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SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
  
 FORM 10-Q (Mark One) x
    
    Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended October 2, 2004
 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.  Delaware
    
    77-0158076(State or other jurisdiction of
    
    (IRS Employerincorporation or organization)
    
    Identification No.)
 460 Ward Drive,
Santa Barbara, California 93111-2356
(Address of principal executive offices & zip code) (805) 690-4500
(Registrants telephone number including area code)   Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes    x   No   o Indicate by check mark
whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act Yes    x   No   o As of November 5, 2004, there were 92,111,026 shares of the Registrants Common Stock outstanding. 1




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SUPERCONDUCTOR TECHNOLOGIES INC. INDEX TO FORM 10-Q Three and Nine Months Ended October 2, 2004 SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
    
    
    3WHERE YOU CAN FIND MORE INFORMATION
    
    
    3PART I  FINANCIAL INFORMATIONITEM 1 - Financial StatementsCondensed Consolidated Statement of Operations
    
    
    4Condensed Consolidated Balance Sheet
    
    
    5Condensed Consolidated Statement of Cash Flows
    
    
    6Notes to Unaudited Interim Condensed Consolidated Financial Statements
    
    
    7ITEM 2 - Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    22ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    31ITEM 4. Disclosure Controls and Procedures
    
    
    31PART II - OTHER INFORMATIONITEM 1 - Legal Proceedings
    
    
    32ITEM 5  Other Information
    
    
    32ITEM 6  Exhibits
    
    
    33SIGNATURE
    
    
    35EX-10.1EX-10.2EX-10.3EX-31.1EX-31.2EX-32.1EX-32.2
  2




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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This report contains forward-looking statements that involve risks and
uncertainties. We have made these statements in reliance on the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Our
forward-looking statements relate to future events or our future performance
and include, but are not limited to, statements concerning our business
strategy, future commercial revenues, market growth, capital requirements, new
product introductions, expansion plans and our funding requirements. Other
statements contained in our filings that are not historical facts are also
forward-looking statements. We have tried, wherever possible, to identify
forward-looking statements by terminology such as may, will, could,
should, expects, anticipates, intends, plans, believes, seeks,
estimates and other comparable terminology. Forward-looking statements are not guarantees of future performance and
are subject to various risks, uncertainties and assumptions that are difficult
to predict. Therefore, actual results may differ materially from those
expressed in forward-looking statements. They can be affected by many factors,
including, those discussed under the caption Managements Discussion and
Analysis of Financial Condition and Results of Operations. Forward-looking
statements are based on information presently available to senior management,
and we do not assume any duty to update our forward-looking statements. 
 WHERE YOU CAN FIND MORE INFORMATION As a public company, we are required to file annually, quarterly and
special reports, proxy statements and other information with the SEC. You may
read and copy any of our materials on file with the SEC at the SECs Public
Reference Room at 450 Fifth Street, N.W., Judiciary Plaza, Washington, DC
20549, as well as at the SECs regional office at 5757 Wilshire Boulevard,
Suite 500, Los Angeles, California 90036. Our filings are available to the
public over the Internet at the SECs website at http:\\.www.sec.gov. Please
call the SEC at 1-800-SEC-0330 for further information on the Public Reference
Room. STI also provides copies of its Forms 8-K, 10-K, 10-Q, Proxy and Annual
Report at no charge to investors upon request and makes electronic copies of
its most recently filed reports available through its website at
www.suptech.com as soon as reasonably practicable after filing such material
with the SEC. 3




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PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements SUPERCONDUCTOR TECHNOLOGIES INC. 
 CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited) Three Months Ended
    
    Nine Months EndedSeptember 27,
    
    October 2,
    
    September 27,
    
    October 2,2003
    
    2004
    
    2003
    
    2004Net revenues:Net commercial product revenues
    
    $
    11,570,000
    
    
    $
    6,053,000
    
    
    $
    25,630,000
    
    
    $
    13,788,000Government and other contract
revenues
    
    
    2,586,000
    
    
    
    1,246,000
    
    
    
    7,328,000
    
    
    
    5,239,000Sub license royalties
    
    
    
    
    
    
    
    
    
    
    41,000
    
    
    
    28,000Total net revenues
    
    
    14,156,000
    
    
    
    7,299,000
    
    
    
    32,999,000
    
    
    
    19,055,000Costs and expenses:Cost of commercial product revenues
    
    
    8,150,000
    
    
    
    6,014,000
    
    
    
    19,450,000
    
    
    
    14,827,000Contract research and development
    
    
    1,728,000
    
    
    
    860,000
    
    
    
    4,661,000
    
    
    
    3,537,000Other research and development
    
    
    985,000
    
    
    
    1,327,000
    
    
    
    4,302,000
    
    
    
    3,808,000Selling, general and administrative
    
    
    4,052,000
    
    
    
    3,451,000
    
    
    
    16,614,000
    
    
    
    12,404,000Restructuring expenses
    
    
    
    
    
    
    785,000
    
    
    
    
    
    
    
    3,298,000Total costs and expenses
    
    
    14,915,000
    
    
    
    12,437,000
    
    
    
    45,027,000
    
    
    
    37,874,000Loss from operations
    
    
    (759,000
    )
    
    
    (5,138,000
    )
    
    
    (12,028,000
    )
    
    
    (18,819,000
    )Interest income
    
    
    44,000
    
    
    
    36,000
    
    
    
    147,000
    
    
    
    83,000Interest expense
    
    
    (136,000
    )
    
    
    (53,000
    )
    
    
    (374,000
    )
    
    
    (1,213,000
    )Net loss
    
    $
    (851,000
    )
    
    $
    (5,155,000
    )
    
    $
    (12,255,000
    )
    
    $
    (19,949,000
    )Basic and diluted loss per common share
    
    $
    (0.01
    )
    
    $
    (0.06
    )
    
    $
    (0.20
    )
    
    $
    (0.25
    )Weighted average number of common
shares outstanding
    
    
    64,939,896
    
    
    
    92,103,424
    
    
    
    61,623,747
    
    
    
    79,697,019
 See accompanying notes to the condensed consolidated financial statements 4




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SUPERCONDUCTOR
TECHNOLOGIES INC. 
 CONSOLIDATED BALANCE SHEET
 December 31,
    
    October 2,2003
    
    2004(See  Note)ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    11,144,000
    
    
    $
    7,135,000Accounts receivable, net
    
    
    8,809,000
    
    
    
    2,173,000Inventory
    
    
    8,802,000
    
    
    
    12,653,000Prepaid expenses and other current assets
    
    
    760,000
    
    
    
    969,000Total Current Assets
    
    
    29,515,000
    
    
    
    22,930,000Property and equipment, net of accumulated depreciation of
$15,061,000 and $16,407,000, respectively
    
    
    12,534,000
    
    
    
    11,344,000Patents, licenses and purchased technology, net of accumulated
amortization of
$3,173,000 and $3,449,000, respectively
    
    
    5,367,000
    
    
    
    4,108,000Goodwill
    
    
    20,107,000
    
    
    
    20,107,000Other assets
    
    
    600,000
    
    
    
    664,000Total Assets
    
    $
    68,123,000
    
    
    $
    59,153,000LIABILITIES AND STOCKHOLDERS EQUITYCurrent Liabilities:Line of credit
    
    $
    3,308,000
    
    
    $
    669,000Accounts payable
    
    
    5,154,000
    
    
    
    2,909,000Accrued expenses
    
    
    4,832,000
    
    
    
    3,752,000Current portion of capitalized lease obligations and long term debt
    
    
    645,000
    
    
    
    57,000Total Current Liabilities
    
    
    13,939,000
    
    
    
    7,387,000Capitalized lease obligations and long term-debt
    
    
    76,000
    
    
    
    37,000Other long term liabilities
    
    
    1,888,000
    
    
    
    1,324,000Total Liabilities
    
    
    15,903,000
    
    
    
    8,748,000Commitments and contingencies-Note 5, 7 and 8Stockholders Equity:Preferred stock, $.001 par value, 2,000,000 shares authorized,
none issued and outstanding
    
    
    
    
    
    
    Common stock, $.001 par value, 125,000,000 shares
authorized, 68,907,109 and 92,111,026 shares issued and
outstanding, respectively
    
    
    69,000
    
    
    
    92,000Capital in excess of par value
    
    
    168,776,000
    
    
    
    186,887,000Notes receivable from stockholder
    
    
    (820,000
    )
    
    
    (820,000
    )Accumulated deficit
    
    
    (115,805,000
    )
    
    
    (135,754,000
    )Total Stockholders Equity
    
    
    52,220,000
    
    
    
    50,405,000Total Liabilities and Stockholders Equity
    
    $
    68,123,000
    
    
    $
    59,153,000
 See accompanying notes to the condensed consolidated financial statements Note: December 31, 2003 balances were derived from audited financial statements 5




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SUPERCONDUCTOR
TECHNOLOGIES INC. 
 CONSOLIDATED STATEMENT OF CASH FLOWS
 Nine Months EndedSeptember 27,
    
    October 2,2003
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (12,255,000
    )
    
    $
    (19,949,000
    )Adjustments to reconcile net loss to net cash used in
operating activities:Depreciation and amortization
    
    
    2,341,000
    
    
    
    2,623,000Asset write-down
    
    
    
    
    
    
    1,862,000Warrant charges
    
    
    13,000
    
    
    
    925,000Increased inventory reserve
    
    
    252,000
    
    
    
    618,000Changes in assets and liabilities:Accounts receivable
    
    
    (485,000
    )
    
    
    6,636,000Inventory
    
    
    (3,306,000
    )
    
    
    (4,469,000
    )Prepaid expenses and other current assets
    
    
    (86,000
    )
    
    
    (208,000
    )Patents, licenses and purchased technology
    
    
    (311,000
    )
    
    
    (354,000
    )Other assets
    
    
    (159,000
    )
    
    
    (63,000
    )Accounts payable, accrued expenses and other long-term liabilities
    
    
    589,000
    
    
    
    (3,889,000
    )Net cash used in operating activities
    
    
    (13,407,000
    )
    
    
    (16,268,000
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (2,405,000
    )
    
    
    (1,682,000
    )Net cash used in investing activities
    
    
    (2,405,000
    )
    
    
    (1,682,000
    )CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from short-term borrowings
    
    
    3,234,000
    
    
    
    5,246,000Payments on short-term borrowings
    
    
    (1,616,000
    )
    
    
    (7,885,000
    )Payments on long-term obligations
    
    
    (948,000
    )
    
    
    (627,000
    )Proceeds from sale of common stock and warrants and
exercise of stock options and warrants
    
    
    10,066,000
    
    
    
    17,207,000Net cash provided by financing activities
    
    
    10,736,000
    
    
    
    13,941,000Net decrease in cash and cash equivalents
    
    
    (5,076,000
    )
    
    
    (4,009,000
    )Cash and cash equivalents at beginning of period
    
    
    18,191,000
    
    
    
    11,144,000Cash and cash equivalents at end of period
    
    $
    13,115,000
    
    
    $
    7,135,000
 See accompanying notes to the condensed consolidated financial statements. 6




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SUPERCONDUCTOR TECHNOLOGIES INC. 
 NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. General Superconductor Technologies Inc. was incorporated in Delaware on May 11,
1987 and maintains its headquarters in Santa Barbara, California. The Company
has operated in a single industry segment, the research, development,
manufacture and marketing of high-performance filters to service providers and
original equipment manufacturers in the mobile wireless communications
industry. The Companys principal commercial product, the SuperLink Rx®,
combines high-temperature superconductors with cryogenic cooling technology to
produce a filter with significant advantages over conventional filters. From
1987 to 1997, the Company was engaged primarily in research and development and
generated revenues primarily from government research contracts. The Company
began full-scale commercial production of the SuperLink Rx® in 1997 and shipped
1,884 units in 2003 and 1,243 and 605 units in the nine months ended September
27, 2003 and October 2, 2004, respectively. The Company continues to be involved as either contractor or subcontractor
on a number of contracts with the United States government. These contracts
have been and continue to provide a significant source of revenues for the
Company. For the nine months ended September 27, 2003 and October 2, 2004,
government related contracts account for 22% and 27%, respectively, of the
Companys net revenues. The unaudited consolidated financial information furnished herein has been
prepared in accordance with generally accepted accounting principles and
reflects all adjustments, consisting only of normal recurring adjustments,
which in the opinion of management, are necessary for a fair statement of the
results of operations for the periods presented. The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
the accompanying notes. Actual results could differ from those estimates and
such differences may be material to the financial statements. This quarterly
report on Form 10-Q should be read in conjunction with the Companys Form 10-K
for the year ended December 31, 2003. The results of operations for the three
and nine months ended October 2, 2004 are not necessarily indicative of results
for the entire fiscal year ending December 31, 2004. 2. Summary of Significant Accounting Policies Basis of Presentation The Companys independent registered public accounting firm has included
in their audit report for 2003-year an explanatory paragraph expressing doubt
about the Companys ability to continue as a going concern due to past losses
and negative cash flows. They included a similar explanatory paragraph in
their audit report for 2002. In 2003, the Company incurred a net loss of
$11,345,000 and negative cash flows from operations of $18,458,000. For the
nine months ended October 2, 2004, the Company had a net loss of $19,949,000
and negative cash flows from operations of $16,268,000. In response during the
current year, the Company adjusted its inventory build plan, reduced direct and
indirect labor, cut certain fixed costs and implemented a reduced workweek. In
the second quarter of 2004, the Company also began a cost restructuring program
to consolidate its research and development operations in Sunnyvale into its
Santa Barbara facility, eliminate an additional 50 positions and accelerate the
implementation of a new lower cost wafer deposition process. The Company completed two financing transactions during the nine months
ended October 2, 2004. First, the Company closed a transaction on April 28,
2004 to expand its credit facility. Silicon Valley Bank amended the Companys
existing line of credit to increase borrowing capacity from 80% to 95% of
eligible accounts receivable. The Company concurrently secured a commitment
for a $2.0 million secured bridge loan from an investor. The investor
subsequently funded $1.5 7




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million of the bridge loan. The Company issued to the
lenders warrants to purchase in the aggregate 600,000 shares of common stock at
$1.85 per share. The bridge loan was subsequently paid in full on May 26,
2004. Upon repayment of the bridge loan the Silicon Valley credit facility
reverted back to it original terms. Second, the Company completed a public offering of 23,000,000 shares of
common stock at $0.80 per share during the second quarter of this year raising
net proceeds of $16.7 million. The Company expects its existing cash resources, together with its line of credit, will be sufficient to fund planned operations into 2005. The Company expects its liquidity to reach an unacceptably low level in the second quarter of 2005 and anticipates a need for additional working capital to fund growth in the third and fourth quarters of 2005. Accordingly, the Company has concluded that it will need additional funding to
provide adequate cash reserves in the event of another downturn in
its business and to fund expected growth in the second half of 2005.
The Companys actual cash requirements will depend on numerous factors, including the rate of growth of sales, the timing and levels of products purchased, payment terms and credit limits from manufacturers, the timing and level of accounts receivable collections and its ability to manage the business profitability. The Company plans to explore various funding opportunities over the next two quarters. There is no assurance that additional financing (public or private) will
be available on acceptable terms or at all. If the Company issues additional
equity securities to raise funds, the ownership percentage of its existing
stockholders would be reduced. New investors may demand rights, preferences or
privileges senior to those of existing holders of common stock. If the Company
cannot raise needed funds, it might be forced to make further substantial
reductions in its operating expenses, which could adversely affect its ability
to implement its current business plan and ultimately its viability as a
company. The Companys interim financial statements have been prepared assuming
that it will continue as a going concern. The factors described above raise
substantial doubt about its ability to continue as a going concern. These
financial statements do not include any adjustments that might result from this
uncertainty. Principles of Consolidation The interim condensed consolidated financial statements include the
accounts of Superconductor Technologies Inc. and its wholly owned subsidiaries
(the Company). All significant intercompany transactions have been eliminated
from the consolidated financial statements. Cash and Cash Equivalents Cash and cash equivalents consist of highly liquid investments with
original maturities of three months or less. Cash and cash equivalents are
maintained with quality financial institutions and from time to time exceed
FDIC limits. Accounts Receivable The Company sells predominantly to entities in the wireless communications
industry and to entities of the United States government. The Company grants
uncollateralized credit to its customers. The Company performs ongoing credit
evaluations of its customers before granting credit. Revenue Recognition Commercial revenues are principally derived from the sale of the Companys
SuperLink Rx® products and are recognized once all of the following conditions
have been met: a) an authorized purchase order has been received in writing, b)
customers credit worthiness has been established, c) shipment of the product
has occurred, d) title has transferred, and e) if stipulated by the contract,
customer acceptance has occurred and all significant vendor obligations, if
any, have been satisfied. Contract revenues are principally generated under research and development
contracts. Contract revenues are recognized utilizing the
percentage-of-completion method measured by the relationship of costs incurred
to total estimated contract costs. If the current contract estimate were to
indicate a loss, utilizing the funded amount of the contract, a provision would
be made for the total anticipated loss. Revenues from research related
activities are derived primarily from contracts with agencies of the United
States Government. Credit risk related to accounts receivable arising from
such contracts is considered minimal. These contracts include cost-plus, fixed
price and cost sharing arrangements and are generally short-term in nature. All payments to the Company for work performed on contracts with agencies
of the U.S. Government are subject to adjustment upon audit by the Defense
Contract Audit Agency. These audits have been completed and agreed to through
2001. Based on historical experience and review of current projects in process,
management believes that the audits will not have a significant effect on the
financial position, results of operations or cash flows of the Company. 8




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Warranties The Company offers warranties generally ranging from one to five years,
depending on the product and negotiated terms of purchase agreements with its
customers. Such warranties require the Company to repair or replace defective
product returned to the Company during such warranty period at no cost to the
customer. An estimate by the Company for warranty related costs is
recorded by the Company at the time of sale based on its actual historical
product return rates and expected repair costs. Such costs have been within
managements expectations. Guarantees In connection with the sales and manufacturing of its commercial products,
the Company indemnifies, without limit or term, its customers and contract
manufactures against all claims, suits, demands, damages, liabilities,
expenses, judgments, settlements and penalties arising from actual or alleged
infringement or misappropriation of any intellectual property relating to its
products or other claims arising from its products. The Company cannot
reasonably develop an estimate of the maximum potential amount of payments that
might be made under its guarantee because of the uncertainty as to whether a
claim might arise and how much it might total. Research and Development Costs Research and development costs are expensed as incurred and include
salary, facility, depreciation and material expenses. Research and development
costs incurred solely in connection with research and development contracts are
charged to contract research and development expense. Other research and
development costs are charged to other research and development expense. Inventories Inventories are stated at the lower of cost or market, with costs
primarily determined using standard costs, which approximate actual costs
utilizing the first-in, first-out method. Provision for potentially obsolete
or slow moving inventory is made based on managements analysis of inventory
levels and sales forecasts. Property and Equipment Property and equipment are recorded at cost. Equipment is depreciated
using the straight-line method over their estimated useful lives ranging from
three to five years. Leasehold improvements and assets financed under capital
leases are amortized over the shorter of their useful lives or the lease term.
Furniture and fixtures are depreciated over seven years. Expenditures for
additions and major improvements are capitalized. Expenditures for minor
tooling, repairs and maintenance and minor improvements are charged to expense
as incurred. When property or equipment is retired or otherwise disposed of,
the related cost and accumulated depreciation are removed from the accounts.
Gains or losses from retirements and disposals are recorded as other income or
expense. Patents, Licenses and Purchased Technology Patents and licenses are recorded at cost and are amortized using the
straight-line method over the shorter of their estimated useful lives or
approximately seventeen years. Purchased technology acquired through the
acquisition of Conductus, Inc. is recorded at its estimated fair value and is
amortized using the straight-line method over seven years. Goodwill Goodwill represents the excess of purchase price over fair value of net
assets acquired. Goodwill is tested for impairment annually in the fourth
quarter after the annual planning process, or earlier if events occur which
require an impairment analysis be performed. The first step of the impairment
test, used to identify potential impairment, compares the fair value of a
reporting unit with its carrying value, including goodwill. If the fair value
of a reporting unit exceeds its carrying value, goodwill of the reporting unit
is considered not impaired. If the carrying amount of a reporting unit exceeds
its fair value, the second step of the goodwill impairment test shall be
performed to measure the amount of impairment loss. The second step of the
goodwill impairment test, used to measure the amount of impairment loss,
compares the implied fair value of the reporting unit goodwill with the
carrying amount of that goodwill. If the carrying amount of the reporting unit
goodwill exceeds the implied fair value of 9




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that goodwill, an impairment loss
shall be recognized in an amount equal to that excess. Long-Lived Assets The realizability of long-lived assets is evaluated periodically as events
or circumstances indicate a possible inability to
recover the carrying amount. Such evaluation is based on various analyses,
including cash flow and profitability projections. The analyses necessarily
involve significant management judgment. In the event the projected
undiscounted cash flows are less than net book value of the assets, the
carrying value of the assets will be written down to their estimated fair
value. 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 business the Company is subject to claims and
litigation. Liabilities relating to these claims are recorded when it is
determined that a loss is probable and the amount of the loss can be reasonably
estimated. The costs of defending the Company in such matters are expensed as
incurred. The Company is currently involved as a defendant in several lawsuits  a
patent infringement case and several substantially identical securities class
actions. These matters are discussed below in Legal Proceedings. The
Company does not believe that a loss is probable or reasonably estimable in any
of these cases and therefore has not recorded any liabilities relating to these
proceedings. The Company periodically reassesses its potential liability as
additional information becomes available. If the Company later determines that
a loss is probable and the amount reasonably estimable, the Company would
record a reserve for the potential loss. The ultimate amount of the loss, if
any, could materially impact its results of operations, financial condition or
cash flows. Income Taxes The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109 (SFAS 109), Accounting for Income
Taxes. SFAS 109 utilizes an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the Companys financial
statements or tax returns. In estimating future tax consequences, SFAS 109
generally considers all expected future events other than enactments of changes
in the tax laws or rates. Valuation allowances are established when necessary
to reduce deferred tax assets to the amount expected to be realized. Marketing Costs All costs related to marketing and advertising the Companys products are
expensed as incurred or at the time the advertising takes place. Advertising
costs were not material in each of the quarters and nine months ended September
27, 2003 and October 2, 2004. 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. Potentially dilutive shares are not included
in the calculation of diluted loss per share because their effect is
antidilutive. Stock-based Compensation As permitted under Statement of Financial Accounting Standards No. 123
(SFAS 123), Accounting for Stock-Based Compensation, the Company has
elected to follow Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees in accounting for its stock options and other
stock-based employee awards. Pro forma information regarding net loss and loss
per share, as calculated under the provisions of SFAS 123, are disclosed in the
notes to the financial statements. The Company accounts for equity securities
issued to non-employees in accordance with the provision of SFAS 123 and
Emerging Issues Task Force 96-18. 10




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If the Company had elected to recognize compensation expense for employee
awards based upon the fair value at the grant date consistent with the
methodology prescribed by SFAS 123, the Companys net loss and net loss per
share would have been increased to the pro forma amounts indicated below: Three Months Ended
    
    Nine Months EndedSeptember 27,
    
    October 2,
    
    September 27,
    
    October 2,2003
    
    2004
    
    2003
    
    2004Net loss:As reported
    
    $
    (851,000
    )
    
    $
    (5,155,000
    )
    
    $
    (12,255,000
    )
    
    $
    (19,949,000
    )Stock-based employee
compensation included in net
loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock-based compensation
expense determined under fair
value method
    
    
    (1,117,000
    )
    
    
    (1,233,000
    )
    
    
    (3,036,000
    )
    
    
    (4,591,000
    )Pro forma
    
    $
    (1,968,000
    )
    
    
    (6,388,000
    )
    
    $
    (15,291,000
    )
    
    
    (24,540,000
    )Basic and Diluted Loss per ShareAs reported
    
    $
    (0.01
    )
    
    $
    (0.06
    )
    
    $
    (0.20
    )
    
    $
    (0.25
    )Stock-based compensation
expense determined under fair
value method
    
    
    (0.02
    )
    
    
    (0.01
    )
    
    
    (0.05
    )
    
    
    (0.06
    )Pro forma
    
    $
    (0.03
    )
    
    $
    (0.07
    )
    
    $
    (0.25
    )
    
    $
    (0.31
    )
 Due to the fact that the Companys employee stock options have
characteristics significantly different from those of traded options and any
changes in the subjective input assumptions can materially affect the fair
value estimates, management does not believe that the existing models provide a
reliable single measure of the fair value of its employee stock options.
Therefore, the Company believes that the pro forma net expense per SFAS 123
calculated above is not a reliable measure of the costs of the Companys stock
option plans. Use of Estimates The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. The significant estimates in the preparation of the
financial statements relate to the assessment of the carrying amount of
accounts receivable, inventory, intangibles, goodwill, estimated provisions for
warranty costs, accruals for restructuring and lease abandonment costs, income
taxes and 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. The Company estimates that the
carrying amount of the debt approximates fair value based on the Companys
current incremental borrowing rates for similar types of borrowing
arrangements. Comprehensive Income (Loss) The Company has no items of other comprehensive income (loss) in any
period other than its net loss. Segment Information The Company operates in a single business segment, the development,
manufacture and marketing of high performance products to service providers,
systems integrators and original equipment manufacturers in the commercial
wireless 11




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##### Table of Contents



telecommunications industry. The Companys principal commercial
product, the SuperLink Rx® combines high-temperature superconductors with
cryogenic cooling technology to produce a filter with significant advantages
over conventional filters. We currently sell most of our product directly to
wireless network operators in the United States. Net revenues derived
principally from government research and development contracts are presented
separately on the statement of operations for all periods presented. Management
views its government research and development contracts as a supplementary
source of revenue to fund
its development of high temperature superconducting products. Net commercial product revenues are derived from the following products: For the three months ended
    
    For the nine months endedSeptember 27,
    
    October 2,
    
    September 27,
    
    October 2,2003
    
    2004
    
    2003
    
    2004SuperLink Rx
    
    $
    10,142,000
    
    
    $
    4,548,000
    
    
    $
    22,771,000
    
    
    $
    10,945,000SuperPlex
multiplexer
    
    
    1,296,000
    
    
    
    1,070,000
    
    
    
    2,500,000
    
    
    
    1,981,000SuperLink Tx
    
    
    17,000
    
    
    
    21,000
    
    
    
    68,000
    
    
    
    21,000Other
    
    
    115,000
    
    
    
    414,000
    
    
    
    291,000

    
    
    
    841,000Total
    
    $
    11,570,000
    
    
    $
    6,053,000
    
    
    $
    25,630,000
    
    
    $
    13,788,000
 Certain Risks and Uncertainties During the two year period ended December 31, 2003, the Company sold 2,811
SuperFilter® units and in the nine months ended September 27, 2003 and October
2, 2004 it sold 1,243 and 605 SuperFilter® units, respectively. The Company has
continued to incur operating losses. The Companys long-term prospects and
execution of its business plan are dependent upon the continued and increased
market acceptance for the product. The Company currently sells most of its products directly to wireless
network operators in the United States and its product sales have historically
been concentrated in a small number of customers. In 2002 U.S. Cellular and
ALLTEL accounted for 8% and 84% of our net commercial revenues, respectively,
and 19% and 24% of accounts receivable, respectively. In 2003, ALLTEL and
Verizon Wireless our two largest customers accounted for 70% and 15% of our net
commercial revenues, respectively, and 21% and 25% of accounts receivable,
respectively. In the nine months ended October 2, 2004, ALLTEL and Verizon
Wireless, our two largest customers, accounted for 63% and 23% of our net
commercial revenues, respectively, and 29% and 18% of accounts receivable,
respectively. The loss of, or reduction in, sales to any of these customers
could have a material adverse effect on the Companys business, financial
condition, results of operations and cash flows. 12




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##### Table of Contents



The Company currently relies on one supplier for purchases of high quality
substrates for growth of high-temperature superconductor films and a limited
number of suppliers for other key components of its products. In connection with the sales of its commercial products, the Company
indemnifies, without limit or term, its customers against all claims, suits,
demands, damages, liabilities, expenses, judgments, settlements and penalties
arising from actual or alleged infringement or misappropriation of any
intellectual property relating to its products or other claims arising from its
products. The Company cannot reasonably develop an estimate of the maximum
potential amount of payments that might be made under its guarantee because of
the uncertainty as to whether a claim might arise and how much it might total. Recent Accounting Pronouncements In March 2004, the consensus of the Emerging Issues Task Force (EITF)
Issue No. 03-06, Participating Securities and the Two-Class Method under FASB
Statement 128, was published. EITF Issue No.03-06 addresses the computations of
earnings per share by companies that have issued securities other than common
stock that contractually entitle the holder to participate in dividends and
earnings of the company. Further guidance on the application and allocations of
the two-class method of calculating earnings per share is also included. The
provisions of EITF Issue No. 03-06 will be effective for
reporting periods beginning after March 31, 2004. The adoption of this
guidance is not expected to have a significant impact on the Companys
financial results of operations and financial position. 3. Short Term Borrowings The Company has a line of credit with a bank. The line of credit expires
March 17, 2005 and is structured as a sale of accounts receivable. The
agreement provides for the sale of up to $5 million of eligible accounts
receivable, with advances to the Company totaling 80% of the receivables sold.
Advances under the agreement are collateralized by all the Companys assets.
Under the terms of the agreement, the Company continues to service the sold
receivables and is subject to recourse provisions.If the bank determines that
there is a material adverse change in the Companys business, they can exercise
all their rights and remedies under the agreement. Advances bear interest at the prime rate (4.75% at October 2, 2004) plus
2.50% subject to a minimum monthly charge. Outstanding amounts under this
borrowing facility at October 2, 2004 totaled $669,000 and are repaid upon
collection of the underlying receivables sold. On April 28, 2004 the Company temporarily expanded its credit facility.
Silicon Valley Bank temporarily amended the Companys existing line of credit
to increase borrowing capacity from 80% to 95% of eligible accounts receivable
on up to the sale of $2.5 million of eligible accounts receivable. Advances
under the modified agreement bore interest at prime rate plus 5.125%. Upon
repayment of the bridge loan described below this credit facility reverted back
to its original terms The Company concurrently secured a commitment for a $2.0 million secured
bridge loan from an investor. The bridge loan bore interest at 12% per annum,
was due by July 31, 2004 and included penalty provisions if there were any
defaults under the agreement. The investor subsequently funded $1.5 million of
the bridge loan. The bridge loan was collateralized by 13




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##### Table of Contents



all the Companys assets
and was subordinated to the Silicon Valley Bank line of credit. The bridge loan
was subsequently paid in full on May 26, 2004. In connection with modification of the existing credit facility with
Silicon Valley Bank and $2 million bridge loan, the Company issued to the bank
warrants to purchase 100,000 shares of common stock at $1.85 per share and to
the bridge lender warrants to purchase 500,000 shares of common stock at $1.85
per share . These warrants expire on April 28, 2011. The fair value of the
warrants issued in connection with the bridge loans were estimated using the
Black-Scholes option pricing method, totaled $802,000 and were accounted for as
debt issuances costs and amortized over the term of the loan. Assumptions used
in the calculation were: dividends of zero percent each year, expected
volatilities of 112%, expected life of 7 years and risk free interest rate of
3.99%. 4. Stockholders Equity Common Stock In the nine months ended October 2, 2004 the Company raised net proceeds
of $16,699,000, net of offering costs of $1,701,000, from the public sale of
23,000,000 shares of common stock at $0.80 per share based on a negotiated
discount to market. This transaction caused the exercise price and the number of shares of the
warrants issued to the bridge lender under the 2004 Bridge Loan to be adjusted
to $1.59 and 581,761, respectively. The exercise price and shares of the
warrants issued in connection with the Series E convertible Preferred Stock
were not affected. Stock Options The following is a summary of stock option transactions under the
Companys stock option plans: Weighted
    
    
    
    
    
    WeightedAverage
    
    Number of
    
    AverageNumber of
    
    
    
    
    
    Exercise
    
    Options
    
    ExerciseShares
    
    Price Per Share
    
    Price
    
    Exercisable
    
    PriceBalance at December 31, 2003
    
    
    7,545,321
    
    
    $
    0.83 - $49.375
    
    
    $
    6.238
    
    
    
    3,268,894
    
    
    $
    8.21Granted
    
    
    2,949,459
    
    
    $
    0.87 - $7.03
    
    
    $
    3.71Exercised
    
    
    (89,777
    )
    
    $
    0.83 -   $4.57
    
    
    $
    2.78Canceled
    
    
    (922,900
    )
    
    $
    1.00 - $41.25
    
    
    $
    5.40Balance at October 2, 2004
    
    
    9,482,103
    
    
    $
    0.87 - $49.375
    
    
    $
    5.60
    
    
    
    5,042,587
    
    
    $
    6.28
 Options for 89,777 shares of common stock were exercised for $249,600
during the period. The outstanding options expire by the end of June 2014. The
exercise prices for these options range from $0.87 to $49.38 per share, for an
aggregate exercise price of approximately $53.1 million. At October 2, 2004,
there were 1,184,185 shares of common stock available for granting future
options. Warrants In connection with modification of the existing credit facility with
Silicon Valley Bank and $2 million bridge loan, the Company issued to the bank
warrants to purchase 100,000 shares of common stock at $1.85 per share and to
the bridge lender warrants to purchase 500,000 shares of common stock at $1.85
per share . These warrants expire on April 28, 2011. The bridge lender warrants
contain weighted average antidilution provisions which adjust the warrant
exercise price and number of shares in the event the Company sells equity
securities at a discount to then prevailing market prices. The amount of the
adjustment depends on the size of the below-market transaction and the amount
of the discount to the market price. These warrants include call, net exercise,
registration rights and penalty provisions if the sale of the shares underlying
the warrants were not registered within a certain timeframe or if the
registration statement effectiveness is not maintained. 14




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##### Table of Contents



The following is a summary of outstanding warrants at October 2, 2004: Common SharesCurrently
    
    Price perTotal
    
    Exercisable
    
    Share
    
    Expiration DateWarrant related to issuance of Series E Preferred Stock
    
    
    1,166,477
    
    
    
    1,166,477
    
    
    $
    19.28
    
    
    September 29, 2005Warrants related to issuance of common stock
    
    
    397,857
    
    
    
    397,857
    
    
    
    5.50
    
    
    March 10, 20071,406,581
    
    
    
    1,406,581
    
    
    
    1.19
    
    
    December 17, 2007*1,162,790
    
    
    
    1,162,790
    
    
    
    2.90
    
    
    June 24, 2008*Warrants related to April 2004 Bridge Loans
    
    
    581,761
    
    
    
    581,761
    
    
    
    1.59
    
    
    April 28, 2011*100,000
    
    
    
    100,000
    
    
    
    1.85
    
    
    April 28, 2011*Warrants assumed in connection with the Conductus,
Inc. acquisition
    
    
    219,690
    
    
    
    219,690
    
    
    
    6.667
    
    
    December 10, 2004*72,756
    
    
    
    72,756
    
    
    
    22.383
    
    
    August 7, 20051,095,000
    
    
    
    1,095,000
    
    
    
    4.583
    
    
    September 27, 20076,000
    
    
    
    6,000
    
    
    
    31.25
    
    
    September 1, 2007Total
    
    
    6,208,912
    
    
    
    6,208,912
 * The terms of these warrants contain net exercise provisions, wherein
instead of a cash exercise investors can elect to receive common stock
equal to the difference between the exercise price and the average closing
sale price for common shares over 10-30 days immediately preceding the
exercise date. During the nine months ended October 2, 2004 the following warrants were
exercised: Warrants
    
    
    
    
    
    Common SharesIssuedIn Accordance WithWarrants
    
    Price per
    
    
    
    
    
    Net ExerciseExercised
    
    Share
    
    For Cash
    
    ProvisionsWarrants related to bank borrowings
    
    
    123,525
    
    
    $
    3-3.25
    
    
    $
    
    
    
    
    71,312Warrants related to issuance of common stock
    
    
    42,857
    
    
    
    5.50
    
    
    
    235,714
    
    
    
    Total
    
    
    166,382
    
    
    
    
    
    
    
    235,714
    
    
    
    71,312
 5. Legal Proceedings Patent Litigation The Company is engaged in a patent dispute with ISCO International, Inc.
relating to U.S. Patent No. 6,263,215 entitled Cryoelectronically Cooled
Receiver Front End for Mobile Radio Systems. ISCO filed a complaint on July
17, 2001 in the United States District Court for the District of Delaware
against the Company and its wholly owned subsidiary, Conductus, Inc. The ISCO
complaint alleged that the Companys SuperFilter product and Conductus
ClearSite® product infringe ISCOs patent. The matter went to trial on March
17, 2003. On April 3, 2003, the jury returned a unanimous verdict that the Companys
SuperFilter III product does not infringe the patent in question, and that
ISCOs patent is invalid and unenforceable. The jury also awarded the Company
$3.8 million in compensatory damages based upon a finding that ISCO engaged in
unfair competition and acted in bad faith by issuing press releases and
contacting our customers asserting rights under this patent. On April 17, 2003, the Company filed a Motion for Attorneys Fees and
Disbursements, in which the Company asked the court to award the Company its
attorneys fees and other litigation expenses. On the same date, ISCO filed a
motion, asking the court to overturn the verdict and grant a new trial. In
August 2003, the court rejected ISCOs request to overturn the jurys verdict
that the patent is invalid and not infringed by the SuperFilter III product,
and accepted the jurys verdict that 15




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##### Table of Contents



the patent is unenforceable because of
inequitable conduct committed by one of the alleged inventors. ISCO
subsequently filed a notice of appeal as to this portion of the courts
decision. The court overturned the jurys verdict of unfair competition and bad
faith on the part of ISCO and the related $3.8 million compensatory damage
award to the Company, and also denied the Company request for reimbursement of
its legal fees associated with the case. The Company has filed a notice of
appeal as to this portion of the courts decision. Litigation expenses on the ISCO matter totaled $90,000 and $4,784,000 for
the three and nine month periods ended September 27, 2003, respectively, and
$25,000 and $438,000 for the three and nine month periods ended October 2,
2004, respectively. Class Action Lawsuits The Company has been named as a defendant in several substantially
identical class action lawsuits filed in the United States District Court for
the Central District of California in April 2004. The cases were consolidated
in August 2004, and the plaintiffs filed an amended consolidated complaint in
October 2004. The plaintiffs allege securities law violations by the Company
and certain of its officers and directors under SEC Rule 10b-5 and Sections
10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The
complaint was filed on behalf of a purported class of people who purchased our
stock during the period between January 9, 2004 and March 1, 2004. The
plaintiffs base their allegations primarily on the fact that the Company did
not achieve our forecasted revenue guidance of $10 to $13 million for the first
quarter of 2004. The complaint seeks unspecified damages. 6. Earnings Per Share The computation of per share amounts for the three and nine month periods
ended September 27, 2003 and October 2, 2004 is based on the average number of
common shares outstanding for the period. Options and warrants to purchase
18,664,666 and 15,691,015 shares of common stock during the three and nine
months periods ended September 27, 2003 and October 2, 2004, respectively,
were not considered in the computation of diluted earnings per share because
their inclusion would be anti-dilutive. 7. Commitments and Contingencies Operating Leases The Company leases its offices and production facilities under
non-cancelable operating leases that expire at various times over the next
seven years. Generally leases contain escalation clauses for increases in
annual renewal options and require the Company to pay utilities, insurance,
taxes and other operating expenses. For the three and nine months ended September 27, 2003, rent expense was
$299,000 and $922,000, respectively. For the three and nine months ended
October 2, 2004, rent expense was $298,000 and $944,000, respectively. Capital Leases The Company leases certain property and equipment under capital lease
arrangements that expire at various dates through 2007. The leases bear
interest at various rates ranging from 8.56% to 14.95%. Patents and Licenses The Company has 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 16




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##### Table of Contents



amounts. In the event that the Company fails to pay minimum annual
royalties, these licenses may automatically become non-exclusive or be
terminated. These royalty obligations terminate in 2009 to 2020. Royalty
expenses totaled $179,000 in 2001, $294,000 in 2002 and $572,000 in 2003. For
the three and nine months ended September 27, 2003, royalty expense totaled
$141,000 and $386,000, respectively. For the three and nine months ended
October 2, 2004, royalty expense totaled $94,000 and $370,000, respectively.
Under the terms of certain royalty agreements, royalty payments made may be
subject to audit. There have been no audits to date and the Company does 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: OperatingYear ending December 31,
    
    Licenses
    
    Leases
    
    Capital LeasesRemainder of 2004
    
    $
    68,000
    
    
    $
    630,000
    
    
    $
    18,0002005
    
    
    270,000
    
    
    
    2,440,000
    
    
    
    52,0002006
    
    
    270,000
    
    
    
    1,552,000
    
    
    
    22,0002007
    
    
    253,000
    
    
    
    1,405,000
    
    
    
    15,0002008
    
    
    158,000
    
    
    
    1,448,000
    
    
    
    Thereafter
    
    
    1,775,000
    
    
    
    4,516,000
    
    
    
    Total payments
    
    $
    2,794,000
    
    
    $
    11,991,000
    
    
    
    107,000Less: amount representing
interest
    
    
    
    
    
    
    
    
    
    
    (13,000
    )Present value of minimum lease
    
    
    
    
    
    
    
    
    
    
    94,000Less current portion
    
    
    
    
    
    
    
    
    

    
    (57,000
    )Long term portion
    
    
    
    
    
    
    
    
    
    $
    37,000
 In connection with the acquisition of Conductus, Inc. as of December 31,
2002 operating leases with remaining commitments totaling $2,044,000 and
$1,758,000 have been abandoned or are considered unfavorable, respectively. A
liability totaling $1,995,000 representing the present value of the minimum
lease payments and executory costs was recorded at December 18, 2002 relating
to the abandoned leases. A liability totaling $1,140,000 representing the
present value of the difference between the fair market rental and lease
commitment was recorded at December 31, 2002 relating to unfavorable leases. As discussed further in the Restructuring Expenses footnote 9, during the
quarter ended October 2, 2004, the Company completed closure of its Sunnyvale
facility. A liability totaling $279,000 was recognized representing the present
value of the remainder of the lease commitment was recorded. In connection
with the closure of this facility, the remaining unfavorable lease commitment
of $558,000 recorded in connection with the acquisition of Conductus, Inc. was
transferred to lease abandonment costs. As of October 2, 2004, the remaining minimum lease commitments on these
operating leases totaled $1,593,000 and are included in the above commitment
table.At October 2, 2004, the present value of the remaining liability related
to the abandoned leases totaled $1,657,000. These amounts are included in
accrued liabilities. Note 8  Contractual Guarantees and Indemnities Warranties The Company establishes reserves for future product warranty costs that
are expected to be incurred pursuant to specific warranty provisions with its
customers. The Companys warranty reserves are established at the time of sale
and updated 17




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##### Table of Contents



throughout the warranty period based upon numerous factors
including historical warranty return rates and expenses over various warranty
periods. During its normal course of business, the Company makes certain
contractual guarantees and indemnities pursuant to which the Company may be
required to make future payments under specific circumstances. The Company has
not recorded any liability for these contractual guarantees and indemnities in
the accompanying consolidated financial statements. A description of
significant contractual guarantees and indemnities existing as of October 2,
2004 is included below: Intellectual Property Indemnities The Company indemnifies certain customers and its contract manufacturers
against liability arising from third-party claims of intellectual property
rights infringement related to the Companys 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, the
Company is unable to determine the maximum amount of losses that it could incur
related to such indemnifications. Director and Officer Indemnities and Contractual Guarantees The Company has entered into indemnification agreements with its directors
and executive officers which require the Company to indemnify such individuals
to the fullest extent permitted by Delaware law. The Companys 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, the Company is unable to determine the maximum amount of losses that
it 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 the Companys business, financial condition or
results of operations. The Company has also entered into severance and change in control
agreements with certain of its executives. These agreements provide for the
payment of specific compensation benefits to such executives upon the
termination of their employment with the Company. General Contractual Indemnities/Products Liability In connection with the sales of its commercial products, the Company
indemnifies, without limit or term, its customers against all claims, suits,
demands, damages, liabilities, expenses, judgments, settlements and penalties
arising from actual or alleged infringement or misappropriation of any
intellectual property relating to its products or other claims arising from its
products. The Company cannot reasonably develop an estimate of the maximum
potential amount of payments that might be made under its guarantee because of
the uncertainty as to whether a claim might arise and how much it might total. Short Term Borrowings Advances under the agreement are collateralized by all the Companys
assets. Under the terms of the agreement, the Company continues to service the
sold receivables and is subject to recourse provisions. Under the terms of the
agreement, if the bank determines that there is a material adverse change in
the Companys business, they can exercise all their rights and remedies under
the agreement. 9. Restructuring Expenses During the quarter ended July 3, 2004, the Company announced the
implementation of a restructuring program to streamline its operations and
reduce its cost structure. In connection with this during the quarter ended
July 3, 2004 the Company recorded cash and non-cash restructuring charges of
$2.5 million. The Company consolidated its research and 18




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##### Table of Contents



development operations
in Sunnyvale into its Santa Barbara facility. Also, the Company reduced its
workforce by approximately 50 positions. The workforce reduction included
reductions associated with the Sunnyvale facilities consolidation, as well as
other strategic reductions in the organization. In addition, as part of the
consolidation the Company accelerated the implementation of a new, lower cost
wafer deposition process called Reactive Co-Evaporation. In connection with this program in the quarter ended October 2, 2004 the
Company incurred additional period expenses of $722,000 to relocate machinery
and equipment and employees and lease abandonment costs relating to its
Sunnyvale facility closed in July. As a result of all cost reduction initiatives, the Company
saved approximately $2.3 million in the quarter ended
October 2, 2004, as compared to the first quarter of 2004. During the quarter ended October 2, 2004, the Company further reduced its
workforce primarily associated with its manufacturing operations and recognized
an additional $63,000 in severance benefits expenses. A summary of the restructuring charges for the quarter and nine months
ended October 2, 2004 and estimated charges for subsequent quarters is as
follows: Quarter
    
    Nine MonthsEnded
    
    EndedOctober 2,
    
    October 2,
    
    Subsequent2004
    
    2004
    
    Quarters
    
    TotalSeverance costs
    
    $
    63,000
    
    
    $
    742,000
    
    
    $
    
    
    
    $
    742,000Fixed assets write offs
    
    
    20,000
    
    
    
    803,000
    
    
    
    
    
    
    
    803,000Purchased technology
write-off
    
    

    
    
    
    
    1,051,000
    
    
    
    
    
    
    
    1,051,000Lease abandonment costs
    
    
    279,000
    
    
    
    279,000
    
    
    
    
    
    
    
    279,000Facility consolidation
costs
    
    
    188,000
    
    
    
    188,000
    
    
    
    50,000
    
    
    
    238,000Employee relocation
cost
    
    
    235,000
    
    
    
    235,000
    
    
    
    190,000
    
    
    
    425,000Total
    
    $
    785,000
    
    
    $
    3,298,000
    
    
    $
    240,000
    
    
    $
    3,538,000
 10. Details of Certain Financial Statement Components and Supplemental
Disclosures of Cash Flow Information and Non-Cash Activities Balance Sheet Data: 19




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##### Table of Contents



December 31,
    
    October 2,2003
    
    2004Accounts receivable:Accounts receivable-trade
    
    $
    6,766,000
    
    
    $
    1,549,000U.S. government accounts receivable-billed
    
    
    2,107,000
    
    
    
    697,000Less: allowance for doubtful accounts
    
    
    (64,000
    )
    
    
    (73,000
    )$
    8,809,000
    
    
    $
    2,173,000
 December 31,
    
    October 2,2003
    
    2004Inventories:Raw materials
    
    $
    1,941,000
    
    
    $
    3,350,000Work-in-process
    
    
    4,803,000
    
    
    
    3,397,000Finished goods
    
    
    2,861,000
    
    
    
    7,117,000Less inventory reserve
    
    
    (803,000
    )
    
    
    (1,211,000
    )$
    8,802,000
    
    
    $
    12,653,000
 December 31,
    
    October 2,2003
    
    2004Property and Equipment:Equipment
    
    $
    21,274,000
    
    
    $
    21,087,000Leasehold improvements
    
    
    5,891,000
    
    
    
    6,176,000Furniture and fixtures
    
    
    430,000
    
    
    
    488,00027,595,000
    
    
    
    27,751,000Less: accumulated depreciation and amortization
    
    
    (15,061,000
    )
    
    
    (16,407,000
    )$
    12,534,000
    
    
    $
    11,344,000
 At December 31, 2003 and October 2, 2004, equipment includes $237,000 of assets financed
under capital lease arrangements, net of $91,000 and $145,000 of accumulated
amortization, respectively. Depreciation expense amounted to $628,000 and $1,769,000 for
the three and nine month periods ended September 27, 2003, respectively and $729,000
and $2,063,000 for the three and nine month periods ended October 2, 2004, respectively.
In connection with a restructuring of the Companys operations and other abandonments in
the second quarter of 2004, $1,526,000 of property and equipment cost and $723,000 of
related accumulated depreciation was written off in the quarter ended July 3, 2004. December 31,
    
    October 2,2003
    
    2004Patents and Licenses:Patents pending
    
    $
    848,000
    
    
    $
    845,000Patents issued
    
    
    1,182,000
    
    
    
    1,516,000Less accumulated amortization
    
    
    (332,000
    )
    
    
    (415,000
    )Net patents issued
    
    
    850,000
    
    
    
    1,101,000Licenses
    
    
    3,310,000
    
    
    
    3,334,000Less accumulated amortization
    
    
    (2,322,000
    )
    
    
    (2,523,000
    )Net licenses
    
    
    988,000
    
    
    
    811,000Purchased technology
    
    
    3,200,000
    
    
    
    1,862,000Less accumulated amortization
    
    
    (519,000
    )
    
    
    (511,000
    )Net purchased technology
    
    
    2,681,000
    
    
    
    1,351,000$
    5,367,000
    
    
    $
    4,108,000
 20




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##### Table of Contents



Amortization expense related to these items totaled $191,000 and $570,000 for the three and nine month periods ended
September 27, 2003, respectively and $155,000 and $562,000 for the three and nine months ended October 2, 2004, respectively.
In connection with a restructuring of the Companys operations in the second quarter of 2004, $1,338,000 of purchased
technology cost and $287,000 of related accumulated amortization was written off. Amortization expenses are expected to total
$160,000 for the remainder of 2004, $500,000 in 2005 and $450,000 in each of the years 2006, 2007 and 2008. December 31,
    
    October 2,2003
    
    2004Accrued Expenses and Other Long Term Liabilities:Compensation related
    
    $
    2,153,000
    
    
    $
    1,292,000Warranty reserve
    
    
    494,000
    
    
    
    525,000Unfavorable lease costs
    
    
    823,000
    
    
    
    Lease abandonment costs
    
    
    1,329,000
    
    
    
    1,657,000Product line exit costs
    
    
    913,000
    
    
    
    840,000Severance costs
    
    
    285,000
    
    
    
    109,000Other
    
    
    723,000
    
    
    
    653,0006,720,000
    
    
    
    5,076,000Less current portion
    
    
    (4,832,000
    )
    
    
    (3,752,000
    )Long term portion
    
    $
    1,888,000
    
    
    $
    1,324,000
 For the nine months ended,September
    
    October 2,27, 2003
    
    2004Warranty Reserve Activity:Beginning balance
    
    $
    351,000
    
    
    $
    494,000Additions
    
    
    173,000
    
    
    
    146,000Deductions
    
    
    (88,000
    )
    
    
    (115,000
    )Ending balance
    
    $
    436,000
    
    
    $
    525,000Unfavorable Lease Costs:Beginning balance
    
    $
    1,140,000
    
    
    $
    823,000Additions
    
    
    
    
    
    
    Deductions
    
    
    (236,000
    )
    
    
    (265,000
    )Transfer to lease abandonment costs
    
    
    
    
    
    
    (558,000
    )Ending balance
    
    $
    904,000
    
    
    $
    Lease Abandonment Costs:Beginning balance
    
    $
    1,995,000
    
    
    $
    1,329,000Additions
    
    
    
    
    
    
    279,000Transfers from unfavorable lease costs
    
    
    
    
    
    
    558,000Deductions
    
    
    (495,000
    )
    
    
    (509,000
    )Ending balance
    
    $
    1,500,000
    
    
    $
    1,657,000
 21




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##### Table of Contents



For the nine months ended,September
    
    October 2,27, 2003
    
    2004Product Line Exit Costs:Beginning balance
    
    $
    1,042,000
    
    
    $
    913,000Additions
    
    
    
    
    
    
    Deductions
    
    
    (98,000
    )
    
    
    (73,000
    )Ending balance
    
    $
    944,000
    
    
    $
    840,000Severance Costs:Beginning balance
    
    $
    1,600,000
    
    
    $
    285,000Additions
    
    
    
    
    
    
    742,000Deductions
    
    
    (1,214,000
    )
    
    
    (918,000
    )Ending balance
    
    $
    386,000
    
    
    $
    109,000
 
 Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations General We develop, manufacture and market 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. Our solutions leverage our expertise in
high-temperature superconducting filters to hear wireless devices with the
best possible clarity while rejecting interfering signals. We believe that
this combination of interference rejection and receiver sensitivity is only
possible using HTS technology. We sell our products directly to wireless
carriers in the Americas, and we have plans to expand internationally. Our
customers to date include ALLTEL, AT&T Wireless, U.S. Cellular, and Verizon
Wireless. We derive our commercial revenues from three product lines:  
    
    SuperLink Rx. In order to receive uplink signals from wireless
handsets, base stations require a wireless filter system to
eliminate, or filter out, out-of-band interference. To address this
need, we offer the SuperLink Rx product line for the receiver
front-end of base stations. These products combine specialized
filters using HTS technology with a proprietary cryogenic cooler and
a cryogenically cooled low-noise amplifier. The result is a highly
compact and reliable cryogenic receiver front-end that can
simultaneously deliver both high selectivity (interference rejection)
and high sensitivity (detection of low level signals). SuperLink Rx
products thereby offer significant advantages over conventional
filter systems.
    
    AmpLink Rx. The recently introduced AmpLink Rx is our
lower-cost receiver front-end product designed specifically to
address the sensitivity requirements of wireless base stations. The
AmpLink Rx is a ground-mounted unit which includes a high-performance
amplifier and up to six dual duplexers. The enhanced uplink provided
by AmpLink Rx 1900 improves PCS network coverage immediately and
avoids the installation and maintenance costs associated with tower
mounted amplifiers. As network interference increases, the AmpLink
Rx 1900 is easily upgradeable to include a SuperLink Rx front-end,
which uses HTS technology to maintain the same sensitivity
improvement while eliminating the effects of increasing interference.
    
    SuperPlex. SuperPlex, our antenna sharing solution is a line
of multiplexers that provides extremely low insertion loss and
excellent cross-band isolation. Products in our SuperPlex line of
high-performance multiplexers are designed to eliminate the need for
additional base station antennas and reduce infrastructure costs.
Relative to competing technologies, these products offer increased
transmit power delivered to the base station antenna, higher
sensitivity to subscriber handset signals, fast and cost-effective
network overlays. The SuperPlex product family offers network
performance benefits synergistic with SuperLink Rx. We began commercial production of the SuperFilter (the precursor to the
SuperLink Rx) in 1997. Our initial commercial sales of our SuperLink products
were to small rural providers who had the most immediate need for range
extension and coverage enhancement. We sold our first systems in the fourth
quarter of 1997. We sold 83 more systems in 1998, 123 systems in 1999, 393
systems in 2000, 438 systems in 2001, 927 systems in 2002, 1,884 systems in
2003 and 1,243 22




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##### Table of Contents



and 605 units in the nine months ended September 27, 2003 and
October 2, 2004. In 2001, U.S. Cellular accounted for 12% of our net commercial
revenues and ALLTEL accounted for 73% of our net commercial revenues. In 2002,
U.S. Cellular accounted for 8% of our net commercial revenues and ALLTEL for
84% of our net commercial revenues. In 2003, ALLTEL accounted for 70% of our
net commercial revenues and Verizon accounted for 15% of our net commercial
revenues. In the nine months ended October 2, 2004, ALLTEL accounted for 63% of
our net commercial revenues and Verizon accounted for 23% of our net commercial
revenues. In our business model, we use government contracts as a source of funds
for our commercial technology development. We typically own the intellectual
property developed under these contracts, and the Federal Government receives a
royalty-free, non-exclusive and nontransferable license to use the intellectual
property for the United States. We acquired Conductus, Inc. on December 18,
2002. Conductus was a competing supplier of high-temperature superconducting
technology for wireless networks. The acquisition of Conductus contributed
$4.6 million to our government revenues in 2003. During 2002 and 2003, we were marketing a power amplifier product called
the SuperLink Tx manufactured by another company. The SuperLink Tx was for
wireless networks that suffer from insufficient transmit power on the downlink
signal path. A competitor acquired our supplier for this product in November
2003. We have not had significant sales of the SuperLink Tx product to date.
We are evaluating alternative sources of power amplifiers for our customers. 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. On an
on-going basis, we evaluate our estimates, including those related to bad
debts, inventories, intangible assets, goodwill, income taxes, warranty
obligations, contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that we believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of the financial
statements. We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. If
the financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required. We write down our inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost of inventory
and the estimated market value based upon assumptions about future demand and
market conditions. If actual market conditions are less favorable than those
projected by management, additional inventory write-downs may be required. Our net sales consist of revenue from sales of products net of trade
discounts and allowances. We recognize revenue when evidence of an arrangement
exists, contractual obligations have been satisfied, title and risk of loss
have been transferred to the customer and collection of the resulting
receivable is reasonably assured. At the time revenue is recognized, we
provide for the estimated cost of product warranties if allowed for under
contractual arrangements. Our warranty obligation is effected by product
failure rates and service delivery costs incurred in correcting a product
failure. Should such failure rates or costs differ from these estimates,
accrued warranty costs would be adjusted. In connection with the sales and manufacture of its commercial products,
the Company indemnifies, without limit or term, its customers and contract
manufactures against all claims, suits, demands, damages, liabilities,
expenses, judgments, settlements and penalties arising from actual or alleged
infringement or misappropriation of any intellectual property relating to its
products or other claims arising from its products. The Company cannot
reasonably develop an estimate of the maximum potential amount of payments that
might be made under its guarantee because of the uncertainty as to whether a
claim might arise and how much it might total. Contract revenues are principally generated under research and development
contracts. Contract revenues are recognized utilizing the
percentage-of-completion method measured by the relationship of costs incurred
to total estimated contract costs. If the current contract estimate were to
indicate a loss, utilizing the funded amount of the contract, a provision would
be made for the total anticipated loss. Revenues from research related
activities are derived primarily from contracts with agencies of the United
States Government. Credit risk related to accounts receivable arising from
such contracts is considered minimal. These contracts include cost-plus, fixed
price and cost sharing arrangements and are generally short-term in nature. 23




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All payments to the Company for work performed on contracts with agencies
of the U.S. Government are subject to adjustment upon audit by the Defense
Contract Audit Agency. Based on historical experience and review of current
projects in process, management believes that the audits will not have a
significant effect on the financial position, results of operations or cash
flows of the Company. We recognized $20 million of goodwill in connection with the acquisition
of Conductus, Inc. in December 2002. During the third quarter of 2003 we
tested the goodwill for possible impairment and determined that there was no
impairment. This goodwill will again be tested for impairment in the fourth
quarter of 2004. If the carrying amount exceeds its implied fair value, an
impairment loss will be recognized equal to the excess. We also review the recoverability of the carrying value of identified
intangibles and other long lived assets on an annual basis or whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of these assets is determined based upon
the forecasted undiscounted future net cash flows from the operations to which
the assets relate, utilizing our best estimates, appropriate assumptions and
projections at the time. These projected future cash flows may vary
significantly over time as a result of increased competition, changes in
technology, fluctuations in demand, consolidation of our customers and
reductions in average selling prices. If the carrying value is determined not
to be recoverable from future operating cash flows, the asset is deemed
impaired and an impairment loss is recognized to the extent the carrying value
exceeded the estimated fair market value of the asset. We account for employee stock-based compensation under the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees(APB 25), as opposed to the fair
value method prescribed by Statement of Financial Accounting Standards No.
123, Accounting for Stock-Based Compensation(SFAS 123). Pursuant to the
provisions of APB 25, we generally do not record an expense for the value of
stock-based awards granted to employees. If the Financial Accounting Standards
Board Proposed Statement of Financial Accounting Standard, Share-Based
Payment, an amendment of FASB Statements No. 123 and 95 is issued, we may be
required to treat the value of stock-based awards granted to employees as
compensation expense in the future, which could have a material adverse effect
on our reported operating results and could negatively affect the price of our
Common Stock. If this proposal is issued, we could decide to reduce the number
of stock-based awards granted to employees in the future, which could adversely
impact our ability to attract qualified candidates or retain existing employees
without increasing their cash compensation and, therefore, have a material
adverse effect on our business, results of operations and financial condition. As permitted under No. 123, the Company has elected to follow Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees in
accounting for its stock options and other stock-based employee awards. Pro
forma information regarding net loss and loss per share, as calculated under
the provisions of SFAS 123, are disclosed in the notes to the financial
statements. The Company accounts for equity securities issued to non-employees
in accordance with the provision of SFAS 123 and Emerging Issues Task Force
96-18. If the Company had elected to recognize compensation expense for employee
awards based upon the fair value at the grant date consistent with the
methodology prescribed by SFAS 123, the Companys net loss and net loss per
share would have been increased to the pro forma amounts indicated below: Three Months Ended
    
    Nine Months EndedSeptember 27,
    
    October 2,
    
    September 27,
    
    October 2,2003
    
    2004
    
    2003
    
    2004Net loss:As reported
    
    $
    (851,000
    )
    
    $
    (5,155,000
    )
    
    $
    (12,255,000
    )
    
    $
    (19,949,000
    )Stock-based employee
compensation included in net
loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock-based compensation
expense determined under fair
value method
    
    
    (1,117,000
    )
    
    
    (1,233,000
    )
    
    
    (3,036,000
    )
    
    
    (4,591,000
    )Pro forma
    
    $
    (1,968,000
    )
    
    $
    (6,388,000
    )
    
    $
    (15,291,000
    )
    
    
    (24,540,000
    )Basic and Diluted Loss per ShareAs reported
    
    $
    (0.01
    )
    
    $
    (0.06
    )
    
    $
    (0.20
    )
    
    $
    (0.25
    )Stock-based compensation
expense determined under fair
value method
    
    
    (0.02
    )
    
    
    (0.01
    )
    
    
    (0.05
    )
    
    
    (0.06
    )Pro forma
    
    $
    (0.03
    )
    
    $
    (0.07
    )
    
    $
    (0.25
    )
    
    $
    (0.31
    )
 24




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Our valuation allowance against the deferred tax assets is based on our
assessments of historical losses and projected operating results in future
periods. If and when we generate future taxable income in the U.S. against
which these tax assets may be applied, some portion or all of the valuation
allowance would be reversed and an increase in net income would consequently be
reported in future years. We are currently involved as a defendant in several lawsuits  a patent
infringement case and several substantially identical securities class actions.
These matters are discussed below in Legal Proceedings. We do not believe
that a loss is probable or reasonably estimable in any of these cases and
therefore have not recorded any liabilities relating to these proceedings. We
periodically reassess our potential liability as additional information becomes
available. If we later determine that a loss is probable and the amount
reasonably estimable, we would record a reserve for the potential loss. The
ultimate amount of the loss, if any, could materially impact our results of
operations, financial condition or cash flows. Backlog Our commercial backlog consists of accepted product purchase orders
scheduled for delivery within 24 months and consists of purchase orders for
both dollar and unit purchase commitments. The exact dollar commitment for
unit commitments may vary depending on the exact units purchased. Based on past
purchasing patterns and expected purchasing trends of customers with unit
commitments, we estimate our backlog at October 2, 2004 to be $380,000, as
compared to $250,000 at December 31, 2003. Results of Operations Trends for 2004 We are a manufacturer of equipment to a relatively small number of
customers and are highly sensitive to any changes experienced by our customers.
We are currently experiencing the downside of such changes with two customers
that we consider important for our revenues in 2004. One of our customers was
recently acquired. We believe that this customer has suspended work
temporarily on certain infrastructure projects because of the acquisition.
Some of these projects involved our products. We also believe that another
customer has decided to greatly accelerate a project to roll out a new third
generation technology that has diverted their human resources. This is
delaying some projects to deploy our product for improvements to their existing
network. We believe these are temporary impediments but cannot be certain of
their duration. We are also aggressively pursuing efforts to have our product
incorporated into our customers new third generation wireless networks. We
believe our product sales will, in the long run, continue to be driven by the
need for efficient capital spending and improved network performance of both
the existing wireless technologies and the new third generation wireless
technologies such as 1X-EVDO, EDGE and W-CDMA. We compete directly with venders of other interference solutions such as
tower mount amplifiers and conventional filters. This creates customer
pressure on our product pricing to match the lower prices of these other
vendors.. Our product pricing has always been influenced by this competition,
and we have responded by continually and substantially reducing our product
costs. We have reduced our product costs in the first nine months of 2004 and
expect further product cost reductions over the next 12 months, but we cannot
predict whether our costs will decline at a rate sufficient to keep pace with
the competitive pricing pressure. Quarter and nine months ended October 2, 2004 as compared to the quarter and
nine months ended September 27, 2003. Total net revenue decreased by $6.9 million, or 48%, from $14.2 million in
third quarter of 2003 to $7.3 million in the third quarter of 2004. Total net
revenues decreased by $13.9 million, or 42%, from $33.0 million in the first
nine months of 2003 to $19.1 million in the same period this year. Total
revenues primarily consist of commercial revenue and government contract
revenue. Net commercial product revenues in the third quarter of 2004 decreased to
$6.1 million from $11.6 million in the same period last year, a decrease of
$5.5 million, or 48%. For the first nine months of 2004, net commercial
product revenues decreased to $13.8 million from $25.6 million in the same
period last year, a decrease of 46%. The decrease in the third quarter of 2004
as compared to the prior year period is primarily the result of lower unit
sales of our SuperLink Rx products of $5.6 million. The decrease in the first
nine months of 2004 as compared to the prior year period is primarily the
result of lower unit sales of our SuperLink Rx products of $11.8 million. The
average selling price of our SuperLink Rx product is comparable 25




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##### Table of Contents



between the
periods. Our two largest customers accounted for 89% of our net commercial
revenues in the nine months ended September 27, 2003 and 86% in the nine months
ended October 2, 2004. Government contract revenues decreased by $1.3 million, or 52%, from $2.6
million in the third quarter of 2003 to $1.2 million in the same quarter of
2004. For the first nine months of 2003, government contract revenues decreased
to $5.2 million from $7.3 million in the same period last year, a decrease of
$2.1 million, or 29%. This decrease is primarily attributable to the completion
of contracts in 2003 and 2004 that have not been replaced. Cost of commercial product revenue includes all direct costs and
manufacturing overhead. The cost of commercial product revenue totaled $6.0
million for the third quarter ended October 2, 2004 and $8.2 million for the
third quarter ended September 27, 2003. The cost of commercial product revenue
totaled $14.8 million for the nine months ended October 2, 2004 and $19.5
million for the nine months ended September 27, 2003. Decreased costs result
primarily from decreased unit shipments partially offset by increased provision
for inventory reserves in both periods of approximately $350,000. Inventory reserves were
increased to align inventory carrying costs with their market value. Our cost of sales includes both variable and fixed cost components. The
variable components consist primarily of materials, assembly and test labor,
overhead, which includes equipment and facility depreciation, transportation
costs and warranty costs. Components of our fixed cost structure include 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. The following is an analysis of our gross profit and margins: Three Months Ended
    
    Nine Months EndedSeptember
    
    
    
    
    
    October
    
    
    
    
    
    September
    
    
    
    
    
    OctoberDollars in thousands
    
    27, 2003
    
    
    
    
    
    2, 2004
    
    
    
    
    
    27, 2003
    
    
    
    
    
    2, 2004Net commercial product sales
    
    $
    11,570
    
    
    
    100
    %
    
    $
    6,053
    
    
    
    100
    %
    
    $
    25,630
    
    
    
    100
    %
    
    $
    13,788
    
    
    
    100
    %Cost of commercial product sales
    
    
    8,150
    
    
    
    70
    %
    
    
    6,014
    
    
    
    99
    %
    
    
    19,450
    
    
    
    76
    %
    
    
    14,827
    
    
    
    108
    %Gross profit
    
    $
    3,420
    
    
    
    30
    %
    
    $
    39
    
    
    
    1
    %
    
    $
    6,180
    
    
    
    24
    %
    
    $
    (1,039
    )
    
    
    (8
    %)
 For the third quarter ended October 2, 2004 we had positive gross profit
of $39,000 from sale of our commercial products as compared to positive gross
profit of $3.4 million in our third quarter of 2003. For the nine months ended
October 2, 2004 we had negative gross profit of $1.0 million from sale of our
commercial products as compared to positive gross profit of $6.2 million in the
nine months ended September 27, 2003. We experienced negative gross profits
because the reduced level of commercial sales was insufficient to cover our
fixed manufacturing overhead costs. Contract research and development expenses totaled $860,000 in the third
quarter of 2004 and $1.7 million in the third quarter of 2003. These expenses
totaled $3.5 million in the first nine months of 2004 and $4.7 million in the
first nine months of 2003. These decreases were the result of lower expenses
associated with performing a fewer number of government contracts. Other research and development expenses relate to development of our
commercial products. These expenses totaled $1.3 million in the third quarter
of 2004, as compared to $985,000 in the same period last year. These expenses
increased in the current year quarter as compared to the prior year due to
increased commercial research and development efforts. These expenses totaled
$3.8 million in the first nine months of 2004 and $4.3 million in the first
nine months of 2003. The decline is due to lower commercial product development
efforts for the year to date period. Selling, general and administrative expenses totaled $3.5 million in the
third quarter of 2004 as compared to $4.1 million in the same period last year.
In the first nine months of 2004 these expenses totaled $12.4 million as
compared to $16.6 million in the same period last year. This decrease in the
third quarter of 2004 as compared to the same quarter in the prior year is
primarily due to lower expenses resulting from the closure of our Sunnyvale
facility. The decrease in the first nine months of 26




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2004 as compared to the
prior year results primarily from lower ISCO litigation expenses and the
closure of our Sunnyvale facility. In the third quarter of 2004 ISCO litigation
expenses totaled $25,000 as compared to $90,000 in the third quarter of 2003.
In the first nine months of 2004 these expenses totaled $438,000 as compared to
$4.8 million in the same period last year. These decreases were partially
offset by higher sales and marketing expenses. During the quarter ended July 3, 2004, we announced the implementation of
a restructuring program to streamline our operations and reduce its cost
structure. In connection with this during the quarter ended July 3, 2004 we
recorded cash and non-cash restructuring charges of $2.5 million. We
consolidated our research and development operations in Sunnyvale into our
Santa Barbara facility. We reduced our workforce by approximately 50 positions.
The workforce reduction included reductions associated with the Sunnyvale
facility consolidation, as well as other strategic reductions in the
organization. In addition, as part of the consolidation we accelerated the
implementation of a new, lower cost wafer deposition process called Reactive
Co-Evaporation. In
connection with this program, in the quarter ended October 2, 2004 we incurred
additional period expenses of $722,000 to relocate machinery and equipment and
employees and lease abandonment costs relating to the closure of our Sunnyvale
facility. In the fourth quarter of 2004, we expect additional restructuring
expenses to relocate machinery and employees to total $240,000. During the quarter ended October 2, 2004, we further reduced our workforce
primarily associated with its manufacturing operations and recognized an
additional $63,000 in severance benefit expenses. As a result of all cost reduction initiatives, the Company
saved approximately $2.3 million in the quarter ended
October 2, 2004 as compared to the first quarter of 2004. Interest income decreased in the third quarter and first nine months of
2004 as compared to the same periods in the prior year because we had less cash
available for investment. Interest expense in the quarter ended October 2, 2004 is comparable to the
same period in the prior year. For the nine months ended October 2, 2004
interest expense totaled $1.2 million as compared to $374,000 in the nine
months ended September 27, 2003. This increase is related primarily to an
$802,000 non-cash charge relating to warrants issued in connection with the
Bridge Loans entered into in April 2004. We had a net loss of $5.2 million for the quarter ended October 2, 2004 as
compared to $851,000 in the same period last year. For the nine months ended
October 2, 2004 our net loss totaled $19.9 million as compared to $12.3 million
in the same period last year. The net loss available to common shareholders totaled $0.06 per common
share in the current quarter, as compared to $0.01 per common share, in the
same period last year. The net loss available to common shareholders totaled
$0.25 per common share in the nine months ended October 2, 2004, as compared to
$0.20 per common share, in the same period last year. Liquidity and Capital Resources We have historically financed our operations through a combination of cash
on hand, cash provided from operations, 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 SEC
covering the public resale by investors of all the common stock issued in our
private placements, as well as any common stock acquired upon exercise of their
warrants. Our principal sources of liquidity consist of existing cash balances
and funds expected to be generated from future operations. As of October 2,
2004, we had working capital of $15.5 million, including $7.1 million in cash
and cash equivalents, as compared to working capital of $15.6 million at
December 31, 2003, which included $11.1 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. We typically
hold such investments until maturity and then reinvest the proceeds in similar
money market instruments. We believe that all of our cash investments would be
readily available to us should the need arise. Cash and cash equivalents decreased by $4.0 million from $11.1 million at
December 31, 2003 to $7.1 million at October 2, 2004. Cash was used in
operations, for the purchase of property and equipment and for the payment of
short and long-term borrowings and was partially offset by cash received from
the sale of common stock in a public offering during the second quarter of
2004. Cash and cash equivalents decreased by $5.1 million from $18.2 million
at December 31, 2002 to $13.1 million at September 27, 2003. Cash used in
operations and investing activities during the first nine months of 2003 was
partially offset by cash received from the sale of common stock and warrants in
a private placement during the second quarter. 27




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Cash used in operations totaled $16.3 million in the first nine months of
2004. We used $13.9 million to fund the cash portion of our net losses. We
also used cash to fund a $9.0 million increase in inventory, prepaid expenses
and other current assets, patents and licenses and accounts payable payments.
Inventory increased during the first nine months of 2004 due to lower than
expected sales. These uses were partially offset by cash generated from the
collection of accounts receivable of $6.6 million. Cash used in operations
totaled $13.4 million in the first nine months of 2003. We used $9.6 million
to fund the cash portion of our net losses. We also used cash to fund a $4.3
million increase in accounts receivable, inventory, patents and licenses and
other assets. Cash generated from the increase in accounts payable and other
accrued expenses totaled $589,000. Net cash used to purchase manufacturing related equipment and tenant
improvements totaled $1.7 million in the first nine months of 2004 and $2.4
million the same period last year. Net cash provided by financing activities totaled $13.9 million in the
first nine months of 2004. Cash received from the sale of common stock and
exercise of options and warrants totaled $17.2 million and borrowings against
our credit and bridge loan facilities totaled $5.3 million. These sources of
cash were partially offset by payments against our credit and bridge loan
facilities totaling $7.9 million and payments against our long-term debt
totaling $627,000. Net cash provided by financing activities totaled $10.7
million in the first nine months of 2003. Cash received from the sale of common
stock and warrants totaled $10.1 million and net borrowings against our credit
facility totaled $1.6 million and was partially offset by the reduction in
long-term borrowings of $948,000. We have a line of credit from a bank. It is a material source of funds
for our business. The line of credit expires March 17, 2005 and is structured
as a sale of our accounts receivable. The bank agreement provides for the sale
of up to $5.0 million of eligible accounts receivable, with advances to us
totaling 80% of the receivables sold. Advances bear interest at the prime rate
(4.75% at October 2, 2004) plus 2.50% subject to a minimum monthly charge.
Outstanding amounts under this borrowing facility at October 2, 2004 totaled
$669,000. The amount outstanding is repaid upon collection of the underlying
accounts receivable. 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. At October 2, 2004, we had the following cash commitments: Payments Due by PeriodLess than 1Contractual Obligations
    
    Total
    
    year
    
    2-3 years
    
    4-5 years
    
    After 5 yearsCapital lease obligations
    
    $
    107,000
    
    
    $
    64,000
    
    
    $
    43,000
    
    
    $
    
    
    
    $
    Operating leases
    
    
    11,991,000
    
    
    
    2,450,000
    
    
    
    3,224,000
    
    
    
    2,921,000
    
    
    
    3,396,000Minimum license

commitment
    
    
    2,794,000
    
    
    
    270,000
    
    
    
    540,000
    
    
    
    322,000
    
    
    
    1,662,000Fixed asset purchase
commitments
    
    
    167,000
    
    
    
    167,000
    
    
    
    
    
    
    
    
    
    
    
    Total contractual cash
obligations
    
    $
    15,059,000
    
    
    $
    2,951,000
    
    
    $
    3,807,000
    
    
    $
    3,243,000
    
    
    $
    5,058,000
 There were no material changes to commitments outside the ordinary course
of business. We plan to invest approximately $150,000 to $250,000 in fixed assets
during the remainder of 2004 to continue to expand manufacturing capacity if
there is sufficient market demand for our products. Our independent registered public accounting firm has included in their
audit report for 2003-year an explanatory paragraph expressing doubt about our
ability to continue as a going concern due to past losses and negative cash
flows. They included a similar explanatory paragraph in their audit report for
2002. In 2003, we incurred a net loss of $11,345,000 and had negative cash
flows from operations of $18,458,000. For the nine months ended October 2,
2004, we had a net loss of $19.9 million and negative cash flows from
operations of $16.3 million. In response during the current year, we adjusted
our inventory build plan, reduced direct and indirect labor, cut certain fixed
costs and implemented a reduced workweek. We also began a cost restructuring
program to consolidated our research and development operations in Sunnyvale 28




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into our Santa Barbara facility, eliminate an additional 50 positions and
accelerate the implementation of a new lower cost wafer deposition process. We completed two financing transactions during the nine months ended
October 2, 2004. First, we closed a transaction on April 25, 2004 to
temporarily expand our credit facility. Silicon Valley Bank amended our
existing line of credit to increase borrowing capacity from 80% to 95% of
eligible accounts receivable. We concurrently secured a commitment for a $2.0
million secured bridge loan from an investor. The investor subsequently funded
$1.5 million of the bridge loan. We issued to the lenders warrants to purchase
in the aggregate 600,000 shares of common stock at $1.85 per share. The bridge
loan was subsequently paid in full on May 26, 2004. Upon repayment of the
bridge loan the Silicon Valley credit facility reverted back to it original
terms. Second, we completed a public offering of 23,000,000 shares of common
stock at $0.80 per share during the quarter raising net proceeds of $16.7
million. We expect our existing cash resources, together with our line of credit, will be sufficient to fund our planned operations into 2005. We expect our liquidity to reach an unacceptably low level in the second quarter of 2005 and anticipate a need for additional working capital to fund growth in the third and fourth quarters of 2005. Accordingly, we have concluded that the company will need additional funding to provide
adequate cash reserves in the event of another downturn in our business and to fund expected growth in the second half of 2005. Our actual cash requirements will depend on numerous factors, including the rate of growth of our sales, the timing and levels of products purchased, payment terms and credit limits from manufacturers, the timing and level of our accounts receivable collections and our ability to manage the business profitability. We plan to explore various funding opportunities over the next two quarters. We cannot assure you that additional financing (public or private) will be available on acceptable terms or at all. If we issue additional equity securities to raise funds, the ownership percentage of our existing stockholders would be reduced. New investors may demand rights, preferences or privileges senior to those of existing holders of common
stock. If we cannot raise any needed funds, we would also 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. In the last several years, we have raised money from investors to cover
our operating losses through public and private offerings. Our ability to
continue to raise funds using these methods may be adversely impacted by any
future NASDAQ listing issues. Our continued NASDAQ listing requires us to
maintain a minimum of $1 share price. Our stock has
traded at less than $1 per share recently. Although NASDAQ de-listing
would not be immediate, our lower share price could make capital raising more
difficult. Our interim financial statements have been prepared assuming that the
Company will continue as a going concern. The factors described above raise
substantial doubt about our ability to continue as a going concern. Our
financial statements do not include any adjustments that might result from this
uncertainty. Net Operating Loss Carryforward As of December 31, 2003, the Company has net operating loss carryforwards
for federal income tax purposes of approximately $215.1 million and for state
income tax purposes of $90.6 million which expire in the years 2004 through
2023. Of these amounts $93.9 million and $30.2 million, respectively resulted
from the acquisition of Conductus. Included in the net operating loss
carryforwards are deductions related to stock options of approximately $24.0
million and $13.0 million for federal and California income tax purposes. 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, the Company has research and development
and other tax credits for federal and state income tax purposes of
approximately $2.6 million and $2.3 million, respectively, which expire in the
years 2004 through 2023. Of these amounts $972,000 and $736,000, respectively
resulted from the acquisition of Conductus. Due to the uncertainty surrounding their realization, the Company has
recorded a full valuation allowance against its 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 based on a statutory rate
of return (usually the applicable federal funds rate, as defined in the
Internal Revenue Code) and the value of the corporation at the time of a
change of ownership as defined by Section 382. Recently, the Company
completed an analysis of its equity transactions and determined that it had a
change in ownership in August 1999 and December 2002. Therefore, the ability
to utilize net operating loss carryforwards incurred prior to the change of
ownership totaling $101.6 million will be subject in future periods to an
annual limitation of $1.3 million. In addition, the Company acquired the right
to Conductus net operating losses, which are also subject to the limitations
imposed by Section 382. Conductus underwent three ownership changes, which
occurred in February 1999, February 2001 and December 2002. Therefore, the
ability to utilize Conductus net operating loss carryforwards of $93.9 million
incurred prior to the ownership 29




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changes will be subject in future periods to
annual limitation of $700,000. Net operating losses incurred by the Company
subsequent to the ownership changes totaled $19.5 million and are not subject
to this limitation. Future Accounting Requirements In March 2004, the consensus of the Emerging Issues Task Force (EITF)
Issue No. 03-06, Participating Securities and the Two-Class Method under FASB
Statement 128, was published. EITF Issue No.03-06 addresses the computations of
earnings per share by companies that have issued securities other than common
stock that contractually entitle the holder to participate in dividends and
earnings of the company. Further guidance on the application and allocations of
the two-class method of calculating earnings per share is also included. The
provisions of EITF Issue No. 03-06 will be effective for reporting periods
beginning after March 31, 2004. The adoption of this guidance is not expected
to have a significant impact on the Companys financial results of operations
and financial position. Forward-Looking Statements This report contains forward-looking statements that involve risks and
uncertainties. We have made these statements in reliance on the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Our
forward-looking statements relate to future events or our future performance
and include, but are not limited to, statements concerning our business
strategy, future commercial revenues, market growth, capital requirements, new
product introductions, expansion plans and the adequacy of our funding. Other
statements contained in this report that are not historical facts are also
forward-looking statements. We have tried, wherever possible, to identify
forward-looking statements by terminology such as may, will, could,
should, expects, anticipates, intends, plans, believes, seeks,
estimates and other comparable terminology. Forward-looking statements are not guarantees of future performance and
are subject to various risks, uncertainties and assumptions that are difficult
to predict. Therefore, actual results may differ materially from those
expressed in forward-looking statements. They can be affected by many factors,
including, but not limited to the following:  
    
    fluctuations in product demand,
    
    the impact of competitive filter products, technologies and pricing,
    
    manufacturing capacity constraints and difficulties,
    
    market acceptance risks, and
    
    general economic conditions. Please read Exhibit 99 to our report on Form 10-K for the year ended
December 31, 2003 entitled Disclosure Regarding Forward-Looking Statements
for a description of additional uncertainties and factors that may affect our
forward-looking statements. Forward-looking statements are based on
information presently available to senior management, and we do not assume any
duty to update our forward-looking statements. 30




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Item 3. Quantitative and Qualitative Disclosures About Market Risk There was no material change in our exposure to market risk at October 2,
2004 as compared with our market risk exposure on December 31, 2003. See
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Market Risk in our 2003 Annual Report on Form 10K. 
 Item 4. Disclosure Controls and Procedures. Evaluation of Disclosure Controls and Procedures The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Companys reports
under the Securities Exchange Act of 1934, as amended (the Exchange Act), is
recorded, processed, summarized and reported within the time periods specified
in the SECs rules and forms, and that such information is accumulated and
communicated to the Companys management, including its Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures. We carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(e)
as of the end of the period covered by this report (the Evaluation Date).
Based on that evaluation, our Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and procedures are
effective in timely alerting them to material information relating to the
Company that as of the Evaluation Date is required to be included in our
periodic SEC filings. Changes in Internal Controls There has been no change in our internal control over financial reporting
(as defined in Exchange Act Rules 13a-15(f) and 15(d)  15(f)) during the third
quarter of 2004 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting. 31




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PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings Patent Litigation We are engaged in a patent dispute with ISCO International, Inc. relating
to U.S. Patent No. 6,263,215 entitled Cryoelectronically Cooled Receiver Front
End for Mobile Radio Systems. ISCO filed a complaint on July 17, 2001 in the
United States District Court for the District of Delaware against us and our
wholly owned subsidiary, Conductus, Inc. The ISCO complaint alleged that our
SuperFilter product and Conductus ClearSite® product infringe ISCOs patent.
The matter went to trial on March 17, 2003. On April 3, 2003, the jury returned a unanimous verdict that our
SuperFilter III product does not infringe the patent in question, and that
ISCOs patent is invalid and unenforceable. The jury also awarded us $3.8
million in compensatory damages based upon a finding that ISCO engaged in
unfair competition and acted in bad faith by issuing press releases and
contacting our customers asserting rights under this patent. On April 17, 2003, we filed a Motion for Attorneys Fees and
Disbursements, in which we asked the court to award us our attorneys fees and
other litigation expenses. On the same date, ISCO filed a motion, asking the
court to overturn the verdict and grant a new trial. In August 2003, the court
rejected ISCOs request to overturn the jurys verdict that the patent is
invalid and not infringed by the SuperFilter III product, and accepted the
jurys verdict that the patent is unenforceable because of inequitable conduct
committed by one of the alleged inventors. ISCO subsequently filed a notice of
appeal as to this portion of the courts decision. The court overturned the
jurys verdict of unfair competition and bad faith on the part of ISCO and the
related $3.8 million compensatory damage award to us, and also denied our
request for reimbursement of our legal fees associated with the case. We have
filed a notice of appeal as to this portion of the courts decision. If the appellate court overturns the jurys verdict and grants ISCO a new
trial, there is a risk that we may not prevail in a second trial. If this
should happen, we could be subject to significant liabilities and be required
to cease using key technology. In any case, the cost of defending continued
litigation by ISCO, or any other intellectual property lawsuit, could
constitute a major financial burden and materially and adversely affect our
results of operations, balance sheet and cash flows. Class Action Lawsuits We were named as a defendant in several substantially identical class
action lawsuits filed in the United States District Court for the Central
District of California in April 2004. The cases were consolidated in August
2004, and the plaintiffs filed an amended consolidated complaint in October
2004. The plaintiffs allege securities law violations by us and certain of our
officers and directors under Rule 10b-5 and Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934, as amended. The complaint was filed on behalf
of a purported class of people who purchased our stock during the period
between January 9, 2004 and March 1, 2004 and seeks unspecified damages. The
plaintiffs base their allegations primarily on the fact that we did not achieve
our forecasted revenue guidance of $10 to $13 million for the first quarter of
2004. We believe the complaint is without merit and intend to defend this
action vigorously. However, we cannot assure you that we will prevail in such
litigation and, if the outcome is unfavorable to us, our reputation,
profitability, balance sheet, cash flow and share price could be adversely affected. 
 Item 5. Other Information (a) Additional Disclosures Consulting Agreement. We entered into a consulting agreement with Charles
Shalvoy, a director, on November 4, 2004. Under the agreement, we may retain
his services from time to time as a consultant on strategic planning matters at
the rate 32




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##### Table of Contents



of $3,000 per day plus reasonable out-of-pocket and travel expenses. As
additional consideration, we agreed to continue his health benefits and grant
him an option to purchase 100,000 shares of common stock. Amendment to Change In Control Agreement. We amended the existing Change
in Control Agreement between the company and Mr. Peter Thomas, our President
and CEO, on November 4, 2004. The original Change in Control Agreement granted
Mr. Thomas certain severance benefits in the event we terminate him in
connection with a change in control of the company (as defined in the
agreement). The amendment increases the amount of his severance benefits under
the agreement from two times his base salary to three times his base salary. (b) Stockholder Nominations There have been no material changes to the procedures by which stockholders may
recommend nominees to our board of directors. Please see the discussion of our
procedures under the heading Board Meetings and Committees on pages 4 and 5
of our 2004 Proxy Statement available online at www.sec.gov. 
 Item 6. Exhibits Number
    
    Description of Document3.1
    
    Amended and Restated Certificate of Incorporation of the Company (1)3.2
    
    Certificate of Amendment of Restated Certificate of Incorporation (2)3.3
    
    Bylaws of the Registrant (3)3.4
    
    Certificate of Amendment of Bylaws dated May 17, 2001 (2)3.5
    
    Certificate of Amendment of Bylaws dated August 8, 2001 (2)4.1
    
    Form of Common Stock Certificate (4)4.2
    
    Third Amended and Restated Stockholders Rights Agreement (3)4.3
    
    Warrant Issued to PNC Bank, National Association in connection with Credit Agreement (3)4.4
    
    Registration Rights Agreement to United States Cellular Corporation (5)4.5
    
    Form of Warrant to United States Cellular Corporation (5)4.6
    
    Warrant Purchase Agreement dated December 1, 1999 with PNC Bank (6)4.7
    
    Warrant Purchase Agreement dated January 12, 2000 with PNC Bank (6)4.8
    
    Certificate of Designations, Preferences and Rights of Series E Convertible Stock (7)4.9
    
    Securities Purchase Agreement dated as of September 29, 2000 between the Company and RGC International
Investors, LDC. (Exhibits and Schedules Omitted) (7)4.10
    
    Registration Rights Agreement dated as of September 29, 2000 between the Company and RGC International
Investors, LDC. (7)4.11
    
    Initial Stock Purchase Warrant dated as of September 29, 2000 between the Company and RGC International
Investors, LDC. (7)4.12
    
    Incentive Stock Purchase Warrant dated as of September 29, 2000 between the Company and RGC
International Investors, LDC. (7)4.13
    
    Registration Rights Agreement, dated March 6, 2002 (8)4.14
    
    Warrants to Purchase Shares of Common Stock, dated March 11, 2002 (8)4.15
    
    Registration Rights Agreement dated October 10, 2002 (9)4.16
    
    Warrants to Purchase Common Stock dated October 10, 2002 (9)4.17
    
    Common Stock Purchase Agreement, dated March 8, 2002 between Conductus, Inc. and the investors
signatory thereto (10)4.18
    
    Warrant to Purchase Common Stock, dated March 8, 2002 by Conductus, Inc. to certain investors (11)4.19
    
    Registration Rights Agreement, dated March 26, 2002, between Conductus, Inc. and certain investors (11)4.20
    
    Warrant to Purchase Common Stock, dated August 7, 2000, issued by Conductus to Dobson Communications
Corporation (12) *
 33




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##### Table of Contents



Number
    
    Description of Document4.21
    
    Form of Series B Preferred Stock and Warrant Purchase Agreement dated September 11, 1998 and September
22, 1998 between Conductus and Series B Investors (13)4.22
    
    Form of Warrant to Purchase Common Stock between Conductus and Series B investors, dated September 28,
1998, issued by Conductus in a private placement (13)4.23
    
    Form of Series C Preferred Stock and Warrant Purchase Agreement, dated December 10, 1999, between
Conductus and Series C Investors (14)4.24
    
    Form of Warrant Purchase Common Stock between Conductus and Series C investors, dated December 10,
1999, issued by Conductus in a private placement (14)4.25
    
    Form of Warrant to Purchase Common Stock dated March 28, 2003, issued to Silicon Valley Bank (15)4.26
    
    Form of Warrant (16)4.27
    
    Form of Registration Rights Agreement (16)4.28
    
    Agility Capital Warrant dated May 2004 (17)4.29
    
    Silicon Valley Bank Warrant dated May 2004(17)10.1
    
    Sunpower License Agreement**10.2
    
    Amendment No. 1 to Change in Control Agreement of M. Peter Thomas10.3
    
    Consulting Agreement with Charles Shalvoy31.1
    
    Statement of CEO Pursuant to 302 of the Sarbanes-Oxley Act of 200231.2
    
    Statement of CFO Pursuant to 302 of the Sarbanes-Oxley Act of 200232.1
    
    Statement of CEO Pursuant to 906 of the Sarbanes-Oxley Act of 200232.2
    
    Statement of CFO Pursuant to 906 of the Sarbanes-Oxley Act of 2002
   (1)
    
    Incorporated by reference from the Registrants Quarterly Report on Form
10-Q filed for the quarter ended April 3, 1999.(2)
    
    Incorporated by reference from the Registrants Quarterly Report on Form
10-Q filed for the quarter ended June 30, 2001.(3)
    
    Incorporated by reference from the Registrants Quarterly Report on Form
10-Q filed for the quarter ended July 3, 1999.(4)
    
    Incorporated by reference from the Registrants Registration Statement on
Form S-1 (Reg. No. 33-56714).(5)
    
    Incorporated by reference from the Registrants Quarterly Report on Form
10-Q filed for the quarter ended October 2, 1999.(6)
    
    Incorporated by reference from the Registrants Registration Statement on
Form S-8 (Reg. No. 333-90293).(7)
    
    Incorporated by reference from the Registrants Annual Report on Form
10-K for the year ended December 31, 1999.(8)
    
    Incorporated by reference from Registrants Annual Report on Form 10-K
for the year ended December 31, 2001.(9)
    
    Incorporated by reference from the Registrants Current Report on Form
8-K, filed October 2, 2002.(10)
    
    Incorporated by reference from the Registrants Annual Report on Form
10-K filed for the year ended December 31, 1997.(11)
    
    Incorporated by reference from the Conductus, Inc.s Registration
Statement on Form S-3 (Reg. No. 333-85928), filed on April 9, 2002.(12)
    
    Incorporated by reference from Conductus, Inc.s Quarterly Report on Form
10-Q, filed with the SEC on November 16, 1998.(13)
    
    Incorporated by reference from Conductus, Inc.s Annual Report on Form
10-K, filed with the SEC on March 30, 2000.(14)
    
    Incorporated by reference from Conductus, Inc.s Annual Report on Form
10-K for the year ended December 31, 1999.(15)
    
    Incorporate by reference from Registrants Quarterly Report on Form 10-Q
for the quarter ended March 29, 2003.(16)
    
    Incorporated by reference from Registrants Current Report on Form 8-K
filed June 25, 2003.(17)
    
    Incorporated by reference from Registrants Registration Statement of Form
S-3 9Reg. 333-89184)*
    
    Confidential treatment has been previously granted for certain portions
of these exhibits. 34




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**
    
    Confidential treatment requested for certain portions of these exhibits. 
 SIGNATURES Pursuant to the requirements 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. SUPERCONDUCTOR TECHNOLOGIES INC.Dated: November 10, 2004
    
    /s/ Martin S. McDermutMartin S. McDermutSenior Vice President, Chief
Financial Officer and Secretary/s/ M. Peter ThomasM. Peter ThomasPresident and Chief Executive Officer
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