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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, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
COMMISSION FILE NUMBER 0-22302
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
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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 March 25, 1999, 12,557,344 shares of the registrant's Common Stock were
outstanding. The aggregate market value on March 25, 1999 of the registrant's
Common Stock held by non-affiliates of the registrant was $14,127,012.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's definitive proxy statement for the
annual meeting of stockholders to be held on June 9, 1999 are incorporated by
reference in Part III of this Form 10-K.
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TABLE OF CONTENTS
PART I
Item 1. Business........................................................................................... 1
Item 2. Properties......................................................................................... 19
Item 3. Legal Proceedings.................................................................................. 19
Item 4. Submission of Matters to a Vote of Security Holders................................................ 21
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.............................. 22
Item 6. Selected Financial Data............................................................................ 24
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 25
Item 7a. Quantitative and Qualitative Disclosures About Market Risk......................................... 28
Item 8. Financial Statements and Supplementary Data........................................................ 29
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............... 49
PART III
Item 10. Directors and Executive Officers of the Registrant................................................. 50
Item 11. Executive Compensation............................................................................. 50
Item 12. Security Ownership of Certain Beneficial Owners and Management..................................... 50
Item 13. Certain Relationships and Related Transactions..................................................... 50
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................... 51
Because the Company 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" (as such term is
defined in Section 21E of the Securities Exchange Act of 1934, as amended) that
reflect the Company's current expectations regarding the future results of
operations, performance and achievements of the Company. These forward-looking
statements are made pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. The Company has tried, wherever
possible, to identify these forward-looking statements by using words such as
"anticipates," "believes," "estimates," "expects," "plans," "intends" and
similar expressions. These statements reflect the Company's current beliefs and
are based on information currently available to it. Accordingly, these
statements are subject to certain risks, uncertainties and contingencies, which
could cause the Company's actual results, performance or achievements to differ
materially from those expressed in, or implied by, such statements. These
factors include, among others, the following: the Company's history of net
losses and the lack of assurance that the Company's earnings will be sufficient
to cover fixed charges in the future; the degree to which the Company is
leveraged and the restrictions imposed on the Company under its existing debt
instruments which may adversely affect the Company's ability to finance its
future operations, to compete effectively against better capitalized competitors
and to withstand downturns in its business or the economy generally; the
Company's current inability to satisfy the minimum maintenance requirements for
the continued listing of its shares of Common Stock for trading on the Nasdaq
National Market which may have a material adverse effect on the liquidity of the
Common Stock and the Company's ability to obtain additional funding as needed if
such shares are delisted; demand for, and acceptance of, the Company's products;
continued downward pressure on the prices charged for the Company's products due
to competition of rival manufacturers of filters for the wireless
telecommunications market; the timing and receipt of customer orders; the
Company's ability to attract and retain key personnel; the effects of legal
proceedings and other factors described in this Form 10-K, including those
described under the heading "Risk Factors," or in other filings of the Company
with the Securities and Exchange Commission. 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 Form 10-K or to reflect the occurrence of unanticipated
events.
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PART I
ITEM 1. BUSINESS
GENERAL
Illinois Superconductor Corporation (the "Company") uses its patented and
proprietary high temperature superconductor ("HTS") materials, radio frequency
("RF") filter designs and cryogenic technologies to develop, manufacture and
market high performance products designed to enhance the quality, capacity,
coverage and flexibility of cellular, Personal Communications Services ("PCS")
and other wireless telecommunications services. Superconductor materials, when
cooled below a critical temperature, are able to transmit an electric current
with either no or minimal loss of energy. Because of this minimal energy loss,
superconductors are attractive for a wide range of commercial applications.
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. 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. The advantage of using
superconductors in RF filters is that more poles can be added without
significant increases in insertion loss. Adding superconductors does not,
however, change the fundamental fact that filter performance depends upon the
number of poles. The Company's highest performing RF filters have more than 30
poles which the Company believes is significantly greater than any other
commercially available filter.
Filters can be designed with a variety of structures including stripline,
microstrip, cavity, dielectric, and waveguide. The Company is able to produce RF
filters using any of these technologies, but has primarily focused on cavity
filters because of their high performance and tuning flexibility. The Company
uses its proprietary thick-film superconducting technology for its RF filters.
The Company believes that relative to other superconducting materials
technologies, thick-film provides for higher RF filter performance and lower
distortion levels. The Company also believes that its thick-film superconductor
technology is unique in its ability to handle high-powered transmit applications
while maintaining very low levels of intermodulation distortion. In addition,
thick-film technology does not require "clean" rooms for manufacturing, which
reduces the cycle time and cost of production. Superconductors become
superconducting at temperatures of roughly -200(Degree) C. These temperature
levels can be maintained using commercially available mechanical cooling
systems. The Company has developed cryogenic packaging systems for its RF
filters which are highly reliable over longer durations and minimize operating
costs.
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.
BUSINESS STRATEGY
The Company's objective is to be the global leader in supplying high
performance RF filter products to the growing wireless telecommunications
market. Key elements of the Company's strategy include the following:
- Offering the Highest Performance RF Filter Systems in the Industry. The
Company's proprietary thick-film and RF filter design technology
permits the Company to build RF filters with a high level of adjacent
band interference rejection coupled with a low level of desired signal
loss. The Company believes that its success will depend upon
maintaining its technological leadership.
- Supplying Price Competitive Products. The Company has been able to
continually reduce its product cost, which has permitted the Company to
competitively price its products. Currently, the price for the
Company's superconducting filters is approaching that of conventional
filters. The Company's lowest price product currently sells for less
than $10,000 per cell site. The Company believes that with superior
performance and competitive pricing it can become the dominant RF
filter manufacturer in the world. In 1997, the Company reduced product
costs by 50%, and in 1998
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the Company reduced product costs by an additional 40%. The Company
believes that it can continue to achieve further cost reductions in the
coming years.
- Providing Solutions for Different Market Needs. The Company has
successfully expanded its product line in response to a wide variety of
customer needs in a cost-effective manner. For rural markets, the
Company currently offers a rural range extension product for under
$10,000, while for urban markets, it offers a 24 pole brick wall RF
filter which it believes is superior to the other RF filters currently
available on the market. The Company has achieved this broad product
portfolio through flexible designs which can quickly be adapted to
different customer needs. By addressing the varied needs of the market
at a reasonable price, the Company aims to provide real value to its
customers.
- Superior Customer Support The Company strives to exceed its customers'
expectations for quality and responsiveness by minimizing service
interruptions. Because of its superior quality and customer support,
the Company was awarded Motorola's superior quality award in 1998.
- Best in Class Reliability. To insure maximum customer retention, the
Company aims to provide the highest level of reliability to its
customers. To achieve this, the Company introduced its proprietary
ATP(TM) technology which insures that its RF filters continue to
operate even when there is a cooling system or power failure. In
addition, the Company has chosen its cooler vendor based on superior
reliability and offers such features as redundant alarms and remote
diagnostics.
- Focusing on Fast Growing Commercial Markets. The Company has focused on
the fast growing wireless telecommunications market and has deferred at
this time pursuing other commercial applications of its proprietary
technology. This focus has minimized overhead costs and allowed the
Company to be first to market with new RF products and a broader
product portfolio than its competitors.
- Building Long-Term Relationships with Customers. Becoming the preferred
RF filter vendor with customers will allow the Company to focus on
expanding its business with new customers and in new markets. To date,
the Company has established strong relationships with six of the
largest wireless operators in the United States. These customers have
placed repeated orders in multiple markets. The Company's largest
customer purchased equipment for over 50 cell sites in the fourth
quarter of 1998.
The Company has received orders from multiple wireless telecommunications
service providers located in the United States, Canada and Asia, including many
of the largest wireless operators in the United States. The Company's RF filters
are now installed in over 100 cell sites in market areas across the United
States. In 1997, commercial orders from wireless service providers were
generally for one or two operational cell sites, with the largest order having
been for five cell sites. In 1998, commercial orders significantly increased
with several wireless service providers deploying the Company's products in tens
of cell sites. The Company's newest product line, the PowerMaster(TM) line of
transmit filters, has generated interest from several major original equipment
manufacturers ("OEMs") that supply cellular and PCS systems equipment to the
wireless service providers.
The Company is an approved vendor for one of the world's largest cellular
system equipment manufacturers and is pursuing similar relationships with other
OEMs. Being an approved vendor allows cellular and PCS service providers in the
U.S. and abroad to purchase the Company's products directly from the OEM, for
use in both new and existing cell sites.
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RISK FACTORS
The following factors, in addition to the other information contained
elsewhere herein, should be considered carefully in evaluating the Company and
its business.
Uncertain Market Acceptance of Superconducting Telecommunications Products
The Company's RF filter products, which are based on the Company's HTS
technology, have not been sold in very large quantities and a sufficient market
may not develop for the Company's products. The Company's customers establish
demanding specifications for performance and reliability. The Company's RF
filter products may not continue to meet product performance and reliability
criteria set by cellular and PCS service providers. Also, the Company's products
may not operate reliably on a long-term basis, the Company may be unable to
manufacture adequate quantities of any products it develops at commercially
acceptable costs or on a timely basis, or the Company's current or future
products may not achieve market acceptance. The Company has experienced, and may
continue to experience, quarterly fluctuations in its results of operations as
its RF filter products attempt to gain market acceptance while being subject to
the lengthy purchase processes of customers. Failure to successfully develop,
manufacture and commercialize products on a timely and cost-effective basis will
have a material adverse effect on the Company's business, operating results and
financial condition.
Limited Operating History; History of Losses; and Uncertainty of Financial
Results
The Company was founded in October 1989 and through 1996 was engaged
principally in research and development ("R&D"), product testing, manufacturing,
marketing and sales activities. The Company has only recently begun to generate
significant revenues from the sale of its RF filter products. Prior to the
commencement of these sales, the majority of the Company's revenues were derived
from R&D contracts, primarily from the U.S. government. The Company does not
expect revenues to increase dramatically until it ships a significantly larger
amount of its RF products. Accordingly, the Company has only a limited operating
history upon which an evaluation of the Company and its prospects can be based.
The Company must be considered in light of the risks, expenses and difficulties
frequently encountered by companies in their early stages of product
commercialization.
The Company has incurred substantial net losses in each year since its
inception. The Company expects to continue to incur operating losses through at
least the end of 1999 as it continues to devote significant financial resources
to its product development, manufacturing, marketing and sales efforts. Even if
the Company is able to overcome the significant remaining manufacturing and
marketing hurdles necessary to sell large quantities of its RF filter products,
the Company may never achieve a profitable level of operations or, if
profitability is achieved, it may not be sustained.
The Company's customers are highly concentrated. The loss of an individual
customer may have a material adverse effect on the Company's business. The
wireless telecommunications market is currently experiencing an increasing rate
of consolidation among the largest wireless operators which may cause a
significant disruption and/or delay in the sales of the Company's products. In
order to continue to grow revenues, the Company may be required to further
reduce the prices of its products. In the event of further price reductions, the
Company may not be able to reduce product costs sufficiently to achieve
acceptable product margins.
Future Capital Needs and Delisting of Common Stock
To date, the Company has financed its operations primarily through public
and private equity and debt financings. Although the Company recently completed
a private placement of $3.3 million in aggregate initial principal amount of
convertible debt securities, the Company believes that it will require
substantial additional funds during the third quarter of 1999 to finance its
product development, manufacturing, marketing and sales activities. In addition,
the Company's outstanding debt instruments contain certain restrictions which
may adversely impair the Company's ability to obtain additional financing. See
"Substantial Leverage; Restrictions Contained in Debt Instruments" below. If
additional funds are raised by issuing other equity or convertible debt
securities, further dilution to existing or future stockholders is likely to
result. If adequate funds are not available on acceptable terms when needed, the
Company would be required to substantially delay, scale-back or eliminate the
manufacturing, marketing or sales of one or more of its products or research and
development programs, or may be required to obtain funds through arrangements
with collaborative partners or others that may require the Company to relinquish
rights to certain of its technologies,
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product candidates or potential products that the Company would not otherwise
relinquish. This would materially adversely affect the Company's business
operating results and financial condition. Inadequate funding also could impair
the Company's ability to compete in the marketplace.
The Company regularly examines opportunities to expand its technology base
and product line through means such as licenses, joint ventures and acquisitions
of assets or ongoing businesses, and may issue securities in connection with
such transactions. However, no commitments to enter into or pursue any such
transactions have been made at this time, and any such discussions may not
result in any such transaction being concluded.
In addition, the Company currently has a limited number of unreserved
authorized shares of its Common Stock, $.001 par value per share (the
"Common Stock"), available for future issuance in connection with financings.
The Company plans to request that its stockholders approve an increase in the
number of authorized shares at the next annual meeting of the Company's
stockholders. Failure to obtain this approval would limit the Company's ability
to raise sufficient funds to support its business plans.
The Company is currently unable to maintain a level of net tangible assets
required to maintain the listing of the Common Stock for trading on the Nasdaq
National Market, and the Common Stock may be delisted for trading on the Nasdaq
National Market in the near future. Such delisting could have a material adverse
effect on the liquidity of the Common Stock and could have a material adverse
effect on the Company's ability to obtain additional funding as needed,
especially if the Company is unable to list the Common Stock for trading on
another securities market or exchange.
Substantial Leverage; Restrictions Contained in Debt Instruments
The Company is substantially leveraged. The degree to which the Company is
leveraged may adversely affect the Company's ability to finance its future
operations, to compete effectively against better capitalized competitors and to
withstand downturns in its business or the economy generally. Although the
Company's outstanding Notes (as defined below under "Substantial Number of
Shares Eligible for Future Sale; Dilution") currently permit, subject to certain
restrictions, the Company to pay accrued interest on such securities in shares
of Common Stock, the Company may be unable to continue to be permitted to do so
in the future. If the Company is no longer permitted to pay accrued interest on
the Notes in shares of Common Stock, the Company may not be successful in
raising additional equity or debt financing sufficient to enable it to pay such
interest in cash. In addition, the Company's outstanding Notes contain
restrictions that may adversely affect the Company's ability to raise additional
equity or debt financing. Under the Notes, the Company is not permitted, without
the prior approval of the holders of the Notes, (i) to incur any additional
indebtedness (other than pursuant to a working capital line of credit in an
amount not to exceed $1 million or to trade creditors in the ordinary course of
business) or to create any lien, pledge, or encumbrance, subject to certain
exceptions, on any assets of the Company, (ii) for so long as a significant
portion of the Notes remain outstanding, to engage in certain sale or merger
transactions, or to engage in certain other transactions which require the
approval of the Company's stockholders, or (iii) to redeem, purchase or
otherwise acquire any equity or debt securities of the Company which are junior
in rights or preferences to the Notes, or to pay any dividend (other than in
shares of Common Stock) with respect to such securities. In addition, in the
event that the Company fails to achieve break-even or positive operating income
during the second quarter of 2000, the Notes may become immediately due and
payable unless the holders thereof agree to modify or waive such provision.
Furthermore, for so long as the amount of Common Stock issuable upon conversion
of the Notes represents 5% or more of the total then outstanding shares of the
Common Stock, the holders of the Notes have the right to designate two members
for election to the Company's Board of Directors.
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Volatility of Common Stock Price
The market price of the Common Stock, like that of many other
high-technology companies, has fluctuated significantly and is likely to
continue to fluctuate in the future. Since January 1, 1998, the closing price of
the Common Stock has ranged from a low of $0.84 per share to a high of $3.31 per
share. Announcements by the Company or others regarding the receipt of customer
orders, quarterly variations in operating results, additional equity or debt
financings, changes in recommendations of securities analysts, results of
customer field trials, scientific discoveries, technological innovations,
litigation, product developments, patent or proprietary rights, government
regulation and general market conditions may have a significant impact on the
market price of the Common Stock. In addition, if in the future the closing
price of the Common Stock as reported on the Nasdaq National Market remains
below $1.00 per share for 30 consecutive days, the Common Stock could be
delisted for trading on the Nasdaq National Market. Such delisting could have a
material adverse effect on the liquidity of the Common Stock.
Limited Experience in Manufacturing, Marketing and Sales
For the Company to be financially successful, it must manufacture its
products in substantial quantities, at acceptable costs and on a timely basis.
Although the Company to date has produced limited quantities of its products for
commercial installations and for use in development and customer field trial
programs, production of large quantities at competitive costs presents a number
of technological and engineering challenges for the Company. The Company may be
unable to manufacture such products in sufficient volume. The Company has
limited experience in manufacturing, and substantial costs and expenses may be
incurred in connection with attempts to manufacture larger quantities of the
Company's products. The Company may be unable to make the transition to large
scale commercial production successfully.
The Company's marketing and sales 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 its products over more
traditional products, as well as competitive superconductive products. The
Company may also elect to enter into agreements or relationships with third
parties regarding the commercialization or 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 agreements or
relationships with third parties on financially acceptable terms, and any third
parties with whom it enters into such arrangements may not be successful in
marketing the Company's products.
To date, the Company's products have been installed in over 100 cell sites
with a wide geographic dispersion. Although the Company's products have not
experienced any significant reliability problems to date, the Company's products
may develop quality 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 the Company's business, operating results and
financial condition.
Competition
The wireless telecommunications equipment market is very competitive. The
Company's products compete directly with products which embody existing and
future competing commercial technologies. In particular, in cellular and PCS
telecommunications applications, the Company competes with conventional RF
component manufacturers whose products are currently in use by the Company's
potential customers. Many of these companies have substantially greater
financial resources, larger R&D staffs and greater manufacturing and marketing
capabilities than the Company. Other emerging wireless technologies, including
"smart antennas" and tower mounted amplifiers, may also provide protection from
RF interference and offer enhanced range to cellular and PCS service providers
at lower prices and/or superior performance, and may therefore compete with the
Company's products. High performance RF filters may not become a preferred
technology to address the needs of cellular and PCS service providers. Failure
of the Company's 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 Company's business, operating results and financial condition.
Although the market for superconductive electronics currently is small and
in the early stages of development, the Company believes 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
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the field. In order to compete successfully, the Company 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 its technology and products and manufacture and market
its products, either alone or with third parties. The Company may be unable to
achieve these objectives. Failure to achieve these objectives would have a
material adverse effect on the Company's business, operating results and
financial condition.
During the fourth quarter of 1998, the Company implemented a new pricing
strategy pursuant to which it reduced the prices for all of its products.
Although sales of the Company's products increased significantly during the
fourth quarter of 1998, such sales growth may not be sustained over subsequent
periods. Similarly, the Company may not be able to continue to reduce product
costs sufficiently to achieve and maintain acceptable product margins.
Management of Growth
The Company's growth to date has caused, and will continue to cause, a
significant strain on its management, operational, financial and other
resources. The Company's ability to manage its growth effectively will require
it to implement and improve its operational, financial, manufacturing and
management information systems and expand, train, manage and motivate its
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 the Company's financial performance in the next
several fiscal quarters. If the Company were to receive substantial orders, the
Company may have to expand its current facility, which could cause an additional
strain on the Company's management personnel and development resources. The
failure of the Company's management team to effectively manage growth could have
a material adverse effect on the Company's business, operating results and
financial condition.
Rapid Technological Change; Possible Pursuit of Other Market Opportunities
The field of superconductivity is characterized by rapidly advancing
technology. The success of the Company will depend in large part upon its
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. The Company will have to continue to
improve its ability to fabricate thick-film HTS devices, design high performance
RF filters and efficient cryogenic subsystems and produce significant quantities
of products based on these improvements. The Company's 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 the Company.
Because HTS product development is a new and emerging field, there may in
the future be new opportunities that are more attractive than those initially
identified by the Company for its targeted markets. As a result, the Company may
elect in the future to commit its resources to such other potentially more
attractive market opportunities. Such election may require the Company to limit
or abandon its current focus on developing, manufacturing, marketing and selling
HTS products for cellular, PCS and other telecommunications markets. The risks
associated with other markets may be different from the risks associated with
the cellular, PCS and other wireless telecommunications markets.
Focus on Wireless Telecommunications Market; Current and Future
Competitive Technologies
The Company has selected the wireless telecommunications market, in
particular the cellular and PCS markets, as the first principal target market
for its superconductor-based products. The devotion of substantial resources to
the wireless telecommunications market makes the Company 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 the Company's business, operating results and
financial condition.
The Federal Communications Commission ("FCC") has adopted rules that
provide preferential licensing treatment for parties that develop new
communications services and technologies. These developments and further
technological advances may make
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available other alternatives to cellular or PCS service, thereby creating
additional sources of competition. Competition to cellular or PCS technologies
could adversely affect the market for the Company's products, or result in
changes in the Company's development and manufacturing programs.
Dependence on a Limited Number of Customers
To date, the Company's marketing and sales efforts have focused on major
cellular service providers in retrofit applications and, to a lesser extent, on
PCS operators and cellular and PCS original equipment manufacturers. During
1998, sales to three of the Company's customers accounted for over 88% of the
Company's total revenues for 1998. The Company expects that if its RF filter
products achieve market acceptance, a limited number of wireless service
providers and OEMs will account for a substantial portion of its revenue during
any period. Sales of many of the 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 the Company's products. Wireless
service providers and the Company's other customers are significantly larger
than, and are able to exert a high degree of influence over, the Company.
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 loss of one or more
of the Company's customers or the failure to attract new customers would have a
material adverse effect on the Company's business, operating results and
financial condition.
Lengthy Sales Cycles
Wireless service providers, wireless equipment OEMs and the Company's other
customers are significantly larger than, and are able to exert a high degree of
influence over, the Company. Prior to selling its products to these customers,
the Company 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. The Company may not obtain the necessary
approvals or ensuing sales of such products may not occur. The length of the
Company's customers' approval process or delays could have a material adverse
effect on the Company's business, operating results and financial condition.
Dependence on Limited Sources of Supply
Certain parts and components used in the Company's RF filter products,
including substrates, vacuum components, and cryogenic refrigerators, are only
available from a limited number of sources. The Company's reliance on these
limited source suppliers exposes the Company 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 the Company's ability to
manufacture and deliver its products on a timely basis and result in the
cancellation of orders, which could have material adverse effect on the
Company's 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 the Company's products, the Company may be
unable to manufacture products in a quantity sufficient to meet its customers'
demand in any particular period. The Company has no guaranteed supply
arrangements with its limited source suppliers, does not maintain an extensive
inventory of parts or components, and customarily purchases parts and components
pursuant to purchase orders placed from time to time in the ordinary course of
business.
To satisfy customer requirements, the Company 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 the Company's requirement for additional
funds. In addition, such excess inventory could become obsolete which would
adversely affect the Company's financial performance. Business disruption,
production shortfalls or financial difficulties of a limited source supplier
could materially and adversely effect the Company by increasing product costs or
reducing or eliminating the availability of such parts or components. In such
events, the inability of the Company to develop alternative sources of supply
quickly and on a cost-effective basis could materially impair the Company's
ability to manufacture and deliver its products on a timely basis and could have
a material adverse effect on its business, operating results and financial
condition.
Intellectual Property and Patents
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The Company's success will depend in part on its ability to obtain patent
protection for its products and processes, to preserve its 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 Company products are based. As of December 31, 1998, the Company has
been issued 20 U.S. patents, has filed and is actively pursuing applications for
16 other U.S. patents, and is the licensee of 10 U.S. patents and patent
applications held by others. One of the Company's patents is jointly owned with
Lucent Technologies, Inc. The Company believes 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 the Company) regarding rights to inventions
claimed in some of the HTS materials patent applications. The Company also
believes there are a large number of patents and patent applications covering RF
filter products and other products and technologies that the Company is
pursuing. Accordingly, the patent positions of companies using HTS materials
technologies and RF technologies, including the Company, are uncertain and
involve complex legal and factual questions. The patent applications filed by
the Company or by the Company's licensors may not result in issued patents or
the scope and breadth of any claims allowed in any patents issued to the Company
or its licensors may not exclude competitors or provide competitive advantages
to the Company. In addition, patents issued to the Company or its 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 the Company.
Others may have developed or may in the future develop similar products or
technologies without violating any of the Company's proprietary rights.
Furthermore, the Company's loss of any license to technology that it now has or
acquires in the future may have a material adverse effect on the Company's
business, operating results and financial condition.
Some of the patents and patent applications owned or licensed by the
Company are subject to non-exclusive, royalty-free licenses held by various
governmental units. These licenses permit these U.S. government units to select
vendors other than the Company to produce products for the U.S. Government which
would otherwise infringe the Company's patent rights which are subject to the
royalty-free licenses. In addition, the U.S. Government has the right to require
the Company to grant licenses (including exclusive licenses) under such patents
and patent applications or other inventions to third parties in certain
instances.
Patent applications in the U.S. are currently maintained in secrecy until
patents are issued. In foreign countries, 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 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 the Company is pursuing, comprehensive
patent searches and analyses associated with HTS materials, RF technologies and
other products and technologies that the Company is pursuing are often
impractical or not cost-effective. As a result, the Company's patent and
literature searches cannot fully evaluate the patentability of the claims in the
Company's patent applications or whether materials or processes used by the
Company for its 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 the Company is pursuing, the Company
believes 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 the Company. In
any such case, to avoid infringement, the Company would have to either license
such technologies or design around any such patents. The Company may be unable
to obtain licenses to such technologies or, if obtainable, such licenses may not
be available on terms acceptable to the Company or the Company 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 the Company, may be necessary to enforce patents issued or licensed to
the Company, to defend the Company against infringement claims made by others or
to determine the ownership, scope or validity of the proprietary rights of the
Company and others. The parties to such litigation may be larger, better
capitalized than the Company and better able to support the cost of litigation.
An adverse outcome in any such proceedings could subject the Company to
significant liabilities to third parties, require the Company to seek licenses
from third parties and/or require the Company to cease using certain
technologies, any of which could have a material adverse effect on the Company's
business, operating results and financial condition.
The Company believes that a number of patent applications, including
applications filed by International Business Machines
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Corporation, Lucent Technologies, Inc., and other potential competitors of the
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 the Company in its present and currently proposed products.
Therefore, there is a substantial risk that one or more third parties may be
granted patents covering YBCO and other HTS materials and their uses, in which
case the Company could not use these materials without an appropriate license.
As with other patents, the Company has no assurance that it will be able to
obtain licenses to any such patents for YBCO or other HTS 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 the Company's
business, operating results and financial condition.
Government Regulations
Although the Company believes that its 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 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 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 the Company's base
station products must enable them to meet FCC technical standards. 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 the Company's 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.
The Company is subject to governmental labor, safety and discrimination
laws and regulations with substantial penalties for violations. In addition,
employees and others may bring suit against the Company for perceived violations
of such laws and regulations. Defense against such complaints could result in
significant legal costs for the Company. Although the Company endeavors to
comply with all applicable laws and regulations, it may be the subject of
complaints in the future which could have material adverse effect on the
Company's business, operating results and financial condition.
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.
However, the operations, business or assets of the Company could be materially
and adversely affected by the interpretation and enforcement of current or
future environmental laws and regulations. In addition, although the Company
believes that its safety procedures for handling and disposing of such materials
comply with the standards prescribed by state and federal regulations, there is
the risk of accidental contamination or injury from these materials. In the
event of an accident, the Company could be held liable for any damages that
result. Furthermore, the use and disposal of hazardous materials involves the
risk that the Company 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 Company's resources or otherwise have a material
adverse effect on the Company's business, results of operations and financial
condition.
Dependence on Key Personnel
The Company's success will depend in large part upon its ability to attract
and retain highly qualified management, administrative, manufacturing,
marketing, sales and R&D personnel. Due to the specialized nature of the
Company's business, it may be difficult to locate and hire qualified personnel.
The loss of services of one of its executive officers or other key personnel, or
the failure of the Company to attract and retain other executive officers or key
personnel, could have a material adverse effect on the Company's business,
operating results and financial condition.
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Business Interruptions and Dependence on a Single U.S. Facility
The Company's primary operations, including engineering, manufacturing,
research, distribution and general administration, are housed in a single
facility in Mt. Prospect, Illinois. Any material disruption in the Company's
operations, whether due to fire, flooding, natural disaster, power loss or
otherwise, would have a material adverse effect on the Company's business,
operating results and financial condition.
Substantial Number of Shares Eligible for Future Sale; Dilution
On March 31, 1999, the Company privately issued an aggregate of $3.3
million initial principal amount of senior convertible notes due May 15, 2002
(the "New Notes"). The New Notes accrue interest at the rate of 6% per annum,
payable in cash or shares of Common Stock at the Company's option, and are
convertible into an aggregate of 2,933,334 shares of Common Stock. In connection
with the issuance of the New Notes, warrants exercisable for an aggregate of
1,320,000 shares of Common Stock at an exercise price of $1.4625 per share (the
"New Warrants") were also issued. The New Warrants expire on March 31, 2002.
Concurrently with the issuance of the New Notes, the Company amended certain
terms of $5.5 million in aggregate principal amount of the Company's senior
convertible notes due May 15, 2002 (the "Amended Notes") and the warrants
exercisable for an aggregate of 2,200,000 shares of Common Stock (the "Amended
Warrants") issued in connection therewith. The Amended Notes accrue interest at
the rate of 6% per annum, payable in cash or shares of Common Stock at the
Company's option, and are convertible into an aggregate of 4,888,889 shares of
Common Stock. The Amended Warrants expire on May 15, 2001 and are exercisable at
an exercise price of $1.4625 per share. In addition, as of March 31, 1999, $4.85
million in aggregate principal amount of the Company's senior convertible notes
due May 15, 2002 issued in May 1998 (the "1998 Notes," and together with the New
Notes and the Amended Notes, the "Notes"), and the warrants exercisable for an
aggregate of 1,940,000 shares of Common Stock issued in connection therewith
(the "1998 Warrants," and together with the New Warrants and the Amended
Warrants, the "Warrants"), remain outstanding. The 1998 Notes accrue interest at
the rate of 2% per annum, which interest is payable in cash or Common Stock at
the Company's option, and are convertible into an aggregate of 3,233,333 shares
of Common Stock. The 1998 Warrants expire on May 15, 2001 and are exercisable at
an exercise price of $3.75 per share. An aggregate of 16,515,556 shares of
Common Stock are issuable upon conversion of the Notes and exercise of the
Warrants which is equal to approximately 132% of the Common Stock outstanding as
of March 31, 1999.
The sale of a substantial number of shares of Common Stock by the Company
or any of its significant stockholders upon the conversion of a substantial
portion of the Notes or the exercise of a substantial portion of the Warrants,
or the perception that such sales could occur, could adversely affect the
prevailing market price of the Common Stock. In addition, any such sale or such
perception could make it more difficult for the Company to sell equity
securities in the future at a time and price that the Company deems appropriate.
As of December 31, 1998, the Company had, including to the 1998 Warrants
and the Amended Warrants, outstanding warrants to purchase 4,678,688 shares of
Common Stock at a weighted average exercise price of $4.33 per share and options
to purchase 1,193,977 shares of Common Stock at a weighted average exercise
price of $6.71 per share (827,321 of which have not yet vested) issued to
employees, directors and consultants pursuant to the Company's Amended and
Restated 1993 Stock Option Plan, as amended, and individual agreements with
management and directors of the Company. In order to attract and retain key
personnel, the Company may issue additional securities, including stock options,
in connection with its employee benefit plans. During the terms of the Notes and
such options and warrants (including the Warrants), the holders thereof are
given the opportunity to benefit from a rise in the market price of the Common
Stock.
The conversion of the Notes into, or the exercise of options and warrants
(including the Warrants) for, Common Stock, as well as the sale or issuance by
the Company of additional shares of Common Stock and/or rights to purchase
Common Stock, would likely have an adverse or dilutive effect on the market
value of the Common Stock. The Company also may in the future offer equity
participation in connection with the obtaining of non-equity financing, such as
debt or leasing arrangements accompanied by warrants to purchase equity
securities of the Company. This could also have a dilutive effect upon the
holders of Common Stock.
Anti-Takeover Provisions
The Company has certain provisions which may be deemed to have a potential
"anti-takeover" effect in that such provisions
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may delay, defer or prevent a change of control of the Company. In February
1996, the Board of Directors of the Company (the "Board of Directors") adopted a
stockholders rights plan (the "Rights Plan"). By causing substantial dilution to
a person or group that attempts to acquire the Company on terms not approved by
the Board of Directors, the Series A Rights and Series B Rights of the Rights
Plan may interfere with certain acquisitions, including acquisitions that may
offer a premium over market price to some or all of the Company's stockholders.
Further discussion of the Rights Plan is set forth herein under the heading
"Market for Registrant's Common Equity and Related Stockholder Matters-Rights
Plan." In addition, the Company's Certificate of Incorporation and By-Laws
contain provisions that include (i) a requirement that stockholder action may be
taken only at stockholders meetings; (ii) the authority of the Board of
Directors to issue series of the Company's preferred stock with such voting
rights and other powers as the Board of Directors may determine; (iii) notice
requirements in the Bylaws relating to nominations to the Board of Directors and
to the raising of business matters at stockholders meetings; and (d) the
classification of the Board of Directors into three classes, each serving for
staggered three-year terms. In addition, the Company's outstanding debt
instruments contain provisions which may be deemed to have a potential
"anti-takeover" effect. The interests of the holders of such debt instruments
could conflict with the interests of the Company's stockholders. See
"Substantial Leverage; Restrictions Contained in Debt Instruments" above.
WIRELESS TELECOMMUNICATIONS INDUSTRY BACKGROUND
The wireless telecommunications industry has experienced significant
growth, both domestically and internationally, in recent years. This growth
appears to be due to the increasing popularity of wireless telecommunications,
the entry of new service providers into the market as governments open up new RF
spectrum, the continuing decline in the price of service and wireless
telephones, and the introduction of new service features. Rapid growth has
intensified RF interference while increasing wireless operators' demand for
improved system quality, lower capital expenditures per customer, and
co-location of multiple antennas with other RF transmitters at a single cell
site.
In the United States, wireless telecommunications services customers now
frequently have a choice of at least four wireless service providers. Digital
technologies such as Global System for Mobile Telecommunications ("GSM"), Code
Division Multiple Access ("CDMA"), and Time Division Multiple Access ("TDMA")
allow operators to offer such advanced features as short message service, fax,
three-way conferencing and call waiting. Wireless systems are also marketed as a
convenient and economical substitute for regular wireline telephone service. In
addition, service providers are also trying to differentiate themselves on the
basis of quality, price, coverage, and advanced service features. The rapid
growth in competition in wireless telecommunications services is forcing
operators to reduce costs and to seek out new cost effective solutions such as
high performance filters which can reduce capital costs while increasing network
capacity. Already, manufacturers and operators are beginning to plan a new and
more advanced form of wireless telecommunications called Third Generation
cellular or "3G." 3G is expected to provide full Internet access and video
teleconferencing services. The first 3G network is expected to become commercial
in Japan in 2001 and in Europe soon thereafter.
Industry statistics demonstrate the rapid growth of the wireless
telecommunications industry. The Cellular Telecommunications Industry
Association ("CTIA") reports that as of June 1998 there were over 60 million
wireless customers in the United States. Industry publications, as well as other
industry sources, have estimated a total worldwide wireless customer base of
approximately 207 million at the end of 1997. Several industry sources have
estimated the customer base will exceed 830 million by the end of 2003. CTIA
reports that there were over 57,000 base stations in the United States as of
June 1998 and, based on industry sources, the Company believes that there are
approximately 205,000 base stations worldwide. The Company further believes that
this worldwide number is growing at a rate of over 35% per year. The Company
anticipates that the need to provide improved service on a cost effective basis
in an increasingly congested environment will lead wireless service providers to
invest in new infrastructure technologies such as high performance RF filters.
The rapid growth and increased competition experienced by the wireless
telecommunications industry has increased the difficulty of providing quality
wireless services. Wireless service providers face the challenge of providing
quality services in an environment increasingly characterized by RF interference
and congestion. In addition, the rapid rate of growth and community concerns
have affected the manner in which service providers locate their base stations.
Many communities are objecting to the proliferation of new towers to provide
wireless services. Base stations which provide the link between a wireless user
and the telecommunications network are being positioned closer together and
often in the same location, which results in RF interference problems. There has
also been a dramatic proliferation in the use of portable hand held phones
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which transmit weaker signals than mobile or car-mounted phones. As a result,
cellular networks which were laid out based on mobile phone power levels have,
in many areas, developed coverage gaps which operators must fill in to satisfy
their goals of providing seamless coverage. To lower costs, many cellular and
PCS operators are sharing antenna sites with other cellular and PCS operators,
and with television stations, paging operators and two-way radio transmitters.
Such close proximity of radio transmitters can cause RF interference problems
which degrade the quality and capacity of wireless telecommunications systems.
Furthermore, in order to compete with these already broadly deployed cellular
networks, new PCS service providers need to deploy coverage quickly and with the
lowest possible capital investment.
Recently, several wireless system operators have sold their antenna towers
to third party management companies which then lease space for base stations and
their antennas back to the system operator. In addition to managing the site for
the existing system operator, these management companies lease additional space
at the tower site to other wireless providers, including television stations,
paging operators and two-way radio transmitters. The Company believes that the
activities of these management companies will facilitate an increase in the
co-location of multiple wireless providers over time. The Company believes that
this trend may lead to an increase in the demand for high performance filters as
concerns over RF interference and congestion increase.
THE COMPANY'S SOLUTION
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 RF front-end
products can increase the capacity and utilization of a wireless base
station by up to 18%. 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 blocked and 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.
- REDUCED CDMA CELL SITE BREATHING. Coverage for CDMA digital systems
decreases as the number of users increases. To maintain network
coverage, an operator can increase the number of cell sites, add radio
carriers, or use the Company's high performance RF filters with cooled
low noise amplifiers ("LNAs").
- IMPROVED BASE STATION RANGE. Based upon comparative field trials in
multiple rural locations in the United States, and as confirmed by
computer propogation models conducted by customers of the Company, the
Company's RF front-end systems (high performance filter and
cryogenically-cooled LNA) 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. This is true for both analog and
digital systems.
- 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 telecommunications operators.
- IMPROVED CALL QUALITY. The Company's RF filter products improve call
quality by reducing dropped and blocked calls. During commercial
installations and field trials, the Company's RF filter products have
frequently demonstrated a 20 to 40 percent reduction in dropped calls
caused by out-of-band interference and base station front-end
overloading. During these commercial installations and field trials,
the Company's RF filter products have also demonstrated a similar
reduction in blocked calls experienced in urban cellular locations. The
Company's RF filter products also frequently improve audio fidelity by
reducing noise and interference.
- SIMPLER TRANSMITTER SYSTEM DESIGNS. The Company believes that its line
of RF transmit filters can allow for simpler, less costly transmitters,
particularly for digital systems. These RF transmit filters should
improve system performance while diminishing system costs.
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- IMPROVED DIGITAL SYSTEM CAPACITY. The Company believes that its
recently introduced line of transmit combiners allow increased capacity
and range in CDMA systems as system loading increases. CDMA systems
appear unable to offer multi-carrier systems without the use of a
combiner, but traditional combiners reduce the power transmitted from
the base station antenna. The Company's filter technology allows
operators to use combiners with lower loss of desired signals.
PRODUCTS
The Company currently offers three product lines to address the needs of
cellular and PCS service providers. The SpectrumMaster(R) product line is
designed primarily to improve the RF performance of cellular and PCS systems in
high interference environments, including urban areas and near airports. The
RangeMaster(R) product line combines the interference rejection advantages of a
superconducting filter with a cooled LNA. RangeMaster(R) is designed to serve
the range extension needs of rural, suburban, or small city cellular and PCS
operators. The PowerMaster(TM) product line incorporates the Company's filter
technologies into RF transmitter products. The PowerMaster(TM) duplexer is
designed to improve and allow the co-location of multiple wireless service
providers at a single cell site. The PowerMaster(TM) combiner is designed to
improve the range and capacity of multi-carrier CDMA systems. Each product line
is available in a variety of performance levels to meet the varying needs of
different operators and in several mounting configurations to fit specific
customer situations. All of the Company's currently offered products can be
supplied in domestic and international frequencies for both cellular (800 MHz)
and PCS (1.9 Ghz) applications. The Company's proprietary RF filter designs
allow the Company to quickly provide new product offerings with minimal
additional engineering and limited manufacturing complexity.
The Company believes that SpectrumMaster(R) is the world's highest
performance commercial receive pre-select RF filter for wireless
telecommunications cell sites. SpectrumMaster(R) improves the performance of
cellular and PCS systems in high interference environments such as urban areas
and airport properties. SpectrumMaster(R) is available in two models.
SpectrumMaster(R) Ultra is a high performance filter with 24 filter poles for
extremely congested RF environments. SpectrumMaster(R) Ultra provides 10,000
times better rejection of unwanted signals than conventional filters, while
losing very little of the desired signal. SpectrumMaster(R) Classic is a 16 pole
filter and provides 1,000 times better rejection of unwanted signals than
conventional filters while having very low loss of desired signals and extremely
linear filter response. Both SpectrumMaster(R) models meet all analog and
digital protocol specifications for cellular and PCS systems in the United
States. In addition, the Company has developed an even higher performance filter
for Third Generation (3G) systems and has shipped a prototype of this product
for testing in Japan. This new product, the SpectrumMaster(R) Extreme filter,
provides 10,000 times better performance than the SpectrumMaster(R) Ultra. The
SpectrumMaster(R)'s modular design allows rapid design modification to meet
other customer requirements. The Company sold its first SpectrumMaster(R)
product to cellular service providers in the second half of 1996 and sales of
SpectrumMaster(R) have continued to grow in 1997 and 1998.
RangeMaster(R) combines a high performance superconducting cavity filter
with a high performance cryogenically-cooled LNA to lower noise resulting from
interference and thermal noise. RangeMaster(R) is available in four models, from
the economical RangeMaster(R) Omega 150 which is targeted at low interference
rural environments to the 16 pole RangeMaster(R) Classic which provides superior
interference protection for more congested locations. The Company has also
developed a prototype RangeMaster(R) Extreme for Third Generation (3G) systems.
In late 1998, the Company introduced All Temperature Performance (ATP(TM)),
a new function for the RangeMaster(R) product line. This series of
superconducting filters provide HTS high performance front-end functions when
cryogenically cooled. However, in the event of power or cooling system failure,
these products continue to provide the filtering of good quality filters using
conventional technology. In addition, these products resume superconducting
performance automatically when power is restored which eliminates the need for
bypass circuitry.
PowerMaster(TM) is a family of high performance transmit filter systems for
use in the base stations of wireless telecommunications operators. The Company
began marketing two models of PowerMaster(TM) products, a transmitter filter and
a duplexer, in February 1997. These products, which incorporate the Company's
new power handling technology, are used in transmit applications. Unique to the
Company, this technology extends the Company's filter applications to include
transmit, in addition to the receive applications already in commercial use. The
PowerMaster(TM) duplexer improves system quality,
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extends range and simplifies the location of cell sites for both cellular and
PCS systems. PowerMaster(TM) technology provides an ultra-high performance
duplexer, which handles continuous power levels of up to 70 watts at 800 Mhz.
The PowerMaster(TM) duplexer allows an operator to obtain the benefits of very
high performance filtering on both the forward and reverse paths in a system.
These benefits include improved call quality, extended range, improved
transmit/receive isolation, and a reduction in the transmit amplifier output
power required to achieve forward path coverage. The PowerMaster(TM) combiner,
which is a low-loss transmit combiner with superior separation, improves
downlink coverage, and minimizes the number of required antennas and feedlines,
thereby lowering a system operator's capital expense.
International Cellular Products Offerings. The Company is adapting its
SpectrumMaster(R), RangeMaster(R), and PowerMaster(TM) product lines for
international wireless markets to address their specific interference rejection
and range extension needs. The Company is developing products for both Asian and
European cellular and PCS markets, including GSM filters in various
configurations. In December 1997, the Company leased two SpectrumMaster(R) units
to a major Asian cellular operator for testing as a basis for potential system
deployment in the operator's Third Generation (3G) networks. A third unit, a
SpectrumMaster(R) Ultra, was leased to this operator in September 1998. In
addition, the Company has leased a RangeMaster(R) unit to a major European
OEM for testing in May 1999.
TECHNOLOGY
The Company possesses proprietary technology in three areas: the design of
high performance RF cavity filters, thick-film superconducting materials
fabrication and cryogenic packaging.
The Company's products are based on its proprietary RF cavity filter
designs. The Company believes that cavity filter technology provides superior
filter performance with low intermodulation distortion when compared with
alternative technologies, such as RF stripline filter technology (which the
Company is also capable of using). The Company has been able to use its cavity
filter technology to offer filters with over 30 poles. The more poles in a
filter, the better its rejection of unwanted signals. The Company believes its
products are superior to other RF filters with regard to rejection of unwanted
signals.
The Company is able to offer RF cavity filters with superior filtering, low
loss of unwanted signals, and high power handling because of its proprietary
thick-film superconducting fabrication technology. The Company's thick-film
fabrication technology allows the Company to utilize a variety of filter
technologies including cavity and strip line designs. The Company's
superconducting technology is simple and relatively inexpensive to manufacture
and offers superconducting yields consistently above 96%. The Company believes
the electrical performance of the Company's products are superior to any
alternative superconducting technology currently available for RF filters. The
Company's thick-film superconducting technology can handle up to 70 watts of
continuous power at 800 Mhz.
High-temperature superconductors become superconducting at -200(Degree) C.
This temperature can be attained using widely available mechanical
refrigerators. The Company has developed proprietary technologies which provide
an efficient, low cost cryogenic package with a long life cycle and minimum
power consumption. Together, the Company believes that its technological
excellence in filter design, superconducting materials and cryogenic packaging
provide it with a unique and well-protected technology advantage over its
competitors.
SALES AND MARKETING
The Company has 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. The Company has
also sold or leased filters to two major international operators and has
successfully tested its PCS RangeMaster(R) product with two of the largest U.S.
PCS operators. The Company has also tested its PowerMaster(TM) line with two
major OEMs and is discussing specifications with others. The Company has been
named as an approved vendor to one of the largest OEMs, allowing cellular and
PCS operators throughout the world the opportunity to purchase the Company's
products directly from the OEM. The Company primarily uses a direct sales force
to sell its products.
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The Company believes that it has reached the stage of volume deployment
with certain of its customers placing larger orders for the Company's products
than before. For example, one of the Company's largest customers purchased
equipment for over 50 cell sites in the fourth quarter of 1998. The Company's
success has been facilitated by the establishment of corporate purchase
agreements with two of the largest operators in the United States under which
the separate operating regions of the operators can place orders directly with
the Company. In the fourth quarter of 1998, the Company implemented a new
pricing structure pursuant to which it reduced and simplified pricing on all of
its products.
The Company's marketing and sales personnel work directly with both PCS
service providers and PCS OEMs to enhance the probability of sales success in
this rapidly growing market. The Company has continued technical discussions
with multiple PCS OEM's regarding integrating the Company's RF filter products
into such OEM's PCS product line. To date, the Company's PowerMaster(TM) PCS
transmit filter/duplexer has been tested in the laboratories of two PCS
equipment OEMs.
During 1998, sales to three of the Company's customers, ALLTEL Corporation,
Bell Atlantic Mobile and Southwestern Bell Corporation, accounted for
approximately 59%, 15% and 14% of the Company's total revenues, respectively,
for the year ended December 31, 1998.
MANUFACTURING
The Company's state-of-the-art manufacturing process provides predictable
product yields and can be easily expanded to meet increased customer demand.
Superconducting component yields are now consistently above 96%, with low scrap
levels. Manufacturing costs were reduced by 50% during 1997 due to volume,
design and yield efficiencies, and reduced by another 40% in 1998 due to
redesign and resourcing efforts. The Company expects further cost reductions in
1999. The Company has focused its manufacturing efforts on maintaining control
of key technologies while avoiding the cost and complexities of vertical
integration. The Company's manufacturing operations consist primarily of the
manufacture of superconducting components from raw materials, and the assembly,
tuning, testing and quality verification of the Company's products. All of these
activities occur at the Company's manufacturing facility in Mt. Prospect,
Illinois, which began operations during 1996. The Company believes that the
manufacture of its RF filter products requires only moderate capital investments
and is scaleable. The Company also believes that capacity can be rapidly
expanded to meet growing demand without the need for large, upfront capital
investments. The Company purchases all of the components for its filter
products, except for superconducting components, from third party suppliers. The
Company believes it has access to adequate supplies of these purchased
components, most of which are produced according to the Company's proprietary
designs and specifications. The Company is using its just-in-time manufacturing
capability to maximize quality, insure flexibility, limit management complexity
and minimize inventory cost.
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 1996, 1997 and 1998 were
approximately $6,423,000, $4,132,000, and $2,935,000, respectively. R&D costs
reimbursed under government contracts and cooperative agreements during 1996,
1997 and 1998 were approximately $200,000, $0, and $0, respectively.
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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, 1998, the Company has been issued 20 U.S. patents, has
filed and is actively pursuing applications for 16 other U.S. patents, and is
the licensee of 10 patents and patent applications held by others. Such patents
and patent applications relate to various aspects of the Company's
superconductor technology, the design of HTS filters, methods for packaging and
cooling, and system implementation techniques. One of the Company's patent
applications has been filed jointly with Lucent Technologies, Inc. and relates
to superconducting filters. Additional inventions are the subject of a group of
patent applications currently under preparation. 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 continue 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.
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.
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.
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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.
Two other companies, Conductus, Inc. and Superconducting Technologies,
Inc., are currently marketing superconducting filters to the wireless
telecommunications marketplace. In addition, a number of large multinational
companies are engaged in R&D programs that could lead to the commercialization
of superconducting filters for the wireless telecommunications marketplace.
These companies include, among others, E.I. DuPont de Nemours & Co., Fujitsu
Corporation, NEC Corporation, Kyocera Corporation, and Matsushita Electric
Industrial Co., Ltd. The Company believes that all of these companies are
working on RF stripline filters using epitaxial thin-film superconducting
technology. None of these filters are expected to be commercially implemented in
the near future. The Company believes that RF stripline superconducting filters,
while smaller, are technically unable to provide equivalent rejection of
unwanted signals, competitively low levels of intermodulation distortion, as
large a number of filter poles, or similar levels of power handling.
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 March 10, 1999, the Company had a total of 63 employees, 14 of whom
hold advanced degrees. Of the employees, 26 are engaged in manufacturing and
production, 16 are engaged in research, development and engineering, and 21 are
engaged in general management, marketing, sales, finance and administration. The
Company also periodically employs a number of consultants and independent
contractors. The Company considers its relations with its employees to be
satisfactory.
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. This facility also houses the Company's manufacturing, research,
development, engineering and marketing activities. The Company believes that
this facility is adequate and suitable for its current needs and that additional
space would be available on commercial terms as necessary to meet any future
needs.
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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 and the parties are in the midst
of discovery.
The Company believes that the suit is without merit and intends to continue
to defend itself vigorously in this litigation. 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 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 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.
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 Common Stock. The
counterclaim sought an amount of damages which the Borrowers allege "cannot
currently be determined." On December 10, 1997, the Company's motion to strike
the Borrowers' fraud defense and dismiss their counterclaim was granted with
leave to amend.
On January 14, 1998, the Borrowers filed amended defenses and counterclaims
based on substantially similar allegations of supposed fraud by the Company. The
Company's answer was filed on April 30, 1998, and the parties are proceeding
with discovery. The Company regards the amended fraud claim as without factual
or legal merit. Effective July 23, 1998, one of the Borrowers, Merrill Weber &
Co., Inc., and the Company reached a settlement of their respective claims. The
Company intends to vigorously pursue recovery of the moneys owed by the other
Borrowers and the Guarantor under the promissory notes and the guarantee.
Lipman Litigation
On January 6, 1998, Jerome H. Lipman, individually and on behalf of all
others similarly situated, filed a complaint
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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 seeks an unspecified amount of compensatory and
punitive damages, and attorneys' fees.
The Company and the Named Directors regard the suit as without factual or
legal merit. Accordingly, on February 17, 1998, the Company and the Named
Directors filed a motion to dismiss Mr. Lipman's complaint. The motion presented
arguments that the claims of Mr. Lipman and the putative class are barred by the
business judgment rule and the plaintiff's failure to fulfill the legal
prerequisites for filing an action against the Named Directors. Prior to a
hearing on the Company's and the Named Directors' motion to dismiss, Mr. Lipman
filed a motion on March 16, 1998, seeking both to amend his proposed putative
class to include Mr. Drobny and to certify the class.
On June 1, 1998, the court granted the Company's and the Named Directors'
motion to dismiss the complaint. Concurrently, Mr. Lipman withdrew his motion to
amend the proposed putative class and certify the class. On June 30, 1998, Mr.
Lipman filed an amended complaint against the Named Directors but excluding the
Company itself as a defendant. The amended complaint alleges 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 seeks 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 alleges that the stock owned by the putative class
lost $61 million due to the financing the Named Directors selected, and seeks an
unspecified amount of compensatory and punitive damages. The Company and the
Named Directors regard the amended complaint as without factual or legal merit.
Accordingly, the Named Directors filed a motion to dismiss Mr. Lipman's amended
complaint on July 29, 1998. The court granted the motion to dismiss in December
1998, finding that Mr. Lipman still had failed to fulfill the prerequisites for
maintaining a shareholder derivative action against the Named Directors. On
January 12, 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 alleges that the Named Directors breached
their duties of loyalty and due care to the putative class and further alleges
that the purported devaluation of the plaintiff's stock resulting from the June
1997 financing was an improper "assessment" on the plaintiffs' shares for which
they seek an unspecified amount of compensatory and punitive damages. In
February 1999, the Company and the Named Directors filed a motion to dismiss the
second amended complaint. A hearing on the motion is scheduled for April 1999.
Greenwald Litigation
On June 24, 1998, Jonathan Greenwald, derivatively on behalf of the
Company, filed a complaint against the Company and the Named Directors in the
court of Chancery of the State of Delaware in and for New Castle County. Mr.
Greenwald's complaint alleges that the Named Directors breached their duties of
good faith, loyalty, due care, and candor by selecting financing for the Company
in 1997 which purportedly reduced the stock price and was supposedly accepted to
entrench the Named Directors. The complaint seeks an unspecified amount of
compensatory damages, various equitable relief and attorney's fees.
The Company and the Named Directors regard the suit as without factual or
legal merit. Accordingly, in January 1999, the Company and the Named Directors
filed a motion to dismiss the complaint arguing that the complaint is barred by
the business judgment rule and the plaintiffs' failure to fulfill the
prerequisites for maintaining a shareholder derivative action against the Named
Directors. A hearing on the motion has not been scheduled.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1998.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The outstanding shares of the Company's Common Stock are listed on the
Nasdaq National Market and trade under the symbol ISCO. The following table sets
forth for the periods indicated the range of high and low closing sale prices
for the Common Stock:
HIGH LOW
---- ---
FISCAL YEAR ENDING DECEMBER 31, 1997
First Quarter................................. $ 18.24 $15.48
Second Quarter................................ $ 12.40 $ 8.00
Third Quarter................................. $ 9.48 $ 7.24
Fourth Quarter................................ $ 3.32 $ 1.24
FISCAL YEAR ENDING DECEMBER 31, 1998
First Quarter................................. $ 3.31 $ 0.88
Second Quarter................................ $ 3.25 $ 1.25
Third Quarter................................. $ 1.94 $ 1.00
Fourth Quarter................................ $ 1.66 $ 0.84
On March 25, 1999, there were approximately 284 holders of record of the
Common Stock.
The Company has never paid cash dividends on the Common Stock and the
Company does not expect to pay any dividends on its Common Stock in the
foreseeable future. In addition, the Company's existing debt instruments limit
the Company's ability to pay dividends. See "Risk Factors - Substantial
Leverage; Restrictions Contained in Debt Instruments."
RIGHTS PLAN
In February 1996, the Board of Directors of the Company adopted a
stockholders rights plan (the "Rights Plan"). In connection with the adoption of
the Rights Plan, the Board of Directors created one series of Preferred Stock,
consisting of 10,000 shares of Series A Junior Participating Preferred Stock
(the "Series A Preferred"). Each share of the Series A Preferred, when and if
issued, entitles the holder thereof to receive dividends equal to 1,000 times
the dividends per share declared with respect to the Common Stock. Holders of
the Series A Preferred are entitled to exercise 1,000 votes per share on all
matters submitted to a vote of stockholders and, except as otherwise required by
law, vote together with the holders of Common Stock as a single class. In the
event of liquidation, such holders would receive a preference of 1,000 times the
aggregate amount to be distributed per share to the holders of Common Stock. In
general, each share of the Series A Preferred is intended to have a value and
voting rights equal to 1,000 shares of Common Stock, and appropriate
anti-dilutive adjustments will be made in accordance with the terms of such
Series A Preferred in the event of certain changes in Common Stock.
Pursuant to the Rights Plan, a Series A Right is associated with, and
trades with, each share of Common Stock outstanding. The record date for
distribution of such Series A Rights was February 22, 1996 (the "Record Date")
and, for so long as the Series A Rights are associated with the Common Stock,
each new share of Common Stock issued by the Company will include one Series A
Right.
Each Series A Right will entitle its holder to purchase one-thousandth of a
share of Series A Preferred of the Company for $200 (subject to adjustment). The
Series A Rights are not exercisable until the earlier of (i) ten days after any
person or group becomes the beneficial owner of 15% or more of the outstanding
Common Stock or (ii) 10 business days (unless extended by the Board of
Directors) after the commencement of a tender offer or exchange offer that would
result in a person or group beneficially owning 15% or more of the Common Stock.
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If any person or group acquires 15% or more of the Common Stock outstanding
(the "Shares Acquisition Date"), each holder of a Series A Right (except the
acquiring party) has the right to receive, upon exercise, (i) shares of Common
Stock of the Company having a market value of two times the exercise price of
the Series A Right and (ii) one Series B Right (Series A Rights and Series B
Rights are hereinafter collectively referred to as the "Rights"). The Board of
Directors has the option, after the Shares Acquisition Date but before there has
been a 50% acquisition of the Company, to exchange both (i) one share of Common
Stock (or one-thousandth of a share of preferred stock) and (ii) one Series B
Right, for each Series A Right (other than Series A Rights held by an acquiring
party). If, after the Series A Rights become exercisable, the Company is
involved in a merger or other business combination, or if the Company sells or
transfers more than 50% of its assets or earning power, or if an acquiring party
engages in certain "self-dealing" transactions with the Company, each Series A
Right and Series B Right then outstanding (other than Rights held by an
acquiring party) will be exercisable for common stock of the other party to such
transaction having a market value of two times the exercise price of the Right.
The Company has the right to redeem the Series A Rights for $.01 per Series A
Right (the "Redemption Price") prior to the Shares Acquisition Date. The Series
B Rights, once issued, are not redeemable. The Rights expire on February 9,
2006.
The Rights have certain anti-takeover effects. The Rights should not
interfere with any merger or business combination approved by the Board of
Directors since the Series A Rights may be redeemed by the Company at the
Redemption Price prior to the time that a person or group has acquired
beneficial ownership of 15% or more of the Common Stock. However, by causing
substantial dilution to a person or group that attempts to acquire the Company
on terms not approved by the Board of Directors, the Rights may interfere with
certain acquisitions, including acquisitions that may offer a premium over
market price to some or all of the Company's shareholders. The Rights are not
intended to prevent an acquisition of the Company on terms that are favorable
and fair to all shareholders. See "Risk Factors - Anti-Takeover Provisions."
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ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data with respect to the
Company as of and for the years ended December 31, 1994, 1995, 1996, 1997 and
1998. The selected financial data for each of the years in the audited five-year
period ended December 31, 1998 have been derived from the financial statements
of the Company. The information set forth below should be read in conjunction
with "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations", and the financial statements, related notes and other
financial information included elsewhere in this Form 10-K.
----------- ----------- ------------ ------------ ------------
1994 1995 1996 1997 1998
----------- ----------- ------------ ------------ ------------
STATEMENT OF OPERATIONS DATA:
Net Revenues.......................... $ 208,168 $ 27,830 $ 209,822 $ 1,038,134 $ 3,242,930
Costs and expenses:
Cost of revenues.................... 194,098 19,286 49,534 4,401,077 7,047,347
Research and development.......... 1,962,678 4,554,946 6,422,921 4,132,019 2,934,784
Selling and marketing............... 454,968 469,600 1,834,640 1,918,044 1,847,680
General and administrative.......... 2,199,597 2,763,615 3,290,810 2,772,274 3,370,058
----------- ----------- ------------ ------------ ------------
(4,603,173) (7,779,617) (11,388,083) (12,185,280) (11,956,939)
Other income (expense):
Investment income .................. 496,392 487,543 503,911 254,781 354,738
Interest expense.................... (8,582) (39,600) (29,602) (17,969) (10,247,919)
----------- ----------- ------------ ------------ ------------
487,810 447,943 474,309 236,812 (9,893,181)
----------- ----------- ------------ ------------ ------------
Net loss................................ $(4,115,363) $(7,331,674) $(10,913,774) $(11,948,468) $(21,850,120)
Preferred Stock dividends............... - - - (143,302) (61,834)
----------- ----------- ------------ ------------ ------------
Net loss plus Preferred Stock dividends. $(4,115,363) $(7,331,674) $(10,913,774) $(12,091,770) $(21,911,954)
=========== =========== ============ ============ ============
Basic and diluted loss per common share. $ (1.15) $ (2.01) $ (2.41) $ (2.34) $ (1.93)
Weighted average number of
common shares outstanding........... 3,578,485 3,641,196 4,536,034 5,156,663 11,345,540
----------- ----------- ------------ ------------ ------------
1994 1995 1996 1997 1998
----------- ----------- ------------ ------------ ------------
BALANCE SHEET DATA:
Cash and cash equivalents............. $ 90,362 $ 953,093 $ 5,188,047 $ 2,766,886 $ 2,152,595
Working capital....................... 9,806,670 5,458,474 5,207,923 4,668,982 4,143,558
Total assets.......................... 14,732,501 11,105,766 13,388,496 11,534,309 10,028,088
Long-term debt/capital lease
obligations, less current portion.. 8,355 509,079 91,618 13,541 9,302,651
Stockholders' equity (net capital
deficiency)........................ 12,821,746 9,185,379 11,520,128 10,046,569 (772,968)
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information contained in this Form 10-K contains forward-looking
statements which involve certain risks, uncertainties and contingencies which
could cause the Company's actual results, performance or achievements to differ
materially from those expressed, or implied, by such statements. See the
italicized language on the introductory page of this Form 10-K.
RESULTS OF OPERATIONS
Years Ended December 31, 1998 and 1997
The Company's net revenues increased $2,204,796 from $1,038,134 in 1997 to
$3,242,930 in 1998, as a result of increased sales of the Company's radio
frequency ("RF") front-end products. Net revenues in the fourth quarter of 1998
were $1,504,497, as compared to $282,384 for the fourth quarter of 1997. This
revenue growth was the result of the increased acceptance of the Company's
products by operators, price reductions that the Company implemented in October
1998 and a large scale deployment of the Company's products by one of the
largest cellular operators in the U.S. However, the Company anticipates
significantly lower revenues in the first quarter of 1999 as compared to the
fourth quarter of 1998. Net revenues from product sales represent gross product
shipments less reserves for potential returns. Such reserves are based on the
Company's historical product return rates. All of the net revenues in 1997 and
1998 were from commercial product sales. The Company has concentrated its
efforts on its commercial product development programs and does not expect
revenues to increase dramatically unless and until it ships a significantly
larger amount of its commercial products.
Cost of product sales was $7,047,347 for the year ended December 31, 1998,
as compared to $4,401,077 for the year ended December 31, 1997. The cost of net
product sales for 1998 and 1997 consisted of direct material, labor and overhead
costs associated with the products that were shipped during the year, plus
approximately $375,000 and $529,000, respectively, of costs, which consisted
primarily of allocated overhead costs, incurred to produce units in ending
finished goods inventory that exceed net realizable value. Due to low
utilization levels and excess capacity in the Company's manufacturing facility,
cost of net product sales exceeded net revenues for the years ended December 31,
1998 and 1997. The Company expects the cost of net product sales to exceed net
revenues until it manufactures and ships a significantly higher amount of its
commercial products.
The Company's internally funded research and development expenses decreased
$1,197,235 from $4,132,019 in 1997 to $2,934,784 in 1998. Research and
development costs were reduced during 1998, as compared to 1997, primarily due
to a reduction in personnel and operating costs during 1998. The Company expects
to continue reducing its research and development expenses during 1999.
Selling and marketing expenses decreased to $1,847,680 in 1998 from
$1,918,044 in 1997. This decrease was due to lower advertising, recruiting and
consulting expenses during 1998 as compared to 1997. The decrease was partially
offset by increased salary and freight expenses in 1998.
General and administrative expenses increased $597,784 from $2,772,274 in
1997 to $3,370,058 in 1998. The increase in general and administrative expenses
was due primarily to higher consultant, legal and office expenses during 1998 as
compared to 1997.
Investment income increased $99,957 from $254,781 in 1997 to $354,738 in
1998. This increase was due to a higher average cash, cash equivalent and
investment balance during 1998.
Interest expense increased $10,229,950 from $17,969 in 1997 to $10,247,919
in 1998. This increase was primarily due to $10,101,401 of non-cash interest
charges related to the Company's Senior Convertible Notes due May 15, 2002,
issued in May 1998.
24
27
Years Ended December 31, 1997 and 1996
The Company's net revenues increased $828,312 from $209,822 in 1996 to
$1,038,134 in 1997, as a result of increased sales of the Company's RF front-end
products. Net revenues from product sales represent gross product shipments less
reserves for potential returns. Such reserves are based on the Company's
historical product return rates. A government contract accounted for $53,122 of
the Company's net revenues in 1996, while all of the net revenues in 1997 were
from commercial product sales.
Cost of net product sales was $4,401,077 for the year ended 1997, as
compared to $0 for the year ended 1996. The cost of net product sales for 1997
consisted of direct material, labor and overhead costs associated