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EX-21 - EX-21 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv21.htm
EX-3.1 - EX-3.1 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv3w1.htm
EX-3.2 - EX-3.2 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv3w2.htm
EX-32.1 - EX-32.1 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv32w1.htm
EX-31.2 - EX-31.2 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv31w2.htm
EX-31.1 - EX-31.1 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv31w1.htm
EX-32.2 - EX-32.2 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv32w2.htm
EX-23.1 - EX-23.1 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv23w1.htm
EX-10.16 - EX-10.16 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv10w16.htm
EX-10.29 - EX-10.29 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv10w29.htm
EX-10.13 - EX-10.13 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv10w13.htm
EX-10.14 - EX-10.14 - SUPERCONDUCTOR TECHNOLOGIES INCv55462exv10w14.htm
Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K
 
ANNUAL REPORT
PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
     
(Mark One)    
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
    For the fiscal year ended December 31, 2009
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
    For the transition period from          to          
 
Commission File Number 0-21074
SUPERCONDUCTOR TECHNOLOGIES INC.
(Exact name of registrant as specified in its charter)
 
         
Delaware     77-0158076  
(State or other jurisdiction of     (IRS Employer  
incorporation or organization)     Identification No. )
 
460 Ward Drive, Santa Barbara, California 93111-2310
 
(Address of principal executive offices) (Zip Code)
 
Registrant’s telephone number, including area code: (805) 690-4500
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of each class
 
Name of each exchange on which registered
 
Common stock, $0.001 par value
  The NASDAQ Stock Market, LLC
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o or     No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o or     No þ
 
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 þ or     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o or     No o
 
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.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company þ
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o or No þ
 
The aggregate market value of the common stock held by non-affiliates was $48.4 million as of June 27, 2009 (the last business day of our most recently completed second fiscal quarter). The closing price of the common stock on that date was $3.76 as reported by the NASDAQ Capital Market. For purposes of this determination, we excluded the shares of common stock held by each officer and director and by each person who was known to us to own 10% or more of the outstanding common stock as of June 27, 2009. The exclusion of shares owned by the aforementioned individuals and entities from this calculation does not constitute an admission by any of such individuals or entities that he or it was or is an affiliate of ours.
 
We had 22,330,051 shares of common stock outstanding as of the close of business on March 1, 2010.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Items 10, 11, 12, 13 and 14 of Part III incorporate information by reference from the definitive proxy statement for the Registrant’s 2010 Annual Meeting of Stockholders.
 


 

 
SUPERCONDUCTOR TECHNOLOGIES INC.
 
FORM 10-K ANNUAL REPORT
Year Ended December 31, 2009
 
Unless otherwise noted, the terms “we,” “us,” “our” refer to the combined and ongoing business
operations of Superconductor Technologies Inc. and its subsidiaries
 
                 
        Page
 
    1  
WHERE YOU CAN FIND MORE INFORMATION
       
 
PART I
      Business     2  
      Risk Factors     6  
      Unresolved Staff Comments     16  
      Properties     16  
      Legal Proceedings     16  
      (Removed)     16  
 
PART II
      Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     16  
      Selected Financial Data     19  
      Management’s Discussion and Analysis of Financial Condition and Results of Operations     20  
      Quantitative and Qualitative Disclosures about Market Risk     30  
      Financial Statements and Supplementary Data     30  
      Controls and Procedures     30  
      Other Information     31  
 
PART III
      Directors, Executive Officers and Corporate Governance     31  
      Executive Compensation     31  
      Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     31  
      Certain Relationships and Related Transactions, and Director Independence     31  
      Principal Accountant Fees and Services     31  
 
PART IV
      Exhibits and Financial Statement Schedules     32  
 EX-3.1
 EX-3.2
 EX-10.13
 EX-10.14
 EX-10.16
 EX-10.29
 EX-21
 EX-23.1
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2


Table of Contents

 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We claim the protection of the safe harbor contained in the Private Securities Litigation Reform Act of 1995 for these forward looking statements. Our forward-looking statements relate to future events or our future performance and include, but are not limited to, statements concerning our business strategy, future commercial revenues, market growth, capital requirements, new product introductions, expansion plans and the adequacy of our funding. Other statements contained in this Report that are not historical facts are also forward-looking statements. We have tried, wherever possible, to identify forward-looking statements by terminology such as “may,” “will,” “could,” “should,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and other comparable terminology.
 
We caution investors that any forward-looking statements presented in this Report, or that we may make orally or in writing from time to time, are based on the beliefs of, assumptions made by, and information currently available to, us. Such statements are based on assumptions and the actual outcome will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect. As a result, our actual future results can be expected to differ from our expectations, and those differences may be material. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on known results and trends at the time they are made, to anticipate future results or trends.
 
Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include the following:
 
  •  limited cash and a history of losses;
 
  •  limited number of potential customers;
 
  •  limited number of suppliers for some of our components;
 
  •  no significant backlog from quarter to quarter;
 
  •  our market is characterized by rapidly advancing technology;
 
  •  fluctuations in product demand from quarter to quarter can be significant;
 
  •  the impact of competitive filter products, technologies and pricing;
 
  •  manufacturing capacity constraints and difficulties; and
 
  •  general economic conditions, such as the current worldwide recession.
 
For further discussion of these and other factors see, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” in this Report.
 
This Report and all subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to our forward-looking statements to reflect events or circumstances after the date of this Report.


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PART I
 
ITEM 1.   BUSINESS
 
General
 
We are a leading company in high temperature superconductor (“HTS”) materials and related technologies. HTS materials have the unique ability to conduct various signals or energy (e.g., electrical current or radio frequency (“RF”) signals) with little or no resistance when cooled to “critical” temperatures. Electric currents that flow through conventional conductors encounter resistance that requires power to overcome and generates heat. HTS materials can substantially improve the performance characteristics of electrical systems, reducing power loss, lowering heat generation and decreasing electrical noise. Circuits designed to remove interference inherent in some RF signals can also be made from HTS materials. Commercial use of HTS materials requires a number of cutting edge technologies, including development of HTS materials, specialized manufacturing expertise to create uniform thin layers of these materials, expert designs of circuits optimized for HTS materials, and technologies to maintain an extremely low temperature environment for HTS applications (although the critical temperatures for HTS are “high” compared with traditional superconductors, they are still extremely cold by other standards).
 
Our Proprietary Technology
 
We are focused on research and development to maintain our technological edge. As of December 31, 2009, we had 34 employees in our research and development division; 9 of our employees have Ph.D.s, and 14 others hold advanced degrees in physics, materials science, electrical engineering and other fields. Our development efforts over the last 22 years have yielded an extensive patent portfolio as well as critical trade secrets, unpatented technology and proprietary knowledge. We enter into confidentiality and non-disclosure agreements with our employees, suppliers and consultants to protect our proprietary information. As of December 31, 2009, we held 59 U.S. patents in the following categories:
 
  •  8 patents for technologies directed toward producing thin-film materials and structures, which expire between 2010 and 2025. We have developed a proprietary state-of-the-art manufacturing process for producing HTS thin-films of the highest quality.
 
  •  32 patents for cryogenic and non-microwave circuit designs, which expire between 2010 and 2028. The expertise of our highly qualified team has allowed us to design and fabricate extremely small, high-performance circuits including RF signal filters.
 
  •  17 patents covering cryogenics, packaging and systems, which expire between 2013 and 2025. Our proprietary and patented cryogenic packaging innovation provides us with a significant competitive advantage in maintaining our HTS materials at their critical temperatures.
 
  •  2 patents covering other superconducting technologies, which expire between 2013 and 2015.
 
As of December 31, 2009, we also had 19 issued foreign patents, 21 U.S. patent applications pending and 60 foreign applications patents pending.
 
We are currently focusing our efforts on applications in areas such as:
 
  •  Wireless Networks.  Our current commercial products help maximize the performance of wireless telecommunications networks by improving the quality of uplink signals from mobile wireless devices. Our products increase capacity utilization, lower dropped and blocked calls, extend coverage, and enable higher wireless data throughput — all while reducing capital and operating costs. We are leveraging our unique filtering technology to pursue wireless business on multiple fronts: capturing wireless business with tier one U.S. wireless carriers for the LTE network build out, and developing our advanced reconfigurable filtering technology, which has the potential to drastically reduce the size and cost of mobile devices.
 
  •  Superconducting Power Applications.  We are adapting our unique HTS materials deposition techniques to deliver energy efficient, cost-effective and high performance 2G HTS wire technology for next generation power applications. A variety of large, high potential, initial target markets have been identified for our 2G


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  HTS wire including: energy (wind turbines, smart grid), industrial (motors, generators) and healthcare (MRI) applications. To accelerate development and manufacturing processes for our 2G HTS wire, we are partnering with HTS industry leaders, United States National Labs and the U.S. Department of Energy (“DOE”). In August 2009, we renewed our two year Cooperative Research and Development Agreement with Los Alamos National Laboratory (“LANL”). These technological interchanges will help us meet the technical challenges and performance metrics for both high performance and cost effective 2G HTS wire.
 
  •  Government Products.  As the worldwide leader in developing tunable HTS filter systems for military applications, we continue to be a crucial partner in the U.S. government’s future success. Our high-performance HTS filter systems have been proven to increase the detection range, reduce interference, and in some cases, detect signals that were previously undetectable with conventional technology. Currently, we actively participate in the development of technologies for application in military communications, signals intelligence, and electronic warfare.
 
Our development efforts can take a significant number of years to commercialize, and we must overcome significant technical barriers and deal with other significant risks, some of which are set out in our public filings, including in particular the “Risk Factors” included in Item 1A of this Report.
 
Our Business Model
 
To be successful, we must use our expertise and our technology to generate revenues in various ways, including government contracts, commercial operations, joint ventures and licenses:
 
Government Contracts
 
We generate significant revenues from government contracts. For 2009, 2008 and 2007, government related contracts accounted for 32%, 40% and 29%, respectively, of our net revenues. We typically own the intellectual property developed under these contracts, and grant the Federal government a royalty-free, non-exclusive and nontransferable license to use it. As a result, our government contracts can not only generate a profit for us, but we can also make additional money through exploiting of the resulting technology in our commercial operations as well as government products, or through licenses or joint ventures. Contracts with the U.S. government contain provisions, and are subject to laws and regulations, that give the government rights and remedies not typically found in commercial contracts, including rights that allow the government to:
 
  •  terminate existing contracts for convenience, which affords the U.S. government the right to terminate the contract in whole or in part any time it wants for any reason or no reason, as well as for default;
 
  •  reduce or modify contracts or subcontracts, if its requirements or budgetary constraints change;
 
  •  cancel or reduce multi-year contracts and related orders, if funds for contract performance for any subsequent year become unavailable;
 
  •  adjust reimbursable contract costs and fees on the basis of audits completed by its agencies through exercise of its oversight rights; and
 
  •  control or prohibit the export of products.
 
Compensation in the event of a termination, if any, is limited to compensation for work completed at the time of termination. In the event of termination for convenience, we may receive a certain allowance for profit on the work performed.
 
Commercial Applications
 
We have chosen to manufacture and sell certain commercial products on our own. To date, our commercial efforts have been focused on the design, manufacture, and sale of high performance infrastructure products for


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wireless voice and data applications. We have three current product lines, all of which relate to wireless base stations:
 
  •  SuperLink®, a highly compact and reliable receiver front-end HTS wireless filter system to eliminate out-of-band interference for wireless base stations, combining filters with a proprietary cryogenic cooler and a cooled low-noise amplifier.
 
  •  AmpLink®, a ground-mounted unit for wireless base stations that includes a high-performance amplifier and up to six dual duplexers.
 
  •  SuperPlex, a high-performance multiplexer that provides extremely low insertion loss and excellent cross-band isolation designed to eliminate the need for additional base station antennas and reduce infrastructure costs.
 
We sell most of our current commercial products to a small number of wireless carriers in the United States, including Alltel, AT&T, Sprint Nextel, T-Mobile and Verizon Wireless. Verizon Wireless and AT&T each accounted for more than 10% of our commercial revenues in 2009, 2008 and 2007. We are seeking to expand our customer base by selling directly to other wireless network operators and manufacturers of base station equipment, including internationally. Demand for wireless communications equipment fluctuates dramatically and unpredictably. The wireless communications infrastructure equipment market is extremely competitive and is characterized by rapid technological change, new product development, product obsolescence, evolving industry standards and price erosion over the life of a product. We face constant pressures to reduce prices. Consequently, we expect the average selling prices of our products will continue decreasing over time. We expect these trends to continue and may cause significant fluctuations in our quarterly and annual revenues. Our commercial operations are subject to a number of significant risks, some of which are set out in our public filings, including in particular the “Risk Factors” included in Item 1A of this Report.
 
Joint Ventures
 
From time to time we may pursue joint ventures with other entities to commercialize our technology. In particular, we have agreed to license certain technology for our SuperLink interference elimination solution for the China market to a joint venture where we own 45 percent of the equity. In 2008, we received orders from the joint venture for our new TD-SCDMA solution to perform lab and field trial activities in China. The lab and field trial was successfully completed in 2008 and in 2009 we successfully completed field trials in the existing China 2G market using our SuperLink solution. In 2009, we recorded a $521,000 loss for impairment of our investment in the joint venture. The commencement of manufacturing and the transfer of our processes to the joint venture will be driven by product demand from the China market. The joint venture’s activities remain subject to successful product marketing efforts in addition to a number of other conditions, including certain critical approvals from the Chinese and United States governments. In particular, we have been in discussions with the United States government concerning the national security implications of our joint venture and investment from Hunchun BaoLi Communication Co. Ltd. (“BAOLI”). There continues to be no assurance that these conditions will be met, or that all required approvals (if obtained) will be obtained on a timely basis. Even if these conditions are met and the approvals received, the results from our joint venture will be subject to a number of significant risks associated with international operations and new ventures, some of which are set forth in our public filings, including in particular the “Risk Factors” included in Item 1A of this Report.
 
Licenses
 
From time to time we grant licenses for our technology to other companies. Specifically, we have granted licenses to, among others, (1) Bruker for Nuclear Magnetic Resonance application, (2) General Dynamics for government applications and (3) Star Cryoelectronics for Superconducting Quantum Interference Device applications.
 
Manufacturing
 
Our manufacturing process involves the assembly of numerous individual components and precision tuning by production technicians. We purchase inventory components and manufacture inventory based on sales forecasts.


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The parts and materials used by us and our contract manufacturers consist primarily of printed circuit boards, specialized subassemblies, fabricated housing, relays and small electric circuit components, such as integrated circuits, semiconductors, resistors and capacitors. We currently manufacture our SuperLink systems at our facilities in Santa Barbara, California. Principal components of our AmpLink and SuperPlex products are produced by foreign manufacturers. Our Santa Barbara facilities currently also house our AmpLink assembly and distribution center.
 
A number of components used in our products are available from only a limited number of outside suppliers due to unique designs as well as certain quality and performance requirements. There are components that we source from a single vendor due to our current production volume. In addition, key components of our conventional products are manufactured by a sole foreign manufacturer. We do not have guaranteed supply arrangements with any of these suppliers, do not maintain an extensive inventory of parts or components and customarily purchase sole or limited source parts and components pursuant to purchase orders. Our reliance on sole or limited source suppliers involves certain risks and uncertainties, many of which are beyond our control, and some of which are set out in our public filings, including in particular the “Risk Factors” included in Item 1A of this Report.
 
Marketing and Sales
 
Because we have a concentrated customer base, we primarily sell using a direct sales force in the U.S. We use indirect channels to market our products to select customers internationally. We demonstrate our products at trade shows, and participate in industry conferences. We also use advertising campaigns, email campaigns, direct mailings, and submission of technical and application reports to recognized trade journals to advertise our solutions to potential customers. We also advertise our products through our website, brochures, data sheets, application notes, trade journal reports and press releases. Our sales and marketing efforts are complemented by a team of sales applications engineers who manage field trials and initial installations, as well as provide ongoing pre-sales and post-sales support.
 
Competition
 
We face competition in various aspects of our technology and product development. Our products compete on the basis of performance, functionality, reliability, pricing, quality, and compliance with industry standards. Our current and potential competitors include conventional RF filter manufacturers, including CommScope, ADC, Powerwave, and RFS and both established and newly emerging companies developing similar or competing HTS technologies. We also compete with companies that design, manufacture and sell antenna-optimizing multiplexers and companies that seek to enhance base station range and selectivity by means other than a superconducting filter, including many original equipment manufacturers such as Ericsson and Nokia. In addition, we currently supply components and license technology to several companies that may eventually decide to manufacture or design their own HTS components, rather than purchasing or licensing our technology. With respect to our HTS materials, we compete with American Superconductor, SuperPower and THEVA, among others. In the government sector, we compete with universities, national laboratories and both large and small companies for research and development contracts, and with larger defense contractors, such as Raytheon and Northrop Grumman, for government products.
 
Research and Development
 
Our research and development efforts primarily involve engineering and design related to improving product lines and developing new products and technologies in the same or similar fields using our core technologies. We spent a total of $7.0 million, $7.0 million and $6.1 million on research and development for 2009, 2008 and 2007, respectively, of which $4.4 million, $3.4 million and $3.2 million, respectively, was for company-funded research and development. Customer-funded research and development, most of which was attributable to work under contracts with the U.S. Government, represented 37%, 52% and 48% of total research and development costs for each of 2009, 2008 and 2007, respectively.


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Environmental Issues
 
We use certain hazardous materials in our research, development and manufacturing operations. As a result, we are subject to stringent federal, state and local regulations governing the storage, use and disposal of such materials. Current or future laws and regulations could require substantial expenditures for preventative or remedial action, reduction of chemical exposure, waste treatment or disposal. Although we believe that our safety procedures for the handling and disposing of hazardous materials comply with the standards prescribed by state and federal regulations, there is always the risk of accidental contamination or injury from these materials. To date, we have not incurred substantial expenditures for preventive action with respect to hazardous materials or for remedial action with respect to any hazardous materials accident, but the use and disposal of hazardous materials involves risk that we could incur substantial expenditures for such preventive or remedial actions. If such an accident were to occur, we could be held liable for resulting damages. The liability in the event of an accident or the costs of such remedial actions could exceed our resources or otherwise have a material adverse effect on our financial condition, results of operations or cash flows.
 
Corporate Information
 
Our facilities and executive offices are located at 460 Ward Drive, Santa Barbara, California 93111, and our telephone number is (805) 690-4500. We were incorporated in Delaware on May 11, 1987. Additional information about us is available on our website at www.suptech.com. The information on our web site is not incorporated herein by reference.
 
Employees
 
As of December 31, 2009, we had a total of 105 employees. None of our employees are represented by a labor union, and we believe that our employee relations are good.
 
Backlog
 
Our commercial backlog consists of accepted product purchase orders with scheduled delivery dates during the next twelve months. We had commercial backlog of $795,000 at December 31, 2009, compared to $272,000 at December 31, 2008.
 
ITEM 1A.   RISK FACTORS
 
The following section includes some of the material factors that may adversely affect our business and operations. This is not an exhaustive list, and additional factors could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for us to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. This discussion of risk factors includes many forward-looking statements. For cautions about relying on such forward looking statements, please refer to the section entitled “Forward Looking Statements” at the beginning of this Report immediately prior to Item 1.
 
Risks Related to Our Business
 
We have a history of losses and may never become profitable.
 
In each of our last five years, we have experienced significant net losses and negative cash flows from operations. In 2009, we incurred a net loss of $13.0 million and had negative cash flows from operations of $7.4 million. In 2008, we incurred a net loss of $12.7 million and had negative cash flows from operations of $12.1 million. Our independent registered public accounting firm has included in its audit reports an explanatory paragraph expressing doubt about our ability to continue as a going concern. If we fail to increase our revenues, we may not achieve and maintain profitability and may not meet our expectations or the expectations of financial analysts who report on our stock.


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The current worldwide recession may adversely affect our business, operating results and financial condition.
 
The United States economy has recently experienced, and continues to experience, a financial downturn, with some financial and economic analysts predicting that the world economy may be entering into a prolonged economic downturn characterized by high unemployment, limited availability of credit, increased rates of default and bankruptcy and decreased consumer and business spending. These developments could negatively affect our business, operating results and financial condition in a number of ways. For example, current or potential customers may delay or decrease spending with us or may not pay us, or may delay paying us for previously purchased products. In addition, this downturn has had, and may continue to have, an unprecedented negative impact on the global credit markets. Credit has tightened significantly in the last several months, resulting in financing terms that are less attractive to borrowers, and in many cases, the unavailability of certain types of debt financing. If this crisis continues or worsens, and if we are required to obtain financing in the near term to meet our working capital or other business needs, we may not be able obtain that financing. Further, even if we are able to obtain the financing we need, it may be on terms that are not favorable to us, with increased financing costs and restrictive covenants.
 
We may need to raise additional capital, and if we are unable to raise capital our ability to implement our current business plan and ultimately our viability as a company could be adversely affected.
 
At December 31, 2009 we had $10.4 million in cash. Our cash resources, together with our line of credit, may not be sufficient to fund our business for at least the next twelve months. We believe the key factors to our future liquidity will be our ability to successfully use our expertise and our technology to generate revenues in various ways, including commercial operations, government contracts, joint ventures and licenses. Because of the uncertainty of these factors, we may need to raise funds to meet our working capital needs.
 
We cannot assure you that additional financing will be available on acceptable terms or at all. If we issue additional equity securities to raise funds, the ownership percentage of our existing stockholders would be reduced. New investors may demand rights, preferences or privileges senior to those of existing holders of common stock. If we cannot raise any needed funds, we might be forced to make further substantial reductions in our operating expenses, which could adversely affect our ability to implement our current business plan and ultimately our viability as a company.
 
We rely on a small number of customers for the majority of our commercial revenues, and the loss of any one of these customers, or a significant loss, reduction or rescheduling of orders from any of these customers, could have a material adverse effect on our business, results of operations and financial condition.
 
We sell most of our products to a small number of wireless carriers. We derived 92% of our commercial product revenues from Verizon Wireless and AT&T in both 2009 and 2008. We derived 75% of our commercial product revenues from Verizon Wireless and AT&T in 2007. Our future success depends upon the wireless carriers continuing to purchase our products, and fluctuations in demand from such customers could negatively impact our results. Unanticipated demand fluctuations can have a negative impact on our revenues and business and an adverse effect on our results of operations and financial condition.
 
In addition, our dependence on a small number of major customers exposes us to numerous other risks, including:
 
  •  a slowdown or delay in the deployment, upgrading or improvement of wireless networks by any one customer could significantly reduce demand for our products;
 
  •  reductions in a single customer’s forecasts and demand could result in excess inventories;
 
  •  each of our customers has significant purchasing leverage over us to require changes in sales terms including pricing, payment terms and product delivery schedules; and


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  •  concentration of accounts receivable credit risk, which could have a material adverse effect on our liquidity and financial condition if one of our major customers declared bankruptcy or delayed payment of their receivables.
 
Many of our customers also provide minimal lead-time prior to the release of their purchase orders and have non-binding commitments to purchase from us. If we fail to forecast our customer’s demands accurately, we could experience delays in manufacturing, which could result in customer dissatisfaction. Additionally, these factors further impact our ability to forecast future revenue.
 
We face competition with respect to various aspects of our technology and product development.
 
Our current products compete on the basis of performance, functionality, reliability, pricing, quality, and compliance with industry standards. Our current and potential competitors include conventional RF filter manufacturers, CommScope, ADC, Powerwave, and RFS and both established and newly emerging companies developing similar or competing HTS technologies. We also compete with companies that design, manufacture and sell antenna-optimizing multiplexers and companies that seek to enhance base station range and selectivity by means other than a superconducting filter, including many original equipment manufacturers such as Ericsson and Nokia. In addition, we currently supply components and license technology to several companies that may eventually decide to manufacture or design their own HTS components, rather than purchasing or licensing our technology. With respect to our HTS materials, we compete with American Superconductor, SuperPower and THEVA, among others. In the government sector, we compete with universities, national laboratories and both large and small companies for research and development contracts, and with larger defense contractors, such as Raytheon and Northrop Grumman, for government products. If we are unable to compete successfully against our current or future competitors, then our business and results of operations will be adversely affected.
 
The wireless communication industry is highly concentrated, which limits the number of potential customers, and further industry consolidation could result in the loss of key customers.
 
The wireless communication industry is highly concentrated in nature and may become more concentrated due to anticipated industry consolidation. As a result, we believe that the number of potential customers for our products may be limited. We also face significant risks in the event any of our key customers is acquired by a company that has not adopted our technology or not adopted it to the same extent. In that event, we could face a significant decline in our sales to the acquired customer.
 
We experience significant fluctuations in sales and operating results from quarter to quarter.
 
Our quarterly results fluctuate due to a number of factors, including:
 
  •  the lack of any contractual obligation by our customers to purchase their forecasted demand for our products;
 
  •  variations in the timing, cancellation, or rescheduling of customer orders and shipments; and
 
  •  high fixed expenses that may disproportionately impact operating expenses, especially during a quarter with a sales shortfall.
 
The nature of our business requires that we promptly ship products after we receive orders. This means that we typically do not have a significant backlog of unfilled orders at the start of each quarter. Our major customers generally have no contractual obligation to purchase forecasted amounts and may cancel orders, change delivery schedules or change the mix of products ordered with minimal notice and minimal penalty. As a result of these factors, we may not be able to accurately predict our quarterly sales. Any shortfall in sales relative to our quarterly expectations or any delay of customer orders would adversely affect our revenues and results of operations.
 
Order deferrals and cancellations by our customers, declining average sales prices, changes in the mix of products sold, increases in inventory and finished goods, delays in the introduction of new products and longer than anticipated sales cycles for our products have, in the past, adversely affected our results of operations. Despite these factors, we maintain significant finished goods, work-in-progress and raw materials inventory to meet estimated order forecasts. If our customers purchase less than the forecasted amounts or cancel or delay existing purchase orders, there will be higher levels of inventory that face a greater risk of obsolescence. If our customers desire to


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purchase products in excess of the forecasted amounts or in a different product mix, there may not be enough inventory or manufacturing capacity to fill their orders.
 
Due to these and other factors, our past results may not be reliable indicators of our future performance. Future revenues and operating results may not meet the expectations of stock analysts and investors. In either case, the price of our common stock could be materially adversely affected.
 
Our sales cycles are unpredictable, making future performance uncertain.
 
The sales cycle for telecommunications products includes identification of decision makers within the customers’ organizations, development of an understanding of customer-specific performance and economic issues, convincing the customer through field trial reports of the benefits of systems offered, negotiation of purchase orders and deployment. Customers who purchase our systems must commit a significant amount of capital and other resources. Our customers must consider budgetary constraints, comply with internal procedures for approving large expenditures and complete whatever testing is necessary for them to integrate new technologies that will impact their key operations. Customer delays can lengthen the sales cycles and have a material adverse effect on our business.
 
We depend on the capital spending patterns of wireless network operators, and if capital spending is decreased or delayed, our business may be harmed.
 
Because we rely on wireless network operators for product purchases, any substantial decrease or delay in capital spending patterns in the wireless communication industry may harm our business. Demand from customers for our products depends to a significant degree upon the amount and timing of capital spending by these customers for constructing, rebuilding or upgrading their systems. The capital spending patterns of wireless network operators depend on a variety of factors, including access to financing, the status of federal, local and foreign government regulation and deregulation, changing standards for wireless technology, overall demand for wireless services, competitive pressures and general economic conditions. In addition, capital spending patterns in the wireless industry can be subject to some degree of seasonality, with lower levels of spending in the first and third calendar quarters, based on annual budget cycles.
 
Our reliance on a limited number of suppliers and the long lead time of components for our products could impair our ability to manufacture and deliver our systems on a timely basis.
 
A number of components used in our products are available from a limited number of outside suppliers due to unique designs as well as certain quality and performance requirements. There are components that we source from a single vendor due to the present volume. Key components of our conventional products are manufactured by a sole foreign manufacturer. Our reliance on sole or limited source suppliers involves certain risks and uncertainties, many of which are beyond our control. These include the possibility of a shortage or the discontinuation of certain key components. Any reduced availability of these parts or components when required could impair our ability to manufacture and deliver our systems on a timely basis and result in the delay or cancellation of orders, which could harm our business.
 
In addition, the purchase of some of our key components involves long lead times and, in the event of unanticipated increases in demand for our solutions, we may be unable to obtain these components in sufficient quantities to meet our customers’ requirements. We do not have guaranteed supply arrangements with any of these suppliers, do not maintain an extensive inventory of parts or components and customarily purchase sole or limited source parts and components pursuant to purchase orders. Business disruptions, quality issues, production shortfalls or financial difficulties of a sole or limited source supplier could materially and adversely affect us by increasing product costs, or eliminating or delaying the availability of such parts or components. In such events, our inability to develop alternative sources of supply quickly and on a cost-effective basis could impair our ability to manufacture and deliver our systems on a timely basis and could harm our business.


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Our reliance on a limited number of suppliers exposes us to quality control issues.
 
Our reliance on certain single-source and limited-source components exposes us to quality control issues if these suppliers experience a failure in their production process or otherwise fail to meet our quality requirements. A failure in single-source or limited-source components or products could force us to repair or replace a product utilizing replacement components. If we cannot obtain comparable replacements or effectively return or redesign our products, we could lose customer orders or incur additional costs, which could have a material adverse effect on our gross margins and results of operations.
 
We expect decreases in average selling prices, requiring us to reduce product costs in order to achieve and maintain profitability.
 
The average selling price of our products has decreased over the years. We anticipate customer pressure on our product pricing will continue for the foreseeable future. We have plans to further reduce the manufacturing cost of our products, but there is no assurance that our future cost reduction efforts will keep pace with price erosion. We will need to further reduce our manufacturing costs through engineering improvements and economies of scale in production and purchasing in order to achieve adequate gross margins. We may not be able to achieve the required product cost savings at a rate needed to keep pace with competitive pricing pressure. Additionally, we may be forced to discount future orders. If we fail to reach our cost saving objectives or we are required to offer future discounts, our business may be harmed.
 
Our ability to protect our patents and other proprietary rights is uncertain, exposing us to possible losses of competitive advantage.
 
Our efforts to protect our proprietary rights may not succeed in preventing infringement by others or ensure that these rights will provide us with a competitive advantage. Pending patent applications may not result in issued patents and the validity of issued patents may be subject to challenge. Third parties may also be able to design around the patented aspects of the products. Additionally, certain of the issued patents and patent applications are owned jointly with third parties. Because any owner or co-owner of a patent can license its rights under jointly-owned patents or applications, inventions made by us jointly with others are not subject to our exclusive control. Any of these possible events could result in losses of competitive advantage.
 
We depend on specific patents and licenses to technologies, and we will likely need additional technologies in the future that we may not be able to obtain.
 
We utilize technologies under licenses of patents from others for our products. These patents may be subject to challenge, which may result in significant litigation expense (which may or may not be recoverable against future royalty obligations). Additionally, we continually try to develop new products, and, in the course of doing so, we may be required to utilize intellectual property rights owned by others and may seek licenses to do so. Such licenses may not be obtainable on commercially reasonable terms, or at all. It is also possible that we may inadvertently utilize intellectual property rights held by others, which could result in substantial claims.
 
Intellectual property infringement claims against us could materially harm results of operations.
 
Our products incorporate a number of technologies, including high-temperature superconductor technology, technology related to other materials, and electronics technologies. Our patent positions, and that of other companies using high-temperature superconductor technology, is uncertain and there is significant risk that others, including our competitors or potential competitors, have obtained or will obtain patents relating to our products or technologies or products or technologies planned to be introduced by us.
 
We believe that patents may be or have been issued, or applications may be pending, claiming various compositions of matter used in our products. We may need to secure one or more licenses of these patents. There can be no assurances that such licenses could be obtained on commercially reasonable terms, or at all. We may be required to expend significant resources to develop alternatives that would not infringe such patents or to obtain licenses to the related technology. We may not be able to successfully design around these patents or obtain licenses to them and may have to defend ourselves at substantial cost against allegations of infringement of third party


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patents or other rights to intellectual property. In those circumstances, we could face significant liabilities and also be forced to cease the use of key technology.
 
We currently rely on specific technologies and may not successfully adapt to the rapidly changing wireless telecommunications equipment market.
 
Wireless telecommunication equipment is characterized by rapidly advancing technology. Our success depends upon our ability to keep pace with advancing wireless technology, including materials, processes and industry standards. For example, we had to redesign our SuperLink product to convert from thallium barium calcium copper oxide to yttrium barium copper oxide in order to reduce the product cost and compete with other technologies. However, even with the lower cost HTS material, SuperLink may not ultimately prove commercially competitive against other current technologies or those that may be discovered in the future.
 
We will have to continue to develop and integrate advances to our core technologies. We will also need to continue to develop and integrate advances in complementary technologies. We cannot guarantee that our development efforts will not be rendered obsolete by research efforts and technological advances made by others.
 
Other parties may have the right to utilize technology important to our business.
 
We utilize certain intellectual property rights under non-exclusive licenses or have granted to others the right to utilize certain intellectual property rights licensed from a third party. Because we may not have the exclusive rights to utilize such intellectual property, other parties may be able to compete with us, which may harm our business.
 
Our failure to anticipate and respond to developments in the wireless telecommunications market could substantially harm our business.
 
Our efforts are focused on the wireless telecommunications market. The dedication of our resources to the wireless telecommunications market makes us potentially vulnerable to changes in this market, such as new technologies like WIMAX, future competition, changes in availability of capital resources or regulatory changes that could affect the competitive position and rate of growth of the wireless industry.
 
We may not be able to compete effectively against alternative technologies.
 
Our products compete with a number of alternative approaches and technologies that increase the capacity and improve the quality of wireless networks. Some of these alternatives may be more cost effective or offer better performance than our products. Wireless network operators may opt to increase the number of transmission stations, increase tower heights, install filters and amplifiers at the top of towers or use advanced antenna technology in lieu of purchasing our products. We may not succeed in competing against these alternatives.
 
We depend upon government contracts for a substantial amount of revenue and our business may suffer if significant contracts are terminated, adversely modified, or we are unable to win new contracts.
 
We derive a substantial portion of our revenue from a few large contracts with the U.S. government. As a result, a reduction in, or discontinuance of, the government’s commitment to current or future programs could materially reduce government contract revenue.
 
Contracts involving the U.S. government may include various risks, including:
 
  •  termination by the government;
 
  •  reduction or modification in the event of changes in the government’s requirements or budgetary constraints;
 
  •  increased or unexpected costs causing losses or reduced profits under contracts where prices are fixed or unallowable costs under contracts where the government reimburses for costs and pays an additional premium;
 
  •  risks of potential disclosure of confidential information to third parties;


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  •  the failure or inability of the main contractor to perform its contract in circumstances where we are a subcontractor;
 
  •  the failure of the government to exercise options for additional work provided for in the contracts; and
 
  •  the government’s right in certain circumstances to freely use technology developed under these contracts.
 
The programs in which we participate may extend for several years, but are normally funded on an annual basis. The U.S. government may not continue to fund programs under which we have entered into contracts. Even if funding is continued, we may fail to compete successfully to obtain funding within such programs.
 
All costs for services under government contracts are subject to audit, and the acceptance of such costs as allowable and allocable is subject to federal regulatory guidelines. We record contract revenues in amounts that we expect to be realized upon final audit settlement. Any disallowance of costs by the government could have an adverse effect on our business, operating results and financial condition. Audits and adjustments may result in decreased revenues and net income for those years. Additionally, because of our participation in government contracts, we are subject to audit from time to time for our compliance with government regulations by various agencies. Government agencies may conduct inquiries or investigations that may cover a broad range of activity. Responding to any such audits, inquiries or investigations may involve significant expense and divert management’s attention. In addition, an adverse finding in any such audit, inquiry or investigation could involve penalties that may harm our business.
 
Because competition for target employees is intense, we may be subject to claims of unfair hiring practices, trade secret misappropriation or other related claims.
 
Companies in the wireless telecommunications industry whose employees accept positions with competitors frequently claim that competitors have engaged in unfair hiring practices, trade secret misappropriation or other related claims. We may be subject to such claims in the future as we seek to hire qualified personnel, and such claims may result in material litigation. If this should occur, we could incur substantial costs in defending against these claims, regardless of their merits.
 
If we are unable to forecast our inventory needs accurately, we may be unable to obtain sufficient manufacturing capacity or may incur unnecessary costs and produce excess inventory.
 
We forecast our inventory needs based on anticipated purchase orders to determine manufacturing requirements. If we overestimate demand, we may have excess inventory, and our suppliers may as well, which could increase our costs. If we underestimate our requirements, our suppliers may have inadequate inventory, which could interrupt manufacturing and result in delays in shipments and recognition of revenues. In addition, lead times for ordering materials and components vary significantly and depend on factors such as the specific supplier, contract terms and demand for any component at a given time. Accordingly, if we inaccurately forecast demand, we may be unable to obtain adequate manufacturing capacity from our suppliers to meet customers’ delivery requirements, which would harm our business.
 
Our success depends on the attraction and retention of senior management and technical personnel with relevant expertise.
 
As a competitor in a highly technical market, we depend heavily upon the efforts of our existing senior management and technical teams. The loss of the services of one or more members of these teams could slow product development and commercialization objectives. Due to the specialized nature of our products, we also depend upon our ability to attract and retain qualified technical personnel with substantial industry knowledge and expertise. Competition for qualified personnel is intense, and we may not be able to continue to attract and retain qualified personnel necessary for the development of our business.
 
We have experienced difficulty recruiting senior management due to the high cost of living in the Santa Barbara area. We have a limited pool of qualified executives in Santa Barbara and may attempt to recruit qualified candidates from across the country. Some candidates have cited the high cost of housing in Santa Barbara as a significant negative factor when considering our employment offers. We have mitigated this problem to a limited


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extent by allowing some executives to maintain their existing residences in other parts of the country and effectively “commute” to our corporate headquarters in Santa Barbara as needed to perform their duties. Regardless, we expect the cost of housing in our area will continue to present a significant obstacle to recruiting senior executives.
 
Regulatory changes negatively affecting wireless communications companies could substantially harm our business.
 
The Federal Communications Commission strictly regulates the operation of wireless base stations in the United States. Other countries also regulate the operation of base stations within their territories. Base stations and equipment marketed for use in base stations must meet specific technical standards. Our ability to sell our high-temperature superconductor filter subsystems will depend upon the rate of deployment of other new wireless digital services, the ability of base station equipment manufacturers and of base station operators to obtain and retain the necessary approvals and licenses, and changes in regulations that may impact the product requirements. Any failure or delay of base station manufacturers or operators in obtaining necessary approvals could harm our business.
 
We may acquire or make investments in companies or technologies that could cause loss of value to stockholders and disruption of business.
 
We may explore opportunities to acquire companies or technologies in the future. Other than the acquisition of Conductus, Inc. in 2002, we have not made any such acquisitions or investments to date and, therefore, our ability as an organization to make acquisitions or investments is unproven. An acquisition entails many risks, any of which could adversely affect our business, including:
 
  •  failure to integrate operations, services and personnel;
 
  •  the price paid may exceed the value eventually realized;
 
  •  loss of share value to existing stockholders as a result of issuing equity securities to finance an acquisition;
 
  •  potential loss of key employees from either our then current business or any acquired business;
 
  •  entering into markets in which we have little or no prior experience;
 
  •  diversion of financial resources and management’s attention from other business concerns;
 
  •  assumption of unanticipated liabilities related to the acquired assets; and
 
  •  the business or technologies acquired or invested in may have limited operating histories and may be subjected to many of the same risks to which we are exposed.
 
In addition, future acquisitions may result in potentially dilutive issuances of equity securities, or the incurrence of debt, contingent liabilities or amortization expenses or charges related to goodwill or other intangible assets, any of which could harm our business. As a result, if we fail to properly evaluate and execute acquisitions or investments, our business and prospects may be seriously harmed.
 
If we are unable to implement appropriate controls and procedures to manage our potential growth, we may not be able to successfully offer our products and implement our business plan.
 
Our ability to successfully offer our products and implement our business plan in a rapidly evolving market requires an effective planning and management process. Growth in future operations would place a significant strain on management systems and resources. We expect that we would need to improve our financial and managerial controls, reporting systems and procedures, and would need to expand, train and manage our work force worldwide. Furthermore, we expect that we would be required to manage multiple relationships with various customers and other third parties.


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Compliance with environmental regulations could be especially costly due to the hazardous materials used in the manufacturing process.
 
We are subject to a number of federal, state and local governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in our business. Any failure to comply with present or future regulations could result in fines being imposed, suspension of production or interruption of operations. In addition, these regulations could restrict our ability to expand or could require us to acquire costly equipment or incur other significant expense to comply with environmental regulations or to clean up prior discharges.
 
The reliability of market data included in our public filings is uncertain.
 
Since we operate in a rapidly changing market, we have in the past, and may from time to time in the future, include market data from industry publications and our own internal estimates in some of the documents we file with the Securities and Exchange Commission. The reliability of this data cannot be assured. Industry publications generally state that the information contained in these publications has been obtained from sources believed to be reliable, but that its accuracy and completeness is not guaranteed. Although we believe that the market data used in our filings with the Securities and Exchange Commission is and will be reliable, it has not been independently verified. Similarly, internal company estimates, while believed by us to be reliable, have not been verified by any independent sources.
 
Our international operations expose us to certain risks.
 
In November 2007, we signed an agreement for a joint venture with BAOLI to manufacture and market our SuperLink® interference elimination solution for the China market. In additional to facing many of the risks faced by our domestic business, if that joint venture or any other international operation we may have is to be successful, we (together with any joint venture partner) must recruit the necessary personnel and develop the facilities needed to manufacture and sell the products involved, learn about the local market (which may significantly different from our domestic market), build brand awareness among potential customers and compete successfully with local organizations with greater market knowledge and potentially greater resources than we have. We must also obtain a number of critical governmental approvals from both the United States and the local country governments on a timely basis, including those related to any transfers of our technology. We must establish sufficient controls on any foreign operations to ensure that those operations are operated in accordance with our interests, that our intellectual property is protected and that our involvement does not inadvertently create potential competitors. There can be no assurance that these conditions will be met. Even if they are met, the process of building our international operations could divert financial resources and management attention from other business concerns. Finally, our international operations will also be subject to the general risks of international operations, such as:
 
  •  changes in exchange rates;
 
  •  international political and economic conditions;
 
  •  changes in government regulation in various countries;
 
  •  trade barriers;
 
  •  adverse tax consequences; and
 
  •  costs associated with expansion into new territories.
 
Risks Related to Our Common Stock
 
Our stock price is volatile.
 
The market price of our common stock has been, and we expect will continue to be, subject to significant volatility. The value of our common stock may decline regardless of our operating performance or prospects. Factors affecting our market price include:
 
  •  our perceived prospects;


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  •  variations in our operating results and whether we have achieved key business targets;
 
  •  changes in, or our failure to meet, earnings estimates;
 
  •  changes in securities analysts’ buy/sell recommendations;
 
  •  differences between our reported results and those expected by investors and securities analysts;
 
  •  announcements of new contracts by us or our competitors;
 
  •  market reaction to any acquisitions, joint ventures or strategic investments announced by us or our competitors; and
 
  •  general economic, political or stock market conditions.
 
Recent events have caused stock prices for many companies, including ours, to fluctuate in ways unrelated or disproportionate to their operating performance. The general economic, political and stock market conditions that may affect the market price of our common stock are beyond our control. The market price of our common stock at any particular time may not remain the market price in the future.
 
We have a significant number of outstanding warrants and options, and future sales of these shares could adversely affect the market price of our common stock.
 
As of March 10, 2010, we had outstanding warrants and options exercisable for an aggregate of 1,530,000 shares of common stock at a weighted average exercise price of $10.08 per share. We have registered the issuance of all these shares, and they will be freely tradable by the exercising party upon issuance. The holders may sell these shares in the public markets from time to time, without limitations on the timing, amount or method of sale. As our stock price rises, the holders may exercise their warrants and options and sell a large number of shares. This could cause the market price of our common stock to decline.
 
Our corporate governance structure may prevent our acquisition by another company at a premium over the public trading price of our shares.
 
It is possible that the acquisition of a majority of our outstanding voting stock by another company could result in our stockholders receiving a premium over the public trading price for our shares. Provisions of our restated certificate of incorporation and bylaws and of Delaware corporate law could delay or make more difficult an acquisition of our company by merger, tender offer or proxy contest, even if it would create an immediate benefit to our stockholders. For example, our restated certificate of incorporation does not permit stockholders to act by written consent and our bylaws generally require ninety days advance notice of any matters to be brought before the stockholders at an annual or special meeting.
 
In addition, our board of directors has the authority to issue up to 2,000,000 shares of preferred stock and to determine the terms, rights and preferences of this preferred stock, including voting rights of those shares, without any further vote or action by the stockholders. At March 10, 2010, 1,388,477 shares of preferred stock remained unissued. The rights of the holders of common stock may be subordinate to, and adversely affected by, the rights of holders of preferred stock that may be issued in the future. The issuance of preferred stock could also make it more difficult for a third party to acquire a majority of our outstanding voting stock, even at a premium over our public trading price.
 
Further, our certificate of incorporation also provides for a classified board of directors with directors divided into three classes serving staggered terms. These provisions may have the effect of delaying or preventing a change in control of us without action by our stockholders and, therefore, could adversely affect the price of our stock or the possibility of sale of shares to an acquiring person.
 
We do not anticipate declaring any cash dividends on our common stock.
 
We have never declared or paid cash dividends on our common stock and do not plan to pay any cash dividends in the near future. Our current policy is to retain all funds and earnings for use in the operation and expansion of our


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business. In addition, our debt agreements prohibit the payment of cash dividends or other distributions on any of our capital stock except dividends payable in additional shares of capital stock.
 
ITEM 1B.   UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2.   PROPERTIES
 
We lease all of our properties. All of our operations, including our manufacturing facility, are located in an industrial complex in Santa Barbara, California. We occupy approximately 71,000 square feet in this complex under a long-term lease that expires in 2016. Although we currently have excess capacity, we believe this facility can be managed in a flexible and cost effective manner and is adequate to meet current and reasonably anticipated needs for approximately the next two years.
 
ITEM 3.   LEGAL PROCEEDINGS
 
From time to time, we are party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of our business. Excluding ordinary, routine litigation incidental to our business, we are not currently a party to any legal proceedings that we believe would reasonably be expected to have a material adverse effect on our business, financial condition or results of operation or cash flow.
 
ITEM 4.   REMOVED
 
 
PART II
 
 
ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market for Common Stock
 
Our common stock is traded on the NASDAQ Capital Market under the symbol “SCON.” The following table shows the high and low sales prices for our common stock as reported by NASDAQ for each calendar quarter in the last two fiscal years:
 
                 
    High   Low
 
2009
               
Quarter ended December 31, 2009
  $ 3.35     $ 2.08  
Quarter ended September 26, 2009
  $ 3.99     $ 2.22  
Quarter ended June 27, 2009
  $ 5.45     $ 0.93  
Quarter ended March 28, 2009
  $ 1.45     $ 0.82  
2008
               
Quarter ended December 31, 2008
  $ 1.50     $ 0.68  
Quarter ended September 27, 2008
  $ 2.43     $ 0.73  
Quarter ended June 28, 2008
  $ 4.83     $ 2.18  
Quarter ended March 29, 2008
  $ 6.80     $ 3.22  
 
Holders of Record
 
We had 164 holders of record of our common stock on March 1, 2010. This number does not include stockholders for whom shares were held in a “nominee” or “street” name. We estimate that there are more than 12,000 beneficial owners of our common stock.


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Dividends
 
We have never paid cash dividends and intend to employ all available funds in the development of our business. We have no plans to pay cash dividends in the near future, and our line of credit does not allow the payment of dividends.
 
Our ability to declare or pay dividends on shares of our common stock is subject to the requirement that we pay an equivalent dividend on each outstanding share of Series A Preferred Stock (on an as-converted basis).
 
Sales of Unregistered Securities
 
We did not conduct any offerings of equity securities during the fourth quarter of 2009 that were not registered under the Securities Act of 1933.
 
Repurchases of Equity Securities
 
We did not repurchase any shares of our common stock during the fourth quarter of 2009.
 
Securities Authorized for Issuance Under Equity Compensation Plans
 
                         
                Number of
 
                Securities
 
    Number of
          Remaining Available
 
    Securities to Be
          for Future Issuance
 
    Issued Upon
    Weighted-Average
    Under Equity
 
    Exercise of
    Exercise Price of
    Compensation Plans
 
    Outstanding
    Outstanding
    (Excluding
 
    Options, Warrants
    Options, Warrants
    Securities
 
Plan Category
  and Rights     and Rights     Reflected in Column(a))  
 
Equity compensation plans approved by security holders
    1,144,876     $ 20.16       213,380  
Equity compensation plans not approved by security holders
                 
                         
Total
    1,144,876     $ 20.16       213,380  
                         


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Stock Performance Graph
 
The stock performance graph and related information presented below shall not be deemed “soliciting material” or “filed” with the Securities and Exchange Commission or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or to the liabilities of Section 18 of the Exchange Act, and shall not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended (the “Securities Act”), or the Exchange Act, except to the extent that we specifically request that such information be treated as soliciting material or specifically incorporate it by reference into such a filing.
 
The graph and table below compare the cumulative total stockholders’ return on our common stock since December 31, 2004 with the Nasdaq Composite Index, and the Nasdaq Telecommunications Index over the same period (assuming the investment of $100 in our common stock and in the two other indices, and reinvestment of all dividends).
 
(PERFORMANCE GRAPH)
 
                                                             
      31-Dec-04       31-Dec-05       31-Dec-06       31-Dec-07       31-Dec-08       31-Dec-09  
Superconductor Technologies
    $ 100.00       $ 30.94       $ 12.73       $ 39.93       $ 7.27       $ 17.55  
Nasdaq Composite
      100.00         101.37         111.03         121.92         72.49         104.31  
Nasdaq-Telecommunications
      100.00         92.79         118.55         129.42         73.79         109.39  
                                                             


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ITEM 6.   SELECTED FINANCIAL DATA
 
The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with our Financial Statements and Notes thereto appearing in Item 15 of Part IV of this Report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.
 
                                         
    Years Ended December 31,  
    2009     2008     2007     2006     2005  
    (In thousands, except per share data)  
 
Statement of Operations Data:
                                       
Net revenues:
                                       
Net commercial product revenues
  $ 7,239     $ 6,768     $ 12,787     $ 17,697     $ 21,080  
Government and other contract revenues
    3,577       4,525       5,115       3,361       3,107  
Sub license royalties
                      20       22  
                                         
Total net revenues
    10,816       11,293       17,902       21,078       24,209  
Costs and expenses:
                                       
Cost of commercial product revenues
    9,102       8,911       12,944       15,922       18,989  
Cost of government and other contract revenues
    2,552       3,649       2,906       2,407       2,806  
Other research and development
    4,399       3,394       3,172       3,488       4,214  
Selling, general and administrative
    6,925       8,151       8,123       9,086       11,442  
Restructuring expenses and impairment charges
          141             38       1,197  
Write off of Goodwill
                      20,107        
                                         
Total costs and expenses
    22,978       24,246       27,145       51,048       38,648  
                                         
Loss from operations
    (12,162 )     (12,953 )     (9,243 )     (29,970 )     (14,439 )
Other income (expense), net
    (817 )     252       117       346       226  
                                         
Net loss
  $ (12,979 )   $ (12,701 )   $ (9,126 )   $ (29,624 )   $ (14,213 )
                                         
Basic and diluted net loss per common share
  $ (0.65 )   $ (0.77 )   $ (0.73 )   $ (2.37 )   $ (1.24 )
                                         
Weighted average number of shares Outstanding
    19,843       16,403       12,488       12,483       11,419  
 
                                         
    Years Ended December 31,
    2009   2008   2007   2006   2005
 
Balance Sheet Data:
                                       
Cash and cash equivalents
  $ 10,365     $ 7,569     $ 3,939     $ 5,487     $ 13,018  
Working capital
    12,557       12,253       3,293       10,158       17,218  
Total assets
    18,126       19,358       16,625       21,904       52,045  
Long-term debt, including current portion
    576       521       563       618       33  
Total stockholders’ equity
  $ 16,241     $ 17,552     $ 9,190     $ 17,951     $ 47,257  


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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes many forward-looking statements. For cautions about relying on such forward looking statements, please refer to the section entitled “Forward Looking Statements” at the beginning of this Report immediately prior to Item 1.
 
General
 
We are a leading company in HTS materials and related technologies. HTS materials have the unique ability to conduct various signals or energy (e.g., electrical current or RF signals) with little or no resistance when cooled to “critical” temperatures. Electric currents that flow through conventional conductors encounter resistance that requires power to overcome and generates heat. HTS materials can substantially improve the performance characteristics of electrical systems, reducing power loss, lowering heat generation and decreasing electrical noise. Circuits designed to remove interference inherent in some RF signals can also be made from HTS materials. Commercial use of HTS materials requires a number of cutting edge technologies, including development of HTS materials, specialized manufacturing expertise to create uniform thin layers of these materials, expert designs of circuits optimized for HTS materials, and technologies to maintain an extremely low temperature environment for HTS applications (although the critical temperatures for HTS are “high” compared with traditional superconductors, they are still extremely cold by other standards).
 
Our Proprietary Technology
 
We are focused on research and development to maintain our technological edge. As of December 31, 2009, we had 34 employees in our research and development division; 9 of our employees have Ph.D.s, and 14 others hold advanced degrees in physics, materials science, electrical engineering and other fields. Our development efforts over the last 22 years have yielded an extensive patent portfolio as well as critical trade secrets, unpatented technology and proprietary knowledge. We enter into confidentiality and non-disclosure agreements with our employees, suppliers and consultants to protect our proprietary information. As of December 31, 2009, we held 59 U.S. patents in the following categories:
 
  •  8 patents for technologies directed toward producing thin-film materials and structures, which expire between 2010 and 2025. We have developed a proprietary state-of-the-art manufacturing process for producing HTS thin-films of the highest quality.
 
  •  32 patents for cryogenic and non-microwave circuit designs, which expire between 2010 and 2028. The expertise of our highly qualified team has allowed us to design and fabricate extremely small, high-performance circuits including RF signal filters.
 
  •  17 patents covering cryogenics, packaging and systems, which expire between 2013 and 2025. Our proprietary and patented cryogenic packaging innovation provides us with a significant competitive advantage in maintaining our HTS materials at their critical temperatures.
 
  •  2 patents covering other superconducting technologies, which expire between 2013 and 2015.
 
As of December 31, 2009, we also had 19 issued foreign patents, 21 U.S. patent applications pending and 60 foreign applications patents pending.
 
We are currently focusing our efforts on applications in areas such as:
 
  •  Wireless Networks.  Our current commercial products help maximize the performance of wireless telecommunications networks by improving the quality of uplink signals from mobile wireless devices. Our products increase capacity utilization, lower dropped and blocked calls, extend coverage, and enable higher wireless data throughput — all while reducing capital and operating costs. We are leveraging our unique filtering technology to pursue wireless business on multiple fronts: capturing wireless business with tier one U.S. wireless carriers for the LTE network build out, and developing our advanced reconfigurable filtering technology, which has the potential to drastically reduce the size and cost of mobile devices.


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  •  Superconducting Power Applications.  We are adapting our unique HTS materials deposition techniques to deliver energy efficient, cost-effective and high performance 2G HTS wire technology for next generation power applications. A variety of large, high potential, initial target markets have been identified for our 2G HTS wire including: energy (wind turbines, smart grid), industrial (motors, generators) and healthcare (MRI) applications. To accelerate development and manufacturing processes for our 2G HTS wire, we are partnering with HTS industry leaders, United States National Labs and the DOE. In August 2009, we renewed our two year Cooperative Research and Development Agreement with LANL. These technological interchanges will help us meet the technical challenges and performance metrics for both high performance and cost effective 2G HTS wire.
 
  •  Government Products.  As the worldwide leader in developing tunable HTS filter systems for military applications, we continue to be a crucial partner in the U.S. government’s future success. Our high-performance HTS filter systems have been proven to increase the detection range, reduce interference, and in some cases, detect signals that were previously undetectable with conventional technology. Currently, we actively participate in the development of technologies for application in military communications, signals intelligence, and electronic warfare.
 
Our development efforts can take a significant number of years to commercialize, and we must overcome significant technical barriers and deal with other significant risks, some of which are set out in our public filings, including in particular the “Risk Factors” included in Item 1A of this Report.
 
Our Business Model
 
To be successful, we must use our expertise and our technology to generate revenues in various ways, including government contracts, commercial operations, joint ventures and licenses:
 
Government Contracts
 
We generate significant revenues from government contracts. For 2009, 2008 and 2007, government related contracts accounted for 32%, 40% and 29%, respectively, of our net revenues. We typically own the intellectual property developed under these contracts, and grant the Federal government a royalty-free, non-exclusive and nontransferable license to use it. As a result, our government contracts can not only generate a profit for us, but we can also make additional money through exploiting of the resulting technology in our commercial operations as well as government products, or through licenses or joint ventures. Contracts with the U.S. government contain provisions, and are subject to laws and regulations, that give the government rights and remedies not typically found in commercial contracts, including rights that allow the government to:
 
  •  terminate existing contracts for convenience, which affords the U.S. government the right to terminate the contract in whole or in part any time it wants for any reason or no reason, as well as for default;
 
  •  reduce or modify contracts or subcontracts, if its requirements or budgetary constraints change;
 
  •  cancel or reduce multi-year contracts and related orders, if funds for contract performance for any subsequent year become unavailable;
 
  •  adjust reimbursable contract costs and fees on the basis of audits completed by its agencies through exercise of its oversight rights; and
 
  •  control or prohibit the export of products.
 
Compensation in the event of a termination, if any, is limited to compensation for work completed at the time of termination. In the event of termination for convenience, we may receive a certain allowance for profit on the work performed.
 
Commercial Applications
 
We have chosen to manufacture and sell certain commercial products on our own. To date, our commercial efforts have been focused on the design, manufacture, and sale of high performance infrastructure products for


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wireless voice and data applications. We have three current product lines, all of which relate to wireless base stations:
 
  •  SuperLink, a highly compact and reliable receiver front-end HTS wireless filter system to eliminate out-of-band interference for wireless base stations, combining filters with a proprietary cryogenic cooler and a cooled low-noise amplifier.
 
  •  AmpLink, a ground-mounted unit for wireless base stations that includes a high-performance amplifier and up to six dual duplexers.
 
  •  SuperPlex, a high-performance multiplexer that provides extremely low insertion loss and excellent cross-band isolation designed to eliminate the need for additional base station antennas and reduce infrastructure costs.
 
We sell most of our current commercial products to a small number of wireless carriers in the United States, including Alltel, AT&T, Sprint Nextel, T-Mobile and Verizon Wireless. Verizon Wireless and AT&T each accounted for more than 10% of our commercial revenues in 2009, 2008 and 2007. We are seeking to expand our customer base by selling directly to other wireless network operators and manufacturers of base station equipment, including internationally. Demand for wireless communications equipment fluctuates dramatically and unpredictably. The wireless communications infrastructure equipment market is extremely competitive and is characterized by rapid technological change, new product development, product obsolescence, evolving industry standards and price erosion over the life of a product. We face constant pressures to reduce prices. Consequently, we expect the average selling prices of our products will continue decreasing over time. We expect these trends to continue and may cause significant fluctuations in our quarterly and annual revenues. Our commercial operations are subject to a number of significant risks, some of which are set out in our public filings, including in particular the “Risk Factors” included in Item 1A of this Report.
 
Joint Ventures
 
From time to time we may pursue joint ventures with other entities to commercialize our technology. In particular, we have agreed to license certain technology for our SuperLink interference elimination solution for the China market to a joint venture where we own 45 percent of the equity. In 2008, we received orders from the joint venture for our new TD-SCDMA solution to perform lab and field trial activities in China. The lab and field trial was successfully completed in 2008 and in 2009 we successfully completed field trials in the existing China 2G market using our SuperLink solution. The commencement of manufacturing and the transfer of our processes to the joint venture will be driven by product demand from the China market. The joint venture’s activities remain subject to successful product marketing efforts in addition to a number of other conditions, including certain critical approvals from the Chinese and United States governments. In particular, we have been in discussions with the United States government concerning the national security implications of our joint venture and investment from BAOLI. There continues to be no assurance that these conditions will be met, or that all required approvals (if obtained) will be obtained on a timely basis. Even if these conditions are met and the approvals received, the results from our joint venture will be subject to a number of significant risks associated with international operations and new ventures, some of which are set forth in our public filings, including in particular the “Risk Factors” included in Item 1A of this Report.
 
Licenses
 
From time to time we grant licenses for our technology to other companies. Specifically, we have granted licenses to, among others, (1) Bruker for Nuclear Magnetic Resonance application, (2) General Dynamics for government applications and (3) Star Cryoelectronics for Superconducting Quantum Interference Device applications.


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Backlog
 
Our commercial backlog consists of accepted product purchase orders with scheduled delivery dates during the next twelve months. We had commercial backlog of $795,000 at December 31, 2009, compared to $272,000 at December 31, 2008.
 
Results of Operations
 
2009 Compared to 2008
 
Net revenues consist primarily of commercial product revenues and government contract revenues. Net revenues decreased by $0.5 million, or 4%, to $10.8 million in 2009 from $11.3 million in 2008.
 
Net commercial product revenues increased by $0.4 million, or 7%, to $7.2 million in 2009 from $6.8 million in 2008. The increase is the result of higher sales volume for our SuperLink products. Average sales prices for our products were essentially unchanged in 2009 from 2008. Our two largest customers accounted for 92% of our net commercial revenues in 2009 and 2008. These customers generally purchase products through non-binding commitments with minimal lead-times. Consequently, our commercial product revenues can fluctuate dramatically from quarter to quarter based on changes in our customers’ capital spending patterns.
 
Government contract revenues decreased by $0.9 million, or 21%, to $3.6 million in 2009 from $4.5 million in 2008. This decrease is attributable to the completion of the first phase of a major contract and a funding gap before the second phase of that contract was funded in our second quarter and increased efforts on our research and development activities.
 
Cost of commercial product revenues includes all direct costs, manufacturing overhead and provision for excess and obsolete inventories. The cost of commercial product revenues totaled $9.1 million for 2009 compared to $8.9 million for 2008, an increase of $0.2 million, or 2%. The higher costs resulted principally from higher production as a result of higher sales. Our expense provision for obsolete inventories totaled $282,000 in 2009 compared to $17,000 in 2008.
 
Our cost of sales includes both variable and fixed cost components. The variable component consists primarily of materials, assembly and test labor, overhead, which includes equipment and facility depreciation, transportation costs and warranty costs. The fixed component includes test equipment and facility depreciation, purchasing and procurement expenses and quality assurance costs. Given the fixed nature of such costs, the absorption of our production overhead costs into inventory decreases, and the amount of production overhead variances expensed to cost of sales increases, as production volumes decline since we have fewer units to absorb our overhead costs against. Conversely, the absorption of our production overhead costs into inventory increases, and the amount of production overhead variances expensed to cost of sales decreases, as production volumes increase since we have more units to absorb our overhead costs against. As a result, our gross profit margins generally decrease as revenue and production volumes decline due to lower sales volume and higher amounts of production overhead variances expensed to cost of sales; and our gross profit margins generally increase as our revenue and production volumes increase due to higher sales volume and lower amounts of production overhead variances expensed to cost of sales. Our inventory is valued at the lower of its actual cost or the current estimated market value of the inventory. We review inventory quantities on hand and on order and record, on a quarterly basis, a provision for excess and obsolete inventory and/or vendor cancellation charges related to purchase commitments. If the results of the review determine that a write-down is necessary, we recognize a loss in the period in which the loss is identified, whether or not the inventory is retained.
 
The following is an analysis of our commercial product gross profit margins for 2009 and 2008:
 
                                 
    Years Ended December 31,  
    2009     2008  
    Dollars in thousands  
 
Net commercial product sales
  $ 7,239       100.0 %   $ 6,768       100.0 %
Cost of commercial product sales
    9,102       125.7 %     8,911       131.7 %
                                 
Gross loss
  $ (1,863 )     25.7 %   $ (2,143 )     (31.7 )%
                                 


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We had a negative gross margin of $1.9 million in 2009 from the sale of our commercial products compared to a negative gross margin of $2.1 million in 2008. The negative gross margin in 2009 is primarily because the reduced level of commercial sales was insufficient to cover our fixed manufacturing overhead costs. Our gross margins were also adversely impacted by a $282,000 charge for excess and obsolete inventory in 2009 and a similar charge of $17,000 in 2008. Gross margins were favorably impacted by $261,000 in 2009 by the sale of previously written-off inventory. There was no similar benefit in 2008. We regularly review inventory quantities on hand and provide an allowance for excess and obsolete inventory based on numerous factors, including sales backlog, historical inventory usage, forecasted product demand and production requirements for the next twelve months.
 
Cost of contract research and development totaled $2.6 million in 2009 compared to $3.6 million in 2008, a decrease of $1.0 million, or 28%. Because these contracts are generally priced on a “cost plus” basis, declines in revenue generally result in declines in associated costs. As a percentage of government revenue, contract research and development expenses decreased from 81% in 2008 to 71% in 2009 because of different cost recognition criteria on one of our 2009 cost-plus contracts.
 
Research and development expenses relate to development of new wireless commercial products and other products related to our expertise. We also incur design expenses associated with reducing the cost and improving the manufacturability of our existing products. These expenses totaled $4.4 million in 2009 compared to $3.4 million in 2008, an increase of $1.0 million, or 30%. In 2009, we increased our new commercial products development effort by $500,000 and in 2008 we capitalized a $521,000 development related to a product for the China market. We have relatively fixed engineering resources, and our research and development expenses vary inversely with the amount of those resources allocated to our government contract activities.
 
Selling, general and administrative expenses totaled $6.9 million in 2009 compared to $8.2 million in 2008, a decrease of $1.3 million, or 16%. The lower expenses in 2009 resulted primarily from a reduction in employees in the fourth quarter of 2008, as well as lower expenses for insurance and consulting.
 
Other expense included a loss from our joint venture with BAOLI in China of $638,000. The loss included a $521,000 expense for impairment and a $117,000 expense for our 45 percent equity ownership of the joint venture’s 2009 operating loss. The adjustment of the fair value expense represents the treatment, as a derivative, of 608,237 warrants that are exercisable for common stock. We used the Black-Scholes valuation model to determine their fair value. There were no such charges in 2008.
 
We incurred no severance charges in 2009. In the fourth quarter of 2008 we reduced our work force and incurred a $141,000 severance charge.
 
Interest income decreased to $24,000 in 2009, compared to $284,000 in 2008, primarily because of dramatically lower interest rates being paid on our money-market account funds.
 
Interest expense in 2009 and 2008 amounted to $32,000.
 
Our loss totaled $13.0 million in 2009, compared to $12.7 million in 2008.
 
The net loss available to common stockholders totaled $0.65 per common share in 2009, compared to $0.77 per common share in 2008.
 
2008 Compared to 2007
 
Net revenues decreased by $6.6 million, or 37%, to $11.3 million in 2008 from $17.9 million in 2007.
 
Net commercial product revenues decreased by $6.0 million, or 47%, to $6.8 million in 2008 from $12.8 million in 2007. The decrease is primarily the result of lower sales volume for our products. Average sales prices for our products were essentially unchanged in 2008 compared to 2007. Our two largest customers accounted for 92% of our net commercial revenues in 2008, compared to 75% in 2007. These customers generally purchase products through non-binding commitments with minimal lead-times. Consequently, our commercial product revenues can fluctuate dramatically from quarter to quarter based on changes in our customers’ capital spending patterns.


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Government contract revenues decreased by $590,000, or 12%, to $4.5 million in 2008 from $5.1 million in 2007. This decrease is primarily attributable to the completion of the first phase of a major contract and a funding gap before the second phase of that contract was funded.
 
The cost of commercial product revenues totaled $8.9 million for 2008 compared to $12.9 million for 2007, a decrease of $4.0 million, or 31%. The lower costs resulted principally from lower production as a result of lower sales. Our expense provision for obsolete inventories totaled $17,000 in 2008 compared to $160,000 in 2007.
 
The following is an analysis of our commercial product gross profit margins for 2007 and 2008:
 
                                 
    Years Ended December 31,  
    2008     2007  
    Dollars in thousands  
 
Net commercial product sales
  $ 6,768       100.0 %   $ 12,787       100.0 %
Cost of commercial product sales
    8,911       131.7 %     12,944       101.2 %
                                 
Gross profit
  $ (2,143 )     (31.7 )%   $ (157 )     (1.2 )%
                                 
 
We had a negative gross margin of $2.1 million in 2008 from the sale of our commercial products compared to a negative gross margin of $157,000 in 2007. The negative gross margin in 2008 is primarily because the reduced level of commercial sales was insufficient to cover our fixed manufacturing overhead costs. Our gross margins were also adversely impacted by a $17,000 charge for excess and obsolete inventory in 2008 and a similar charge of $160,000 in 2007. Gross margins were favorably impacted by $195,000 in 2007 by the sale of previously written-off inventory. There was no similar benefit in 2008.
 
Cost of contract research and development totaled $3.6 million in 2008 compared to $2.9 million in 2007, an increase of $743,000, or 26%. As a percentage of government revenue, contract research and development expenses increased from 57% in 2007 to 81% in 2008 because of different cost recognition criteria on one of our 2008 cost-plus contracts.
 
Research and development expenses relate to development of new wireless commercial products and other products related to our expertise. We also incur design expenses associated with reducing the cost and improving the manufacturability of our existing products. These expenses totaled $3.4 million in 2008 compared to $3.2 million in 2007, an increase of $222,000, or 7%. The increase is due to increased efforts associated with new commercial products development.
 
Selling, general and administrative expenses totaled $8.2 million in 2008 compared to $8.1 million in 2007, an increase of $28,000, or less than 1%. Expenses were lower in 2007 primarily from the reversal of a $610,000 reserve in the first quarter of 2007. In 2008 we had lower insurance premiums and lower selling expenses that were slightly offset by higher legal expenses associated with our China joint venture.
 
In the fourth quarter of 2008 we reduced our work force and incurred a $141,000 severance charge. There was no similar charge in 2007.
 
Interest income increased to $284,000 in 2008, compared to $156,000 in 2007, primarily because of higher cash balances in 2008.
 
Interest expense in 2008 amounted to $32,000, compared to $39,000 in 2007, as a result of lower borrowing levels.
 
Our loss totaled $12.7 million in 2008, compared to $9.1 million in 2007.
 
The net loss available to common stockholders totaled $0.77 per common share in 2008, compared to $0.73 per common share in 2007.


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Liquidity and Capital Resources
 
Cash Flow Analysis
 
As of December 31, 2009, we had working capital of $12.6 million, including $10.4 million in cash and cash equivalents, compared to working capital of $12.3 million at December 31, 2008, which included $7.6 million in cash and cash equivalents. We currently invest our excess cash in short-term, investment-grade, money-market instruments with maturities of three months or less. Our investments have no exposure to the auction rate securities market.
 
Cash and cash equivalents increased by $2.8 million from $7.6 million at December 31, 2008 to $10.4 million at December 31, 2009. In 2009, cash was used principally in operations and to a lesser extent for the purchase of property and equipment. These uses were offset by gross cash proceeds of $10.5 million provided by the sales of common stock.
 
Cash used in operations totaled $7.4 million in 2009. We used $9.2 million to fund the cash portion of our net loss. We also used cash to fund a $600,000 increase in accounts payable payments, patents and licenses payments, higher accounts receivables and prepaid and other current asset payments. These uses were offset by cash generated from the sale of inventory and lower other assets totaling $2.4 million.
 
Net cash used in investing activities totaled $226,000 in 2009 from the purchase of fixed assets.
 
Net cash provided by financing activities in 2009 totaled $10.5 million, net of $800,000 in expenses, from the sale of 3,752,005 shares of common stock at $3.00 per share in June 2009.
 
Financing Activities
 
We have historically financed our operations through a combination of cash on hand, equipment lease financings, available borrowings under bank lines of credit and both private and public equity offerings. We have effective registration statements on file with the Securities and Exchange Commission covering the public resale by investors of common stock issued in our private placements, as well as common stock acquired upon exercise of warrants.
 
As described above, financing activities in 2009 totaled $10.5 million, net of $800,000 in expenses, from the sale of 3,752,005 shares of common stock at $3.00 per share in June 2009.
 
We have an existing line of credit from a bank. The line of credit expires in July 2010. The loan agreement is structured as a sale of our accounts receivable and provides for the sale of up to $3.0 million of eligible accounts receivable, with advances to us totaling 80% of the receivables sold. Advances bear interest at the bank’s prime rate (4.0% at December 31, 2009) plus 2.50% subject to a minimum monthly charge. Advances are collateralized by a lien on all of our assets. Under the terms of the agreement, we continue to service the sold receivables and are subject to recourse provisions. There was no amount outstanding under this borrowing facility at December 31, 2009.
 
Contractual Obligations and Commercial Commitments
 
We incur various contractual obligations and commercial commitments in our normal course of business. They consist of the following:
 
Operating Lease Obligations.  Our operating lease obligations consist of a facility lease in Santa Barbara, California and several smaller equipment leases.
 
Patents and Licenses.  We have entered into various licensing agreements requiring royalty payments ranging from 0.13% to 2.5% of specified product sales. Some of these agreements contain provisions for the payment of guaranteed or minimum royalty amounts. Typically, the licensor can terminate our license if we fail to pay minimum annual royalties.
 
Purchase Commitments.  In the normal course of business, we incur purchase obligations with vendors and suppliers for the purchase of inventory, as well as other goods and services. These obligations are generally


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evidenced by purchase orders that contain the terms and conditions associated with the purchase arrangements. We are committed to accept delivery of such material pursuant to the purchase orders subject to various contract provisions that allow us to delay receipt of such orders or cancel orders beyond certain agreed upon lead times. Cancellations may result in cancellation costs payable by us.
 
Quantitative Summary of Contractual Obligations and Commercial Commitments
 
At December 31, 2009, we had the following contractual obligations and commercial commitments:
 
                                         
    Payments Due by Period  
                2011 and
    2013 and
    2015 and
 
Contractual Obligations
  Total     2010     2012     2014     beyond  
 
Operating leases
  $ 9,741,000     $ 1,307,000     $ 2,707,000     $ 2,843,000     $ 2,884,000  
Minimum license commitment
    1,810,000       175,000       350,000       355,000       930,000  
Fixed asset and inventory purchase commitments
    328,000       328,000                    
                                         
Total contractual cash obligations
  $ 11,879,000     $ 1,810,000     $ 3,057,000     $ 3,198,000     $ 3,814,000  
                                         
 
Capital Expenditures
 
We plan to invest approximately $2.1 million in fixed assets during 2010.
 
Future Liquidity
 
In 2009, we incurred a net loss of $13.0 million and had negative cash flows from operations of $7.4 million. In 2008, we incurred a net loss of $12.7 million and had negative cash flows from operations of $12.1 million. Our independent registered public accounting firm has included in their audit reports for 2009 through 2007 an explanatory paragraph expressing doubt about our ability to continue as a going concern.
 
At December 31, 2009 we had $10.4 million in cash and cash equivalents. Our cash resources, together with our line of credit, may not be sufficient to fund our business for at least the next twelve months. We believe the key factors to our future liquidity will be our ability to successfully use our expertise and our technology to generate revenues in various ways, including commercial operations, government contracts, joint ventures and licenses. Because of the uncertainty of these factors, we may need to raise funds to meet our working capital needs.
 
We cannot assure you that additional financing will be available on acceptable terms or at all. If we issue additional equity securities to raise funds, the ownership percentage of our existing stockholders would be reduced. New investors may demand rights, preferences or privileges senior to those of existing holders of common stock. If we cannot raise any needed funds, we might be forced to make further substantial reductions in our operating expenses, which could adversely affect our ability to implement our current business plan and ultimately our viability as a company.
 
Net Operating Loss Carryforward
 
As of December 31, 2009, we had net operating loss carryforwards for federal and state income tax purposes of approximately $298.8 million and $169.9 million, respectively, which expire in the years 2010 through 2029. Of these amounts, $80.9 million and $23.5 million, respectively, resulted from the acquisition of Conductus. Included in the net operating loss carryforwards are deductions related to stock options of approximately $24.1 million and $13.1 million for federal and California income tax purposes, respectively. To the extent net operating loss carryforwards are recognized for accounting purposes, the resulting benefits related to the stock options will be credited to stockholders’ equity. In addition, we had research and development and other tax credits for federal and state income tax purposes of approximately $3.1 million and $1.4 million, respectively, which expire in the years 2010 through 2029. Of these amounts, $549,000 and $581,000, respectively, resulted from the acquisition of Conductus.
 
Due to the uncertainty surrounding their realization, we have recorded a full valuation allowance against our net deferred tax assets. Accordingly, no deferred tax asset has been recorded in the accompanying balance sheet.


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Section 382 of the Internal Revenue Code imposes an annual limitation on the utilization of net operating loss carryforwards and other tax attributes based on a statutory rate of return (usually the “applicable federal funds rate”, as defined in the Internal Revenue Code) and the value of the corporation at the time of a “change of ownership” as defined by Section 382. We had changes in ownership in August 1999, December 2002 and June 2009. In addition, we acquired the right to Conductus’ net operating losses, which are also subject to the limitations imposed by Section 382. Conductus underwent four ownership changes, which occurred in February 1999, February 2001, December 2002 and June 2009. Therefore, the ability to utilize Conductus’ and our net operating loss carryforwards will be subject annual limitations upon utilization in future periods. We are currently studying the impact of these Section 382 limitations on the future realizability of our various tax attributes.
 
Recent Accounting Pronouncements
 
Recent accounting pronouncements are detailed in Note 2 to our Consolidated Financial Statements included in this Report.
 
Market Risk
 
We are exposed to various market risks, including changes in interest rates. Market risk is the potential loss arising from adverse changes in market rates and prices. We do not enter into derivatives or other financial instruments for trading or speculation purposes. Our money market investments have no exposure to the auction rate securities market.
 
At December 31, 2009, we had approximately $9.7 million invested in a money market account yielding approximately 0.1%. Assuming no yield on this money market account and no liquidation of principal for the year, our total interest income would decrease by approximately $10,000 per annum. As we had no amounts outstanding on our bank loan during 2009, changes in its interest rate would not have affected us.
 
Inflation
 
We do not foresee any material impact on our operations from inflation.
 
Critical Accounting Policies and Estimates
 
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our estimates, including those related to bad debts, inventories, recovery of long-lived assets, income taxes, warranty obligations, contract revenue and contingencies. We base our estimates on historical experience and on various other assumptions that we believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Any future changes to these estimates and assumptions could cause a material change to our reported amounts of revenues, expenses, assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.
 
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the financial statements. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.


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Our inventory is valued at the lower of its actual cost or the current estimated market value of the inventory. We review inventory quantities on hand and on order and record, on a quarterly basis, a provision for excess and obsolete inventory and/or vendor cancellation charges related to purchase commitments. If the results of the review determine that a write-down is necessary, we recognize a loss in the period in which the loss is identified, whether or not the inventory is retained. Our inventory reserves establish a new cost basis for inventory and are not reversed until we sell or dispose of the related inventory. Such provisions are established based on historical usage, adjusted for known changes in demands for such products, or the estimated forecast of product demand and production requirements. Our business is characterized by rapid technological change, frequent new product development and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Demand for our products can fluctuate significantly. Our estimates of future product demand may prove to be inaccurate, and we may understate or overstate the provision required for excess and obsolete inventory.
 
Our net sales consist of revenue from sales of products, net of trade discounts and allowances. We recognize revenue when evidence of an arrangement exists, contractual obligations have been satisfied, title and risk of loss have been transferred to the customer and collection of the resulting receivable is reasonably assured. At the time revenue is recognized, we provide for the estimated cost of product warranties if allowed for under contractual arrangements and return products. Our warranty obligation is affected by product failure rates and service delivery costs incurred in correcting a product failure. Should such failure rates or costs differ from these estimates, accrued warranty costs would be adjusted.
 
We indemnify, without limit or term, our customers against all claims, suits, demands, damages, liabilities, expenses, judgments, settlements and penalties arising from actual or alleged infringement or misappropriation of any intellectual property relating to our products or other claims arising from our products. We cannot reasonably develop an estimate of the maximum potential amount of payments that might be made under our guarantees because of the uncertainty as to whether a claim might arise and how much it might total.
 
Contract revenues are principally generated under research and development contracts. Contract revenues are recognized utilizing the percentage-of-completion method measured by the relationship of costs incurred to total estimated contract costs. If the current contract estimate were to indicate a loss, utilizing the funded amount of the contract, a provision would be made for the total anticipated loss. Contract revenues are derived primarily from research contracts with agencies of the United States Government. Credit risk related to accounts receivable arising from such contracts is considered minimal. These contracts include cost-plus, fixed price and cost sharing arrangements and are generally short-term in nature.
 
All payments to us for work performed on contracts with agencies of the U.S. Government are subject to adjustment upon audit by the Defense Contract Audit Agency. Based on historical experience and review of current projects in process, we believe that the audits will not have a significant effect on our financial position, results of operations or cash flows. The Defense Contract Audit Agency has audited us through 2003.
 
We periodically evaluate the realizability of long-lived assets as events or circumstances indicate a possible inability to recover the carrying amount. Long-lived assets that will no longer be used in our business are written off in the period identified since they will no longer generate any positive cash flows for us. Such evaluation is based on various analyses, including cash flow and profitability projections. The analyses necessarily involve significant management judgment. In the event the projected undiscounted cash flows are less than net book value of the assets, the carrying value of the assets will be written down to their estimated fair value. Our future cash flows may vary from estimates.
 
Stock-based employee compensation cost is recognized using the fair-value based method for all awards granted on or after the beginning of 2006. We issue stock option awards and restricted share awards to employees and to non-employee directors under our stock-based incentive plans. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. Compensation cost related to restricted share awards is recorded based on the market price of our common stock on the grant date. We recognize compensation expense over the expected vesting period on a straight-line basis from the grant date.
 
Our valuation allowance against the deferred tax assets is based on our assessments of historical losses and projected operating results in future periods. If and when we generate future taxable income in the U.S. against


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which these tax assets may be applied, some portion or all of the valuation allowance would be reversed and an increase in net income would consequently be reported in future years.
 
ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Market Risk.”
 
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
All information required by this item is listed in the Index to Financial Statements in Part IV, Item 15(a)1 of this Report.
 
ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
Not applicable.
 
ITEM 9A(T).   CONTROLS AND PROCEDURES
 
Disclosure Controls and Procedures; Changes in Internal Control Over Financial Reporting
 
We have established disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). As of the end of the period covered by this report we carried out an evaluation under the supervision and with the participation of our management, including the our Chief Executive Officer and Controller (“Principal Financial Officer”), of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities and Exchange Act of 1934, as amended. Based upon that evaluation, the Chief Executive Officer and Controller concluded that our disclosure controls and procedures are effective.
 
There were no changes in our internal controls over financial reporting during the fourth quarter of the year ended December 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
We do not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
 
Management’s Report on Internal Control Over Financial Reporting
 
The report below shall not be deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section, and shall not be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate it by reference into such a filing.
 
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Our management assessed the effectiveness of our internal controls over financial reporting as of December 31, 2009. In making its assessment of the effectiveness of our internal controls over financial reporting, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on these criteria, our management has concluded that, as of December 31, 2009, our internal control over financial reporting is effective. This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant


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to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.
 
ITEM 9B.   OTHER INFORMATION
 
None.
 
PART III
 
ITEM 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
The information required by this item is incorporated by reference to our Proxy Statement for the 2010 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of our year ended December 31, 2009.
 
ITEM 11.   EXECUTIVE COMPENSATION
 
The information required by this item is incorporated by reference to our Proxy Statement for the 2010 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of our year ended December 31, 2009.
 
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
The information required by this item is incorporated by reference to our Proxy Statement for the 2010 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of our year ended December 31, 2009.
 
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 
The information required by this item is incorporated by reference to our Proxy Statement for the 2010 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of our year ended December 31, 2009.
 
ITEM 14.   PRINCIPAL ACCOUNTING FEES AND DISCLOSURES
 
The information required by this item is incorporated by reference to our Proxy Statement for the 2010 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the end of our year ended December 31, 2009.


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PART IV
 
ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
(a) The following documents are filed as part of this Report:
 
1. Index to Financial Statements.  Our financial statements and the Report of Stonefield Josephson, Inc., Independent Registered Public Accounting Firm are included in Part IV of this Report on the pages indicated:
 
         
    Page
 
    F-1  
    F-2  
    F-3  
    F-4  
    F-5  
    F-6  
 
2. Financial Statement Schedule Covered by the Foregoing Report of Independent Registered Public Accounting Firm.
 
         
    F-23  
 
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.
 
3. Exhibits
 
         
Number
 
Description of Document
 
  3 .1   Restated Certificate of Incorporation of Registrant as amended through March 1, 2006.(25)
  3 .2   Amended and Restated Bylaws of Registrant.(25)
  4 .1   Form of Common Stock Certificate.(24)
  4 .2   Certificate of Designations of Registrant of Series A Convertible Preferred Stock of Registrant filed November 13, 2007.(23)
  4 .3   Certificate of Designations, Preferences and Rights of Series E Convertible Preferred Stock of Registrant.(3)
  4 .4   Warrant to Purchase Stock issued by Registrant to Silicon Valley Bank and Registration Rights Agreement.(10)
  4 .5   Form of Warrant Agreement dated August, 2005.(17)
  10 .1   1992 Director Option Plan (as amended through January 1997).(1)***
  10 .2   Form of 1992 Director Stock Option Agreement.(1)***
  10 .3   Amended and Restated 1998 Non-Statutory Stock Option Plan, including Form of Stock Option Agreement.(4)***
  10 .4   1999 Stock Plan.(2)***
  10 .5   Form of 1999 Stock Plan Stock Option Agreement.(2)***
  10 .6   Form of Change in Control Agreement dated March 28, 2003.(7)***
  10 .7   Form of Amendment No. 1 to Change in Control Agreement dated as of May 24, 2005.(18)***
  10 .8   Form of Amendment No. 2 to Change in Control Agreement dated as of December 31, 2006. (20)***
  10 .9   Accounts Receivable Purchase Agreement by and between Registrant and Silicon Valley Bank, dated March 28, 2003, effective date June 23, 2003.(7)


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Number
 
Description of Document
 
  10 .10   Accounts Receivable Purchase Modification Agreement by and between Registrant and Silicon Valley Bank dated March 17, 2004.(9)
  10 .11   Amendment to Purchase Agreement by and between Registrant and Silicon Valley Bank dated as of April 28, 2004.(11)
  10 .12   Accounts Receivable Purchase Modification Agreement by and between Registrant and Silicon Valley Bank dated March 16, 2005.(15)
  10 .13   Third Amendment to Loan and Security Agreement by and between Registrant and Silicon Valley Bank dated June 16, 2006.(25)
  10 .14   Fourth Amendment to Loan and Security Agreement by and between Registrant and Silicon Valley Bank dated June 18, 2007.(25)
  10 .15   Sixth Amendment to Loan and Security Agreement by and between Registrant and Silicon Valley Bank dated July 31, 2008.(24)
  10 .16   Seventh Amendment to Loan and Security Agreement by and between Registrant and Silicon Valley Bank dated July 31, 2009.(25)
  10 .17   Patent License Agreement by and between Registrant and Lucent Technologies GRL LLC.(8)**
  10 .18   License Agreement between Registrant and Sunpower dated May 2, 2005.(12)**
  10 .19   Employment Agreement between Registrant and Jeffrey Quiram dated as of February 14, 2005.(13)***
  10 .20   Stock Option Grant and 2003 Equity Incentive Plan Option Agreement between Registrant and Jeffrey Quiram dated February 14, 2005. (13)***
  10 .21   Amendment to Employment Agreement between Registrant and Jeffrey Quiram dated as of December 31, 2006.(20)***
  10 .22   2003 Equity Incentive Plan As Amended May 25, 2005. (16)***
  10 .23   Form of Notice of Grant of Stock Options and Option Agreement for 2003 Equity Incentive Plan.(13)***
  10 .24   Management Incentive Plan (July 24, 2006).(19)***
  10 .25   Employment Agreement between Registrant and Terry White dated as of April 11, 2005.(14)***
  10 .26   Amendment to Employment Agreement between Registrant and Terry White dated as of December 31, 2006.(20)***
  10 .27   Form of Director and Officer Indemnification Agreement.(18)***
  10 .28   Lease Agreement between the Registrant and 1200 Enterprises LLC dated as of June 1, 2001.(6)
  10 .29   Second Amendment to Lease Agreement between the Registrant and 1200 Enterprises LLC dated January 19, 2009.(25)
  10 .30   Agreement between Registrant and Hunchun BaoLi Communication Co., Ltd. (“BAOLI”) dated August 17, 2007.(21)
  10 .31   First Amendment to Agreement between Registrant and BAOLI dated November 1, 2007(22)
  10 .32   Second Amendment to Agreement between Registrant and BAOLI dated January 7, 2008.(22)
  10 .33   Framework Agreement between Registrant and BAOLI dated November 8, 2007.(22)
  10 .34   Sino-Foreign Equity Joint Venture Contract between Superconductor Investments (Mauritius) Limited and BAOLI dated December 8, 2007 (Exhibit A to Framework Agreement with BAOLI).(22)
  10 .35   Form of Technology and Trademark License Agreement between Superconductor Investments (Mauritius) Limited, Registrant and BAOLI (Exhibit B to Framework Agreement).(22)
  14     Code of Business Conduct and Ethics.(18)
  21     List of Subsidiaries.(25)
  23 .1   Consent of Stonefield Josephson Inc, Independent Registered Public Accounting Firm.(25)
  31 .1   Statement of CEO Pursuant to 302 of the Sarbanes-Oxley Act of 2002.(25)
  31 .2   Statement of CFO Pursuant to 302 of the Sarbanes-Oxley Act of 2002.(25)
  32 .1   Statement of CEO Pursuant to 906 of the Sarbanes-Oxley Act of 2002.(25)
  32 .2   Statement of CFO Pursuant to 906 of the Sarbanes-Oxley Act of 2002.(25)

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(1) Incorporated by reference from Registrant’s Registration Statement on Form S-8 filed April 15, 1998 (File No. 333-50137).
 
(2) Incorporated by reference from Registrant’s Registration Statement on Form S-8 filed November 4, 1999 (File No. 333-90293).
 
(3) Incorporated by reference from Registrant’s Current Report on Form 8-K filed October 4, 2000.
 
(4) Incorporated by reference from Registrant’s Registration Statement on Form S-8 filed March 6, 2001 (File No. 333-56606).
 
(5) Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001.
 
(6) Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 30, 2002.
 
(7) Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 29, 2003.
 
(8) Incorporated by reference from Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003, filed March 11, 2004.
 
(9) Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q for the quarter ended April 3, 2004, filed May 12, 2004.
 
(10) Incorporated by reference from Registrant’s Registration Statement on Form S-3 (File No. 333-117107), filed July 2, 2004.
 
(11) Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q for the quarter ended July 3, 2004, filed August 11, 2004.
 
(12) Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q for the quarter ended October 2, 2004, filed November 10, 2004.
 
(13) Incorporated by reference from Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004.
 
(14) Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q for the quarter ended April 2, 2005.
 
(15) Incorporated by reference from Registrants’ Current Report on Form 8-K filed April 4, 2005.
 
(16) Incorporated by reference from Registrant’s Current Report on Form 8-K filed May 27, 2005.
 
(17) Incorporated by reference from Registrant’s Current Report on Form 8-K filed August 11, 2005.
 
(18) Incorporated by reference from Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005.
 
(19) Incorporated by reference from Registrant’s Current Report on Form 8-K filed July 28, 2006.
 
(20) Incorporated by reference from Registrant’s Annual Report on Form 10-K for the year ended December 31, 2006.
 
(21) Incorporated by reference from Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 29, 2007.
 
(22) Incorporated by reference from Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007.
 
(23) Incorporated by reference from Registrant’s Current Report on Form 8-K/A filed February 25, 2008.
 
(24) Incorporated by reference from Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008.
 
(25) Filed herewith.
 
** Confidential treatment has been previously granted for certain portions of these exhibits.
 
*** This exhibit is a management contract or compensatory plan or arrangement.
 
(b) Exhibits. See Item 15(a) above.


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Report of Independent Registered Public Accounting Firm
 
To: The Board of Directors and Stockholders of Superconductor Technologies, Inc.
Santa Barbara, California
 
We have audited the accompanying consolidated balance sheets of Superconductor Technologies, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2009. Our audits also included the consolidated financial statement schedule listed in the Index at Item 15(a)(2) as of and for the three years ended December 31, 2009. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Superconductor Technologies, Inc. as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Further, the accompanying schedule is, in our opinion, fairly stated in all material respects in relation to basic financial statements as a whole.
 
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the company as a going concern. As discussed in Note 2, the Company has incurred significant net losses since its inception and has an accumulated deficit of $225,665,000 and expects to incur substantial additional losses and costs. The foregoing matters raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are described in Note 2 of the accompanying financial statements. These financial statements do not include any adjustments that might result from the outcome of these uncertainties.
 
/s/  Stonefield Josephson, Inc.
 
Los Angeles, California
March 16, 2010


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
 
                 
    December 31,
    December 31,
 
    2009     2008  
 
ASSETS
Current Assets:
               
Cash and cash equivalents
  $ 10,365,000     $ 7,569,000  
Accounts receivable, net
    462,000       355,000  
Inventory, net
    2,644,000       5,278,000  
Prepaid expenses and other current assets
    445,000       416,000  
                 
Total Current Assets
    13,916,000       13,618,000  
Property and equipment, net of accumulated depreciation of $21,076,000 and $19,943,000, respectively
    1,832,000       2,739,000  
Patents, licenses and purchased technology, net of accumulated amortization of $2,384,000 and $2,055,000, respectively
    2,163,000       2,252,000  
Investment in joint venture
          521,000  
Other assets
    215,000       228,000  
                 
Total Assets
  $ 18,126,000     $ 19,358,000  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
               
Accounts payable
  $ 467,000     $ 707,000  
Accrued expenses
    671,000       578,000  
Fair value of warrant derivative
    171,000        
Current portion of capitalized lease obligations
    50,000       80,000  
                 
Total Current Liabilities
    1,359,000       1,365,000  
Other long term liabilities
    526,000       441,000  
                 
Total Liabilities
    1,885,000       1,806,000  
Commitments and contingencies (Notes 7 and 8)
               
Stockholders’ Equity:
               
Preferred stock, $.001 par value, 2,000,000 shares authorized, 611,523 issued and outstanding
    1,000       1,000  
Common stock, $.001 par value, 250,000,000 shares authorized, 22,512,033 and 17,869,030 shares issued and outstanding, respectively
    23,000       18,000  
Capital in excess of par value
    241,882,000       230,219,000  
Accumulated deficit
    (225,665,000 )     (212,686,000 )
                 
Total Stockholders’ Equity
    16,241,000       17,552,000  
                 
Total Liabilities and Stockholders’ Equity
  $ 18,126,000     $ 19,358,000  
                 
 
See accompanying notes to the consolidated financial statements


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
 
                         
    Years Ending December 31  
    2009     2008     2007  
 
Net revenues:
                       
Net commercial product revenues
  $ 7,239,000     $ 6,768,000     $ 12,787,000  
Government and other contract revenues
    3,577,000       4,525,000       5,115,000  
                         
Total net revenues
    10,816,000       11,293,000       17,902,000  
Costs and expenses:
                       
Cost of commercial product revenues
    9,102,000       8,911,000       12,944,000  
Cost of government and other contract revenues
    2,552,000       3,649,000       2,906,000  
Research and development
    4,399,000       3,394,000       3,172,000  
Selling, general and administrative
    6,925,000       8,151,000       8,123,000  
Restructuring expenses and impairment charges
          141,000        
                         
Total costs and expenses
    22,978,000       24,246,000       27,145,000  
                         
Loss from operations
    (12,162,000 )     (12,953,000 )     (9,243,000 )
Other Income and Expense
                       
Impairment of asset for, and noncontrolling interest in, joint venture
    (638,000 )            
Adjustments to fair value of derivatives
    (171,000 )            
Interest income
    24,000       284,000       156,000  
Interest expense
    (32,000 )     (32,000 )     (39,000 )
                         
Net loss
  $ (12,979,000 )   $ (12,701,000 )   $ (9,126,000 )
                         
Basic and diluted net loss per common share
  $ (0.65 )   $ (0.77 )   $ (0.73 )
                         
Basic and diluted weighted average number of common shares outstanding
    19,842,687       16,402,509       12,487,593  
                         
 
See accompanying notes to the consolidated financial statements


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
 
                                                                 
    Convertible
                Capital in
    Receivable
             
    Preferred Stock     Common Stock     Excess of
    From
    Accumulated
       
    Shares     Amount     Shares     Amount     Par Value     Stockholder     Deficit     Total  
 
Balance at December 31, 2006
        $       12,483,367     $ 12,000     $ 208,825,000     $ (27,000 )   $ (190,859,000 )   $ 17,951,000  
Exercise of stock options
                    3,350               26,000                       26,000  
Issuance of common stock (net of costs)
                                    (27,000 )                     (27,000 )
Stock-based compensation
                    24,697               339,000                       339,000  
Reserve for impairment
                                            27,000               27,000  
Net loss
                                                    (9,126,000 )     (9,126,000 )
                                                                 
Balance at December 31, 2007
                12,511,414       12,000       209,163,000             (199,985,000 )     9,190,000  
Exercise of stock options
                                                               
Issuance of common stock (net of costs)
                    5,101,361       5,000       10,563,000                       10,568,000  
Stock-based compensation
                    256,255       1,000       593,000                       594,000  
Issuance of Series A Preferred
    611,523       1,000                       9,900,000                       9,901,000  
Net loss
                                                    (12,701,000 )     (12,701,000 )
                                                                 
Balance at December 31, 2008
    611,523       1,000       17,869,030       18,000       230,219,000             (212,686,000 )     17,552,000  
Exercise of stock options
                                                               
Issuance of common stock (net of costs)
                    3,752,005       4,000       10,452,000                       10,456,000  
Stock-based compensation
                    890,998       1,000       1,211,000                       1,212,000  
Issuance of Series A Preferred
                                                               
Net loss
                                                    (12,979,000 )     (12,979,000 )
                                                                 
Balance at December 31, 2009
    611,523     $ 1,000       22,512,033     $ 23,000     $ 241,882,000     $     $ (225,665,000 )   $ 16,241,000  
                                                                 
 
See accompanying notes to the consolidated financial statements.


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
 
                         
    Years Ended December 31,  
    2009     2008     2007  
 
CASH FLOWS FROM OPERATING ACTIVITIES:
                       
Net loss
  $ (12,979,000 )   $ (12,701,000 )   $ (9,126,000 )
Adjustments to reconcile net loss to net cash used for operating activities:
                       
Depreciation and amortization
    1,462,000       1,735,000       2,333,000  
Stock-based compensation expense
    1,212,000       587,000       339,000  
Provision for excess and obsolete inventories
    282,000       17,000       160,000  
Noncontrolling interest in joint venture
    117,000              
Fair value of derivatives
    171,000              
Asset impairment for joint venture
    521,000              
Reserve for impairment of note and interest receivable
                (583,000 )
Changes in assets and liabilities:
                       
Accounts receivable
    (107,000 )     2,057,000       (877,000 )
Inventories
    2,352,000       (1,880,000 )     2,403,000  
Prepaid expenses and other current assets
    (147,000 )     (26,000 )     574,000  
Patents and licenses
    (240,000 )     (315,000 )     (169,000 )
Other assets
    14,000       9,000       16,000  
Accounts payable and accrued expenses
    (92,000 )     (1,603,000 )     (465,000 )
                         
Net cash used in operating activities
    (7,434,000 )     (12,120,000 )     (5,395,000 )
CASH FLOWS FROM INVESTING ACTIVITIES:
                       
Proceeds from the sale of property and equipment
                26,000  
Purchase of property and equipment
    (226,000 )     (179,000 )     (191,000 )
Investment in joint venture
          (521,000 )      
                         
Net cash used in investing activities
    (226,000 )     (700,000 )     (165,000 )
CASH FLOWS FROM FINANCING ACTIVITIES:
                       
Proceeds from shares to be issued
                4,000,000  
Payments on long-term obligations
                (14,000 )
Net proceeds from sale of common stock and exercise of warrants and options
    10,456,000       16,450,000       26,000  
                         
Net cash provided by financing activities
    10,456,000       16,450,000       4,012,000  
                         
Net increase (decrease) in cash and cash equivalents
    2,796,000       3,630,000       (1,548,000 )
Cash and cash equivalents at beginning of year
    7,569,000       3,939,000       5,487,000  
                         
Cash and cash equivalents at end of year
  $ 10,365,000     $ 7,569,000     $ 3,939,000  
                         
 
See accompanying notes to the consolidated financial statements.


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
 
Note 1 — The Company
 
Superconductor Technologies Inc. (together with our subsidiaries, “we” or “us”) was incorporated in Delaware on May 11, 1987. We maintain our headquarters in Santa Barbara, California. We develop and produce high temperature superconducting (HTS) materials and associated technologies. We have generated more than 100 patents as well as proprietary trade secrets and manufacturing expertise, providing interference elimination and network enhancement solutions to the commercial wireless industry. In addition, we are now leveraging our key enabling technologies, including radio frequency filtering, HTS materials and cryogenics, to pursue emerging opportunities in the electrical grid and in equipment platforms that utilize electrical circuits.
 
From 1987 to 1997, we were engaged primarily in research and development and generated revenues primarily from government research contracts. Since then, we have provided solutions for wireless infrastructure in the telecommunications industry. Our commercial product offerings are divided into the following three areas: SuperLink (high-temperature superconducting filters), AmpLink (high performance, ground-mounted amplifiers) and SuperPlex (high performance multiplexers).
 
Our research and development contracts are used as a source of funds for our commercial technology development. We continue to be involved as either contractor or subcontractor on a number of contracts with the United States government. These contracts have been, and continue to provide, a significant source of revenues for us. For 2009, 2008 and 2007, government related contracts accounted for 32%, 40% and 29%, respectively, of our net revenues.
 
Note 2 — Summary of Significant Accounting Policies
 
Basis of Presentation
 
In 2009, we incurred a net loss of $13.0 million and had negative cash flows from operations of $7.4 million. In 2008, we incurred a net loss of $12.7 million and had negative cash flows from operations of $12.1 million.
 
At December 31, 2009 we had $10.4 million in cash and cash equivalents. Our cash resources, together with our line of credit, may not be sufficient to fund our business through 2010. We believe the key factors to our future liquidity will be our ability to successfully use our expertise and our technology to generate revenues in various ways, including commercial operations, government contracts, joint ventures and licenses. These factors leave substantial doubt about our ability to continue as a going concern. Because of the uncertainty of these factors, we may need to raise funds to meet our working capital needs.
 
We cannot assure you that additional financing will be available on acceptable terms or at all. If we issue additional equity securities to raise funds, the ownership percentage of our existing stockholders would be reduced. New investors may demand rights, preferences or privileges senior to those of existing holders of common stock. If we cannot raise any needed funds, we might be forced to make further substantial reductions in our operating expenses, which could adversely affect our ability to implement our current business plan and ultimately our viability as a company.
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of Superconductor Technologies Inc. and its wholly owned subsidiaries. All significant intercompany transactions have been eliminated from the consolidated financial statements.
 
Cash and Cash Equivalents
 
Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less. Cash and cash equivalents are maintained with quality financial institutions and from time to time exceed FDIC limits. Historically, we have not experienced any losses due to such concentration of credit risk.


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Accounts Receivable
 
We sell predominantly to entities in the wireless communications industry and to entities of the United States government. We grant uncollateralized credit to our customers. We perform usual and customary credit evaluations of our customers before granting credit. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine the allowance based on historical write-off experience. Past due balances are reviewed for collectibility. Accounts balances are charged off against the allowance when we deem it is probable the receivable will not be recovered. We do not have any off-balance-sheet credit exposure related to our customers.
 
Revenue Recognition
 
Commercial revenues are principally derived from the sale of our SuperLink, AmpLink and SuperPlex family of products and are recognized once all of the following conditions have been met: a) an authorized purchase order has been received in writing, b) the customer’s credit worthiness has been established, c) shipment of the product has occurred, d) title has transferred, and e) if stipulated by the contract, customer acceptance has occurred and all significant vendor obligations, if any, have been satisfied.
 
Contract revenues are principally generated under research and development contracts. Contract revenues are recognized utilizing the percentage-of-completion method measured by the relationship of costs incurred to total estimated contract costs. If the current contract estimate were to indicate a loss, utilizing the funded amount of the contract, a provision would be made for the total anticipated loss. Revenues from research-related activities are derived primarily from contracts with agencies of the United States Government. Credit risk related to accounts receivable arising from such contracts is considered minimal. These contracts include cost-plus, fixed price and cost sharing arrangements and are generally short-term in nature.
 
All payments to us for work performed on contracts with agencies of the U.S. Government are subject to adjustment upon audit by the Defense Contract Audit Agency. Contract audits through 2003 are closed. Based on historical experience and review of current projects in process, we believe that the audits will not have a significant effect on our financial position, results of operations or cash flows.
 
Shipping and Handling Fees and Costs
 
Shipping and handling fees billed to customers are included in net commercial product revenues. Shipping and handling fees associated with freight are generally included in cost of commercial product revenues.
 
Warranties
 
We offer warranties generally ranging from one to five years, depending on the product and negotiated terms of purchase agreements with our customers. Such warranties require us to repair or replace defective product returned to us during such warranty period at no cost to the customer. Our estimate for warranty related costs is recorded at the time of sale based on our actual historical product return rates and expected repair costs. Such costs have been within our expectations.
 
Guarantees
 
In connection with the sales and manufacturing of our commercial products, we indemnify, without limit or term, our customers and contract manufacturers against all claims, suits, demands, damages, liabilities, expenses, judgments, settlements and penalties arising from actual or alleged infringement or misappropriation of any intellectual property relating to our products or other claims arising from our products. We cannot reasonably develop an estimate of the maximum potential amount of payments that might be made under our guarantee because


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
of the uncertainty as to whether a claim might arise and how much it might total. Historically, we have not incurred any expenses related to these guarantees.
 
Research and Development Costs
 
Research and development costs are expensed as incurred and include salary, facility, depreciation and material expenses. Research and development costs incurred solely in connection with research and development contracts are charged to contract research and development expense. Other research and development costs are charged to other research and development expense.
 
Inventories
 
Inventories are stated at the lower of cost or market, with costs primarily determined using standard costs, which approximate actual costs utilizing the first-in, first-out method. We review inventory quantities on hand and on order and record, on a quarterly basis, a provision for excess and obsolete inventory and/or vendor cancellation charges related to purchase commitments. If the results of the review determine that a write-down is necessary, we recognize a loss in the period in which the loss is identified, whether or not the inventory is retained. Our inventory reserves establish a new cost basis for inventory and are not reversed until we sell or dispose of the related inventory. Such provisions are established based on historical usage, adjusted for known changes in demands for such products, or the estimated forecast of product demand and production requirements. Costs associated with idle capacity are expensed immediately.
 
Property and Equipment
 
Property and equipment are recorded at cost. Equipment is depreciated using the straight-line method over their estimated useful lives ranging from three to five years. Leasehold improvements and assets financed under capital leases are amortized over the shorter of their useful lives or the lease term. Furniture and fixtures are depreciated over seven years. Expenditures for additions and major improvements are capitalized. Expenditures for minor tooling, repairs and maintenance and minor improvements are charged to expense as incurred. When property or equipment is retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts. Gains or losses from retirements and disposals are recorded in selling, general and administrative expenses. There were no disposals in 2009. In 2008, we disposed of older, fully depreciated equipment with an acquisition cost of $598,000. There was no gain or loss on those dispositions.
 
Patents, Licenses and Purchased Technology
 
Patents and licenses are recorded at cost and are amortized using the straight-line method over the shorter of their estimated useful lives or approximately seventeen years. Purchased technology acquired through the acquisition of Conductus, Inc. in 2002 was recorded at its estimated fair value and is amortized using the straight-line method over seven years.
 
Long-Lived Assets
 
The realizability of long-lived assets is evaluated periodically as events or circumstances indicate a possible inability to recover the carrying amount. Long-lived assets that will no longer be used in the business are written off in the period identified since they will no longer generate any positive cash flows for us. Periodically, long lived assets that will continue to be used by us will need to be evaluated for recoverability. Such evaluation is based on various analyses, including cash flow and profitability projections. The analyses necessarily involve significant management judgment. In the event the projected undiscounted cash flows are less than net book value of the assets, the carrying value of the assets will be written down to their estimated fair value. We tested our long lived assets for recoverability during 2009 and determined there was no impairment.


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Table of Contents

 
SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Restructuring Expenses
 
Liability for costs associated with an exit or disposal activity are recognized when the liability is incurred.
 
Loss Contingencies
 
In the normal course of our business we are subject to claims and litigation, including allegations of patent infringement. Liabilities relating to these claims are recorded when it is determined that a loss is probable and the amount of the loss can be reasonably estimated. The costs of our defense in such matters are expensed as incurred. Insurance proceeds recoverable are recorded when deemed probable.
 
Income Taxes
 
We recognize deferred tax liabilities and assets based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit (expense) results from the change in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all deferred tax assets will not be realized. The guidance further clarifies the accounting for uncertainty in income taxes and sets a consistent framework to determine the appropriate level of tax reserve to maintain for uncertain tax positions. This interpretation uses a two-step approach wherein a tax benefit is recognized if a position is more-likely-than-not to be sustained. The amount of the benefit is then measured to be the highest tax benefit that is greater than 50% likely to be realized and sets out disclosure requirements to enhance transparency of our tax reserves. Guidance is also provided on the accounting for related interest and penalties, financial statement and disclosure. We are currently not under examination by any taxing authority nor have we been notified of an impending examination. The oldest tax year that remains open to possible evaluation and interpretation of our tax position is 1995. As of December 31, 2009, we had net operating loss carryforwards for federal and state income tax purposes of approximately $298.8 million and $169.9 million, respectively. Due to the uncertainty surrounding their realization, we recorded a full valuation allowance against our net deferred tax assets. Accordingly, no deferred tax asset has been recorded in the accompanying balance sheets.
 
Marketing Costs
 
All costs related to marketing and advertising our products are expensed as incurred or at the time the advertising takes place. Advertising costs were not material in each of the three years in the period ended December 31, 2009.
 
Net Loss Per Share
 
Basic and diluted net loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding in each year. Net loss available to common stockholders is computed after deducting accumulated dividends on cumulative preferred stock, deemed dividends and accretion of redemption value on redeemable preferred stock for the period and beneficial conversion features on issuance of convertible preferred stock. Potential common shares are not included in the calculation of diluted loss per share because their effect is anti-dilutive.
 
Stock-based Compensation Expense
 
We have in effect several equity incentive plans under which stock options and awards have been granted to employees and non-employee members of the Board of Directors. We are required to estimate the fair value of share-based awards on the date of grant. The value of the award is principally recognized as expense ratably over the requisite service periods. We have estimated the fair value of stock options as of the date of grant using the Black-Scholes option pricing model. The Black-Scholes model considers, among other factors, the expected life of the


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Table of Contents

 
SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
award and the expected volatility of our stock price. We evaluate the assumptions used to value stock options on a quarterly basis. The fair values generated by the Black-Scholes model may not be indicative of the actual fair values of our equity awards, as it does not consider other factors important to those awards to employees, such as continued employment and periodic vesting.
 
The following table presents details of total stock-based compensation expense that is included in each functional line item on our consolidated statements of income:
 
                         
    2009     2008     2007  
 
Cost of revenue
  $ 32,000     $ 22,000     $ 14,000  
Research and development
    287,000       122,000       56,000  
Selling, general and administrative
    893,000       443,000       269,000  
                         
    $ 1,212,000     $ 587,000     $ 339,000  
                         
 
The impact to the Consolidated Statement of Operations for 2009, 2008 and 2007 on basic and diluted earnings per share was $0.06, $0.04 and $0.03, respectively. No stock compensation cost was capitalized during the periods.
 
Use of Estimates
 
The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The significant estimates in the preparation of the financial statements relate to the assessment of the carrying amount of accounts receivable, inventory, fixed assets, intangibles, goodwill, estimated provisions for warranty costs, accruals for restructuring and lease abandonment costs, contract revenues, income taxes and disclosures related to the litigation. Actual results could differ from those estimates and such differences may be material to the financial statements.
 
Fair Value of Financial Instruments
 
The carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value due to the short-term nature of these instruments. We estimate that the carrying amount of debt approximates fair value based on our current incremental borrowing rates for similar types of borrowing arrangements.
 
Comprehensive Income
 
We have no items of other comprehensive income in any period and consequently have not included a Statement of Comprehensive Income.
 
Segment Information
 
We operate in a single business segment, the research, development, manufacture and marketing of high performance products used in cellular base stations to maximize the performance of wireless telecommunications networks by improving the quality of uplink signals from mobile wireless devices. We currently derive net commercial product revenues primarily from the sales of our SuperLink, AmpLink and SuperPlex products. We currently sell most of our products directly to wireless network operators in the United States. Net revenues derived principally from government research and development contracts are presented separately on the condensed consolidated statement of operations for all periods presented.


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Table of Contents

 
SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Certain Risks and Uncertainties
 
Our long-term prospects are dependent upon the continued and increased market acceptance for our products.
 
We currently sell most of our products directly to wireless network operators in the United States and our product sales have historically been concentrated in a small number of customers. In 2009, we had two customers that represented 51% and 11% of total net revenues and 38% of accounts receivable. In 2008, these two customers represented 44% and 13% of total net revenues and 7% of accounts receivable. The loss of or reduction in sales, or the inability to collect outstanding accounts receivable, from any of these customers could have a material adverse effect on our business, financial condition, results of operations and cash flows.
 
We currently rely on a limited number of suppliers for key components of our products. The loss of any of these suppliers could have material adverse effect on our business, financial condition, results of operations and cash flows.
 
In connection with the sales of our commercial products, we indemnify, without limit or term, our customers against all claims, suits, demands, damages, liabilities, expenses, judgments, settlements and penalties arising from actual or alleged infringement or misappropriation of any intellectual property relating to our products or other claims arising from our products. We cannot reasonably develop an estimate of the maximum potential amount of payments that might be made under our guarantee because of the uncertainty as to whether a claim might arise and how much it might total.
 
For more risks of our business, see Item 1A, “Risk Factors” in our Annual Report on Form 10-K and other filings with the Securities and Exchange Commission.
 
Recent Accounting Pronouncements
 
In June 2009, the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“Codification”) was issued. The Codification is the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities. The Codification is effective for financials statements issued for interim and annual periods ending after September 15, 2009. The implementation of this standard did not have a material impact on our consolidated financial position or results of operations.
 
In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for the consolidation of variable interest entities. The guidance affects the overall consolidation analysis and requires enhanced disclosures on involvement with variable interest entities. The guidance was effective for fiscal years beginning after November 15, 2009. Implementation did not have a material impact on our consolidated financial position or results of operations.
 
In September 2009, the FASB issued additional guidance on measuring the fair value of liabilities effective for the first reporting period (including interim periods) beginning after issuance. We do not expect that implementation of this guidance will have a material impact on our consolidated financial position or results of operations.
 
In September 2009, the FASB issued additional guidance on measuring fair value of certain alternative investments effective for the first reporting period (including interim periods) ending after December 15, 2009. Implementation has not had a material impact on our consolidated financial position or results of operations.
 
In October 2009, the FASB issued amendments to the accounting and disclosure for revenue recognition. These amendments, effective for fiscal years beginning on or after June 15, 2010 (early adoption is permitted), modify the criteria for recognizing revenue in multiple element arrangements and the scope of what constitutes a non-software deliverable. We are currently assessing the impact on our consolidated financial position or results of operations.
 
In January 2010, the FASB issued guidance that requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair value measurements and information on purchases, sales, issuances, and settlements on a gross basis in


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Table of Contents

 
SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
the reconciliation of Level 3 fair value measurements. The guidance is effective for annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures that are effective for annual periods beginning after December 15, 2010. We do not expect the adoption of this guidance to have a material impact on our consolidated financial position or results of operations.
 
Note 3 — Short Term Borrowings
 
We have a line of credit with a bank. There was no amount outstanding under this borrowing facility at December 31, 2009. The line of credit expires July 2010 and is structured as a sale of accounts receivable. The agreement provides for the sale of up to $3.0 million of eligible accounts receivable, with advances to us totaling 80% of the receivables sold. Any advances would bear interest at the bank’s prime rate (4.0% at December 31, 2009) plus 2.50% subject to a minimum monthly charge. Advances (if any) under the agreement are collateralized by all of our assets. Under the terms of the agreement, we continue to service the sold receivables and are subject to recourse provisions.
 
The agreement contains representations and warranties, affirmative and negative covenants and events of default customary for financings of this type. The failure to comply with these provisions, or the occurrence of any one of the events of default, would prevent any further borrowings and would generally require the repayment of any outstanding borrowings. Such representations, warranties and events of default include (a) non-payment of debt and interest hereunder, (b) non-compliance with terms of the agreement covenants, (c) insolvency or bankruptcy, (d) material adverse change, (e) merger or consolidation where our stockholders do not hold a majority of the voting rights of the surviving entity, (f) transactions outside the normal course of business, or (g) payment of dividends.
 
Note 4 — Income Taxes
 
We incurred a net loss in each year of operation since inception resulting in no current or deferred tax expense for 2009, 2008 and 2007.
 
The benefit for income taxes differs from the amount obtained by applying the federal statutory income tax rate to loss before benefit for income taxes for 2009, 2008 and 2007 as follows:
 
                         
    2009     2008     2007  
 
Tax benefit computed at Federal statutory rate
    34.0 %     34.0 %     34.0 %
Increase (decrease) in taxes due to:
                       
Change in valuation allowance
    (39.8 )     (39.8 )     (39.8 )
State taxes, net of federal benefit
    5.8       5.8       5.8  
Impairment of Goodwill (not deductible for tax)
                 
                         
      %     %     %
                         
 
The significant components of deferred tax assets (liabilities) at December 31 are as follows:
 
                 
    2009     2008  
 
Loss carryforwards
  $ 112,187,000     $ 108,940,000  
Capitalized research and development
    1,102,000       1,468,000  
Depreciation
    2,582,000       2,541,000  
Tax credits
    3,984,000       3,916,000  
Inventory
    330,000       343,000  
Acquired intellectual property
    (90,000 )     (90,000 )
Other
    514,000       540,000  
Less: valuation allowance
    (120,609,000 )     (117,658,000 )
                 
    $     $  
                 


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Table of Contents

 
SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The valuation allowance increased by $2,951,000 in 2009, $2,376,000 in 2008, and $3,129,000 in 2007.
 
As of December 31, 2009, we had net operating loss carryforwards for federal and state income tax purposes of approximately $298.8 million and $169.9 million, respectively, which expire in the years 2010 through 2029. Of these amounts $80.9 million and $23.5 million, respectively, resulted from the acquisition of Conductus. Included in the net operating loss carryforwards are deductions related to stock options of approximately $24.1 million and $13.1 million for federal and California income tax purposes, respectively. To the extent net operating loss carryforwards are recognized for accounting purposes the resulting benefits related to the stock options will be credited to stockholders’ equity. In addition, we had research and development and other tax credits for federal and state income tax purposes of approximately $3.1 million and $1.4 million, respectively, which expire in the years 2010 through 2029. Of these amounts $549,000 and $581,000, respectively resulted from the acquisition of Conductus.
 
Due to the uncertainty surrounding their realization, we have recorded a full valuation allowance against our net deferred tax assets. Accordingly, no deferred tax asset has been recorded in the accompanying balance sheet.
 
Section 382 of the Internal Revenue Code imposes an annual limitation on the utilization of net operating loss carryforwards and other tax attributes based on a statutory rate of return (usually the “applicable federal funds rate”, as defined in the Internal Revenue Code) and the value of the corporation at the time of a “change of ownership” as defined by Section 382. We had changes in ownership in August 1999, December 2002, and June 2009. In addition, we acquired the right to Conductus’ net operating losses, which are also subject to the limitations imposed by Section 382. Conductus underwent four ownership changes, which occurred in February 1999, February 2001, December 2002 and June 2009. Therefore, the ability to utilize Conductus’ and our net operating loss carryforwards will be subject to annual limitation upon utilization in future periods. We are currently studying the impact of these Section 382 limitations on the future realizability of our various tax attributes.
 
Note 5 — Stockholders’ Equity
 
Preferred Stock
 
Pursuant to our Certificate of Incorporation, the Board of Directors is authorized to issue up to 2,000,000 shares of preferred stock (par value $.001 per share) in one or more series and to fix the rights, preferences, privileges, and restrictions, including the dividend rights, conversion rights, voting rights, redemption price or prices, liquidation preferences, and the number of shares constituting any series or the designation of such series. In February 2008, we issued to Hunchun BaoLi Communication Co. Ltd. (“BAOLI”) and two related purchasers a total of (a) 3,101,361 shares of our common stock and (b) 611,523 shares of our Series A Preferred Stock (convertible into 6,115,230 shares of our common stock) in exchange for net proceeds of $14.9 million in cash after offering costs of $89,000, of which $4.0 million was received in 2007. Subject to the terms and conditions of our Series A Preferred Stock and to customary adjustments to the conversion rate, each share of our Series A Preferred Stock is convertible into ten shares of our common stock so long as the number of shares of our common stock beneficially owned by BAOLI and affiliates following such conversion does not exceed 9.9% of our outstanding common stock. Except for a preference on liquidation of $.01 per share, each share of Series A Preferred Stock is the economic equivalent of the ten shares of common stock into which it is convertible. There is no beneficial conversion feature related to the conversion of the preferred shares, as the value of the common shares into which the preferred shares convert does not exceed the recorded amount of the preferred at date of issuance. Except as required by law, the Series A Preferred Stock does not have any voting rights.
 
Common Stock
 
In a registered direct offering completed in June 2009 we raised proceeds of $10.5 million, net of offering costs of $800,000, from the sale of 3,752,005 shares of common stock at $3.00 per share based on a negotiated discount to market.


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
In a registered direct offering completed in May 2008 we raised net proceeds of $5.6 million, net of offering costs of $442,000, from the sale of 2,000,000 shares of common stock at $3.00 per share based on a negotiated discount to market. For both the 2008 and 2009 offerings, we determined the offering price based principally on negotiations between us, the placement agent and the selected institutional investors and on our consideration of the closing prices (including high, low and average prices) and trading volumes of our common stock on the Nasdaq Capital Market primarily during the 30 trading days proceeding the date we determined the offering price.
 
As noted above, in February 2008, we issued to BAOLI and two related purchasers a total of (a) 3,101,361 shares of our common stock and (b) 611,523 shares of our Series A Preferred Stock (convertible into 6,115,230 shares of our common stock) in exchange for net proceeds of $14.9 million in cash net of offering costs of $89,000.
 
Other than the $4.0 million cash deposit on the BAOLI stock sale described above, we raised no money from the sale of our common stock in 2007.
 
Equity Awards
 
At December 31, 2009, we have four equity award option plans, the nonstatutory 1992 Directors Stock Option Plan, 1998 and 1999 Stock Option Plans and the 2003 Equity Incentive Plan (collectively, the “Stock Option Plans”) although we can only grant new options under the 2003 Equity Incentive Plan. Under the 2003 Equity Incentive Plan, stock awards may be made to our directors, key employees, consultants, and non-employee directors and may consist of stock options, stock appreciation rights, restricted stock awards, performance awards, and performance share awards. Stock options must be granted at prices no less than the market value on the date of grant.
 
At December 31, 2009, 213,380 shares of common stock were available for future grants under the 2003 Equity Incentive Plan.
 
There were no stock option exercises in 2009 or 2008 and 3,350 shares were issued upon option exercises in 2007.
 
We did not grant stock options in 2009. For 2008 and 2007, the weighted average fair value of options has been estimated at the date of the grant using the Black-Scholes option-pricing model. The following are the significant weighted average assumptions used for estimating the fair value under our stock option plans:
 
                 
    2008   2007
 
Per share fair value at grant date
  $ 3.57     $ 2.15  
Risk free interest rate
    2.47 %     4.34 %
Expected volatility
    109 %     98 %
Dividend yield
    0 %     0 %
Expected life in years
    4.0       4.0  
 
The expected life was based on the contractual term of the options and the expected employee exercise behavior. Typically, options to our employees have a 3 or 4 year vesting term and a 10 year contractual term. Options vest at 33% or 25%, respectively, after one year and thereafter vest ratably on a monthly basis. Options to Board Members have a 10 year contractual term and vest 50% after one year and 50% after two years. The risk-free interest rate is based on the U.S. Treasury zero-coupon issues with a remaining term equal to the expected option life assumed at the grant date. The future volatility is based on our 4 year historical volatility. We used an expected


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
dividend yield of 0% because we have never paid a dividend and do not anticipate paying dividends. We assumed a 10% aggregate forfeiture rate based on historical stock option cancellation rates over the last 4 years.
 
At December 31, 2009, 213,380 shares of common stock were available for future grants and options covering 1,144,876 shares were outstanding but not yet exercised. Option activity during the three years ended December 31, 2009 was as follows:
 
                 
          Weighted
 
    Number of
    Average
 
    Shares     Exercise Price  
 
Outstanding at December 31, 2006
    1,154,941     $ 38.33  
Granted
    45,670       2.96  
Canceled
    (455,403 )     41.68  
Exercised
    (3,350 )     7.42  
                 
Outstanding at December 31, 2007
    741,858       34.24  
Granted
    576,590       4.83  
Canceled
    (84,423 )     9.60  
Exercised
           
                 
Outstanding at December 31, 2008
    1,234,025       22.18  
Granted
           
Canceled
    (89,149 )     48.20  
Exercised
           
                 
Outstanding at December 31, 2009
    1,144,876     $ 20.16  
                 
 
The following table summarizes information concerning currently outstanding and exercisable stock options at December 31, 2009:
 
                                         
          Weighted
                   
          Average
          Exercisable  
          Remaining
    Weighted
          Weighted
 
Range of
  Number
    Contractual
    Average
    Number
    Average
 
Exercise Prices
  Outstanding     Life in Years     Exercise Price     Exercisable     Exercise Price  
 
$1.43 — $4.90
    205,600       7.58     $ 3.67       132,249     $ 3.65  
 5.12 — 5.80
    412,912       8.13       5.12       312,090       5.12  
 6.70 — 7.02
    232,500       5.39       6.90       232,500       6.90  
 8.00 — 39.38
    158,978       1.88       19.28       158,978       19.28  
40.00 — 493.75
    134,886       .89       115.22       134,886       115.22  
                                         
      1,144,876       5.75     $ 20.16       970,703     $ 22.96  
                                         
 
Our outstanding options expire on various dates through July 2018. The weighted-average contractual term of outstanding options is 5.75 years and the weighted-average contractual term of currently exercisable stock options is slightly less than 5.75 years. At December 31, 2009, outstanding options covering 15,700 shares, with an intrinsic value of $28,000, had an exercise price less than the current market value and 11,838 of these shares, with an intrinsic value of $21,000 were exercisable. The number of options exercisable and weighted average exercise price at December 31, 2008 and 2007 totaled 674,061 and $36.67 and 663,174 and $37.87, respectively.
 
In May 2009, we issued awards covering 55,000 shares of restricted stock, vesting 50% after one year of service and 50% after two years of service. The per share weighted average grant-date fair value was $3.24. In January 2009, we issued awards covering 835,998 shares of restricted stock, vesting 50% after one year of service and 50% after two years of service. The per share weighted average grant-date fair value was $1.00. In


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
September 2008, we issued awards covering 20,000 shares of restricted stock, all vesting after two years of service, with a per share weighted average grant-date fair value of $1.62. A 10% aggregate forfeiture rate was assumed for all awards.
 
In July 2006, we issued restricted stock awards totaling 331,000 shares with a cliff vest after two years of service and a per share weighted average grant-date fair value of $1.50. A 10% forfeiture rate was assumed. In July 2008, 302,000 of these shares fully vested in one single installment and have been expensed over the prior periods as compensation expense. We issued 256,255 of these shares and withheld 45,745 shares for statutory minimum tax withholding requirements.
 
The impact of all equity awards on the condensed consolidated statements of operations for 2009 was an expense of $1.2 million and $0.06 on basic and diluted earnings per share. The 2008 and 2007 impact on net income was an expense of $587,000 and $339,000, respectively, and $0.04 and $0.03 on basic and diluted earnings per share, respectively. No stock compensation cost was capitalized during the periods. The total compensation cost related to non-vested option awards not yet recognized was $1.1 million and the weighted-average period over which the cost is expected to be recognized is 1.2 years. The total compensation cost related to non-vested stock awards not yet recognized was $318,000, and the weighted-average period over which the cost is expected to be recognized is 8 months.
 
Warrants
 
The following is a summary of outstanding warrants at December 31, 2009:
 
                                 
    Common Shares  
          Currently
    Price per
       
    Total     Exercisable     Share     Expiration Date  
 
Warrants related to August 2005 financing
    608,237       608,237     $ 6.25       August 16, 2010 ***
Warrants related to April 2004 financing
    10,000       10,000     $ 18.50       April 28, 2011 *
                                 
Total
    618,237       618,237                  
                                 
 
 
* The terms of these warrants contain net exercise provisions, under which holders can elect to receive common stock equal to the difference between the exercise price and the sale price for common shares on the exercise date or the date immediately preceding the exercise date instead of paying the exercise price in cash.
 
** These warrants contain special anti-dilution adjustment provisions relating to the price of other issuances. Under the issuances in 2009, the exercise price of these warrants was adjusted to $6.25.
 
We determined that the 608,237 warrants related to issuance of common stock are subject to fair value accounting as a derivative. Using the Black-Scholes valuation model, the significant weighted average assumptions for estimating the fair value of these warrants at December 31, 2009 were as follows: expected life of 8 months; risk free interest rate of 0.2%; expected volatility of 118% and; dividend yield of 0%. The December 31, 2009 fair value of those warrants was estimated to be $171,000.
 
No warrants were exercised during 2009 and 2008. During 2007, the BAOLI offering caused the exercise price and the number of shares of certain warrants issued in 2004 to be adjusted to $8.34 and 110,880, respectively. In November 2007, the holder of these warrants elected the net exercise provision of this warrant, and received 24,697 shares of our common stock.
 
Note 6 — Employee Savings Plan
 
In December 1989, the Board of Directors approved a 401(k) savings plan (the “401(k) Plan”) for our employees that became effective in 1990. Eligible employees may elect to make contributions under the terms of the


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
401(k) Plan; however, contributions by us are made at the discretion of management. We contributed $241,000 to the 401(k) Plan in 2009 and $287,000 in 2008 and made no contributions to the 401(k) Plan in 2007.
 
Note 7 — Commitments and Contingencies
 
Operating Leases
 
We lease our offices and production facilities under a non-cancelable operating lease that expires in November 2016. This lease contains a minimum rent escalation clause that requires additional rental amounts after the first year. Rent expense for this lease with minimum annual rent escalation is recognized on a straight line basis over the minimum lease term. This lease also requires us to pay utilities, insurance, taxes and other operating expenses and contains one five-year renewal option at 95% of the then current market rental value.
 
For 2009, 2008 and 2007, rent expense was $1,126,000, $1,122,000 and $1,104,000, respectively.
 
Capital Leases
 
We leased certain property and equipment under a capital lease arrangement that expired in 2007.
 
Patents and Licenses
 
We have entered into various licensing agreements requiring royalty payments ranging from 0.13% to 2.5% of specified product sales. Certain of these agreements contain provisions for the payment of guaranteed or minimum royalty amounts. In the event that we fail to pay any minimum annual royalties, these licenses may automatically be terminated. These royalty obligations terminate in 2010 to 2020. Royalty expenses totaled $161,000 in 2009, $150,000 in 2008 and $172,000 in 2007. Under the terms of certain royalty agreements, royalty payments made may be subject to audit. There have been no audits to date and we do not expect any possible future audit adjustments to be significant.
 
The minimum lease payments under operating and capital leases and license obligations are as follows:
 
                 
          Operating
 
Years Ended December 31,
  Licenses     Leases  
 
2010
  $ 175,000     $ 1,307,000  
2011
    175,000       1,338,000  
2012
    175,000       1,369,000  
2013
    175,000       1,401,000  
2014
    180,000       1,442,000  
Thereafter
    930,000       2,884,000  
                 
Total payments
  $ 1,810,000     $ 9,741,000  
                 
 
Note 8 — Contractual Guarantees and Indemnities
 
During our normal course of business, we make certain contractual guarantees and indemnities pursuant to which we may be required to make future payments under specific circumstances. We have not recorded any liability for these contractual guarantees and indemnities in the accompanying consolidated financial statements.
 
Warranties
 
We establish reserves for future product warranty costs that are expected to be incurred pursuant to specific warranty provisions with our customers. Our warranty reserves are established at the time of sale and updated


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
throughout the warranty period based upon numerous factors including historical warranty return rates and expenses over various warranty periods.
 
Intellectual Property Indemnities
 
We indemnify certain customers and our contract manufacturers against liability arising from third-party claims of intellectual property rights infringement related to our products. These indemnities appear in development and supply agreements with our customers as well as manufacturing service agreements with our contract manufacturers, are not limited in amount or duration and generally survive the expiration of the contract. Given that the amount of any potential liabilities related to such indemnities cannot be determined until an infringement claim has been made, we are unable to determine the maximum amount of losses that we could incur related to such indemnifications.
 
Director and Officer Indemnities and Contractual Guarantees
 
We have entered into indemnification agreements with our directors and executive officers, which require us to indemnify such individuals to the fullest extent permitted by Delaware law. Our indemnification obligations under such agreements are not limited in amount or duration. Certain costs incurred in connection with such indemnifications may be recovered under certain circumstances under various insurance policies. Given that the amount of any potential liabilities related to such indemnities cannot be determined until a lawsuit has been filed against a director or executive officer, we are unable to determine the maximum amount of losses that we could incur relating to such indemnifications. Historically, any amounts payable pursuant to such director and officer indemnifications have not had a material negative effect on our business, financial condition or results of operations.
 
We have also entered into severance and change in control agreements with certain of our executives. These agreements provide for the payment of specific compensation benefits to such executives upon the termination of their employment with us.
 
General Contractual Indemnities/Products Liability
 
During the normal course of business, we enter into contracts with customers where we agreed to indemnify the other party for personal injury or property damage caused by our products. Our indemnification obligations under such agreements are not generally limited in amount or duration. Given that the amount of any potential liabilities related to such indemnities cannot be determined until a lawsuit has been filed against a director or executive officer, we are unable to determine the maximum amount of losses that we could incur relating to such indemnifications. Historically, any amounts payable pursuant to such guarantees have not had a material negative effect on our business, financial condition or results of operations. We maintain general and product liability insurance as well as errors and omissions insurance, which may provide a source of recovery to us in the event of an indemnification claim.
 
Short Term Borrowings
 
We have a line of credit with a bank. The line of credit expires July 2010 and is structured as a sale of accounts receivable. The agreement provides for the sale of up to $3.0 million of eligible accounts receivable, with advances to us totaling 80% of the receivables sold. Advances under the agreement (See Note 3) are collateralized by all our assets. Under the terms of the agreement, we continue to service the sold receivables and are subject to recourse provisions. Under the terms of the agreement, if the bank determines that there is a material adverse change in our business, they can exercise all their rights and remedies under the agreement, including demanding immediate payment of outstanding amounts. There was no amount outstanding under this facility during 2009.


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Contractual Contingency
 
We had a contract to deliver several custom products to a government contractor, with respect to which delivery of the product was delayed because we were unable to manufacture the products for technical reasons. In December 2008, new terms and amended specifications were agreed upon and in September 2009 we delivered and the customer accepted the products.
 
Note 9 — Legal Proceedings
 
From time to time, we are party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of our business. Excluding ordinary, routine litigation incidental to our business, we are not currently a party to any legal proceedings that we believe would reasonably be expected to have a material adverse effect on our business, financial condition or results of operation or cash flow.
 
Note 10 — Earnings Per Share
 
Basic and diluted earnings (loss) per share is based on the weighted-average number of common shares outstanding.
 
Since their impact would be anti-dilutive, our loss per common share does not include the effect of the assumed exercise or vesting of any of the following shares:
 
                         
    2009     2008     2007  
 
Outstanding stock options
    1,144,876       1,234,025       741,858  
Outstanding stock awards
    910,998       20,000       331,000  
Outstanding warrants
    618,237       352,466       468,745  
                         
Total
    2,674,111       1,606,491       1,541,603  
                         
 
Note 11 — Restructuring Expenses and Impairment Charges
 
There were no restructuring expenses or impairment charges in 2009 or 2007. In December 2008, we initiated an effort to reduce our cost structure and incurred $141,000 in severance related expense. Severance expense included in cost of goods sold was $19,000 and severance expense included in operating expenses was $122,000.
 
Note 12 —  Details of Certain Financial Statement Components and Supplemental Disclosures of Cash Flow Information and Non-Cash Activities
 
Balance Sheet Data:
 
                 
    December 31,
    December 31,
 
    2009     2008  
 
Accounts receivable:
               
Accounts receivable-trade
  $ 204,000     $ 110,000  
U.S. government accounts receivable-billed
    269,000       320,000  
Less: allowance for doubtful accounts
    (11,000 )     (75,000 )
                 
    $ 462,000     $ 355,000  
                 
 


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
                 
    December 31,
    December 31,
 
    2009     2008  
 
Inventories:
               
Raw materials
  $ 2,010,000     $ 2,753,000  
Work-in-process
    543,000       1,038,000  
Finished goods
    919,000       2,348,000  
Less: inventory reserves
    (828,000 )     (861,000 )
                 
    $ 2,644,000     $ 5,278,000  
                 
 
                 
    December 31,
    December 31,
 
    2009     2008  
 
Property and Equipment:
               
Equipment
  $ 15,743,000     $ 15,537,000  
Leasehold improvements
    6,761,000       6,741,000  
Furniture and fixtures
    404,000       404,000  
                 
      22,908,000       22,682,000  
Less: accumulated depreciation and amortization
    (21,076,000 )     (19,943,000 )
                 
    $ 1,832,000     $ 2,739,000  
                 
 
Depreciation expense amounted to $1,134,000, $1,401,000 and $1,877,000 respectively, in 2009, 2008 and 2007. In 2007 and 2008, we disposed of older, fully depreciated equipment with an acquisition cost of $1,344,000 and $598,000, respectively. There were no gains or losses from these dispositions.
 
                 
    December 31,
    December 31,
 
    2009     2008  
 
Patents and Licenses:
               
Patents pending
  $ 1,118,000     $ 940,000  
Patents issued
    1,141,000       1,059,000  
Less accumulated amortization
    (477,000 )     (409,000 )
                 
Net patents issued
    664,000       650,000  
Licenses pending
    18,000       39,000  
Licenses
    563,000       563,000  
Less accumulated amortization
    (200,000 )     (167,000 )
                 
Net licenses Issued
    363,000       396,000  
Purchased technology
    1,706,000       1,706,000  
Less accumulated amortization
    (1,706,000 )     (1,479,000 )
                 
Net purchased technology
          227,000  
                 
    $ 2,163,000     $ 2,252,000  
                 

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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Amortization expense related to these items totaled $328,000, $334,000 and $331,000 respectively in 2009, 2008 and 2007. Amortization expenses related to these items are expected to total $105,000 in 2010 and 2011.
 
                 
    December 31,
    December 31,
 
    2009     2008  
 
Accrued Expenses and Other Long Term Liabilities:
               
Salaries payable
  $ 107,000     $ 12,000  
Compensated absences
    397,000       375,000  
Compensation related
    39,000       12,000  
Warranty reserve
    255,000       261,000  
Deferred rent
    384,000       325,000  
Other
    236,000       114,000  
                 
Total
    1,418,000       1,099,000  
Less current portion
    (892,000 )     (658,000 )
                 
Long term portion
  $ 526,000     $ 441,000  
                 
 
                         
    2009     2008     2007  
 
Warranty Reserve Activity:
                       
Beginning balance
  $ 261,000     $ 380,000     $ 428,000  
Additions
    17,000       41,000       75,000  
Deductions
    (23,000 )     (160,000 )     (123,000 )
                         
Ending balance
  $ 255,000     $ 261,000     $ 380,000  
                         
Lease Abandonment Costs:
                       
Beginning balance
              $ 8,000  
Additions
                 
Transfers from unfavorable lease costs
                 
Deductions
                  (8,000 )
                         
Ending balance
  $     $     $  
                         
Product Line Exit Costs:
                       
Beginning balance
              $ 319,000  
Additions
                 
Deductions
                (319,000 )
Change in estimate relating to previous exit costs accrual
                 
                         
Ending balance
  $     $     $  
                         
Severance Costs:
                       
Beginning balance
              $ 32,000  
Additions
          141,000        
Deductions
                (32,000 )
                         
Ending balance
  $     $ 141,000     $  
                         


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Supplemental Cash Flow Information:
 
                         
    2009   2008   2007
 
Cash paid for interest
  $ 32,000     $ 32,000     $ 32,000  
 
Quarterly Financial Data (Unaudited)
 
                                 
    First Quarter   Second Quarter   Third Quarter   Fourth Quarter
 
2009
                               
Net revenues(1)
  $ 1,677,000     $ 2,631,000     $ 4,292,000     $ 2,216,000  
Loss from operations(2)
    3,496,000       3,286,000       2,179,000       3,201,000  
Net loss
    3,542,000       4,108,000       1,819,000       3,510,000  
Basic and diluted loss per common share
  $ (0.20 )   $ (0.23 )   $ (0.08 )   $ (0.16 )
Weighted average number of shares outstanding
    17,869,030       18,170,470       21,621,035       21,621,035  
2008
                               
Net revenues(1)
  $ 3,471,000     $ 2,949,000     $ 3,595,000     $ 1,278,000  
Loss from operations(2)
    2,398,000       3,411,000       3,294,000       3,850,000  
Net loss
    2,308,000       3,349,000       3,235,000       3,809,000  
Basic and diluted loss per common share
  $ (0.17 )   $ (0.21 )   $ (0.18 )   $ (0.21 )
Weighted average number of shares outstanding
    13,636,083       16,316,072       17,750,761       17,869,030  
 
 
(1) Our revenues vary from quarter to quarter as our customers provide minimal lead-time prior to the release of their purchase orders and have non-binding commitments to purchase from us.
 
(2) Includes increased reserve for inventory obsolescence of $12,000, $90,000, $90,000 and $90,000, respectively, in the 2009 quarters and $0, $15,000, $0 and $2,000, respectively, in the 2008 quarters.


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SUPERCONDUCTOR TECHNOLOGIES INC.
 
Schedule II — Valuation and Qualifying Accounts
 
                                         
    Additions
        Charged to
  Charged to
       
    Beginning
  Costs &
  Other
      Ending
    Balance   Expenses   Accounts   Deductions   Balance
 
2009
                                       
Allowance for Uncollectible Accounts
  $ 75,000     $     $     $ (64,000 )   $ 11,000  
Reserve for Inventory Obsolescence
    861,000       611,000             (644,000 )     828,000  
Reserve for Warranty
    261,000       43,000             (49,000 )     255,000  
Deferred Tax Asset Valuation Allowance
    117,658,000       2,951,000                   120,609,000  
2008
                                       
Allowance for Uncollectible Accounts
    75,000                         75,000  
Reserve for Inventory Obsolescence
    1,015,000       17,000             (171,000 )     861,000  
Reserve for Warranty
    380,000       41,000             (160,000 )     261,000  
Deferred Tax Asset Valuation Allowance
    115,282,000       2,376,000                   117,658,000  
2007
                                       
Allowance for Uncollectible Accounts
    75,000                         75,000  
Impairment for Notes Receivable from Stockholder
    1,007,000       (583,000 )           (424,000 )      
Reserve for Inventory Obsolescence
    1,367,000       (195,000 )           (157,000 )     1,015,000  
Reserve for Warranty
    428,000       75,000             (123,000 )     380,000  
Deferred Tax Asset Valuation Allowance
  $ 112,153,000     $ 3,129,000     $     $     $ 115,282,000  


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SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 17th day of March 2010.
 
SUPERCONDUCTOR TECHNOLOGIES INC.
 
  By: 
/s/  Jeffrey A. Quiram
Jeffrey A. Quiram
President and Chief Executive Officer
 
POWER OF ATTORNEY
 
KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints William J. Buchanan, his attorney-in-fact, with full power of substitution, for him in any and all capacities, to sign any and all amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact or his substitute or substitutes, may do or cause to be done by virtue hereof.
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
 
             
Signature
 
Title
 
Date
 
         
/s/  Jeffrey A. Quiram

Jeffrey A. Quiram
  President, Chief Executive Officer and Director (Principal Executive Officer)   March 17, 2010
         
/s/  William J. Buchanan

William J. Buchanan
  Controller (Principal Accounting Officer) (Principal Financial Officer)   March 17, 2010
         
/s/  David W. Vellequette

David W. Vellequette
  Director   March 17, 2010
         
/s/  Lynn J. Davis

Lynn J. Davis
  Director   March 17, 2010
         
/s/  Dennis J. Horowitz

Dennis J. Horowitz
  Director   March 17, 2010
         
/s/  Martin A. Kaplan

Martin A. Kaplan
  Director   March 17, 2010
         
/s/  John D. Lockton

John D. Lockton
  Chairman of the Board   March 17, 2010


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