (immediately
exercisable at $12.96 per share) to purchase an additional 370,370.37 shares of
the Common Stock, for a total price of $4,000,000. The remedy sought by Mr.
Siegler was a sale to him of such securities on the terms of the November 1995
private placement. On August 16, 1996, the Company's motion to dismiss Mr.
Siegler's complaint was granted with leave to amend. On September 19, 1996, Mr.
Siegler's motion for reconsideration was denied.
On October 10, 1996, Mr. Siegler filed his First Amended Verified
Complaint and Jury Demand, seeking a jury trial and money damages equal to the
difference between $8,800,000 (370,370.37 shares at $10.80 per share and
370,370.37 shares at $12.96 per share) and 740,740.74 multiplied by the highest
price at which the Common Stock traded on The Nasdaq Stock Market between
November 20, 1995 and the date of judgment. Mr. Siegler also preserved his claim
for specific performance for purposes of appeal. On November 1, 1996, the case
was transferred to the Circuit Court of Cook County, Illinois, County
Department, Law Division. The Company's Answer was filed on November 21, 1996.
The Company filed a motion for summary judgment against Mr. Siegler,
which was on hold pending the deposition of an expert retained by Mr. Siegler in
the case. The Company deposed this witness in March 2000. A hearing on the
Company's summary judgment motion was held in June 2000, and the motion was
subsequently denied. The trial date has been set for August 7, 2001.
The Company believes that the suit is without merit and intends to
continue to defend itself vigorously in this litigation. The Company is also
disputing Mr. Siegler's method of calculating damages. However, if Mr. Siegler
prevails in this litigation and is awarded damages in accordance with the
formula described above, such judgment would have a material adverse effect on
the Company's operating results and financial condition.
Note Litigation
On February 22, 2000, the Company reached a settlement agreement with
the Borrowers (defined below), whereby the Company agreed to release the
Borrowers' obligations under the notes in return for the Borrowers' surrender of
210,196 warrants to purchase common stock of the Company held by them and
discharge of their counterclaims. As a result of this settlement, the Company
recorded a charge of $822,776 to additional paid-in capital in the first quarter
of 2000, reflecting the carrying amount of the notes of $680,696 and related
accrued interest of $142,080, which approximated the fair value of the warrants
surrendered. The following is a historical summary of events that led to the
settlement agreement just described:
On July 10, 1997, the Company filed a complaint against Sheldon Drobny;
Howard L. "Buzz" Simons, joint tenant with Aric and Corey Simons; Aaron Fischer;
Stewart Shiman; Sharon D. Gonsky, d/b/a SDG Associates; Gregg Rosenberg; Stacey
Rosenberg; Merrill Weber & Co., Inc.; Drobny/Fischer Partnership, an Illinois
general partnership; and Ruben Rosenberg (collectively, the "Borrowers"), and
Paradigm Venture Investors, L.L.C. (the "Guarantor") in the Circuit Court of
Cook County, Illinois, County Department, Law Division. The complaint seeks to
enforce the terms of loans made to the Borrowers by the Company and evidenced by
promissory notes dated December 13, 1996, in the aggregate principal amount of
$698,508 ($680,696 of which remains unpaid as of December 31, 1999) and the
guarantee by the Guarantor of the Borrowers' obligations under these promissory
notes. The Borrowers' notes were issued to the Company in connection with the
Borrowers' exercise of warrants to purchase shares of the Common Stock in
December 1996.
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On September 30, 1997, the Borrowers and the Guarantor responded to the
Company's complaint. Concurrently, the Borrowers filed a counterclaim alleging
that they exercised the warrants in reliance on the Company's alleged fraudulent
representations to certain Borrowers concerning a third-party's future
underwriting of a secondary public offering of the Company's Common Stock.
Lipman Litigation
The Illinois Appellate Court denied plaintiffs' subsequent motion for a
re-hearing on October 23, 2000 and plaintiffs did not seek review before the
Illinois Supreme Court. Accordingly, this litigation has been concluded without
any loss to the Company or its directors. The following is a historical summary
of events that led to the dismissal of this litigation against the Company:
In January 1998, Jerome H. Lipman, individually and on behalf of all others
similarly situated, filed a complaint against the Company and eight of its
former or current directors: Leonard A. Batterson, Michael J. Friduss, Peter S.
Fuss, Edward W. Laves, Steven L. Lazarus, Tom L. Powers, Ora E. Smith and Paul
G. Yovovich (collectively, the "Named Directors") in the Circuit Court of Cook
County, Illinois, County Department, Chancery Division. The complaint alleged
that the Named Directors breached their duties of loyalty and due care to the
putative class of stockholders by selecting financing for the Company in June
1997 which supposedly entrenched the Directors and reduced the Common Stock
price. The complaint also alleged that the Named Directors breached their duty
of disclosure by not informing the stockholders that the selected financing
would erode the Common Stock price. Mr. Lipman's complaint sought certification
of a class consisting of all owners of the Common Stock during the period from
June 6, 1997 through November 21, 1997, excluding the Named Directors and
Sheldon Drobny. The complaint also sought an unspecified amount of compensatory
and punitive damages, and attorneys' fees.
In February 1998, the Company and the Named Directors filed a motion to
dismiss Mr. Lipman's complaint, arguing in part that the plaintiff's claims were
barred by their failure to fulfill the legal prerequisites for suing the Named
Directors. In June 1998, the court granted the Company's and the Named
Directors' motion to dismiss the complaint. Thereafter Mr. Lipman filed an
amended complaint against the Named Directors but excluding the Company itself
as a defendant. The amended complaint alleged that the Named Directors breached
their duties of loyalty and due care to the putative class of stockholders by
selecting financing for the Company in June 1997 and thereafter drawing two
tranches of the financing. The amended complaint sought certification of a class
consisting of all owners of the Common Stock during the period from May 15, 1997
through December 31, 1997, excluding the Named Directors. Mr. Lipman's amended
complaint alleged that the stock owned by the putative class lost $61 million
due to the financing the Named Directors selected, and sought an unspecified
amount of compensatory and punitive damages. The Named Directors filed a motion
to dismiss Mr. Lipman's amended complaint which the court granted in December
1998, finding that Mr. Lipman still had failed to fulfill the prerequisites for
maintaining a shareholder derivative action against the Named Directors. In
January 1999, Mr. Lipman and two added former stockholders filed a second
amended complaint against the Named Directors and again including the Company
itself as a defendant. The second amended complaint alleged that the Named
Directors breached their duties of loyalty and due care to the putative class
and further alleged that the purported devaluation of the plaintiffs' stock
resulting from the June 1997 financing was an improper "assessment" on the
plaintiffs' shares for which they sought an unspecified amount of compensatory
and punitive damages. The Company and the Named Directors filed a motion to
dismiss the second amended complaint which the Court granted in April 1999,
finding that (i) the plaintiffs could not assert their stock devaluation claims,
except derivatively, and (ii) the plaintiffs still had failed to fulfill the
prerequisites for maintaining a shareholder derivative action against the Named
Directors. In May 1999, the plaintiffs filed a third amended complaint against
the Company and the Named Directors. The third amended complaint reiterated the
plaintiffs' previous allegations that the Named Directors breached their duties
of loyalty, due care and candor to the putative class, and again alleged the
plaintiffs' claims of an improper "assessment." The third amended complaint also
asserted two claims of purported common law fraud and a supposed violation of
the Illinois Consumer Fraud Act based on allegations that the Company and the
Named Directors had selectively disclosed "material, non-public confidential
information" to the non-party financier in order to obtain the financing that
the Company selected in June 1997, which allegedly reduced the Common Stock
price. The plaintiffs sought an unspecified amount of
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compensatory and punitive damages, and attorneys' fees. In June 1999, the
Company and the Named Directors filed a motion to dismiss the third amended
complaint, arguing in part that the plaintiffs still had failed to fulfill the
prerequisites for asserting their stock devaluation claims as a shareholder
derivative action, and that the plaintiffs' claims of selective disclosure and
fraud was barred on substantive and procedural grounds. In August 1999, the
Court granted the Company's and the Named Directors' motion, and dismissed the
suit with prejudice.
Thereafter the plaintiffs filed a motion for reconsideration of the
dismissal which the Court denied in September 1999. In October 1999, the
plaintiffs filed their notice of appeal from the dismissal orders. All briefing
on the appeal was completed in May 2000. The Illinois Appellate Court denied
plaintiffs' subsequent motion for rehearing on October 23, 2000 and plaintiffs
did not seek review before the Illinois Supreme Court.
Laves Litigation
On July 17, 2000 Edward W. Laves filed an action(the "Complaint") in the
Law Division of the Circuit Court of Cook County , Illinois, against the Company
and three of its directors (George Calhoun, Samuel Perlman, and Mark Brodsky)
charging the Company with constructive termination under and in breach of
plaintiff's employment agreement, and with violation of the Illinois Wage
Payment and Collection Act. Plaintiff seeks damages "estimated to exceed $9.5
million." The Company filed an appearance on behalf of all Defendants on October
3, 2000. On October 6, 2000, the Company filed on Defendants' behalf a Motion to
Dismiss the Complaint. On January 22, 2001, the court issued an order granting
our Motion to Dismiss the claims against the Individual Defendants, but denied
our Motion to Dismiss with respect to claims against the Company. On February
21, 2001, Plaintiff filed a Motion to reconsider the court's dismissal of claims
against the Individual Defendants. On March 13, 2001, we filed an Answer to the
Complaint and a Memorandum in Opposition to this Motion to Reconsider. By order
dated March 15, 2001, the court allowed Laves leave to file an amended Motion to
Reconsider. A hearing is scheduled for May 16, 2001, to consider the amended
Motion to Reconsider. Laves has submitted discovery requests in support of the
Complaint. The Company believes the claims to be without merit and plans to
vigorously defend itself in this action.
16(b) Litigation
On February 22, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $15 million, less legal fees and
certain other expenses. Two of the Company's stockholders, Elliott Associates,
L.P. and Elliott International, L.P. (formerly Westgate International, L.P.),
have agreed to make this settlement payment in order to resolve claims asserted
against them and certain present and former directors. The shareholder
litigation remains outstanding against other third parties. A notice regarding
the settlement has been mailed to all shareholders. The court hearing to
consider the settlement is scheduled for March 30, 2001.
On March 16, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $5 million, less legal fees and
certain other expenses. Alexander Finance has agreed to make this settlement
payment in order to resolve claims asserted against them. A notice regarding the
settlement has been mailed to all shareholders. The court hearing to consider
the settlement is scheduled for April 27, 2001.
The following is an historical summary of events that led to the settlements
announced above:
On February 26, 1999, Mark Levy, derivatively on behalf of the Company,
filed a complaint against Southbrook International Investments, Ltd.
("Southbrook"), Elliott Associates, L.P. ("Elliott"), and Elliott International,
L.P. ("Elliott International"), and against the Company as a "nominal
defendant." The complaint filed in the United States District Court for the
Southern District of New York, alleges that Southbrook, Elliott and Elliott
International, while having beneficial ownership of more than 10% of the
Company's common stock, traded the Company's common stock such that the Company
is entitled to recover short swing profits under Section 16(b) of the Securities
Exchange Act of 1934 in connection with purchases and sales of Company
securities within six month
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periods. The complaint seeks to recover from Southbrook, Elliott and Elliott
International their respective profits (in unspecified amounts) from those
transactions. No relief is sought against the Company as a nominal defendant.
Elliott and Elliott International are currently investors in the Company
with substantial rights to acquire Company common stock by conversion of notes
and exercise of warrants, and three of the current six directors of the Company
were appointed in accordance with an agreement dated November 5, 1999 by and
between
Elliott, Elliott International, an unaffiliated investor, and the Company. Two
of such directors, Messrs. Mark Brodsky and Norbert Lou, are employed by a
company that provides management services to, and is under common control with,
Elliott and Elliott International.
An amended complaint dated September 2, 1999 was served on the Company. The
amended complaint raises the same claims alleged in the original complaint. As a
"nominal defendant" the Company, by agreement with the plaintiff, has not
responded to the lawsuit, but has reserved its right to move to dismiss any
amended pleading.
Defendants moved to dismiss the amended complaint in February 2000. In
response, the plaintiff cross-moved for leave to amend its complaint again. The
proposed new pleading added Alexander Finance, LP as a defendant for the Section
16(b) claims, proposed to add two new theories pursuant to which defendants may
be found liable under Section 16(b), and also proposed to add state law breach
of fiduciary duty claims against current directors, at the time of filing,
Howard Hoffman, Tom L. Powers, Mark D. Brodsky, George Calhoun and Samuel
Perlman and former directors Edward W. Laves, Robert D. Mitchum and Terry S.
Parker, based on the board of directors' decision to issue convertible notes and
warrants to the defendants convertible or exercisable for shares of common stock
at $0.25 per share.
Following a hearing on August 17, 2000, the court allowed plaintiff leave
to file his new amended complaint. The court also denied without prejudice
defendants' motion to dismiss the initial 16(b) complaint (as amended). However,
defendants may raise this motion again following resolution of a similar case by
the Second Circuit Court of Appeals.
On February 22, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $15 million, less legal fees and
notice expenses. Two of the Company's stockholders, Elliott Associates, L.P. and
Elliott International, L.P. (formerly Westgate International, L.P.), have agreed
to make this settlement payment in order to resolve claims asserted against them
and certain present and former directors. The shareholder litigation remains
outstanding against other third parties. A notice regarding the settlement has
been mailed to all shareholders. The court hearing to consider the settlement is
scheduled for March 30, 2001.
On March 16, 2001, the Company announced that a settlement of previously
disclosed shareholder litigation has been reached, which, subject to court
approval, will result in the Company receiving $5 million, less legal fees and
notice expenses. Alexander Finance has agreed to make this settlement payment in
order to resolve claims asserted against them. A notice regarding the settlement
has been mailed to all shareholders. The court hearing to consider the
settlement is scheduled for April 27, 2001.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security hold